Should young people self-insure against the risk of needing long-term care later in life, or should they buy insurance?
In a Feb 13 Wall Street Journal commentary (behind a pay wall), Manisha Thakor, chief executive of Santa Fe, N.M.- based MoneyZen Wealth Management LLC, argued they should self-insure. “By taking the money you would have put in long-term-care premiums and investing them in a low cost 60/40 balanced index fund, you can create your own pool of funds to draw on down the road if need be–and avoid the dreaded “claim denied” scenario,” she wrote.
To see if her advice makes sense, first look at the risk: The odds that a 65 year old will need no care at all before death are about one in three, while about one in five will need care for five years or more. The cost of nursing home care today is about $80,000-a-year. Home health care can cost about $35,000.
Now, imagine you are age 35. You can buy a decent LTC policy that pays $200/day for 3 years with a rider that increases benefits by 4 percent-a-year to protect against inflation for about $65/month. That’s equal to a benefit of about $219,000 in today’s dollars.
Now assume instead that each month you invest that $65 in a lifecycle mutual fund that holds 60 percent stocks and 40 percent bonds. Let’s say the long-term rate of return will be 6 percent (that’s more conservative than some think, but the days of 8 percent annual returns are probably over). Further assume you won’t need long-term care until you are 85, so you’ll have 50 years of compounding. At age 85, you’ll have roughly $230,000.
And there are other advantages to self-insuring. That $65/month premium will surely increase over the next half century. In a recent interview, the CEO of LTC insurance giant Genworth figured annual increases of 2-5 percent are not unreasonable. There is also the question of whether your carrier will still be in business in 2064 and what happens if it is not.
Plus, of course, if you don’t need costly supports and services before you die, you (or your heirs) get to keep the money.
So, it’s a no-brainer, right? The best course for a 35-year-old is to self-insure.
Not so fast. The numbers can work, but only if you have the discipline to invest that $65 every month for the next 600 months. Through illness, kids, and job loss. And remember, that $65 is on top of all other savings you’ll need—for a house, the kids’ college, and the rest of your retirement. Don’t fool yourself, it takes a lot of discipline. Insurance forces you to save.
And there’s more. The rising cost of long-term care will eat up that $230,000 pretty quickly. Today, it may cover 2 or 3 years of care. Five decades from now, it will cover you for only a fraction of that time. Good insurance could protect against inflation.
And what happens if you need care for, say, 10 years? Very few of us can save enough to pay for a decade of care—which could easily exceed $1 million.
Finally, there is the risk of needing long-term supports and services at a young age. The chances are relatively low (though data for disability before age 65 are notoriously unreliable). But if you suffer a catastrophic injury at, say 40, you may need costly personal assistance for decades—and you will only have had five years to save.
So what is the right answer? Ideally, middle- and upper-income people would save enough to pay for the first year or two of care, and insure against truly catastrophic long-term care costs. But few of us have either the income or the discipline to do that. And it is effectively impossible to buy long-term care insurance to cover more than 5 years of care.
So what most people face is an impossible choice. Realistically, most won’t save for their long-term care needs despite Ms. Thakor’s advice (many won’t even save enough for healthy retirement). Yet, they won’t buy LTC insurance either, and for the most part can’t buy catastrophic coverage even if they want to. That means yet another generation unprepared and likely with nowhere to turn but Medicaid.