by Steve Goodman
CPA, MBA – President & Chief Executive Officer
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Statistics indicate that seven out of 10 Americans over the age of 65 will need some form of long-term care (LTC) services during their lifetime. In addition, four out of 10 Americans over 65 will enter a nursing home and two out of 10 will remain there for at least five years. Long term care can run more than $100,000/year. As we live longer but not necessarily healthier, the financial effects of an extended need for long term care can be overwhelming.
The need is evident. Most people approaching retirement know it. The government recognizes the problem. And people in the medical and insurance industries are acutely aware of the problem. Roughly 40 years ago, the industry began selling long term care insurance. As a new insurance product, the industry made several assumptions to pricing the product.
The industry’s assumptions were off the mark. They underpriced the policies resulting in some large losses for the industry. The industry assumed more policy lapses that occurred. They assumed higher interest rates to allow the insurance companies to accumulate cash in the policies. They underestimated the rise in long term care costs. And they underestimated the effects of longer longevity.
For the last decade, insurance companies have been raising prices, sometimes by 30% to 50% or more annually, to reprise their policies to reflect costs. Industry experts anticipate that most insurance companies have caught up with current costs. They do not anticipate large future increases. Yet medical care costs continue to rise faster than the overall rate of inflation. An additional 50% increase over the coming 10 to 15 years is not out of the question.
With all the need for long term care insurance, few people will buy it. There are many reasons, but perhaps the key reasons are as follows:
- It is expensive. Most people buy these policies in their sixties. By that time, $3,000 to $5,000 in annual premiums are common.
- The industry sells LTC insurance on a ‘use it or lose it’ basis. Many people are unwilling to invest $3,000 to $5,000 for possibly the rest of their lives with no guarantee of any return.
- LTC insurance requires medical underwriting. People who wait until they need this insurance are those most likely to be rated or declined in underwriting.
- People tend to buy LTC insurance as part of their retirement transition. In retirement, most people seek ways to cut costs. Plans to increase spending for LTC insurance seems contrary to the objective of reducing costs.
- Premiums have risen drastically over the past several years. People are familiar with horror stories of price increases from others who may have bought their policies years previously.
- Premiums are not guaranteed. Many people want a fixed price alternative.
Many people are not going to buy LTC insurance but need to find a way to pay for their long term care needs. The industry response has been to develop alternatives. Readers should note that no alternative offers the same level of coverage as a pure LTC policy. There must be a corresponding reduction in benefits on every alternative to offer a more consumer-friendly price.
Alternative Means of Paying for Long Term Care
To provide a basis for comparison, the traditional long term care policy is presented first. The policies described include the basic features common to most policies. Each policy may have variations for each feature.
Traditional long-term care insurance — These policies are available with monthly, semi-annual, or annual premiums. Premium increases and/or benefit reductions are possible. Many LTC insurance policies require caregiver licensure in the state of policy issuance. Other policies will specify which facilities they will cover in each state. LTC policies typically cover the following:
- Nursing Homes – some policies cover more than just room and board.
- Assisted Living – a residence with apartment style rooms where the residence typically offers meals, transportation, activities, on-site medically trained staff, etc.
- Adult Day Care Services
- Homecare Services – Includes help with Activities of Daily Living (ADL’s) and often help in maintaining the home’s cleanliness and upkeep.
- Home Modifications – Ramps, grab bars, etc.
- Care Coordination – Concierge medical and living services
Policies offer either a specific number of years of benefits payable or maximum dollar value of payouts or both. Policies also include an elimination period in which payments are not paid. For individuals, policy premiums are deductible medical care expenses.
Life insurance-based long-term care insurance – These policies include a death benefit in addition to a long-term care benefit. There are three ways that these policies may be offered; as a hybrid life insurance-LTC insurance policy, as a life insurance policy with an LTC rider, or as a life insurance policy with a chronic illness rider. Technically, the government does not define the chronic illness rider as a long term care product. It is prohibited for companies and agents to market it as such.
Like insurance policies, all three options provide a death benefit provided no or only some of the maximum long term care benefit is utilized. This relieves policyholders of the ‘use it or lose it’ concern. Some also include a return of premium option when the policy is surrendered. All require medical underwriting.
- Chronic care riders are the most restrictive in terms of what they cover. An insured’s condition must last more than 90 days with a high probability that it will last for the rest of the insured’s life. Chronic care riders typically exclude pre-existing conditions. Most chronic care policies pay a per diem amount, regardless of actual expenses, from the time the elimination period ends until either policy benefits are exhausted or dead. Most chronic care riders work on an acceleration of benefits basis. That is, payments for long term care coverage will reduce the policy death benefit. Most, but not all, offer a guaranteed premium cost. As a life insurance policy, premiums are not deductible.
- Life insurance with an LTC rider. This option works like the chronic care rider with a few exceptions. Any condition requiring LTC benefits lasting more than 90 days is covered. It need not be a permanent condition, such as a broken hip. Coverage can also start, stop, and restart based on an insured needing care, then recovering, then needing care again over time. LTC riders typically pay for covered services, not a per diem amount. This can extend the life of the policy for future needs. Most, but not all, LTC riders come with a premium cost guarantee. Most work on an acceleration of benefits basis. Premiums are not deductible as medical expenses.
- A hybrid policy is the joining of a life insurance policy and an LTC policy. It is the big brother to the life insurance-rider option. Most policies offer a guaranteed premium, though many are structured as single premium payment policies. The policies are often cancellable after 10 years or so with some return of premium. Much of the compound interest normally associated with a maturing life insurance policy is siphoned off to pay LTC costs for the insured pool. As such, as a life insurance policy, the death benefit is paltry. Premiums are not tax deductible as they are mixed with a life insurance component.
Another strategy is to repurpose an existing permanent life insurance policy. For example, maybe you purchased permanent insurance years ago but no longer need this policy for income replacement. You are not concerned about leaving a death benefit to beneficiaries. You can exchange this policy for either a hybrid policy of a life insurance policy with an LTC rider. If you are more concerned about outliving your assets due to unforeseen long-term care costs than you are about leaving a legacy or an inheritance, this could be a good solution.
Annuity with LTC rider — These policies provide an increased withdrawal benefit in the event of an LTC need. The withdrawal can be used to pay for care expenses. A rider added to the annuity includes this coverage. This may be a good option if you are in poor health and thus not eligible for traditional long-term care insurance. It is also an option for those who do not have enough savings to support separate retirement and long-term care strategies.
Annuities with LTC riders use a portion of the interest normally used to support the annuity to subsidize the LTC costs. The insurance company assumes that those requiring LTC funds have a shorter life expectancy than those not needing the funds, thereby creating an offset in costs. Annuities with LTC riders are nearly always single payment annuities. These policies typically have a two-year window from policy initiation in which they do not pay. The premium is not tax deductible.
Short term care policy – Also known as convalescent insurance, a short term care policy typically pays for 180 to 360 days for covered services. Each policy specifies a maximum daily payment. Short term care covered services is not abroad as long term care covered services. Some do not pay for assisted living or for home care.
These policies typically require medical underwriting, thought the standards for short term policies are less restrictive than for long term care and life insurance. Waiting periods tend to be short before benefits can begin. Medicare will pay for up to 20 days of similar services bringing the total coverage to a maximum of 380 days. Premiums are not guaranteed. Historically, price increases have substantially better behaved than long term care policies.
As short term policies, these policies are less expensive than long term care policies. However, they do little for the policyholder who will spend 3 to 5 years needing long term care. If one presumes that insurance is purchased to cover outlier events, then short term care insurance is but a partial solution to paying for long term care expenses. Short term care policies are generally available through age 85. Most policies allow an insured to use the full benefits in the event of a recovery followed by a second period of convalescence.
Health Savings Accounts – HSA’s can be used to pay long term care insurance premiums as the government considers these premiums to be medical expenses. Those who have a high deductible medical plan are eligible to establish an HSA. You must not have access to another medical policy, including Medicare. Therefore, this generally applies to people under 65 years old.
HSA contributions are pre-tax income. Subject to the IRS specified age-based limitations, people can use these funds to pay for LTC insurance premiums.
Medicaid – Medicaid will cover long term care as a last resort. When people have depleted virtually all their assets, Medicaid is there to pay for the care. There are a few caveats, however. The first is that you must be nearly destitute. The government is fully aware that people think they can sign over their substantial assets to their children and then let the government pick up the tab. Uncle Sam and the states are wise to this. They will go back a number of years to recover those assets.
Secondly, long term care facilities that accept Medicaid patients may not be places you want to spend your final years. Just as some doctors will not accept Medicare patients due to low doctor payments, some care facilities provide a level of service and care that Medicaid will not cover. As a Medicaid patient, your options may be limited.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.