The Long-Term Care Funding Dilemma - Krishna Wealth Planning

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In my experience, starting a discussion about long-term care often lands as an abstract concept or a real, visceral threat…rarely in between. Over time middle ground is usually found. It’s often a challenge to think about this topic in a rational way, but it’s worth the effort as the stakes are high. This piece explores a few ways you might choose to face the dilemma of long-term care funding.

Why Think about Long-Term Care Now?

To start a definition may help. Long-term care is simply custodial care, the type of services needed if you’re unable to perform normal activities of daily living. Such services can be performed in locations like your home, adult day care, assisted living facilities, and nursing homes.

While part of the normal aging process and life cycle, it’s no surprise that most wouldn’t want to think about this let topic alone plan for it. But like many things in life, it’s often the things we don’t want to think about that deserve far more attention.

I’ve learned much about the topic from Chris Brauner, Director of Risk Management at First Element Insurance Planners. Chris recently pointed out to me: “There’s no more motivated person to purchase long-term care insurance than someone who has provided for a family member who needed care.”

This leads to the key planning question: For the risk of long-term care, should you plan to self-fund, buy insurance, or use a combination of both?

A Brief Look at the Costs of Long-Term Care

Before attempting to answer that, let’s appreciate the financial magnitude of long-term care. Note that Medicare and Medicare Supplements do NOT cover long-term care. For families with low enough assets and income, Medicaid could provide some benefits.

To get a feel for the costs involved, you could check out Genworth’s cost of care survey. Here you can search based on your own city and zip code. For example, the annual median cost of a semi-private room in a Houston, Texas nursing facility was around $68,000 in 2020. While costs can vary by region and time period, recent studies have shown that costs have substantially outpaced inflation over the last 15 years.

The high (and rising) costs of long-term care may result in you having more concerns about outliving your income and assets. It can also change the way you think about preserving certain assets to pass on to your heirs.

Caveats

In the rest of this blog, we’ll look at three solutions for funding long-term care. Notably within each, there are likely creative variations and specific tactics that won’t be mentioned. But these are the broad paths I most commonly encounter in practice today.

As a fee-only firm, Krishna Wealth planning does not derive compensation from the sale of financial products, including life and long-term care insurance policies. However, I work closely with experienced professionals to put solutions in place for my clients.

One – Traditional Long-Term Care Insurance

Think of traditional long-term care insurance like other types of insurance policies you might have. If you have homeowner’s insurance, you hope the adverse outcome of a destructive fire never occurs, but you’re protected if it does. Furthermore, if the fire (or other disaster) never happens, there is no mechanism to reclaim any part of the premiums you paid in. Similarly, traditional long-term care insurance policies are “use it or lose it.”

Typically, you’re able to collect on long-term care insurance when you cannot perform 2 of 6 Activities of Daily Living. Cognitive impairments may also trigger benefits.

Here’s an example of what a standard policy benefit might look like:

Daily Benefit Amount: $200
Elimination Period: 90 days
Benefit Period: 5 Years
Total Benefit Amount: $200 x 1,825 (total days in 5 years) = $365,000

A policy like this would be quoted at a certain premium based on your age, health and other factors, Costs can be controlled by making the tradeoff of accepting lower daily benefits, lower number of payout years and/or higher elimination (waiting) period. Plans can be further customized, albeit with a higher premium, if you added benefit “riders”. A couple of popular examples include:

Shared Care Option – For married couples, if one spouse needed care and exhausted the benefits of his/her policy, then it’s possible to dip into the benefits of the other spouse. Some carriers may offer discounts for married couples buying policies at the same time.
Inflation Protection – As long-term care benefits may not pay out until the distant future, it’s important to preserve the purchasing power of those benefits. To solve this, carriers typically offer a fixed cost of living adjustment that will increase the nominal dollar amount of your pool of benefits. Examples include compound inflation protection of 5 percent or 3 percent, with of course a higher premium for the former.

Drawbacks of Traditional Long-Term Care Insurance

Premiums are not guaranteed and could rise in the future. Why would premiums rise? Various factors insurance companies use are lower policy lapse rates, higher policy usage rates and cost of care increasing faster than expected. If you’re hit with a premium increase notice, it could create the uncomfortable decision of letting a policy lapse or reducing the benefit.
Premium fatigue is a real possibility. Aside from the just pure cost of the insurance, long-term care events (if they happen at all) tend to be many years into the future. If timely premium payments are not made, your policy can lapse. You need to be in it for the long haul.
Less carriers today offer traditional long-term care insurance compared to hybrids discussed in the next section. The risk here is that it can be harder to find good coverage. If you do find it, you may have to pay a premium in a marketplace that may be getting less competitive.

A Few More Observations about Long-Term Care Insurance

Typically, you would prefer an “Indemnity” to a “Reimbursement” policy. This means if your claim for benefits is approved, you (as policy owner) would get a fixed dollar benefit every month for the duration stated in your contract. A reimbursement policy, however, requires you to submit bills and receipts to get reimbursed.
All else equal, if you’re a woman you will pay more for long-term care insurance than a man of the same age and health status. From the insurance company’s point of view, it’s a fair discrimination. Statistically, women live longer and utilize more years of long-term care service than men.
Even if you want long-term care insurance, there’s no guarantee you can get it. They have stricter medical underwriting standards compared to life insurance, for example. This makes it tricky to answer the question “when should I buy long-term care insurance?”. Ideally, you’d wait as long as possible, but the very nature of aging may lead to your losing eligibility or facing higher costs. Pre-existing conditions become a high bar when trying to qualify for coverage.
If available as an employee benefit, that may be more optimal. Typically, long-term care insurance is purchased in the private marketplace, independent of your work/company. Because most employee benefits lapse upon you leaving that work, it really wouldn’t do much good for something like long-term care protection! However, if you have access to long-term care insurance through your work, it will have to be portable. This means you can continue to have coverage after you leave that employer. I haven’t seen many private companies that offer this. One non-private example is a program offered to active employees of the Federal Government.

Two – Hybrid Life/Long-Term Care Insurance

A hybrid, sometimes called a linked-benefit, policy can be viable alternative to traditional long-term care insurance. More carriers appear to be offering these types of policies today compared to traditional.

The key feature of a hybrid policy is the flexibility. They are designed to provide at least some benefit should you “live, die or quit.”

Live – If you live long enough and end up needing long-term care, hybrids are designed to pay out benefits like a traditional policy described above.
Die – If you die before needing long-term care, a death benefit is paid out to your heirs. The amount is typically at least the amount of premiums you paid in, but it is often a fixed dollar amount that won’t grow over time or keep up with inflation.
Quit – If you choose to surrender your policy in the future, you may be able to recoup most, if not all, the premiums you paid in. You many need to hold the policy for a certain number of years to meet vesting requirements.

Hybrids may also offer some flexibility on how you pay the premiums. For example, they may have guaranteed level premiums and for a fixed term (e.g., 10-years) and then you’re paid up completely. Some hybrids allow you to pay a single large premium upfront then you’re paid up after that. Unlike a traditional policy, you don’t have the uncertainty of dealing with a future premium hike.

One drawback of hybrids is a higher initial premium cost, relative to traditional policies. They are often less customizable than traditional policies. For example, they often wouldn’t have a shared care option for spouses as noted earlier. But they do have inflation protection riders which are usually advisable to have.

Three – Self-Funding for Long-Term Care

For various reasons, you may not want or be able to include insurance in your long-term care planning. It can then help to look at some of the pros and cons of the self-funding approach.

Pros for Self-Funding Long-Term Care

There’s no hard rule that says insurance must be used in your plan to address the long-term care dilemma. You can self-fund and attempt to cover most (if not all) your future long-term care spending from your own assets. Some factors in favor of this approach include:

Potential Higher Legacy Wealth – If it turns out you do not need long-term care, all else equal, your legacy wealth and long-term purchasing power will be higher. Of course, this kind of statement is true for avoiding the purchase of any insurance on an adverse outcome that never occurs!
Family Support – Self-funding may be a superior option if you’re confident one or more family members are willing (and able) to provide for your care. Although you should carefully consider the emotional and financial burden that could place on your family. Some long-term care insurance policies have provisions for family caregivers.
Flexibility – Money not locked into insurance premiums, if not spent, can be used to solidify other areas of your financial plan.

Cons for Self-Funding Long-Term Care

There’s often a behavioral aspect to financial decisions. While you may not like paying insurance premiums (who does?), they do provide somewhat of a forced savings mechanism. If you want to attempt to self-fund for long-term care, consider how the following hurdles might affect you.

Discipline – It takes a certain discipline and patience to save and invest the money you would have otherwise paid in insurance premiums.
Taxes – If you cannot save money in a tax-sheltered way, there can be a “tax-drag” to overcome. For example, this can be exposure to ordinary income and capital gains taxes.
Market Risk – You may have a high expected return on your investments, but those returns are not guaranteed. A long-term care insurance policy, conversely, provides a contractual guarantee for a certain pool of benefit dollars.
The Return Hurdle – Generally, when doing “internal rate of return” (IRR) comparisons, you will likely find that your IRR on a self-directed investment approach is significantly lower than insurance if it turns out you need long-term care benefits at a relatively younger age (say 65 as opposed to 85).

What’s Your Long-Term Care Solution?

Hopefully, this piece has expanded your awareness of the long-term care funding dilemma and provided ideas for how you might approach this in your own financial plan. In the end, there may not be a clear-cut winner between the insurance and self-funding approach. The key is to acknowledge the risk and factor in long-term care expenses in your financial plan. Then you can work on solutions that make sense for you and your family.

If you have comments or questions on this piece, please drop me a line at: [email protected]

References

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