As a faculty member of Massachusetts Continuing Legal Education (MCLE), I was recently asked to speak to a large group of attorneys about the ‘evolution’ of long-term care insurance. Clearly, since the emergence of the ‘modern’ mutual fund in the wake of the Revenue Act of 1978, few financial products have undergone such drastic change in such a short period of time. In fact, coincidental to the request from MCLE regarding the lecture, I had been working on a pilot program for a large national long-term care insurance carrier that would seek to provide other financial options to protect those whom had been declined for ‘traditional’ long-term care insurance. In the long-term care arena, the percentage of declined applicants has reached near epidemic proportion due to the confluence of several different factors—historically low interest rates and incorrect actuarial assumptions regarding lapse ratio (i.e., how many claims would not have to be paid due to death of the insured or discontinuance of premium payments) are chief among them.
Even among those who can medically qualify for long-term care insurance, many have concerns about the potential for future premium increases and cost recovery risk—the possibility of paying a long-term care insurance premium for 30 years and then dropping dead of a heart attack on the 18th green after sinking a 30 foot birdie putt to break 80. In other words, it’s not just all of the premiums paid that could have been redirected elsewhere for those 30 years but also the rate of return that could have been earned on those dollars that generates a healthy amount of reticence among prospective LTCI purchasers.
Fortunately, insurance carriers know that, deep down, you don’t really hate insurance per se, you just hate paying for it. Accordingly, they have created new products and “riders” (i.e., contractual features) on existing products that purport to assuage all of your deepest concerns regarding the cost recovery risk of long-term care protection. However, there are many different types and subtle variations between carrier contracts so it is imperative that you not only educate yourself on the topic but also carefully examine each individual contract to ascertain exactly what is covered—and what is not.
To illustrate, the brief conversation below took place recently with Dale (oral surgeon in his early 60’s) and Denise (attorney in her late 50’s), husband and wife clients of an investment manager (‘Ted’) with whom I’ve been working for the past 6 years. Both clients shared a concern over the future cost of long-term health care and how to protect their assets.
Me: So what is it that keeps you up at night?
Dale: Well, according to Ted, we’re on track for retirement unless we have some major health catastrophe that’s not covered by insurance. In that case, who knows if we’ll be ok financially…
Denise: Also—and I know this really isn’t your area—I’m very pessimistic about the market and Dale’s practice given what’s been happening as a result of the Affordable Care Act. So we’re holding a lot of money in “cash” and we’re getting NO rate of return on it. In fact, we’re actually losing money because the tiny bit of interest we receive from the bank is less than inflation. Ted’s given us some ideas—bond-based investments—but we’re concerned about interest rates increasing. Ted says that bonds could lose value in that case if we don’t want to hold them to maturity and that worries us because who knows when we’ll need that money.
Me: Have you looked at traditional long-term care insurance to address your first concern?
Denise: Yes. But, we feel that it’s too expensive. Plus, what if we never use the benefit? All that money gone… I don’t even think Dale will qualify for long-term care given his arthritis. And, although we like the idea of having the financial ability to receive care at home, all of the policies we looked at won’t pay for a family member to take care of us because they’re not “professionals” when it comes to caregiving. Given that our daughters live close by and they’d be taking time off from work to take care of us, it would be nice to be able to pay them from long-term care insurance dollars.
Me: I understand. Are you familiar with concept of asset-based long-term care insurance? In other words, you could reposition a lump sum of cash into a single-pay life insurance policy. If you ever became unable to perform 2 out of 6 Activities of Daily Living (ADLs), the policy death benefit could be used during life to deal with the additional costs that long-term care brings.
Dale: We did look at that product. For us, we thought it was a good option at first glance. But, it didn’t look like there was any possibility that we’d get any rate of return at all on our money. It would just remain the same amount we contributed. So, in effect, the rate of return we’d be giving up (presuming we could get a rate of return somewhere else) was the real cost to that product if we needed all the money back during a tough time and never needed the long-term care insurance protection.
Denise: Right. Plus, we were told that Dale wouldn’t qualify from a health standpoint so it was never really a viable option for him.
Me: There are a couple of different carriers that offer ‘asset-based’ contracts that are similar to the one you just described. However, the major difference is that each of these contracts provides you with the potential for a rate of return on your money (based on a percentage of the stock market return on a year-to-year basis) with no risk of loss.
Denise: So we can get a potential rate of return on our cash but with an ability to get our money back with no risk of loss. Sounds great.
Dale: Sounds too good to be true.
Me: Yes, I get that a lot. I can review the details of the contract with you and show you an illustration so you can make an educated decision on whether it’s appropriate for you.
Denise: What about the long-term care concern? How does it help us there?
Me: Well, similar to the other ‘single-payment’ contract you looked at, this one gives you an ability to accelerate the death benefit in the event that you cannot perform 2 out of 6 ADLs permanently. The difference is that this is not a true long-term care rider. Instead, it is a chronic illness rider.
Dale: What’s the difference?
Me: Long-term care insurance is technically classified as health insurance. So, the underwriting is different. It is underwritten for Morbidity—the probability that you’ll be unable to perform 2 out of 6 Activities of Daily Living (eating, bathing, transferring from a bed to a chair etc.) for at least 90 days during your lifetime. Conversely, a chronic illness rider on a base life insurance contract enables the owner to accelerate (i.e. to take during life) the death benefit if the insured cannot perform 2 out of 6 ADLs permanently. The benefit is not underwritten for Morbidity; only Mortality as are all other life insurance contracts.
Denise: So, a condition like Dale’s arthritis—because it is not a Mortality risk—wouldn’t preclude him from qualifying for a chronic illness rider, right?
Me: Correct. Incidentally, for that same reason, with certain carriers, I’ve actually obtained this rider for clients with Parkinsons, MS and other conditions that don’t necessarily affect mortality.
Dale: OK. So what’s the cost for the chronic illness rider relative to long-term care insurance?
Me: There is no additional cost to a chronic illness rider.
Dale: What’s the catch then?
Me: Well, with the majority of policies, when you use the death benefit during life, the total death benefit is reduced because you’re taking it today instead of at death. In other words, it’s the present value of your future death benefit. The amount of reduction—as you might have guessed—decreases as you get older with most policies as well.
Denise: What about the policy that you mentioned for us? The one that can give us a rate of return on our cash with the ability to get it back anytime we want? Is there a reduction on that one?
Me: Yes, but only if you take it in a lump sum. If so, there’s a reduction of between 15-25% depending on whether you’re being cared for at home or in a nursing home. However, if you are getting care at home, you can take the entire death benefit—with no reduction—over a 60 month period. And, the rate of return on your lump sum premium will be driven by the S&P 500 Index with no risk of principal loss. You won’t receive all of the S&P return, but I’ve had clients return over 9% during the course of the year.
Dale: That sounds perfect for us.
Me: OK. Let’s get started.