How does one deal with a risk that has a high probability of occurrence, an unquestionably high cost when it happens, and insurance products meant to hedge the risk that are complex and more expensive than they used to be? This is the conundrum facing Americans heading into retirement when it comes to Long Term Care. Please understand that the article’s aim is not to promote a particular insurance company or product. This is not a sales pitch. The objective is to help you better understand options available to you when paying potential Long Term Care Expenses.
The rising cost of medical care is a huge issue facing retirees. While the term “medical care” loosely describes any type of medical expense, the combination of Medicare and supplemental medical insurance covers a great deal of the acute care that may be needed. While the cost of those coverages will likely increase, there is a potentially far more costly form of care looming on the horizon – Long Term Care. Long Term Care is defined as the ongoing care of individuals who can no longer independently perform basic activities of daily living (ADLs)–such as bathing, dressing, or eating–due to an illness, injury, or cognitive disorder. This care can be provided in a number of settings, including your home, assisted-living facilities, adult day-care centers, hospices, and nursing homes. Many people mistakenly believe that their general health insurance will pay for long-term care or that Medicare will cover it when they get older. In reality, neither health insurance nor Medicare covers traditional “custodial care” for chronic conditions, if that is the only care needed.
Today, the odds of a married couple age 65 needing Long Term Care are approaching 70%, meaning that in a typical retirement it is almost certain that at least one person will need care. Combine that with the demographics that predict the number of people over age 80 (those most likely to need Long Term Care) will triple over the next 30 years1, and you have a recipe for trouble. As the supply of care providers gets strained and the demand for care increases, costs could increase dramatically. As the costs for home care, nursing homes, and assisted living escalate, you may wonder how you’re going to be able to afford long-term care – and you should!
When faced with a risk that has a high probability and a high cost, it usually makes sense to outsource that risk to an insurance company. In the case of Long Term Care, that was the solution for those in good health for many years. However, the insurance industry miscalculated several things about Long Term Care that have had negative impacts. Incorrect assumptions led companies to seriously underprice policies, and the result was the subsequent need for rate hikes, or in some cases the exit from the industry for carriers.
One of the biggest miscalculations that carriers made was on interest rates. Instead of rising as expected, rates plunged during the financial crisis and have been slow to climb off their crisis lows. Low rates have reduced the returns that insurers have earned on invested premiums, making long-term care insurance less profitable. Insurers also assumed that many more people would drop their policies than actually have. More people sticking with the coverage means more people eventually go “on claim,” leading insurers to face larger payouts than they anticipated.
Price hikes have generated ill will for the industry. Yet it’s not like the carriers are trying to make a lot of money on those older policies, said Al Schmitz, a principal and consulting actuary with actuarial firm Milliman in Milwaukee. “They’re just trying to stop the bleeding.”
Given that backdrop, what is a prudent individual to do about the potential for large Long Term Care expenses? Below are 5 things to consider when thinking about Long Term Care:
1. Keep Your Current Policy – If you have an existing Long Term Care insurance policy, you should consider holding onto to it, and keep paying for it! In many cases, the benefits from older policies may be richer, and the premiums less expensive than policies issued today. Even if your carrier gives you a substantial premium increase – it may still be in your best interest to keep that coverage in force.
2. Look at Long Term Care Insurance Differently – With some creative design, LTC policies can still be a critical tool to hedge the risk of a care need. Many older policies contained benefits for an unlimited timeframe, and had high levels of inflation protection, but the costs for those features today can be prohibitive. Instead, you might consider a policy that pays a substantial benefit ($200 per day or more) for 3-5 years and has more modest inflation protection (3%, or linked to Consumer Price Index). It might not cover 100% of a future care need, but it can go a long way towards protecting your nest egg while still allowing money in your budget for the retirement you envisioned.
3. Add a Long Term Care Rider to a Life Insurance Policy – Life insurance companies have responded to the changes in the LTC marketplace by adding Long Term Care riders to their permanent life insurance contracts. By paying a bit more in premium than a typical life insurance contract, the face amount of the policy can now be used as either a death benefit, or a long term care benefit. The attraction here is that you know the death benefit amount is going to benefit your family one way or another. Either your beneficiaries receive tax free death benefits, or you access long term care dollars without having to spend other assets. These policies are intended for those who already have a need for life insurance. Because life insurance policies contain expenses and fees for mortality charges, the premiums are typically higher than for traditional long term care policies. However, the idea that premium dollars can perform double duty for life insurance or Long Term Care benefits is attractive in some instances.
4. Evaluate Hybrid or Linked-Benefit Policies – For those with the ability to reallocate a portion of their investment portfolio to cover Long Term Care, hybrid policies are worth investigating. Unlike the life insurance / LTC rider combination, the Hybrids don’t offer a substantial death benefit. They are designed for the client who wants to insure against a Long Term Care need, but doesn’t like the idea of paying premiums for insurance that might never be used. These hybrid policies are typically funded in a lump sum, or in a few substantial premium payments. They provide a substantial Long Term Care benefit upon the first premium payment, and if you were to pass away they would pay a death benefit, but it wouldn’t be much above the premiums paid in. Additionally, after a surrender period, most policies allow you to access your premium dollars (typically 80-100% of what you have paid in) if you no longer want the coverage. While these policies should never be considered an “investment”, the flexibility of having LTC coverage, the assurance that your beneficiaries receive a death benefit of at least your premiums paid, and the chance to recoup your costs if you surrender the contract is attractive to those who have the ability to fund them.
5. Recalculate if you Plan to Self-Insure – Many people dislike the idea of buying insurance to cover the possibility of Long Term Care. After seeing the statistics, it becomes clear that Long Term Care is a real risk, and ignoring it wouldn’t be wise. Whether a health condition precludes you from obtaining any type of insurance, or because you are convinced you can handle it with your own resources – make sure you run some projections on what it might cost if there was a care need. Today’s Bay Area care facilities can easily cost over $10,000 per month for full time care. If you inflate that over 20 years it is expected to be almost $30,000 per month 2. You can vaporize a portfolio very quickly at that rate of spending. You may want to consider building a little more wiggle room into your retirement projections before retiring so that you feel comfortable that you can truly afford that risk.
The Long Term Care Conundrum will continue to challenge Americans for years to come as the baby boomers age and more and more people require care. It seems logical that the rising demand would create more competition for providers both in the care space and in the insurance to pay for that care, but the timing and the financial ramifications can’t be confidently forecasted. While we can’t predict how care costs will escalate or the insurance industry will respond to the marketplace, there are steps you can take to plan today. Use your advisors as resources to help you understand your risk so that you don’t need to leave your cost of care to chance.