Journal of Financial Planning - December 1998

Long-term-care insurance may be appropriate for some clients, but the prospect of rapidly rising premiums is going to make this a close call in some cases.

Live Long and Prosper?

by Peter Katt, CFP, LIC

While live long and prosper may be Vulcan Spock's dictum, live too long and face financial uncertainty has become the slogan of long-term care (LTC) insurance marketers. Typically LTC insurance will cover some or all of the costs associated with nursing home care, home care or adult day care. Generally LTC insurance benefits are triggered when an insured is no longer able to perform two or three common activities of daily living (dressing, eating, bathing, toileting, mobility and taking medicine) or has a cognitive impairment or a medical necessity. The amount of benefit, the length of time it is paid, inflation protection and the waiting period are variables that each insured selects for themselves.

LTC refers to custodial care due to chronic infirmities and should not be confused with full-time or intermittent skilled nursing care associated with acute medical episodes. Skilled nursing care, whether in a facility or at home, is covered in part by Medicare. Medicare supplement insurance covers some of the gaps in Medicare coverage, but neither cover LTC costs. Some studies indicate that many Americans are confused about this issue, believing that Medicare will pay some long-term care costs. It doesn't. Medicaid, on the other hand, may pay for some or most long-term care costs if the claimant's income and assets place them at or near the poverty level.

A Needs Analysis

I believe potential LTC needs ideally should be evaluated around age 50, a time when it is likely that retirement resources can be reasonably estimated. Such an analysis would make an estimate of income available from pension sources including Social Security, income investments (such as bonds), growth investments (such as equities), and use investments (such as a home). Retirement goals and plans might be considered, especially estimating income needs. Typically, there are three retirement phases. First, a very active phase during which more income may be desired for travel and such. Second, a less active phase that may require less income, and a final phase during which there is the potential need for custodial care.

Since the largest cost associated with LTC is custodial nursing home care, this is the cost that should be planned for. Obtain the cost of living in the area where each individual client intends to retire. Typically, nursing home costs will range from $3,000 to $9,000 a month depending on the area and quality of the facility. Determining whether your client should purchase LTC insurance can best be explained with three short case studies.

• Dr. and Mrs. Welby both are in their mid-fifties. Dr. Welby wants to retire in about five years. As a self-employed physician, he has been able to accumulate a large pension fund which, when combined with Social Security, will provide him and his wife with income of around $15,000 a month. They have growth and use investments of some $3 million. The Welbys have no need for LTC insurance since it is nearly certain that their current income, plus converting some of their growth investments to income investments, if necessary, can easily cover nursing home care for both of them.

• Mr. and Mrs. Woods both are in their early sixties. Mr. Woods intends to retire in three years as a research administrator with a pharmaceutical company. His pension plus Social Security will provide them with income of $4,500 a month, which will continue at about the same level if Mrs. Woods survives him. They have growth and income investments of some $600,000 and a home without mortgage valued at $200,000. Nursing home costs at the best facility in their area are $6,000 a month per person. Each has significant longevity in their families, making lengthier LTC a greater probability. An analysis yields the conclusion that LTC costs for both, even for a medium period of time, would have considerable negative effect on their net worth, so they decide to purchase $7,000 of LTC insurance for both.

• Mrs. Stanton-a widow, age 65-worked in the local paper mill. Her small pension combined with her Social Security will provide $1,000 a month. She has a nest egg of about $15,000. Mrs. Stanton needs LTC insurance, but she can't afford it. She will have to depend on Medicaid after her nest egg is used up in the event she needs LTC assistance.

LTC Insurance Policy Structure

At the end of this column I list several LTC insurance articles that discuss many of the issues related to this subject in far more detail than this column can provide. As such, I am listing the policy benefits I believe are important without necessarily detailing all of the variables.

• Benefit amount. The usual range is between $100 and $300 a day. ($3,000 to $9,000 a month). The benefit amount should be directly related to the cost for nursing home care in the areas where your clients intend to retire.

• Waiting period. The usual range is zero days to one year. Offer your clients the waiting period with the best percentage savings, which may not be the maximum waiting period.

• Benefit period. The range is one year to lifetime. The longer the benefit period the higher the cost. Because LTC insurance is so new, morbidity/ mortality studies are not available. Based on some extrapolation of life insurance companies' life expectancy tables for Table F-rated insureds, I estimate the following life expectancy ranges (which might roughly correlate with the length of time a client might live once beginning LTC insurance benefits): male age 72-life expectancy is nine years; male age 87-life expectancy is five years; female age 72-life expectancy is 12 years; and female age 87-life expectancy is 7 years. For the most conservative clients, buying lifetime benefits, at least for females, is probably a good idea.

• Inflation protection. The usual inflation factor is five percent. Some policies figure this as simple interest and others figure it as compound interest. The inflation protector increases the benefit from the first day of the policy, not from the first day that benefits are received. Simple interest inflation protection increases the policy cost by about 45 to 85 percent, depending on age. Compound interest inflation protection increases the policy cost by about 65 percent to twofold, depending on age.

Premium Variability

Table 1 provides typical premiums for LTC insurance. LTC insurance is guaranteed renewable. Its pricing variability is really a good thing because fixed pricing would almost certainly result in insureds being overcharged, or if too little premium is charged it could cause company insolvency, leaving the payment of benefits in doubt. But pricing variability needs to be understood and planned for so premium increases, should they occur, are understood in advance by your clients.

I believe it is more likely than not that current LTC pricing may be too low. There are three factors that might contribute to this. First, the investment yield being projected by sellers of LTC insurance may not be met. For example, if an investment yield of 7.5 percent is estimated by the insurance company, but several years later it is expected that a yield of only 6.5 percent can be sustained, this might cause a premium increase on the magnitude of 25 percent, depending on the insured's age.

Second, I am unaware of any authoritative study regarding the probabilities of benefits being triggered for the socioeconomic group typically buying LTC insurance policies. Therefore, calculating estimated benefit costs may be far more of a guess than companies would wish to admit. Also, I am not sure to what extent companies have taken into account the inherent increase in benefits simply because people have the coverage. That is, without coverage, someone might be willing to put up with the inconveniences of their own or a spouse's old-age infirmities, but after paying out all of those premiums, insureds may be far more motivated to get a return on their premium costs. For example, if a company is expecting one in five to eventually need benefits, but actual experience is that one in four receive benefits the premium costs might have to rise 25 percent to cover the payment of larger benefits than insurance companies planned for.

Third, nonguaranteed insurance premiums in a competitive selling environment have a tendency to be set too low to encourage policy sales. As long as companies can increase premiums, selling for prices that may be too low becomes a problem for the insureds. I suggest anyone buying LTC insurance anticipate premium increases on the magnitude of 50 percent annually, just to be safe.

Miscellaneous LTC Issues

Following are other LTC issues you should be aware of and research.

• Tax consequences. There may be some tax advantages to buying LTC insurance. Generally LTC insurance premiums are deductible if, combined with qualifying other medical costs, they exceed 7.5 percent of adjusted gross income. This isn't likely for most taxpayers. Generally LTC insurance benefits are received tax free.

• Reimbursement or per diem benefits. An LTC insurance policy can either pay the full daily benefit regardless of the actual charges for LTC services, or it can pay the actual LTC charge up to the maximum benefit purchased allowed by the policy. Reimbursement policies generally have a different benefit amount for nursing home care and home care. For example, if the nursing home reimbursement maximum is $200 a day, the home care reimbursement maximum would be $100.

• The life insurance alternative. Some life insurance marketers are trumpeting the use of life insurance living benefits as a better alternative to LTC insurance. Some policies allow the policy owner to obtain cash from the life insurance policy while the insured is still alive. The advance is repaid at death from the life insurance proceeds. While this method may provide an alternative for a short term LTC needs, it is my view that it should only be used when no other options remain and not if the LTC need may exist for a good deal of time.

• Cheaper may not be better. As mentioned previously, LTC insurance premiums are variable and there is little experience with this type of insurance. Companies promising lower cost may be offering it because obscure policy provisions may not be favorable, or it is a bait-and-switch gambit and the premiums will almost certainly be raised.

• Best companies to buy from. This is a difficult issue because LTC is such a new type of insurance that we don't have much experience with the full cycle of selling, administering and paying benefits. Rather than guessing which companies may be better, it is best to just wait and see.

Conclusion

As I indicated in my case studies, LTC costs will likely be covered (1) the old fashioned way by paying these costs yourself; (2) by purchasing LTC insurance; (3) with a social safety net in which taxpayers pick up the tab, or a combination of these three. I would advise those with the resources to provide for their own LTC costs to forgo insurance; however, future events, especially offering better tax incentives, may cause LTC insurance to become a more rational choice even for the more affluent. Stay tuned.

Additional Reading

1. "Long-Term Care Options Proliferate on Tax Breaks," prepared by the staff of Best's Policy Reports, Best's Review, March 1997, Vol. 97, No. 11, pp. 64Ð67.

2. "The New Tax Rules Governing Long-Term Care Insurance-Part I," written by John T. Adney, J.D., and Craig R. Springfield, J.D., LL.M., Journal of the American Society of CLU & ChFC, September 1997, Vol. LI, No.5, pp. 56Ð66.

3. "Long-Term Care-A Vital Product in an Evolving Environment," written by Jacquelyn S. Coy, CLU, and Paul J. Winn, CLU, ChFC, Journal of the American Society of CLU & ChFC, September 1997, Vol. LI, No.5, pp. 68Ð75.

4. The Long Term Care Handbook, by Jeff Sadler, published by National Underwriter.

Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, Volume 11, Issue 6, December 1998.

Peter Katt, CFP, LIC, sole proprietor of Katt & Co., is a fee-only life insurance adviser located in Kalamazoo, Michigan (269.372.3497).