For most people, a successful retirement means finding a way to ensure their money outlasts them. Achieving this goal is usually done by saving enough money and then creating a practical and sustainable budget. Unexpected and unplanned costs can jeopardize this, so it’s important to have the right insurance to provide protection against the unknown. One type that’s changed in recent years is long-term care insurance (LTCi). There are different LTCi options available today, and it can seem overwhelming when trying to find the right fit. This article introduces the different types of LTCi.
Let’s start with a quick definition of what long-term care is and how LTCi works. An individual may need care if they have a physical illness, disability or cognitive impairment for a prolonged amount of time that prevents them from caring for themselves. When a person can’t provide self-care, it means they’re unable to carry out basic tasks known as activities of daily living (ADLs): bathing, dressing, eating, continence, toileting and transferring. An LTCi policy provides benefits if the person can’t perform two of the ADLs and/or they have a cognitive impairment (such as Alzheimer’s Disease).
Some key factors that apply to LTCi policies are:
- Elimination period: This is the waiting period before the insurance benefits kick in, which is typically 30, 60, 90, 180 or 365 days. During this period, other assets or resources are needed to provide care. The shorter the elimination period, the higher the premium.
- Benefit amount: An LTCi policy pays a maximum amount on a daily or monthly basis. (i.e., $150/day). Long-term care costs vary by geographic region, so it’s important to know how much it costs in your area. Higher benefits mean higher premiums.
- Age: Younger and healthier people have lower rates.
- Reimbursement vs. indemnity: Some LTCi policies reimburse based on the actual expenses that are incurred. Other LTCi policies are an indemnity plan which pays a monthly cash benefit, regardless of the exact amount of expenses.
- Inflation options: Some LTCi policies offer protection against rising costs by increasing the benefit by a set amount each year. Typical inflation protection rates are 3% or 5% compounding or non-compounding interest.
Traditional Long-Term Care Insurance
Traditional LTCi is the most common type of LTCi. Typically, traditional LTCi policies are specifically designed to provide long-term care benefits, premiums are paid for life and the premiums are not guaranteed to stay the same. This means the premiums may rise after the policy is purchased. If the policy is not used for long-term care services or if you stop paying the premium, you will not receive a refund or any sort of benefit. Over the past few years, we have seen people choose to discontinue their traditional LTCi policies because premiums have increased 10%, 20% or 30%, making the policy unattractive and in some cases unaffordable. If a policy was established 10 years ago, that’s 10 years’ worth of premium payments that are now a sunk cost.
Hybrid Annuity with Long-Term Care Insurance
Annuities have been around for a several years, but tying LTCi to an annuity is relatively new. A hybrid annuity with LTCi is a fixed deferred annuity that offers an LTCi benefit that’s a multiple of the single premium. In other words, the amount that you initially put into the annuity can be multiplied to determine the amount of your LTCi benefit. The multiple is predetermined by the insurance company when the policy is first issued, and it’s commonly 3x, 4x or 5x.
Initial single premium x Multiple = LTCi benefit
$100,000 x 3 = $300,000 in long-term care insurance
If the LTCi benefit ($300,000 in Example 1) is needed, it’s paid out on a monthly basis to the insured. This means you could leverage $100,000 and turn it into $300,000 worth of LTCi. Alternatively, if long-term care is never needed, the original $100,000 can be left to your estate as a death benefit, or the policy could be cancelled and you could receive the $100,000 back. Also, since the initial premium is a one-time event, there’s no chance of unexpected rising premiums in the future.
Hybrid Life Insurance with Long-Term Care Insurance
Combining life insurance with long-term care is similar to the hybrid annuity, with some key differences. Like the annuity, a hybrid life insurance policy offers a way to increase the amount available for long-term care while still offering a death benefit to your heirs. One major difference is how the monthly long-term care benefit amount is determined. This is done by calculating a percentage of the death benefit defined by the life insurance. For our example, we’ll use 2%.
Initial Single Premium = $100,000 | Death Benefit = $305,243| Long-Term Care Benefit = 2%
$305,243 x 2% = $6,105 in monthly long-term care insurance
In Example 2, a $100,000 initial premium could provide a death benefit of $305,243 or $6,105/month of LTCi. If this policy was written to provide long-term care benefits for 5 years, that means the potential LTCi benefit is $366,300 ($6,105 x 12 months x 5 years).
Another major difference is how premiums are paid. In Example 2, we assumed the $100,000 premium was done once as a single amount. Unlike hybrid annuities, though, premiums into hybrid life policies can be made over time. This means payments do not need to be done all at once, which can make the hybrid life policy more attractive to someone who doesn’t have a large lump sum readily available.
It’s also important to note that a hybrid life insurance policy requires an applicant to go through underwriting. This means someone with pre-existing health concerns may be denied when applying for this type of insurance. If this is a concern, the hybrid annuity may be a better option.
The chart below illustrates the similarities and differences between the three types of LTCi.
As with all insurance-based decisions, it’s best to talk through your options with a professional. Here at Merriman, we do not sell insurance, but we do work with our clients to make sure their wealth management plan addresses long-term care. For some, the best option may be to self-insure by having adequate savings and resources. For others, it may be a combination of self-insuring and obtaining the right type of LTCi. If you’d like to learn more about how to put together a comprehensive wealth management plan, please feel free to contact us and set up a time to meet with one of our Wealth Advisors.