Should you buy long-term care insurance or save up to self-insure? There are many trade-offs to consider. And, surprise: It doesn’t have to be one or the other.
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The decision on whether to buy long-term care insurance vs. self-insuring is a question many clients ask. If you can afford to self-insure based on your planning, then the choice boils down to whether you would like to retain the risk or share the risk with an insurance company. The goal would be to take the worst-case scenario off the table, if possible.
Insurance companies offer many different long-term care products with various bells and whistles (such as LTC with life insurance or annuities), so it is important to determine what you would like to cover and what you can afford to pay on premiums. Since you have no idea of what the future holds for you, and there are many variables and unknowns — such as if and when you will need care or how much the insurance company may raise the premiums in the long term — this decision comes down to what makes you sleep well at night.
You will also need to make sure you qualify for long-term care, as some pre-existing conditions may prevent you from being insurable. (For example, you might be denied if you already need help bathing or dressing or you have Alzheimer’s or certain cancers.) You can also potentially get a discounted premium if you and your spouse choose to purchase policies together. Long-term care costs and increases in premiums can also vary by state.
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Some policies allow you to use the benefit in whatever way you would like — so, if it’s a three-year benefit option and a starting monthly benefit of $6,000, this means you have a total starting coverage of $6,000 times 36 months, or $216,000. If you start using the benefits this year, as an example, and you used the maximum benefit every month, you would run out of money in just over three years. However, if you start using 50% of the monthly benefit instead, then your coverage can last twice as long, or six years.
For the majority of people, buying a long-term care policy is all about care at home, according to a study by Boston College. The study puts the lifetime risk of needing nursing home care at 44% and 58% for 65 or older men and women, respectively. Also, the study concluded that nursing home stays are shorter than previously believed: 10 months for the typical single man and 16 months for a woman.
If you decide you want to go ahead with a policy, there are several considerations, such as:
How many years should you insure for? What are the advantages and disadvantages to insuring for longer and shorter periods?
According to the Society of Actuaries’ studies on long-term care insurance claims, the average time for claims that last longer than a year ranged from 3½ to four years in 2014. Usually, two to four years is a good ballpark; three years is about average. The longer the benefit period the policy offers and the higher the policy benefit amount, the higher the cost to the policy buyer. So, it is a trade-off between accumulating and using the benefits and not using them at all. Essentially, the longer the benefit period that the LTC policy offers, the higher the risk the client might end up paying thousands of dollars in premiums and getting nothing in return.
Can the policy premiums rise and, if so, by how much?
Many insurance companies increase premiums, and you have no idea if or when this may happen. You might be paying $3,000 annually for a policy for 15 years and the insurance company decides to raise your premium to $5,000. If you decide this is too costly after 15 years and cancel the policy, you have already paid $45,000 to the insurance company and have not used the benefit. However, like other insurance such as homeowners, you may be paying for peace of mind but never have to claim on it.
Clients who cannot afford to self-insure currently because they do not have enough assets accumulated may be able to buy a LTC policy during their earlier years. As time progresses, there may be a point where their assets can support a long-term care event — and at this point, they can terminate their policy or modify it for less coverage. Keep in mind when a single person goes into LTC their expenses may move laterally (if you go into care you will probably sell your house and car and no longer travel), but with a couple, when one goes into care and the other doesn’t, the other spouse still has their usual living expenses, so you are faced with increased costs.
Is this a cash plan (indemnity) or a reimbursement plan?
A cash plan has more flexibility, because you are paid a cash benefit equaling the entire daily benefit, vs. being reimbursed for actual expenses. A reimbursement policy will only pay the full daily benefit when the actual cost of care is greater than or equal to the daily benefit.
Policies with a cash benefit are more expensive. However, if you have a cash plan, you have the option of paying a relative or friend to care for you.
If you do go into care and come out, does the policy reset, or do the benefits paid reduce the benefit available for the next occurrence?
Some policies have a restoration of benefits rider, which increases the total amount of care your policy will cover. If you go into care and recover, the benefit will reset to the maximum amount as if you never used it. So, if your lifetime benefit was $300,000 and you went into care and used $150,000, once you come off the claim for a certain period of time (usually 180 days) the benefit resets to the original $300,000.
Are there any policies with compound interest available, and if so, what do they cost?
Compound interest policies have better inflation protection but may have higher premiums. Some policies have a 5% simple interest, vs. others with a 3% compound interest. Depending on the policy and the rate, simple interest may be a better option over the long term as the breakeven point may not occur until later. Inflation is compounded, but if the LTC policy uses simple interest, at a certain point inflation overcomes the simple interest and the policy pays for less than the actual costs.
Does the policy have a waiting period?
The shorter the period, the more expensive the rider. You will be responsible for any costs during the waiting period.
LTC usually turns into a less-than-ideal investment at some point. The decision to buy is very individualized, and if you happen to use it early, it can be a good investment, because you have paid less premiums upfront and are using the benefits. The longer you take to use a policy, the lower the return on the policy. If you end up using the policy in the first five to 10 years, this can be very advantageous. However, the longer you take to use the benefits, the more sense it may make to just put money aside yourself if you can afford to self-insure. Of course, there is no way of knowing if and when an event will happen.
Note: We are not licensed insurance agents and cannot give insurance advice but can help you through the process of deciding what is best for you and provide a broad overview of the advantages and disadvantages. Please discuss this with your agent before purchasing or making any changes to your existing policies.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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Senior Financial Adviser, Evensky & Katz/Foldes Financial Wealth ManagementRoxanne Alexander is a senior financial adviser with Evensky & Katz/Foldes Financial handling client analysis on investments, insurance, annuities, college planning and developing investment policies. Prior to this, she was a senior vice president at Evensky & Katz working with both individual and institutional clients. She has a bachelor’s in accounting and business management from the University of the West Indies, she received an MBA at the University of Miami in finance and investments.
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