Long-Term Care and Premium Risk
A question has been asked: How do you address the risk of a Long-Term Care premium cost going unused and the expense eating into your assets?
Well, let’s start with the fact that some risk of dying with unused but paid-for assets is often unavoidable. But this area of financial planning is different from our other products in its pushback by clients, in cost, “risk”, and reasoning.
The “risk” that Long-Term Care policies cover is the cost of enormously expensive healthcare destroying an individual’s or family’s savings if the need arises. Statistically, 7 out of 10 people will need some form or level of that kind of care after the age of 65. Paying for the coverage, just in case, is discussed further here.
Long-Term Care (LTC) insurance, similar to the policies we know today, came to be in 1974 and was poorly priced from the start. Why? The insurance policies we are familiar with, Life, Auto, etc. are priced based on the insurer’s experience with such policies. With the early LTC policies, there were no direct records, so the issuers used what seemed reasonable comparisons. Data from Life, Health, Auto, and whatever was available was used to create a pricing strategy.
Two very important factors the issuers misjudged were 1) the cost of healthcare and its eventual increases, and 2) the “lapse” rate. A “lapse” is the closing of a policy, for any reason. It might be death of the insured, unaffordability, or simply forgetting to pay a required premium.
If you’ll allow me to generalize here, it seems there are two prominent types of individuals that we see when discussing financial planning in the context of the LTC coverage: those that consider it an important risk management tool for their later years, and those that don’t.
Those in the second group, in my opinion, are often unable or unwilling to envision, or admit to, their own possible human frailties in old age. “No, my dad lived to be 114…in fact he’s still driving to Mt Rushmore annually…so, I’ll be fine.” Of course, sometimes it’s affordability or “risk” of never using the thing that is costly but be aware of the unwilling-to-admit thing.
The information above applies to “traditional, stand-alone policies” (TSAP) that are a single purpose item: to pay for care if the insured cannot perform 2 out of 6 activities of daily living. Those 6 are: Bathing, Dressing, Toileting, Transferring, Continence, and Feeding. Additionally, Dementia is an automatic trigger for coverage/care. Keep in mind: the TSAP is a financial risk management tool.
With the TSAP, more history is important to understand. Due to the initial lack of insights for pricing, and as the issuers gained experience, premiums increased, not only on new policies, but on established policies as well.
Key point: when an issuer wants to sell some form of insurance in any of the states, the issuer must obtain approval from that state’s insurance department regulators. The “book of business” (the specific series of product) must be explained in full with features, formulas, and pricing; sometimes changes are requested by those regulators. TSAPs are different from most other insurance in that the issuer reserves the right to, later, increase premiums on established policies (with state regulator’s approval).
Based on experience of claims and cost of care on a book of business (a sold series of policies from the past), an insurance carrier/issuer might ask a state’s regulators for approval to increase premiums by some percentage (e.g., 60%). In the context of increases, the issuer will lay out how holders of those policies might decrease the policy’s size or features to avoid some of the increase. The regulators might push back with a lower percentage and/or require the increase to take effect, in steps, over a few years. In the past many companies expected lapses to occur as premium increases on old policies were introduced.
Remember that first group mentioned above? “Those that consider it an important risk management tool for their later years.” The importance of this was that as premium increases were announced, fewer policies than the issuers expected were dropped. This meant that the company’s exposure to claims and costs went beyond expectations; this has been a continuing factor in price increases (premiums) over time.
Why would regulators allow LTC premium increases? Think Medicaid.
Medicare and Medicaid were created through an amendment to a Social Security Administration (SSA) law from 1965. The importance of Medicaid lies here: while the federal government has an overall control over Medicaid, the states get funding from the fed, then the states both design and administer their programs within federal rules.
There exists a potential problem in each state, to varying degrees: running out of Medicaid money.
Many people are under the impression that, in old age, Medicare will provide for LTC. It will not. Medicare is for “acute care,” something you will heal from (e.g., broken arm or appendicitis). Medicaid is intended for “chronic care,” something that will continue for a prolonged or for-life period. So, why not just use Medicaid for LTC?
To have Medicaid pay an individual’s LTC bills, that individual must qualify beyond the medical aspect and into the financial. The rules for “qualification” for Medicaid funding are almost the same in all 50 states: you must be “indigent,” aka poor. If you have wealth, a relative term, you do not qualify. I will not go into the rules here, but the point is that the states would rather individuals use their own money to pay for LTC, not drain the reserves of the state.
Point: an entire section of the legal industry is dedicated to “Eldercare” as attorneys work with how to qualify for Medicaid.
So, what to do?
Remember the poor policy pricing in the early years? As the reality of increasing care costs and policy mispricing appeared, many issuers, plentiful in the 90’s and early 2000’s, dropped out of the business of selling new TSAP policies as profitability proved tough to achieve. Today, there are few left.
State regulators know providing LTC policies for the state’s citizens requires insurance companies (issuers) to sell them. For companies to provide policies, they must see the possibility for profits in their LTC business. So, regulators have generally accepted increasing premiums on established older policies as a necessary evil with the issuer’s continuing business in mind.
To be clear, experience has driven pricing strategy adjustments and with the few issuers left, new premiums today are higher than in the past, inflation notwithstanding.
Again, there are still some providers of traditional stand-alone policies (TSAP). Premiums are viewed as a major cost by many potential customers. Of course, if the customer/insured makes a claim and care is provided through the policy, those premiums are viewed as money well spent. However, the issuer is always at some risk, even with the higher premiums today, as the profit margin on this business is thin, and the cost of care is difficult to control.
What did the Insurance Industry do?
Many life insurance providers added LTC or Chronic Care riders (an “add-on”) to “permanent” life insurance. In simple terms, the rider allows for accessing part of the (eventual) death benefit to pay healthcare bills if the insured qualifies, using the “2 out of 6 activities…” or dementia test. Some riders require “permanence” of the health issue(s), some allow for recovery. This approach decreased a company’s risk as the eventual death claim was more a certainty and carried a higher certainty of cost.
How does that affect a customer considering purchase?
The purchase of permanent life insurance carries a higher premium than a TSAP as there is the additional cost of life insurance, however the insured can see a recovery of premium over the years through cash value accumulation in that life policy. If the insured dies, the family/beneficiary will see a payout through the death benefit, again recovering costs.
Further, the specific cost of the LTC or Chronic rider is quite low in comparison to TSAP. Of course, the type of permanent life insurance carries its own attributes beyond the LTC aspect. This approach does require further explanation but not here.
Two additional points: 1) TSAPs often offer a “return of premium rider” that can provide some reimbursement of the premiums in certain circumstances, but that is a nuance specific to a given policy/company. 2) Single-premium Universal Life (UL) policies are sometimes used for the LTC rider; no further comment there, but multi-premium Universal Life Insurance policies are a massive risk as the policies are subject to increasing cost as described here:
https://82financial.com/blog/2023/7/4/why-i-will-not-sell-universal-life-insurance
I prefer “Participating Whole Life Insurance” for the task of covering LTC (with a rider) as there are growth guarantees, and through that feature, I know the policy will be there for me if I need LTC. Where the policy design carries risk of lapse (e.g., UL), that risk is not only loss of a life insurance benefit, but also loss of LTC.
One last point: an LTC policy or Life with rider policy does not have to be all-or-none. Partial coverage does help mitigate the risk of cost of care when the need arises.
Need more info? Please let me know.