Broker Check

Strategy Needed to Deal With Increases to Long-term Care Insurance


by Darren L. Zagarola, CFP®, CPA, PFS

As published on Princeton.Patch.com, May 13, 2013

Long-term care (LTC) insurance, like most insurance, is a gamble for both the insured and the insurer. As explained in my Sept. 27, 2012 post, LTC services provide custodial care for those unable to perform the basic activities of daily living. It is custodial care, not medical care. For the insured, the risk is the cost of premium payments versus the cost of future care needed. Basically, by receiving payment of an annual premium, the insurance company accepts the risk of paying for the insured's future care up to an agreed-upon value (daily or monthly benefit) for an agreed-upon length of time (benefit period).

For example, an insured individual pays the insurer $100,000 in premiums over 20 years and never uses the policy. Conversely, another person may decide to accept an increased level of risk by saving the premium outlays – the $100,000 -- only to use a larger portion of his retirement nest egg to pay for care in retirement. For the insurer, the gamble is whether the premiums received today can pay for tomorrow's covered costs. The insurer accepts the risk, hoping that the cost of the premium is more than the cost of the healthcare the insured will need over the life of the policy.

However, the insurer has one significant advantage: The insurer can request somewhat of a “do over.” In recent meetings, clients informed us they received notifications of premium increases for long-term care policies they have held for a number of years. The increases are significant, some being more than 40 percent. Clients first ask, “How can they do this to us?” and then ask “What should we do?”

Answering “How can they do this to us?”

The answer to the first question is that insurance companies are not doing it to “you.” They can't do so arbitrarily. LTC rates are based on three basic forecasts: interest rate and investment return estimates, healthcare cost estimates, and an estimate of how many policies will lapse over time. The premiums of an LTC policy are guaranteed renewable, so as long as the policy remains in good standing -- meaning the insured continues to pay the premium -- the insurance company must maintain current coverage. To raise rates, insurance companies must request an increase from the state's Department of Insurance for an entire class of policies (not just yours) by claiming it made a mistake when these policies were issued. For example, they can request a premium increase for all policies granted during a certain period of time. If the state's Department of Insurance approves, then all insured individuals who obtained a policy in that period will receive notice of a premium increase.

Several factors have combined to create the perfect storm that has caused some insurers to leave the industry and others to request increases.

The Great Recession and subsequent government and Federal Reserve Board actions to kick start the economy triggered a long period of low interest rates and low investment returns. This impacts the pool of money set aside by the insurers. Premium payments received are invested in fixed income investment products to be available for future expected costs. In the current record low interest rate environment, the actual growth for these premiums has not met original forecasts.

Healthcare costs continue to increase significantly.

The number of people using their LTC policies is greater than anticipated as the population ages and overall healthcare improves, thus extending life expectancies.

These three issues mean that there is not enough growth of the assets collected and there are more-than-expected outflows of payments on existing policies. Keep in mind, these approved increases are only allowed for adjusted future expectations; they are not allowed to make up for prior losses.

Answering “What should we do?”

The answer to the second question, “What should we do?” depends on the options presented by the insurer. A small piece of good news here: The insurer typically offers several options in the letter discussing the increased premiums. The first two choices are simple: Pay the new policy premiums or cancel the policy. Although simple in that it's a yes/no answer, the decision is far from black and white. Other options offer the current premium to be maintained by reducing a certain aspect of coverage, such as adjusting the daily/monthly benefit, inflation rider or benefit period. Let's look at these options from a financial standpoint:

Maintain current policy coverage with inflated premium. If individuals have sufficient income and assets to meet their current needs, they may pay the increased premium amount and maintain the coverage originally deemed appropriate. Remember, even though the premium increase is significant, it will be less than the premium for a new policy with the same benefits. Under this option, the risk remains with the insurer.

Terminate coverage. This seems drastic and an unlikely choice for those who have made LTC a part of their financial plans. Coverage was purchased to meet a financial goal and most likely that coverage is still needed. Terminating the coverage transfers the risk of long-term care back to you.

Reduce the daily benefit. When the LTC policy was purchased, a daily or monthly benefit -- the amount of dollars the insurer will provide for your care – was chosen. For example, let's say a $150 daily benefit or $4,500 monthly benefit was chosen by the insured. The insurer will pay the LTC facility that amount for care when needed. Most people select a daily/monthly benefit amount equal to the average cost of care in their local area. The insurer will offer to maintain the current premium if the policy holder decreases the daily benefit. In this instance, it means accepting a slightly higher level of risk, but most of the risk remains with the insurer.

Reduce the benefit period. Similar to the daily/monthly benefit, when an LTC policy is purchased, a benefit period or length of time is chosen. This is typically a period of years, between three and five, for which the insurer will cover the insured's LTC costs. The average length of stay in an LTC facility is less than three years, although it continues to increase. The insurer will offer to maintain an individual's current premium if the benefit period is decreased. Again, the individual accepts a slightly higher level of risk, but most of the risk remains with the insurer.

Reduce the inflation rider. Most LTC coverage includes an inflation rider, which increases the daily/monthly benefit amount by a certain percentage on an annual basis. The typical inflation rider is five percent. Given rising health care costs, an inflation rider is recommended for most policies. The insurer will maintain the insured's current premium if the inflation rider is decreased.

Although receiving a notification of an increase in long-term care premiums is unpleasant, we advise you to avoid cutting off your financial planning nose to spite your face. The key is understanding the new choices offered and how they impact plans for your financial future. Analyze the situation similarly to when the insurance was first obtained. Based on your individual family health history and financial situation, and given an understanding of the cost of care in your area, modify the policy choices to ensure that your financial plans remain on track.