Get Ready for 2012 Social Security, Medicare Changes

The Social Security COLA will rise next year, but so will insurance premiums for basic Medicare.

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Social Security's annual cost of living adjustment (COLA) seems assured of rising in 2012 by a few percent—its first increase in three years. Whether that gain winds up putting many dollars in beneficiaries' pockets is another matter.

[See 10 Ways to Boost Your Social Security Checks.]

There are complex links between annual changes in Social Security and Medicare insurance premiums. Depending on your annual income and when you began Medicare, much or all of your COLA gains could be eaten up by higher Medicare premiums.

The Social Security COLA is based on a version of the U.S. Consumer Price Index tailored for people who work. It's called the CPI for Urban Wage Earners and Clerical Workers, or the CPI-W. Every year, Social Security looks at the CPI-W average during the third quarter of the year, compares it with the average during the previous year's third quarter, and designates any percentage increase as the following year's COLA.

Following a big surge in oil prices in the summer of 2008, the CPI-W spiked and led to a big 5.8 percent COLA increase for 2009—the program's largest in 25 years. Oil prices later declined and so did overall inflation. In both 2009 and 2010, the third-quarter average for the CPI-W was less than it was during 2008's third quarter. As retirees know all too well, this meant no COLA in 2010 or 2011.

[See Zero Social Security COLA Again for 2011.]

Since last summer, however, energy and other prices have risen. At the end of July, the CPI-W was 4.1 percent higher than in July 2010, and the index stood at 222.686. This is 3.3 percent higher than the CPI-W average of 215.495 during the third quarter of 2008.

Prices for crude oil have plunged in recent weeks, so it's possible that the CPI-W would dip during the next two months. However, food prices have been rising, and prices for imported goods are up 14 percent from a year ago, due primarily to the diminished purchasing power of a weaker U.S. dollar.

If the COLA does rise by a few percent, it would also trigger the first increase in three years for Part B Medicare premiums. Parts A and B, commonly known as traditional Medicare, cover hospitals plus physician and outpatient expenses. There is no premium for Part A coverage. The government backs Part B premiums directly out of a beneficiary's Social Security payment.

There is a "hold harmless" clause that prohibits Social Security payments from declining from one year to the next. So, the absence of a COLA in 2009 and 2010 meant that there could be no increase in Part B premiums for existing beneficiaries. This premium has thus been frozen at $96.40 a month for about 75 percent of beneficiaries.

Another provision of the law requires Part B premiums to finance 25 percent of the costs of providing covered services. With premiums frozen for most beneficiaries but healthcare costs still rising, Medicare had to look to the new and higher-income beneficiaries to pay bigger premiums to maintain that 25 percent finance level.

[See Medicare Drug Premiums Won't Rise in 2012.]

New enrollees in 2011, for example, pay a monthly Part B premium of $115.40 if they earned less than $85,000 a year ($170,000 for couples). Rates for higher-income earners rise substantially, and the wealthiest beneficiaries pay premiums approaching 80 percent of their costs, not 25 percent.

"In most years, a significant portion of the cost-of-living increases received by most Social Security beneficiaries" is used to pay for higher Medicare premiums, Rudolph G. Penner wrote in a recent study for the Urban Institute. Social Security benefits thus are "not keeping up with inflation, and for those retired a long time, the real value of the net benefit can erode significantly."

Looking ahead, Penner said in the study, "the rapid growth in healthcare costs is leaving the entire population with relatively less to spend on non-health goods and services, and the elderly are affected the most because so much more of their income goes to healthcare."

One of the impacts of raising Part B premiums would be to make it more attractive for beneficiaries to seek coverage through a Medicare Advantage (MA) policy. MA policies compete with traditional Medicare. Dan Mendelson, head of Avalere Health, a Washington, D.C.-based healthcare consultancy, says he projects MA premium increases in 2012 to be modest. Open enrollment for 2012 plans begins October 15 and extends until December 7. Details on any changes to the 2012 COLA and increases in Part B premiums are expected to be announced later in October.

Mendelson says he expects lots of insurance-plan changes next year, particularly involving the use of preferred pharmacy providers. By requiring policyholders to use a certain pharmacy, he explained, an insurer can drive lower costs at that pharmacy. "Consumers are going to have to be thinking about their out of pocket liability" when they shop for 2012 coverage, he said, "and also the fact that there will be more innovative products in the marketplace."

Twitter: @PhilMoeller