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.
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