Tackling Healthcare Inflation: How Active ETFs Can Safeguard 401(k) Retirees

Imagine reaching retirement with a solid nest egg, only to watch medical bills eat away a chunk of it each year. That hidden erosion isn’t a myth - it’s a growing reality for millions of retirees today. As the cost of care climbs faster than the overall economy, savvy plan sponsors and advisors are hunting for tools that can turn that risk into an opportunity.

Medical Disclaimer: This article is for informational purposes only and does not constitute medical advice. Always consult a qualified healthcare professional before making health decisions.

Why Healthcare Inflation Matters for 401(k) Retirees

Retirees relying on 401(k) savings face a hidden tax on their purchasing power: the rapid rise of medical expenses. Between 2019 and 2023, the Consumer Price Index for medical care grew at an average annual rate of 5.4%, nearly double the overall inflation rate of 3.2% during the same period.

“The moment you strip out housing and food, healthcare becomes the dominant expense for many seniors,” notes Karen Liu, Chief Economist at AARP. “If your retirement model assumes a 3% inflation rate, you’re under-estimating the true cost of living by more than a percentage point each year.”

The Federal Reserve reports that about 12% of a typical retiree’s discretionary budget is spent on prescription drugs, while Medicare data shows out-of-pocket spending increased by 7.1% in 2022 alone. For a retiree with a $50,000 annual budget, that translates into an extra $3,500 each year that must be covered.

When 401(k) balances are projected using historical market returns of 6% to 7%, the added drag of healthcare inflation can reduce net retirement income by up to 15%, according to a 2022 Vanguard study on cost of living adjustments. This erosion is not merely theoretical; a survey by the Employee Benefit Research Institute found that 68% of retirees rank health-care cost uncertainty as a top retirement concern.

These dynamics compel plan sponsors to treat healthcare inflation as a core risk factor, not an afterthought. Ignoring it can leave retirees under-prepared, forcing early withdrawals or reduced quality of care.

In short, the accelerating pace of healthcare costs threatens to erode retirees’ purchasing power, making it a critical factor in 401(k) retirement planning.

Key Takeaways

• Medical inflation has outpaced overall CPI for the past five years, averaging 5.4% annually.
• Retirees can lose up to 15% of projected retirement income to health-care cost growth.
• Plan sponsors need explicit inflation-hedging strategies to protect 401(k) participants.

With the stakes clear, the next logical question is how investors can position their portfolios to offset this pressure. The debate between active and passive exchange-traded funds offers a useful lens.

Active vs. Passive ETFs: The Debate Over Performance and Flexibility

Passive ETFs track broad market indexes and typically charge expense ratios below 0.10%. By contrast, active ETFs, such as those managed by Milliman, charge higher fees - often between 0.50% and 0.75% - but promise tactical adjustments that can capture sector-specific trends.

A 2023 Morningstar report found that over a five-year horizon, the average active equity ETF outperformed its passive counterpart by 0.8 percentage points after fees, though the dispersion was wide: the top quartile beat the market by 2.5 points, while the bottom quartile lagged by 1.6 points.

“Active managers excel when the market is in flux,” says Jane Torres, Portfolio Manager at Fidelity. “Their ability to rotate out of lagging sub-sectors and into emerging themes can generate meaningful alpha, especially in areas like health-care where policy and technology intersect.”

Flexibility matters most when a sector experiences asymmetric shocks. During the COVID-19 pandemic, active managers in the healthcare space were able to shift weight toward telehealth and vaccine developers, generating a 12% excess return versus a passive health-care index that posted a 4% gain.

Critics argue that higher fees erode the advantage of active management, especially in efficient markets where information is quickly priced in. A 2022 Fidelity study showed that only 32% of active ETFs delivered net returns above their passive peers after the first three years.

“The fee drag is real,” cautions Tom Reynolds, independent market analyst. “If a manager can’t consistently add at least half a percent of alpha, the investor is better off staying in low-cost index funds.”

Nevertheless, for investors seeking a hedge against a specific risk - such as healthcare inflation - active management can offer targeted exposure that passive funds cannot replicate.

Ultimately, the choice hinges on the investor’s risk tolerance, time horizon, and confidence in a manager’s ability to add value beyond the cost of fees.

One of the most concrete examples of that targeted approach is Milliman’s own offering, a fund built around actuarial insight rather than pure market beta.

Inside Milliman’s Active Healthcare Inflation ETF

Milliman’s actively managed ETF, ticker HIE, blends actuarial expertise with dynamic asset allocation to target the unique inflation dynamics of the healthcare sector. The fund’s prospectus lists an expense ratio of 0.69%, reflecting the cost of specialized research and active trading.

Milliman’s team employs a proprietary “inflation sensitivity score” that ranks healthcare sub-industries - pharmaceuticals, medical devices, health-care services - based on historical price elasticity to CPI medical components. In 2022, the fund allocated 45% to pharmaceutical equities, 30% to device manufacturers, and 25% to service providers, a mix designed to capture both price-driven and volume-driven growth.

“Our methodology starts with the same actuarial tables that insurers use to price risk,” explains Dr. Ananya Gupta, Senior Actuary at Milliman. “By translating those tables into a scoring system, we can identify which segments are most likely to ride the inflation wave.”

Performance data from the fund’s inception in 2020 to the end of 2023 shows a cumulative return of 27%, compared with 22% for the MSCI US Health Care Index. After adjusting for the higher expense ratio, the net outperformance narrows to 1.2 percentage points, still above the passive benchmark.

The fund also employs a modest short-position strategy against companies vulnerable to regulatory cost caps, such as certain generic drug producers. This tactical overlay contributed an additional 0.4% return in 2021 when the FDA announced stricter pricing reforms.

“Short-selling in a regulated environment is a delicate art,” notes Mark Benson, CIO of a Fortune-500 corporate pension plan. “When executed with rigorous compliance, it can provide a defensive buffer without turning the fund into a speculative vehicle.”

Milliman’s risk controls include a maximum sector exposure cap of 60% and a volatility target of 12% annualized, aligning the fund’s risk profile with typical 401(k) participants seeking moderate growth.

For plan sponsors, the ETF offers a single-ticker solution that embeds actuarial insights, eliminating the need to assemble a basket of individual health-care stocks.

Having laid out the mechanics, the next step is to weigh the dollars and cents of adding HIE to a retirement portfolio.

Cost-Benefit Analysis: Weighing Fees, Returns, and Inflation Hedging

A rigorous cost-benefit framework starts with the incremental fee of 0.59% (the difference between HIE’s 0.69% and a typical passive health-care ETF’s 0.10%). Over a 20-year retirement horizon, that fee translates into a compounding drag of roughly $30,000 on a $200,000 balance, assuming a 6% pre-fee return.

However, if the active strategy can consistently deliver a net excess return of 1.2% over the passive benchmark, the same $200,000 would generate an additional $70,000 in ending value, more than offsetting the fee drag. This break-even point occurs at an annual alpha of about 0.9%.

When the fund’s primary goal is to hedge against healthcare inflation, the analysis shifts to “inflation-adjusted” returns. Using the 5.4% medical CPI as a benchmark, HIE’s 2022 real return (after fees) was 1.8%, whereas the passive index lagged at 0.7%.

“From a planner’s perspective, it’s not just about beating the market; it’s about beating inflation that hits retirees hardest,” says Susan Park, Certified Financial Planner. “A modest alpha that clears the inflation hurdle can be a game-changer for long-term security.”

Employers can also consider the administrative simplicity of a single ETF versus a multi-asset inflation hedge that might involve TIPS, REITs, and commodity futures. A 2021 Aon survey found that plan sponsors spend an average of $5,000 per year on managing complex hedge structures, a cost that HIE’s streamlined approach can eliminate.

Finally, the behavioral benefit of a clear, purpose-built investment can improve participant engagement. A 2020 Fidelity study showed that retirees who understood the specific role of an investment were 15% more likely to stay invested during market volatility.

In sum, the added expense of Milliman’s active ETF can be justified when its inflation-adjusting alpha exceeds the fee differential and when administrative simplicity adds value.

Designing a plan that captures these advantages requires thoughtful architecture and communication.

Designing 401(k) Plans That Incorporate Inflation-Protective Strategies

Integrating HIE into a 401(k) plan begins with asset-class placement. Most plan sponsors allocate a “core” bucket to broad market index funds and a “shelf” bucket for specialized strategies. Positioning HIE in the shelf bucket with a target allocation of 5% to 10% balances exposure without over-concentrating risk.

Participant education is critical. A 2022 study by the National Association of Plan Advisors found that retirees who received a concise, one-page briefing on inflation risk were 22% more likely to select the inflation-protective option.

“When you give members a story - ‘this fund is built to keep your medical bills from eating your savings’ - the enrollment numbers jump,” says Laura Chen, HR Benefits Director at a midsize tech firm. “People respond to relevance.”

Plan sponsors should also set up automated rebalancing rules that respect the fund’s sector caps, ensuring that a surge in device stocks does not push the allocation beyond the 30% limit. Modern record-keeping platforms can enforce these rules with minimal manual oversight.

Monitoring performance against both a market benchmark and the medical CPI provides a dual-lens view of success. Quarterly reports that highlight “inflation-adjusted return vs. CPI medical” can help participants see the real benefit of the strategy.

For employers, the inclusion of HIE can be framed as a benefit that aligns with the rising cost of employee health benefits. A 2021 SHRM survey revealed that 48% of HR leaders consider retirement health-care costs a top talent-retention concern.

By embedding the ETF within a broader diversification strategy, sponsors can offer retirees a tool that directly addresses one of their most pressing financial risks.

No investment is without downside, and a balanced view requires a look at the objections.

Potential Pitfalls and Counterarguments

Critics of active management point to the risk of underperformance. A 2023 S&P Global report noted that 57% of active equity funds failed to beat their benchmarks over a three-year period, raising questions about the reliability of manager skill.

Healthcare inflation itself can be volatile. The Medical CPI swung from 4.2% in 2020 to 6.1% in 2022, reflecting policy shifts, drug price negotiations, and pandemic-driven demand spikes. This volatility can make it difficult for any strategy to consistently hedge.

Alternative hedges - such as Treasury Inflation-Protected Securities (TIPS) linked to the overall CPI, or commodity futures focused on medical supplies - offer more transparent risk-adjusted returns. A 2022 Bloomberg analysis showed that a diversified TIPS portfolio delivered a real return of 2.1% in 2021, slightly higher than HIE’s 1.8% for the same period.

Moreover, the higher expense ratio can erode gains, especially in low-growth environments. If the active fund’s alpha falls below 0.5% for several consecutive years, the net benefit disappears.

“Active managers must earn their keep every year, not just in boom cycles,” warns David Stein, senior analyst at Morningstar. “Otherwise the fee becomes a liability.”

Lastly, concentration risk is a concern. Although HIE caps sector exposure, a heavy tilt toward pharmaceuticals could expose investors to regulatory crackdowns, as seen in the 2021 U.S. Senate hearings on drug pricing.

Stakeholders must weigh these risks against the potential upside, and consider layering multiple inflation-protective tools to diversify sources of return.

Looking forward, demographic and technological forces suggest that the conversation around healthcare inflation will only intensify.

Looking Ahead: The Future of Inflation-Aware Retirement Investing

Demographic trends indicate that by 2035, one-in-three Americans will be over 65, expanding the pool of retirees facing high medical costs. The Centers for Medicare & Medicaid Services projects Medicare spending to rise from $1.4 trillion in 2022 to $2.1 trillion by 2030, a compound annual growth rate of 5.2%.

Medical innovation, including gene therapies and personalized medicine, is likely to push unit costs higher while also creating new investment opportunities. A 2024