Evaluating Long Term Care Insurance Products

Let’s face it, just like your car and your fridge, our parts wear out sooner or later and so the thought of needing help to do routine things (walking, dressing, bathing, etc.) at some point later in life should make sense.   We’ve all seen the statistics about the probability of needing care services as we age.  It’s easy to put it aside after trying to decipher all of the terms and acronyms defining the issue of long-term care and even easier to get stuck over how best to fund an expense that is difficult to pinpoint and far off in the future.

How you look at this issue and how you decide to fund the cost for caregiving in the future is entirely personal.  Some of us have ample resources to self-insure while others with zero resources rely on government (Medicaid) programs.  The majority, however, fall somewhere in the middle, which makes it more complicated.

In my experience, choosing insurance funding for long-term care expenses typically has little to do with the cost and is ultimately an emotional decision.  Folks who have “put off” the issue for years will suddenly call for an appointment as soon as they have experienced a care event, typically with a parent, in their own family.   Once “reality” sets in, our perceptions change and the #1 reason we buy long-term care insurance is to ensure that we are not a burden to our children or other family members.

A second reason, that I prefer to emphasize, is so that there is a plan in place to ensure that you get care when you need it.  We hear it all of the time.   Funds that parents put aside for their care are not used because children don’t want to spend it.  Even most adult children will do whatever they can first before tapping into their inheritance!  They’ll provide your care themselves (family members are the #1 source of caregiving in the U.S.) or pay for limited care at home so that you get by for as long as possible.  By this point, you’re likely dependent on others and no longer in any condition or position to influence this outcome (i.e., the quality of your care).

Even if you can self-insure, having a pool of funds set aside that doesn’t conflict with your children’s perception of their potential inheritance can make a big difference in the quality of your care and in preserving family harmony.  As a result, some folks with significant assets will still utilize long-term care insurance specifically for this purpose.  Why?  First, to ensure that your assets go exactly where you want them to go.  Second, so you can tell your children (or siblings or friends) with confidence that a plan is in place with specific resources earmarked for your care and so there is no second guessing on this issue.  This way, they can orchestrate your care rather than having to administer your care and time spent together becomes quality time rather than a task for them.  Third, they understand that long-term care insurance, when actually used, is a competitive investment.  The initial leverage created by insurance products (putting up a small amount of premium relative to the dollar amount of benefits received) results in a return on investment that is difficult for many of us to replicate on our own.

There are two primary long-term care insurance alternatives today:

• Traditional Long Term Care insurance
• Asset-Based (“Hybrid”) insurance products

Both have pros/cons, are complicated like other types of insurance, and each may be helpful in specific situations depending on your financial needs and objectives.

Traditional Long-term care insurance

This is pure insurance and, like all of the other insurance we pay for (homeowners, auto, health, umbrella, life, etc.), it only pays off if you file a claim for benefits.

You can budget for the annual premiums like all of your other insurance and so it’s typically purchased by folks who are still working (in their 50s and early 60s) and where their earned income easily covers the premium.  A portion of the premium may be deductible as a medical expense (the amount depends on your age) to the extent that you can itemize deductions.  You can design a contract to “share” benefits with a spouse or domestic partner (i.e. a surviving spouse can inherit any benefits not used by the first to die) and, where the policy qualifies for your state’s “partnership” program, you can preserve assets equal in value to the total long-term care insurance benefit received (as a non-qualified resource), for Medicaid eligibility purposes.  The partnership provision provides an additional incentive for your children to use your long-term care benefits first rather than spending down or transferring/gifting your other assets.

The two primary drawbacks to traditional long-term care insurance are (1) annual premiums are not guaranteed and, like all of your other insurance, can increase over time and (2) if you don’t use it, then you “lose it” – you get nothing for the premiums paid like all other pure insurance products.

Asset-Based (“Hybrid”) Long-term care insurance

Hybrid products were created to address the drawbacks of traditional long-term care insurance.  Hybrids guarantee that the insured or heirs will receive either (1) long-term care benefits, (2) a death benefit or (3) the contract’s cash surrender value.  With a hybrid contract, you won’t “lose it” if you don’t use it.  Second, the premiums on today’s hybrid policies are typically guaranteed to never increase.

A drawback for Hybrids, however, is that you need the resources available to pay much more up-front for the coverage.  As opposed to paying a few thousand dollars a year for life with traditional long-term care insurance, hybrids typically require all of the premium to be paid-up-front for a commensurate level of benefits or over some shortened time period – 1 – 10 years.

If you are considering paying $3,000 annually for life for a traditional long-term care insurance contract, then you’re probably going to need to front 30 years or so worth of these payments (say $90,000) for a hybrid contract with similar long-term care benefits.  Not everyone can swing a high five or low six-figure payment up-front, and fewer can swing two of these if you looking for coverage for two people.

As a result, I see hybrids used more by folks after they’ve retired in their late 60s or early 70s, when the cost of budgeting annual premiums for traditional long-term care becomes less appealing, and where they may have cash set aside that they never intend to invest.  In this case, such cash is “re-allocated” to a Hybrid contract and the only risk is the opportunity cost of what they could earn on keeping the cash on hand/outside of the contract.

Comparing Options

Even for folks with the resources on hand to fund a Hybrid contract, a case can be made to invest those funds instead.  A simple example would be to buy a 30-year bond and use the bond’s interest to fund the annual premium for a traditional long-term care insurance policy.  In this scenario, the insured can potentially receive the LTC benefits and the insured’s family can receive the amount that they set aside to fund it (the par value of a bond at maturity plus any excess/incremental interest, if any, not needed for the traditional LTC insurance premium).

In addition, traditional long-term care premiums may be tax deductible, the benefits may potentially be shared with a surviving spouse, and, after the contract benefits are exhausted and the insured becomes Medicaid eligible, a dollar amount equal to the long-term care benefits received may also be preserved for heirs (not have to be “spent down”).  Only traditional long-term care insurance contracts are “partnership” eligible.

With the hybrid approach, contract values are refundable only to the extent the insured doesn’t use any of the contract’s long-term care benefits.  The death benefit and cash value of a Hybrid contract are reduced on a dollar-for-dollar basis by any long-term care benefits used.  You don’t get both.  If you pay a $100,000 premium into a Hybrid contract and use $40,000 of long-term care benefits, then your family will only get the $60,000 difference.

An appealing option for Hybrid contracts, however, is to fund them by using the cash surrender value in a permanent life insurance contract or a non-qualified (non-IRA) annuity contract you may already own, where the cash surrender value can be “exchanged” tax-free into a hybrid long-term care insurance contract.  This technique is even more appealing where the cash value of the existing contract has a taxable gain as any long-term care benefits received through the replacement, hybrid contract will be received income tax-free.

Conclusion

We all should consider the risk of not preparing for future long-term care expenses in the context of our overall retirement plan and the impact it may have on our family or potential caregivers.

If insurance is a consideration, be sure to work with an advisor who has experience with this type of planning and expertise with the various funding alternatives and insurance contract options available.

We are having these conversations regularly so if you or a loved one needs assistance with long-term care planning, funding options, or in evaluating insurance contracts you own, please reach out to your ACM Wealth Advisor.

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