Sensible Perspectives

Assessing Long-Term Care Insurance

Posted by on June 3, 2015

In case you missed the May 1, 2015 Wall Street Journal article on long-term care insurance (Long-term Care Insurance: Is it Worth it?, by Leslie Scism), it was an exposé of sorts on the declining allure and questionable value of long-term care insurance.  The main points of the article were:

  • LTC insurance carriers have significantly increased prices and reduced benefits in recent years, making this product less attractive to consumers.
  • The amount of coverage one needs may be over-stated, due to “typical” stays in nursing homes by men and women, and because Medicare pays a higher percentage of the costs than previously thought.
  • There may be less expensive options for obtaining coverage by purchasing “hybrid policies”, but buyer beware.

Let’s examine each of the author’s assertions:

More expensive, reduced benefits

It is certainly true that insurers have increased premiums substantially (in some cases by over 80% in the past few years).  These price increases occurred because the premiums were unrealistically low to begin with, given the amount of coverage offered.  Basically, when insurers designed earlier policies, they underestimated policy retention rates – the number of consumers who continued their policies in force rather than letting them lapse – as well as the number of successful claims likely to be filed by policyholders.  And they overestimated future interest rate levels, which factor into insurers’ return on premiums invested.

As a result, LTC insurers have been losing money on older policies and have applied for, and in many cases been granted, significant price increases by state insurance commissioners.  They have increased prices on new policies and reduced benefits in order to increase profitability.  They are also more selective about who they sell to, favoring younger, healthier applicants with fewer pre-existing conditions and a healthier family history.

So, are policies sold now too expensive?  I would prefer to say that these policies are now more realistically priced.  If LTC insurers had designed policies with yearly premium increases, in the same vein as auto or homeowner policies, and many group policies, perhaps the increases would be more tolerable, and insurers wouldn’t get such bad press.  (This is, in fact, what John Hancock has done with some of their newly designed policies.)

Although we are unlikely to see 80% price increases on the newer policies anytime soon, it would be unrealistic to assume that insurers will never again increase their prices on existing policies — if for no other reason than just to keep pace with inflation.  When Sensible Financial® includes the cost of LTC insurance in our clients’ financial plans, we build in future premium increases to match inflation.

How much insurance does one actually need?

The author cites a Boston College study’s findings that a “typical” stay in a nursing home is 10 months for men and 16 months for women, and that Medicare often pays for some of this care in the first 100 days.  However, this is just nursing care.  According to the American Association for Long-term Care Insurance, in 2014, the average number of days in an assisted living facility was 19 months, and 18 months for home care.  And Medicare doesn’t pay for either of these.  (Actually, Medicare has other restrictions that might make a person in a nursing facility ineligible for reimbursement.)

Regardless of which study we consider, one should not purchase LTC insurance to cover the “typical” need for care.  The purpose of insurance is to cover low probability losses with high potential impact.  In the case of long-term care, that would be an extended stay in a nursing home or an assisted living facility in the unlikely event of a long, protracted illness or condition.  Most people who can afford long-term care insurance can self-insure the first year or two of long-term care with existing retirement assets.  They should be insuring against the long stay.

In addition, you need not and should not insure against the full cost of care.  If you were to need long-term care, you would most likely not be spending nearly as much on consumption (e.g., food, clothing, and entertainment, to name a few).  If a single person or both spouses need to move into a facility, they would likely sell their home and would no longer need to cover annual home operating costs.  Both categories of saved resources can be repurposed toward long-term care.  The insurance should make up the rest of the cost.

What are the alternatives to standard LTC insurance?

As the author points out, realizing that some consumers will balk at the prices of standard LTC insurance, agents often suggest so-called “hybrid” policies – products that combine LTC insurance with either permanent life insurance or annuities.  There are several problems with these products.  For starters, the LTC benefits tend to be watered down, with more restrictive and less generous provisions than you would find in a standard LTC policy.  Also, permanent life insurance is expensive, and most people do not need permanent insurance.  Where life insurance is indicated, term insurance is more appropriate in most circumstances.  Finally, these products come with the lure of potential policy dividends that can (theoretically) offset some of the cost of the policy.  However, the dividends may not materialize, as we’ve seen recently with some policies whose dividends declined to zero over the past decade, due to the low interest rate environment.

A less common product offering is LTC insurance bundled with an “index” annuity.  Rather than having a fixed or variable interest rate, the insurer pays interest tied to a stock market benchmark such as the S&P 500.  The author correctly points out that insurers typically cap the percentage of the index’s gain they will pay annually.  As a result, the returns often don’t measure up.  And let’s not forget that most deferred annuities come with high administrative and sub-account fees (typically 2.5% to 3%).

In conclusion, LTC insurance has become more expensive, less generous in its benefits, and more difficult to buy.  However, standard products from financially strong companies still have a role to play for those whose net worth is not high enough to self-insure many years of long-term care, but who can afford some amount of insurance.  If you are considering purchasing this insurance, Sensible Financial can work with you to determine a realistic amount and type of coverage that is right for you and won’t break your budget.