Long-term care expenses can be the single largest expense that a person faces in retirement. Having a plan to cover them is an important part of our stewardship responsibility. There are different options to pay for these costs, and purchasing long-term care insurance is one of them.
This post is meant to provide a general overview of the different types of insurance, how long-term care insurance works and the areas you need to think through as you consider your options. It is not exhaustive, but I hope increases your knowledge of a complex and very important topic.
Why Is It Important?
Long-term care is expensive. According to Genworth (an insurance company), in 2022 the national average cost of a private room in a nursing home facility was $9,034 a month. Having a home health aide brought into your home, would cost on average about $5,148 a month (you can use Genworth’s cost of care calculator to see costs in your area). The final cost ultimately depends on where you choose to receive care and how much you need. However, most people find that the costs are much greater than they can afford.
There are four ways to pay for long-term care:
1. Self-insure – this usually requires a couple to have several million dollars. However, with the ever-increasing cost of care, even that may not be enough
2. Move to a retirement community – some communities have a benevolence fund that can backstop you financially if you run out of money
3. Buy insurance – it won’t cover all your expenses, but can help cover a large part. If you want to stay in your home and don’t have millions of dollars saved, this can be an important part of your plan
4. Government – when you have depleted your assets, the government (via Medicaid) will pay for your long-term care medical needs.
If you fail to plan how to address this major expense, you may end up being forced into the option you did not want, because you won’t have options at that point. Planning ahead enables you to make decisions, rather than forcing your family or friends to make them for you.
Insurance – How Does It Work?
Insurance is bought to provide for a need that someone may not be able to cover. Long-term care insurance is normally purchased years before any medical event is on the horizon. When a medical event occurs, the policyowner follows the terms set forth in the policy to access their benefits.
Policies are purchased through an insurance agent licensed in your state of residence. They are paid a commission by the insurance company when you buy a policy.
There are two main types of long-term care insurance – traditional and hybrid:
This is the type of policy that comes to mind when you think of long-term care insurance. You pay a set premium every year you own the policy until you die (or cancel the policy). If you have a medical event, they will reimburse you for those expenses covered under the policy after certain conditions are met. If you don’t use any of the benefit, when you pass away, your heirs receive nothing (there are riders you can add to fix this, but they are expensive and beyond the scope of this post).
Older policies that were written many years ago have seen their premiums increase dramatically over the past 5-10 years. The insurance industry underestimated how long people would live and the costs associated with long-term care. Many policyowners have been put in a difficult position of paying much more for their policy or reducing the policy benefits to keep the price affordable. Newer policies written today reflect these learned lessons, but there is still a chance that premiums may rise down the road.
As less people have been buying traditional long-term care insurance, the insurance industry developed an alternative to help deal with people’s concerns. A hybrid policy is one that combines life insurance and long-term care insurance in one policy.
Here is how it works. An individual buys a hybrid policy for a lump sum of $100,000 (or a payment over several years). The insurance company gives them access to a pool of funds – let’s say $300,000 that can be used for long-term care needs. They still have an elimination period, daily maximum and lifetime benefit maximum (see below for explanation on these terms). If the policyowner does not use the funds for long-term care, then the insurance company pays their heirs a little more than the initial $100,000 premium as a tax-free death benefit.
The hybrid policy’s premium doesn’t go up in later years. It also allows you use a smaller portion of funds for long-term care expenses and ensures that either you or your heirs will get a benefit from the money in the policy. Some policies even allow the policyowner to receive their $100,000 back at any time. Due to the flexibility of these policies, it tends to be more expensive than traditional insurance.
There are quite a few moving parts to policies and several key terms to be aware of. Not all insurance companies use the same terms or have the same moving parts, so this is a general guide to help you understand the important concepts:
Activities of Daily Living (ADL)
These include: bathing, dressing, eating, transferring, toileting and continence. When you are unable to do two of the six listed above, you become eligible for a long-term care insurance claim. Developing a severe cognitive impairment such as Alzheimers may also qualify you for benefits.
The time you must wait before the insurance company will cover your long-term care expenses. It is normally 90 days, but can be longer or shorter. Let’s say you develop a medical condition and you can’t do two of the six ADL’s listed above. Your inability to do the two ADL’s would need to continue for more than 90 days. After 90 days pass, then your policy will begin to cover your long-term care expenses.
The shorter the elimination period, the higher your premium is.
Is the maximum amount the insurance company will pay for a day’s worth of care. For example, if you have a $300 daily benefit and your expenses are averaging $500 a day, the insurance company will only send you $300 a day. The higher your daily benefit, the more expensive your policy is.
Indemnity vs Reimbursement
Indemnity pays you the daily benefit with no need to provide any receipts. This option is more expensive, but can allow you to save the extra amount of the benefit if your medical expenses are low. For example, if your cost of care is $200/day but your policy daily benefit is $300/day, the insurance company will send you $300/day, and you can save the extra $100/day.
Reimbursement policies are the most common type and only pay you the amount of your actual expenses. This can potentially extend your coverage (by months or years) as your expenses may not be close to the daily benefit (see example under policy maximum below).
Years of Coverage
Is how many years the insurance company will pay out the full daily benefit. Oftentimes, this is 3 years (as this is the average need for long-term care), however, it can be higher or lower. The more years covered, the more expensive the policy will be.
Is the maximum total amount the insurance company will pay out. This is determined by the daily benefit and years of coverage that are selected. For example, if your daily benefit is $300/day and you are covered for 3 years, your lifetime benefit will be around $328,500.
For reimbursement policies this becomes important, as your policy may pay a benefit for a longer period of time (limited by the policy maximum). For example, if you have a daily benefit of $300 for 3 years and a policy maximum of $328,500; if your expenses are $200/day, then you could receive $200/day for approximately 4.5 years.
There are three main options: none, simple and compound.
1. None is the cheapest as it does not provide any inflation protection. If your benefit is $300/day, it will still be $300/day 20 years from now
2. Simple is the next cheapest, but does not keep pace with inflation, as it only pays interest on the original amount. Let’s say you have a $300/day daily benefit with 5% simple interest. Each year the benefit will grow by $15 (year 2’s benefit will be $315/day, year 3 – $330 etc). By year 20 your daily benefit would be approximately $585.
3. Compound interest is the most expensive, but provides the best way to keep pace with inflation. he interest gets applied to the prior year’s benefit, including the interest paid. For example, if you have a $300/day benefit with 5% compound interest, year 2’s daily benefit will be $315/day while year 3’s daily benefit will be $330.75/day. By year 20, your daily benefit would be approximately $758.
Ultimately, none of these methods will ensure you keep pace with inflation tied to actual long-term care costs. However, if you buy the policy at a younger age, having inflation protection is very valuable.
As you can see, long-term care insurance becomes very complicated, very quickly. If you have stuck with me so far, here are some of the key points you will want to focus on as you consider this option:
What Does It Cover?
Most new policies cover everything from skilled nursing to staying in your home and having medical care brought in. This allows the policyowner to choose what care they want and where they want to receive it. However, not all policies are this way, so be sure to understand the fine print.
Long-term care insurance is meant to help cover some of the costs, but not all of them. As coverage is expensive, you want to cover what you need, and plan on paying out of pocket for the rest.
Long-term care costs will only increase from here. If you are younger and purchasing a policy, you will want to consider your options to help keep pace with inflation. Yes, it costs more (or reduces your immediate benefit), but if you need help in your later years, it will make a difference.
If you buy traditional long-term care insurance, there is the potential of having to pay more down the road. In order to raise prices, an insurer has to raise them for everyone in the same class of policies, not just your policy. Though their pricing has incorporated lessons learned from the earlier policies, as people live longer, your premium may still increase in your later years.
Insurance Company Matters
Getting a cheaper price from a lower rated insurer may not be a good thing. You want the insurer to be around in 20 years when you need to start receiving benefits. Research the insurer and see if they are financially strong. As there are fewer companies offering long-term care insurance, this is extremely important.
When a couple buys long-term care insurance, they may receive a discount if they each buy a policy from the same insurer. This needs to be weighed against using different insurers, as it may/may not be cheaper for each spouse to buy a policy at different insurers.
Hybrid policies are much more flexible, as someone (either you or your beneficiaries) will get a benefit from the policy. Traditional long-term care policies are a use it or lose type of policy (unless you purchase an additional rider).
Medicaid is the government program that helps pay long-term care expenses, once you have spent down your assets to about $2,000. With an increasing number of people needing government assistance to pay for long-term care, a joint federal-state policy initiative called the Long-term Care Partnership Program was established. The Partnership applies only to traditional long-term care policies, and encourages people to buy private insurance, to decrease the strain on Medicaid. If you buy a policy that qualifies for the Partnership Program, you are able to pass money to your heirs without fear of Medicaid trying to recover the money.
Let’s say you buy a policy (that qualifies for the Partnership Program, purchased from a private company) with $200,000 of long-term care benefit. If you use the full benefit, you are able to qualify for Medicaid with $202,000 in assets (not just the $2,000). The $200,000 can be left to your heirs – Medicaid will not pursue those funds for reimbursement.
It is important to check with the insurance company to determine if the policy you are looking at is part of the program, and if your state participates (Pennsylvania does).
If you purchase a qualified long-term care insurance policy, there may be some tax benefits that will help with your premium. Also, the benefits paid out under a reimbursement qualified policy are generally tax-free. You will want to discuss this in more detail with your Accountant and Insurance Agent prior to purchasing a policy.
Creating a plan to pay for your potential long-term care expenses is very valuable. Even if you never need long-term care, it will take a burden off you and your loved ones.
The plan of how to pay for it is one step of the process. The other step is to think through where you would want to receive care. Too often people do not think this entire process through, and they end up someplace they would never choose. Make a plan so you can receive care in the setting you would prefer.
Points to Consider
- The cost (or reduced benefits) of purchasing long-term care insurance tend to accelerate around age 70, so you don’t want to be procrastinate.
- Long-term care insurance will not cover all the costs of care.
- Explore all your options, don’t limit yourself. This is an important and potentially very costly decision.
- Do you want your doctor or family deciding where to send you in your time of need, or do you want to plan ahead so you have a say?
- Be sure to discuss this thoroughly with your financial advisor and insurance agent (if they are not the same person) to ensure you know your options.