Comparing Long-Term Care Alternatives

Should clients buy expensive long-term care insurance they might never need, or go without insurance and risk a big hit to their life savings? For advisors whose clients face this critical dilemma, there’s now a third option: life insurance and annuity products that also incorporate long-term care insurance.   

I’ll compare these alternatives, using financial modeling to develop a more precise understanding of the financial implications of the choices advisors and clients face. But first, let’s review the financial products that address long-term care needs in more detail.

The traditional insurance model

Traditional long-term care (LTC) insurance is a straightforward insurance product with a menu of options. The purchaser pays annual or monthly premiums and is reimbursed if and when they require long-term care services such as professional care at home, or in assisted living, or in a nursing home. In order to qualify for payment, the insured must satisfy certain criteria – typically being unable to perform two or more Activities of Daily Living (ADLs) – such as dressing or eating – or suffering from significant cognitive impairment. A menu of options affects pricing, including:

  • Waiting or elimination period – the time from becoming eligible until claim payments begin
  • Monthly maximum benefit – a cap on how much will be paid per month for benefits
  • Benefit period – the maximum number of years that payments will be made (which may be extended if less than the maximum monthly benefit is used)
  • Inflation protection – the annual rate of increase, from date of issue, in the monthly maximum benefit

Despite meeting an important need, long-term care insurance has never been very popular – only about 10% of retirees carry this insurance. Annual premiums of $1,500 to $3,000, or even more, are a significant deterrent. The past few years have been particularly difficult for long-term care insurers for various reasons. The interest rates they earn on policy reserves have been falling, and claims have gotten more expensive at the same time as claimants have required care for longer durations. Meanwhile, “lapse rates” have declined – a higher percentage of policyholders are keeping their policies well into old age, when claims are most prevalent. To protect the solvency of their business, insurers have gotten permission from state insurance departments to significantly increase premiums on both existing and new business, which has alarmed consumers. Some major insurers, including Prudential and MetLife, are so concerned about the viability of the business that they have stopped selling new policies altogether.

The most-cited reason for not buying long-term care insurance is concern about future premium increases. But some members of the advisory community feel that most, if not all, the bad news for the industry has already been factored into current prices, in which case future premium increases should be less of a risk. Michael Kitces laid out this case in an October 24, 2012 post on his blog, and I agree with his reasoning. There is always some chance of further premium increases, but I believe that risk is low, and that long-term care insurance is worth careful consideration.