Long-Term Care Insurance (LTCI): The Good, the Bad, and the Ugly

Nothing can completely sabotage a retirement lifestyle like unexpected elder-care expenses.

My father’s dementia developed rapidly. Within a year, he no longer knew me, much less how to perform most activities of daily living (ADLs). The need for a care facility was immediate and the cost was mind-boggling.

We were “lucky,” I was told. My parents had invested in long-term care insurance (LTCI), and yes, I cannot imagine how they would afford the care Dad needs without it. But accessing the insurance benefits came with several unexpected twists and turns. Forethought and careful planning are essential, because if LTCI is not filed precisely, there are certain expenses the insurance will not cover.

During my reluctant education in long-term care, I realized how ill-prepared most people are for this particular financial risk. Only 10% of the elderly currently have a private LTCI plan in place. How should the remaining 90% fund this expense? Is LTCI their best option? As an adviser, what would you suggest to your clients?

Consider the following pros and cons, including a few alternative suggestions, before you make any recommendations.

The Pluses

As Mark Meiners, a professor of health administration and policy at George Mason University, pointed out:

“70% of those who reach 65 will need long-term care. With long-term care costing as much as $250 a day, it doesn't take long to completely deplete a lifetime of savings — even if you're 'lucky' enough to only need it for a relatively short period of time.”

LTCI thus provides the peace of mind of knowing that a good portion of your client’s future needs will be met.

Another benefit is the simple fact that it is insurance, effectively pooling the costs and spreading out the risks. While far from inexpensive, LTCI is much cheaper than saving and paying for a long-term care emergency out of pocket. As Meiners put it:

“In theory, it's true, if a person invested $3,500 a year instead of using it to pay insurance premiums, the investment might grow enough to cover any eventual long-term care bill. But as nice as it sounds, most people simply won't set aside additional savings for long-term care needs.”

Once a client qualifies, most LTCI policies are “guaranteed renewable.” This means they cannot be canceled because of the policy holder's age, physical condition, or mental health. In effect, the policy won’t expire unless your client uses up the benefits or stops making premium payments.

Also, the benefits paid through a LTCI policy are generally not taxed as income. If federal standards deem a client’s LTCI policy "tax-qualified" and their itemized medical costs are in excess of 7.5% of adjusted gross income, they can deduct the value of the premiums from their federal income taxes. The amount of the deduction depends on their age.

Finally, no one wants to be a burden to their family. Unanticipated long-term care expenses can wipe out a client's savings. LTCI can help prevent that, reducing any financial burdens on clients or any of their family members who step in to help.

The Minuses

The two most obvious stumbling blocks with LTCI are qualifying and cost. The American Association for Long-Term Care Insurance (AALTCI) estimates that people should expect to pay an average of $2,170 per year to cover a healthy 60-year-old couple on a plan that provides a $150 daily benefit for up to three years. But this is only an average, and prices vary dramatically depending on the purchaser's age, the level of inflation-adjustment protection, and the size of the daily benefit.

Using a cost-risk-benefit analysis, Prescott Cole, a senior staff attorney with California Advocates for Nursing Home Reform (CANHR), stated that:

“Long-term-care insurance does not compare favorably with other insurance products. With long-term-care insurance the costs are high, the risks are low, and the benefits are low, but with, for instance, fire insurance, the costs are low, the risks are low and the benefits are high.”

Assuming cost is not a deterrent, your clients must qualify for coverage. Ideally, policies should be purchased when your clients are young and healthy. This is rarely the case, however. If they are older or have serious pre-existing health conditions, clients may not be able to get coverage. Most plans require an individual to pass a physical before offering coverage.

LTCI providers will often decline to insure people with the following pre-existing conditions: Alzheimer's disease, dementia, multiple sclerosis (MS), Parkinson's disease, and stroke. “Somewhere in the 15–20 percent range of people who try to buy this insurance are actually denied because they 'fail' this part of the process," Anne Tumlinson wrote. "In other words, the insurance companies think many of us are too big of a risk.”

Should a client have to file for LTCI benefits, the insurance company will not provide them until it makes an independent determination that a severe need for long-term care exists. According to the American Association of Retired Persons (AARP), "benefit triggers" must be met before a policy holder starts to receive benefits: “Most companies look to your inability to perform certain 'activities of daily living' (ADL) to figure out when you can start to receive benefits. Generally, benefits begin when you need help with at least two or three ADLs.”

It is not uncommon for there to be a waiting period in a LTCI policy that works like a deductible. Once the benefit triggers have been met, your clients must then wait three to four months before their medical costs are covered. As Cole put it, “Most long-term-care policies don't pay anything until the person has been in a nursing home for more than 90 days. If more than two-thirds of those going into nursing homes leave before 90 days are up, it is unlikely that most consumers will receive any benefits at all.”

Statistically, the AALTCI reports that “for someone with a 90-day elimination period, the lifetime chance of someone buying coverage at age 60 and using policy benefits was 35%. So, 35% will use their coverage and 65% will not. As you might assume, the decline is because during those first 90 days, some people will recover and some will die.”

Keep in mind that LTCI policies only pay a fixed amount per day for a limited period of time — that daily amount is a critical factor when calculating the initial premiums. The time period is “typically capped at three years, because open-ended plans have proven too risky for insurers,” according to National Public Radio (NPR).

Also, coverage can be limited to that provided by specific certified home-care agencies or state-licensed professionals.

Finally, LTCI premiums can increase: A company cannot single your client out for a rate hike, but it can raise premiums on a class of similar policies in their state, and most premiums do end up increasing during the length of the policy.

As an example, LTCI policy holders in Pennsylvania were shocked when their 2016 renewal notices indicated that premiums would rise by as much as 130%, with annual rates on pace to reach in excess of $8,000 for some policies. And the problem is not unique to Pennsylvania. Many industry observers expect rates to increase dramatically across the country in the years ahead.

"There are a number of factors contributing to the explosive growth in long-term care insurance premiums," Maryalene LaPonsie explained. "Carriers assumed people would drop policies as they got older. However, that didn't happen in many cases. What's more, people are living longer and aren't necessarily living healthier. As a result . . . many insurance companies have fled the market and those that remain have increased premiums significantly to keep up with costs.”

Meanwhile, premiums for almost all of the federal government's existing LTCI policies for federal employees and retirees will rise by 83% on average.

So, what are the alternatives to LTCI?

Newly developed hybrid or linked-benefit products are options. One product that's growing increasingly popular is a form of life insurance that includes tax-qualified long-term care riders. Jamie Hopkins observed:

"These hybrid life insurance and long-term care policies give the policy owner access to the majority of the death benefit if long-term care services are needed. If long-term care services are not needed or all of the death benefit is not used up to pay for long-term care expenditures, the remaining death benefit is paid out to the beneficiaries upon the death of the policy owner.”

These can be sold to older people who have health difficulties and can't afford long-term care policies, and their waiting periods tend to be shorter. Also, they usually feature fixed premiums and have different coverage rules.

Another option is annuities with long-term care riders. Your client purchases an annuity but rather than taking withdrawals, earmarks the money for long-term care. If the client never requires care, they can elect to receive the money after the annuity matures or bequeath it to their heirs. According to Teresa Mears:

“These annuities require a hefty upfront payment, but if you need long-term care, your overall cost may be lower than what you'd spend on insurance premiums. However, don't expect much in the way of interest.”

High-deductible health insurance plans featuring health savings accounts (HSAs) are another way to put money aside tax-free for qualified long-term care medical costs. Also, your clients may be able to use their HSA to pay for part of their LTCI, if the insurance is tax-qualified.

A final alternative is using home equity through a line of credit, a reverse mortgage, or selling property outright in order to fund long-term care. This option assumes, of course, sufficient equity exists to cover the long-term care expenses.

Funding long-term care requires a kind of clairvoyance — an ability to anticipate future needs, future costs, and future health conditions. It is an incomplete science at best. But with full knowledge of your clients' health, assets, and expenses, as well as the pros and cons of all potential options, you will be able to recommend the long-term care plan that best meets their needs.

If you liked this post, don't forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author's employer.

Image credit: ©iStockphoto.com/Ocskaymark