When it comes to Long Term Care “Should You Buy Inflation
Protection Insurance?”
Should you buy inflation protection for long-term care insurance?
Absolutely. In fact, if you don’t think you can afford that extra coverage, you
should probably rethink whether you should buy the insurance at all.
The issue of inflation
protection was just one of the subjects that I, along with financial adviser
Michael Kitces and insurance industry spokesman Jesse Slome, discussed on a
Wall Street Journal webcast on Monday. The Journal’s Anne Tergesen wrote a nice
article this week that also touched on the inflation issue.
There is a reasonable debate
about how much additional coverage you should buy, but there is no doubt that
nearly everyone should buy some. Here are just some reasons why:
Typically, buyers of long-term
care insurance are in their 50s or early 60s. But you probably won’t need
substantial help with daily living until you are in your 80s. That means the
cost of long-term services and supports—whether you receive care at home, in a
nursing home, or in some other setting--will rise year after year for thirty
years before you ever collect benefits.
As a result, what looks like a
pretty good benefit today will be worth far less when you eventually make a
claim.
How much less? Say you buy a
three year policy that promises to pay $150-a-day (a bit more generous than a
typical policy). Today, according to the latest survey of long-term care costs
by ltc insurer Genworth, a private room in a nursing home averages $240-a-day,
or nearly $88,000-a-year. Your $150-a-day policy would cover 58 percent of the
cost and you’ll pick up the additional $90 out of savings or retirement income.
that might be manageable. But
if inflation averages 3 percent a year (the long-term average for the overall
economy), in 30 years the purchasing power of that $150 will shrink to less
than $62. Or to put it another way, that $240 daily cost of a nursing home bed
would increase to $582. However you prefer to think about it, your insurance
would cover only about one-quarter of your daily costs instead of nearly 60 percent.
It is true that inflation will
also increase the size of your nest egg (in nominal dollars), but will you have
the resources to pick up the difference?
Of course, there is no way to
predict increases in long-term care costs over the next 30 years. The Genworth
study and others like it provide some useful information but also can be
misleading.
Here's one problem: Genworth
reports that the median cost for that private nursing home room increased by an
annual average of 4.19 percent over the past five years. But that was a period
when we were slowly climbing out of the worst recession since the 1920s and
many measures of inflation, including labor costs, remained stagnant. Thus, I’d
be very careful about using the last five years to predict the next 30.
The study also found that the
cost of home health aides rose very slowly over the past five years, only about
1.32 percent. But again, be warned. As more people age at home, the demand for
home care workers is likely to explode and as a result costs could go up a lot
faster in the future.
Buying inflation protection
isn’t cheap. It can easily increase your premiums by 50 to 100 percent. But if
you don’t think you can afford it, you might want to reconsider whether you
should buy at all.
Unfortunately, you’ll be faced
with a mind-numbing set of choices. A policy may offer 3, 4, or 5 percent
annual inflation protection, or an increase tied to the Consumer Price Index.
You also may have to choose between compound or simple inflation coverage. The
differences may seem small but over 30 years they’ll add up.
Finally, you may be offered an
alternative called a future purchase or guaranteed purchase option (to further
complicate matters the industry often just uses the initials FPO). Unlike automatic
inflation protection, this option won't automatically increase your benefit but
instead it will allow you to buy more coverage at regular intervals as you age.
But remember, as you boost benefits you’ll pay higher premiums. While this
option may mask the true cost of insurance by reducing the initial price, you
could end up paying more over time than if you bought inflation protection
up-front.
So what should you do? Like so
much in the world of long-term care insurance, much depends on your tolerance
for risk and your overall financial situation. But I’d get a minimum of 3
percent compound inflation coverage and even more if you can afford it.