Only about 10% of seniors over age 65 have long-term care insurance. It is easy to understand why. The product is complicated, and costly mistakes are easy to make when buying it.
There are two mistakes people make most often when purchasing long-term care insurance. More people would buy the insurance if they knew how to avoid these mistakes, and those who purchase it would have better, more affordable coverage.
Major mistake number one is to buy the lowest premium policy. I am all for keeping costs down. But I want bargains. In other words, I want to get a good value for my dollar. The lowest-cost item is not always a bargain. It is possible to buy the lowest cost item and pay for more than you are getting.
A major factor in the premiums for a long-term care policy is the inflation protection clause. You need inflation protection in a long-term care policy. Long-term care expenses, especially nursing home expenses, are increasing much faster than inflation. Most analysts advise planning on about a 7% annual increase in costs.
Since most purchasers of long-term care policies do not expect to need the coverage for 15 or 20 years, inflation protection is critical. Suppose long-term care costs $150 a day in your area. In 20 years at even 5% inflation, the cost if $400 a day. An adequate insurance policy today with no inflation protection will be totally inadequate when you need the coverage.
Yet, the AARP estimates that about 40% of long-term care insurance buyers do not take the inflation protection. Another group of buyers buy inflation protection, but they buy the wrong kind because it costs less. There are two ways you can buy the wrong protection.
Most individual policies offer either simple or compound inflation protection. You want compound protection, because price increases are compounded. Simple protection costs you less, but it provides significantly less protection.
Many group policies, such as those sold through employers, offer a different inflation protection option: automatic benefit increase or a future purchase option.
An automatic benefit increase is similar to the compound inflation protection in an individual policy. Your daily benefit adjusts automatically each year at a compounded rate.
The future purchase option gives you the choice of increasing the benefit level of your policy, usually every two to three years.
With an automatic benefit increase policy, the future cost increases already are built into your premiums. You pay a higher initial premium than for the purchase option policy. The automatic benefit increase policy premiums can be two or three times the initial premium of a purchase option policy.
With the future purchase option policy, each time you exercise the option to increase benefits, the premiums increase. The premiums over time are likely to increase so that they are much higher than the premiums on an automatic benefit increase policy. After 10 years or so the two premiums will be equal. After that, the future purchase option premiums continue to increase. After about 20 years, the purchase option premiums will be several times the automatic benefit premiums.
That is how the lowest initial cost policy ends up costing you substantially more, and might provide less coverage. In many cases, the policy will be un-affordable and will be dropped after a period of years – at just about the time the policyholder is reaching the age when the coverage is most needed.
When evaluating any choice in a long-term care policy, don’t focus on the initial premium. You want an estimate of how the premium will change over your lifetime under each choice.
Major mistake number two is to buy too much coverage. Gold-plated or “Cadillac coverage” always is comforting. Often it is unnecessary and leaves the policyholder worse off financially than lesser coverage would.
A great fear of seasoned citizens is that an extended nursing home stay will deplete their estates. The average annual stay in a nursing home costs over $70,000, and it costs close to $120,000 in a high-cost area such as New York City. It is easy to see why people fear that having to spend years in a nursing home will diminish their estates.
That is why many people buy guaranteed lifetime coverage with their long-term care policies. But buying such a policy means you will pay a lot of money for coverage you aren’t likely to need.
A study by the actuarial consulting firm Milliman USA analyzed the claims filed under about 1.7 million long-term care policies. It found that most claims were for only short periods of care. About 76.7% of claims were for less than two years. Only 3.6% of claims were for long-term care of four to five years. About 4.3% were for care lasting more than five years. The study did not show the occurrence of care longer than five years.
These results mean the vast majority of us will have our long-term care needs covered by policies with a three year limit on coverage. These policies cost almost 40% less than those with lifetime benefits.
As we’ve shown in the past, there might be less expensive ways than insurance to protect your family’s wealth if you are one of the few who need extended care. For example, you can purchase a long-term care policy with a three year coverage limit and a life insurance policy with a benefit of $500,000 or more. The life insurance will replace funds spent on extended long-term care and will be cheaper than long-term care insurance. If you are insurable for a long-term care policy, you should be able to purchase a reasonable cost life insurance policy.
There are other policy provisions that can reduce the premiums on long-term care insurance, and ways other than insurance to provide for payment of long-term care. These methods are covered in some detail in my book, The New Rules of Retirement.