Long Term Care Insurance Coverage

By Glenn J. Downing, MBA, CFP®

This is a big topic and a big part of financial planning for retirement.  The statistic is that by age 75, 75% of us will have needed some long-term care.  So the question is, how can I prepare for this risk financially? 

A principle of risk management is to insure risks of low frequency and high severity.  We insure our homes against hurricanes, and our cars against collisions.  We insure our lives against premature death, and our incomes against disability.  So it makes sense to insure our retirement assets against a financially devastating long term illness.  The point is not to spend all the accumulated assets on the first spouse to become sick, leaving the surviving spouse impoverished. 

Long Term Care Policies

The insurance industry introduced long-term care policies roughly a generation ago.  Policy benefits were triggered by needing substantial help and assistance in performing 2 of 6 ADLs – activities of daily living.  Think of what you do when the alarm clock rings, and you’ll remember them:  you get up (transferring), go pee (toileting), wash up (bathing), get dressed (dressing), have breakfast (eating), and maintain continence throughout the day.  Think about it:  substantial help and assistance in any 2 of these areas is a fairly low bar for many elderly people to reach. 

The industry completely mis-priced the product initially – that is, way too low.  Policies had lifetime benefits, with a 5% annual inflation rider.  They were indemnity policies, meaning they simply cut you a check once a month and you did whatever you wanted with the money.  I actually have a client with this type of policy.  It now pays way more than she needs each month to live in a beautiful assisted living residence, so she simply invests the excess with us. 

Policy Pricing

Policy pricing is based on a daily benefit, and then benefit period, with riders.  Here is a current quote, so you can get an idea of pricing:  female age 64 with no health issues.  $200/day benefit, for 60 months.  This policy will pay for 5 years only, and not beyond that.  90 day elimination period, meaning the policy will begin to pay at the end of the 4^th month after a claim is approved.  It has a 3% lifetime compound inflation benefit.  The $200/day benefit this year becomes $206 next year, and $212 the year after.  This policy’s annual premium is $8934.30. 

How about options?  If the client chose a 4% lifetime compound inflation rider, the premium rises to $11,329.23.  With no inflation rider, the premium drops to $5041.93.  A standard policy feature is waiver of premium, meaning that when the insured goes out on claim, premiums are waived. 

Everyone who reads this will think the same thing:  great buy if I use it, but a waste of money if I don’t!  Well, sort of.  Do you think that way about your auto insurance?  Dammit, I didn’t have a crash in the previous 6 months, so I wasted all those premium dollars!  No, of course not.  You pay for insurance.  Insurance is a risk mitigation tool. 

Look Closer at the Numbers

Let’s look a little closer at these numbers.  Say you decide to self-insure.  You’re going to take the $8934.30 annual premium and invest it to earn 8% per year.  After 11 years (age 75) you will have accumulated $148,715.77.  A nice amount.

Now take the $200/day benefit and inflate it up by 5% per year over those 11 years.  5% is actual and real – I can tell you from the time when my own parents needed care and from an elderly friend who was in assisted living.  In 11 years today’s $200 cost becomes $342.06.  Now do some quick division - $148,715.77 divided by $342.  You will have saved enough for 435 days of care – just over one year!

Now you see clearly your risk / return trade off:  if you do go out on claim at age 75, then this is the best money you ever spent.  The policy will pay out $360,000 before factoring in inflation.  But . . . if you remained healthy for the whole of your life, you would have “wasted” $8934.30/year times the number of years you paid this premium, plus associated earnings. 

The Life Insurance With Riders Option

To meet this objection, clients can look at life insurance policies with long term care riders.  Using the same proposed insured as above, she could purchase a whole life policy with a death benefit of $150,000 and a Continuation of Benefits rider for lifetime coverage with 3% inflation.  The total premium here is $10,707.90.  The way this works is that the base policy’s benefit is used up in the first 25 months, and then the rider kicks in.  If you never go out on claim, your beneficiaries receive the $150,000 policy death benefit.  If you do go out on claim, you have lifetime coverage. 

The bottom line here is that long term care insurance is a far less interesting proposition than it was 20 years ago.  Many companies totally withdrew from this market, leaving few surviving players.  Others have come back in, but with policies that have greatly reduced benefits.  

A Critical Area of Retirement Planning

This remains a critical area of retirement financial planning.  In days gone by extended families lived together on the farm.  Today, not so much – families can be disbursed throughout the country.  Planning for a long-term illness takes some serious thought. 

A Few More Thoughts

• If you have a Health Savings Account (HSA) in conjunction with a high deductible health insurance plan, you can pay LTC insurance premiums from the HSA.  In that way you can gain coverage with pre-tax dollars.  
• Medicare only pays for skilled nursing care after a 3-day hospital care - not for long-term care.  
• You may find a previous post, What Happens When My Mother Runs Out of Money? useful.  

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