What Everyone Ought to Know About Long Term Care Insurance

You’ve seen the stats.  Long term care is expensive, and we’re all likely to need it at some point in our lives.  The cost of spending time in a nursing home or assisted living facility adds up quickly, which is why many retirees choose to insure against it through a long term care insurance policy.

Problem is, since there’s a high likelihood of requiring long term care, insurance is an expensive proposition in its own right.

Are you better off crossing your fingers and hoping you don’t need expensive care for a long period of time?  Or is it better to cover this risk through an insurance policy that will cost you an arm and a leg anyway?

This post will cover the essentials of long term care insurance, including exactly how to decide whether picking up a policy is a good decision for you and your family.

 

Long Term Care: The Stats

So here’s the big question.  What are the chances you’ll ever need long term care?  According to longtermcare.gov, about 70% of people turning 65 will need long term care services at some point in their lives.  With the average annual cost of a nursing home totaling about $96,000 these days, this can be a scary proposition.

The stats can be misleading, though.  Many people who need long term care services only need them for short periods of time.  And since most long term care policies have elimination periods (the period before the policy starts paying out) of around 90 days, many people won’t even need care long enough for their coverage to kick in.

What Everyone Ought to Know About Long Term Care Insurance

What Everyone Ought to Know About Long Term Care Insurance

The Case For Buying Long Term Care Insurance

It’s probably no surprise that an extended stay at a long term care facility could easily wipe out most of your net worth.  At $100,000 per year, a 3 year stay for a couple would add up to: $100,000 * 3 * 2 = $600,000.

For this reason buying long term care insurance can make a lot of sense.  If you’ve been diligent about saving for retirement, future long term care needs could completely deplete your savings.

For example, let’s say you’ve saved up $1.25 million throughout your career.  Based on the stats above, there’s a 12% chance that you’ll need long term care for 3-5 years, and a 12% chance you’ll need it for 5+ years.  That means there’s a 24% chance you’ll need care for at least three years – which would cost you at minimum $300,000.  That’s almost a quarter of your retirement savings, and not something many people would want to gamble.

By purchasing an insurance policy, you could transfer this risk to an insurance company in exchange for a monthly or annual premium.  Essentially, you’d be trading the possibility of a big bill from a nursing home or other LTC facility for the definite cost of the insurance premiums.

 

The Case Against Buying Long Term Care Insurance

You shouldn’t buy LTC insurance just because long term care can be expensive, though.  Since there’s a relatively good chance you’ll need long term care at some point in your life, insurance policies are mighty expensive too.

A recent quote I saw for a very healthy couple of 55 and 57 ran $5,681 in annual premiums.  The maximum annual benefit was $90,000, the total max benefit was $270,000 (providing a benefit period of 3 years), and it had an elimination period of 90 days.  There was also a 3% inflation rider, meaning the annual & max benefits would increase 3% per year as LTC costs increase.

Here’s a Real Life Example:

Let’s say this couple purchased the policy, and paid the premiums dutifully every year.  If they lived to 85 and 87 (slightly longer than their life expectancies), they’d be paying premiums for 30 years.  Assuming their premiums don’t increase, this would be a total out of pocket cost of $5,681 * 30 = $170,430.

How much care does $170,430 provide?  At $96,000 per year, a little longer than 21 months.  This is the breakeven point, at which it doesn’t matter whether the couple purchases the insurance or not.  After adding the standard 90 day elimination before benefits kick in, one of the two would need care for at least two years for the policy to pay off.  If neither needed care, or if they needed care for a total of less than two years, they’d be better off saving the premium dollars.

So what’s the probability that one of them will need care for longer than two years?  The statistics from the American Association of Long Term Care Insurance above lump the average nursing home stay into a 1-3 period.  But a 2005 study by Kemper, Kosimar, and Alecxih is a little more granular.  It may be a little older, but the data is still useful:

What Everyone Ought to Know About Long Term Care Insurance

*Kemper, Kosimar, and Alecxih, 2005

Based on this data (assuming it’s still semi-accurate) we can actually calculate the probability of meeting our breakeven point.  I’ll save you the math, but basically the numbers come down to:

The probability that either spouse will need care for longer than 2 years, plus the probability that both spouses need care for 1-2 years.  

Any other possibility won’t meet our breakeven point.  That includes the possibility that either or both spouses do not need care, or need care for less than two years in total.  If either of these situations comes true, the couple total care will fall under our breakeven point of two years.

To make a long story short, there’s a 56.3% probability that purchasing a long term care policy would pay off.

This example makes many assumptions though, and uses a premium for a very healthy non-smoking couple with zero medical problems.  It’s likely that most 55 year old couples would need to pay more for coverage based on their health record, thus increasing the breakeven point.  That said, the 56.3% probability for a 65 year old couple above is lower than what it’d be for a 55 year old couple as well.

What’s the Worst That Can Happen?

The probability of whether an insurance policy will pay off isn’t usually how we decide whether or not to buy insurance.  If we just looked at small percentage of dying in any given year, we might never buy life insurance.

If the risk of something bad happening could be catastrophic to us or our families, that’s when most people want to purchase coverage.  Knowing that there might only be a 56.3% that you’d be better off buying a long term care policy is helpful, but we really want to know whether it could be catastrophic to you if you needed care but didn’t have coverage.

So what’s the worst that can happen?  If you don’t opt for coverage but end up needing it, the expense can risk your financial independence.  It won’t put you out on the street, though.  Medicaid does offer long term care coverage, but in order to qualify for Medicaid your assets will need to be depleted below a certain level first.  So while the program does offer coverage if you need it, you’d need to sell off any vacation homes or second autos before you’d qualify.

 

So Who is LTC Insurance Best Suited For?

LTC policies are best suited for people who are not wealthy enough to self insure, but have enough saved to afford a policy.  To determine whether you can self insure, you’ll need to determine whether a three year stay in a long term care facility would jeopardize your financial independence.

Most LTC insurance policies have maximum benefits periods of three years.  So, even if you opt for coverage, if you need care for longer than three years you’ll probably be paying for it out of pocket.  Based on the stats, this is about 24% of people who stay in a nursing home.

For example, let’s say a John and Sally live a lifestyle that costs $80,000 per year.  Using some back of the envelope math, if they wanted to be somewhat conservative they might use a 3.5% annual withdrawal rate from their portfolio.  This means they’d need to build a nest egg of: $80,000 / 3.5% = $2,285,714 in order to retire comfortably.

So, if John and Sally had a nest egg of $3,000,000, they could self insure.  They need $2.29 million to afford their lifestyle, and another $600,000 in potential LTC costs (about three years of coverage for both of them), for a total need of $2.89 million.  Their savings exceeds their needs:

What Everyone Ought to Know About Long Term Care Insurance

If you’re among the majority of Americans and can’t self-insure, you’ll need to determine whether to buy a policy.  And again, if the cost of the policy itself jeopardizes your financial independence, LTC insurance won’t do you any good.  You’d be trading the possibility that LTC costs would cripple your finances for the certainty that LTC insurance premiums would.

Let’s say that the annual premium for an LTC policy for John & Sally would run $7,500.  If they’re 60, they’d probably be paying premiums for around 30 years until they’re 90.  Using some more back of the envelope math (that doesn’t account for the time value of money or premium increases), the total cost would be 30 * $7,500 = $225,000.

If this cost is enough to bring their total savings below the amount they need to live, LTC insurance won’t do them any good.  For example, let’s say that John & Sally figure they need $1.25 million to live on in retirement.  If they’d saved exactly $1.25 million, the cost of the LTC insurance would mean they’d need to adjust their lifestyle & reduce spending in order to afford the coverage.  They still might decide to purchase the insurance.  But by doing so, they’d be trading the possibility that a big expense would force a lifestyle adjustment for the certainty of adjusting their lifestyle.

What Everyone Ought to Know About Long Term Care Insurance

 

You May Want to Consider Long Term Care Coverage If

So should you purchase a policy?  Based on the stats, LTC policies make sense anyone who’s financial situation would be jeopardized by a three year stay in a nursing home.  Coverage could be a good idea if:

  • You want to leave an estate after you die
  • You don’t have enough assets to self-insure
  • You have enough retirement income to cover your living expenses and the cost of a policy

If the premiums will put you in a tight situation themselves, don’t buy it.  But if you have enough retirement income to afford a policy, it can help ensure you’ll have some assets to leave to your estate after you die.

 

The Best Time to Buy Long Term Care Coverage

The general consensus here is that if you do want to purchase long term care coverage, the best time to do so is in your mid-50s.

When you purchase coverage, the annual premiums are based on your age and health at that time.  The rates are “locked in”, and won’t increase each year as you get older (and more likely to require long term care).

They’re not locked in forever, though.  Insurance companies can raise premiums on existing policies, but must jump through several hoops to do so.  First, they must raise rates for an entire “class” of policyholders.  They can’t single you out and raise only your premium if your health deteriorates.  The insurance company must also make their case and get approval from your state before raising premiums.  So, while your premiums aren’t guaranteed to stay the same forever, they are somewhat “sticky.”

What Everyone Ought to Know About Long Term Care Insurance

On the other hand, the premiums on a new policy will increase every year as you get older.  Insurance companies know that your health rarely improves once you reach your mid 50s.   While you’re in your 50s, premiums on new policies increase 2-4% every year on your birthday.  Once you reach your 60s, this rate jumps to 6-8% every year on your birthday.

That being said, if you decide you do need long term care coverage, the best time to shop around is probably while you’re in your 50s.  Your premiums might increase occasionally, but if you wait until you’re in your 60s a policy could become prohibitively expensive.

 

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