Development of the Last-Year-of-Life Valuation Model for Retiree Medical Plans

The last-year-of-life valuation model is an alternative to the average-claims-cost life annuity model that is currently in general use for valuing retiree medical benefits. The last-year-of-life valuation model splits an average cost into a higher than average decedent cost and a lower than average survival cost. This paper explains how the model can be constructed from existing age-graded claims with very little additional effort. The model can be used in several different situations; it sheds some light on the high costs associated with the increased utilization of hospital and medical services at the end of life and may produce a better estimate of the value of retiree medical benefits when improvements in life expectancy are anticipated. Improvements in life expectancy over the past decade have eroded the margin of conservatism built into the mortality tables currently in use, and it is anticipated that, spurred on by regulatory assumption sets that will soon be mandated for certain pension plan funding calculations, employee-benefit actuaries will soon update their assumptions to reflect expectations of further improvements in mortality. As average per capita claims costs implicitly represent today’s mortality rates, use of the averageclaims-cost valuation model with a projected mortality table will likely overstate the long-term cost of the benefits while the last-year-of-life valuation model can be used to provide an unbiased measure of the long-term cost of the benefits.