Insured for old age? An economist explains the dangers of long-term care insurance
Paul Solman: Back in the 1970s, my wife and I, then in our 30s, began saving for the future. My biggest concern: outliving our nest egg. Worst case: a devastating disability that would require care we couldn’t afford. I thought that we shouldn’t subject our kids to a future choice that might pit their penury against our misery. We began to save like ants. Or maybe dung beetles.
Then — I think it was in the 1980s — we heard about long-term care insurance. It was a lot cheaper in those days, but my wife and I both worked, our savings trajectory looked promising, and I asked myself the following question: If one or both of us, just a year or two ahead of the baby boom, would need long-term care, wouldn’t untold millions in our cohort? And if so, how could insurance companies afford to pay for us all? Unless, that is, they fought our claims and made collecting on them a nightmare, just at that point in life where we’d be least able to put up a fight? My conclusion: save so as to self-insure.
It’s very gratifying, then, to see my skepticism mostly confirmed by someone who has carefully thought through the problem. Financial education guru and longtime economics professor Lewis Mandell, whose new book, “What to Do When I Get Stupid: A Radically Safe Approach to a Difficult Financial Era”, has inspired a number of extremely popular posts on this page, including “An 8.3 Percent Return on Your Money, Guaranteed for Life?” and “How Detroit Leaders Ignored Causes of Bankruptcy for 65 Years”.
Lew Mandell: Long-term care insurance, which can help pay for nursing home stays, has become very expensive, primarily because people are living longer. More recently, many state insurance regulators have allowed increases in premiums for existing policies to offset low insurance company interest earnings on their investments, caused largely, many argue, by the Fed’s quantitative easing. The combination of rising costs and increasingly inadequate benefits should cause all of us to rethink the value of long-term care insurance.
If you have carefully funded your core retirement expenses with a combination of secure sources of lifetime income, including Social Security retirement benefits, pensions and annuities, you should be in pretty good shape. About the only risk to a secure retirement is the possibility that you or your partner may require expensive nursing care for a long period of time. At an annual cost that can approach or exceed $100,000 for care in an Alzheimer’s unit, your carefully constructed plans can quickly be shot to hell.
According to the American Association of Retired Persons (AARP), the average annual cost for long-term care insurance that pays a maximum of only $150 a day for up to three years, and won’t pay for the first 90 days, is summarized in the table at left adapted from the AARP Guide to Long-Term Care. (Note that rates for couples may be up to 30 percent per person less than for individuals.)
These premiums are for policies that adjust for “simple” inflation of 5 percent per year. Over the past two years, the average cost for a private room in a U.S. nursing home has increased annually by 4.8 percent to $94,170 per year (semi-private rooms are about 12 percent cheaper), so the 5 percent inflation adjustment isn’t far off actual recent increases.
Unfortunately, a simple inflation adjustment adds 5 percent of the original benefit per year and does not compound like actual inflation. A daily benefit of $150 per day will go up by 50 percent to $225 in 10 years with a simple inflation policy, but the actual cost will increase 63 percent (at 5 percent annual compounded inflation) to $245. However, the added cost for moving from a simple inflation adjustment to the more accurate compounded adjustment would add 25 percent to the cost of a policy for a 65 year-old person.
The most critical thing to realize is the total amount that such a policy will pay you if you remain in a nursing home for the three full years (after your first 90 uncompensated days): just $164,250, unadjusted for inflation. That’s $150 a day times 365 days in a year times three years. Therefore, if you have that amount in liquid assets per person (money not needed to fund core expenses), you can self-insure for that three-year period.
If you do invest in such a long-term care policy, the probability of collecting on it is low. According to Prescott Cole in a recent article in the Wall Street Journal, about two-thirds of seniors stay in a nursing home for less than 90 days, which means that they get no compensation from their policies. Furthermore, fewer than 6 percent of those admitted will still be in the nursing home after two years. In fact, fewer than 4 percent of seniors currently reside in nursing homes.
If your objective is to completely cover your core retirement expenses, you will probably need more nursing home coverage than $150 a day (even adjusted for inflation) and will definitely need more than three years of total coverage to cover the unlikely, but extremely expensive, possibility that nursing home care will be needed for many years. For a single person, moving to a nursing home for care of indefinite length (as in the case of Alzheimer’s) generally means that the former residence can be sold, and nearly all needs will be provided by the nursing home or paid for by Medicare. Lifetime income can now be used to offset the cost of the nursing home. Once your assets are exhausted, you are generally moved onto Medicaid, so the only reason to protect assets is to leave an inheritance. Therefore, it may not be financially beneficial for a single person without heirs to pay for long-term care insurance.
Long-term care insurance may actually be more important for a healthy spouse whose partner is in a nursing home. If one partner goes into a nursing home for several years, it can easily drain the family’s resources, leaving the healthy partner without the means to fund his or her core expenses. To qualify for Medicaid in most states, the healthy partner, called the “community spouse,” can hold onto the house, one car and maximum financial assets of $115,920 in 2013 (although individual states have lowered this amount to as little as $23,184). If the community spouse or another dependent relative lives there, the house may be kept with no equity limit.
If neither community spouse nor another dependent lives in the house, homes with equity values from $536,000 to $802,000 (depending on the state) may be retained when the owner accepts Medicaid for long-term care, provided that the owner signs a form stating his or her intent to return to the house. Medicaid is then entitled to be reimbursed from the equity of the home when it is sold, generally after the recipient’s death, so it is seldom worthwhile to pay real estate taxes, insurance, utilities and maintenance for a home owned by a long-term care Medicaid recipient.
The community spouse may also use all of the income in his or her name from pensions and Social Security and as much as $35,760 in income from the Medicaid-assisted spouse in 2013 (which can be lowered by states). Income above this level must be applied toward nursing home expenses.
Although Medicaid laws and limits are given here for illustrative purposes only and are subject to change and interpretation, understanding them does help explain many experts’ contention that there is a narrow window of wealth that should determine a couple’s need for long-term care insurance. At the bottom end, if non-home, non-car assets are below $115,920, Medicaid will kick in to fund the partner who needs long-term care. At the upper end, if non-home assets are above about $700,000, a couple can self-fund most nursing home stays without depleting assets. It is those whose wealth ranges from about $150,000 to $700,000 who have the greatest need for conventional long-term care insurance.
The likelihood that a spouse’s nursing home stay will be so prolonged as to drain more than $700,000 is relatively small, but it’s still a risk. So if you fall in that middle wealth bracket, you may wish to purchase an available, but seldom-purchased, policy that pays for many more than the three years that are “standard.” A good tradeoff is to choose a policy with a long elimination period (to reduce cost) but one that pays indefinitely. Currently, the longest elimination period available on most policies is 365 days. It is strange that just a small sliver of buyers chooses to save money by self-insuring for more than the standard 90 days — money that could be better used to buy extended policy coverage to prevent catastrophic loss.
Economists feel that the purpose of insurance is to pay for very expensive but unlikely events, which means that we should self-insure against affordable but more likely events. This is analogous to upping the deductible on automobile collision insurance from $50, which causes the policy to be very expensive, to $500 or $1,000, which makes the policies much less expensive.
According to the American Association for Long Term Care Insurance, the cost of a policy that pays benefits for an unlimited amount of time is only about a third more expensive than a standard policy that pays for just three years of care. You can even pay for nearly a third of that added cost by increasing the elimination period on your policy from the standard 90 days to 180 days. Now you’re beginning to think like an economist — insure against the big losses you can’t afford and don’t sweat the small stuff.
In spite of paying expensive premiums for many years, some individuals who are “covered” by long-term care insurance policies are surprised to find their claim denied by their insurance company. If you look at the fine print of a policy, you will find that eligibility is generally determined by one’s inability to perform certain “activities of daily living.” These include bathing, continence, dressing, eating, toileting and transferring (moving from one place to another). Before they pay benefits, most insurers require a physician to certify that you are unable to perform two or more of these activities, although some policies specify an even greater number. To make things even more complex, many insurance companies will not pay unless you need hands-on assistance to perform an activity rather than stand-by assistance.
Bottom line, if you have long-term care insurance, look hard at its limitations and your own financial situation before you decide to continue paying its premiums (particularly if rates increase). If you don’t have such insurance, carefully consider whether its likely benefits are worth the costs.