2005-02-10 / Business & Finance

Learning The Real Cost Of Long-Term Care Facilities

I had some clients in the office last week that received a recommendation to buy long-term care insurance policies. They asked for my opinion. I said to them, “It is not my decision to make; it is yours. My job is to give you good information with which to make good decisions.” So I ran two scenarios for them.

I’ll refer to the clients as John, age 67 and Mary, age 65. John retired in 1998 from a large international company. Their income consists of a pension of $28,000, Social Security of $20,000 and approximately $34,000 from investments. In addition, he holds some muni bonds and investment real estate. When we added his 401(k) of $530,000, their house at $475,000 and all their other assets and subtracting a small loan of $7,750, we arrived at a net worth of $1,727,000.

Since they live a modest lifestyle, they don’t have to withdraw any mo-ney from their assets. In fact, they are still depositing about $15,000 into their investment accounts because their in-come is $82,000 and their expenses are $67,000. If they continue on the same path and they live to age 90, their estates will grow to $4,760,469.

Unlike most folks, these people don’t need long-term care insurance because they won’t run out of their own money if they were to go into a facility for several years. They can afford to self-insure a long-term care stay. The question is should they?

Now we are down to the basics of insurance. As I recall from my CERTIFIED FINANCIAL PLANNER(tm) practitioner textbooks, one should hold risks that they can afford and ship off to an insurance carrier those they cannot. This is usually done through deductibles and co-insurance. Let’s look at an indemnity medical insurance policy as an example.

Let’s say you start with a deducti-ble of $500, which means you pay the first $500 of any medical costs. Then, there is the co-insurance. Of the next $5,000, you pay 20% and the insurance company pays 80%. Should you need the benefit, this would cost you $1,000 (20% of $5,000) and the insurance company would pay $4,000 (80% of $5,000). Any expenses above $5,000 would be completely paid for by the insurance carrier. With this type of policy your maximum annual exposure is $1,500.

Long-term care insurance works a little differently. Instead of a deductible, you have a waiting period during which no benefits are paid. Typically, you have waiting periods of 30, 60, or 90 days, although most contracts can go out two years. This is the “deducti-ble” of long-term care insurance.

The next item is the amount of money you will receive as a daily benefit should you require a facility. With the annual cost of a facility in this geographic area weighing in around $70,000, fully ensuring the cost would require you to buy a daily benefit of $200. However, if you wanted to re-duce the annual premium you could self-insure some of the cost and purchase a lesser daily benefit, perhaps $150 per day.

Your next decision is: How long are the benefits paid? At the low end, you can buy two years of coverage. For a higher premium, you could in-sure five years of coverage, or if you have a lot of longevity in your family, you might want to spend the money to insure a lifetime benefit. There are other benefits that you might want to consider, e.g., an inflation rider, home

benefits and others depending on your situation.

The projections I ran for John and Mary are as follows: If one of them went into a facility for five years at the age of 70, assuming an inflation factor of 3%, the first year of care would cost $98,106; the fifth year would be $110,419. The total cost would be $521,152; however, this does not tell the whole story.

As noted above, we projected their net worth at age 90 to be $4,760,469. The projected net worth that included the long-term stay was only $3,429,833. The difference is $1,330,636. How can that be? The cost of the long-term care facility was only $521,152. The difference, $809,484, is a result of the earnings loss on the $521,152 over their lifetimes. It may be astonishing, but it is true and we used reasonable assumptions of earnings, i.e., 2% on savings accounts, 5% on bonds and 8% on stocks. (The explanation is com-pounding.)

The annual cost for long-term care insurance policies for John and Mary is about $5,000. We’ve just seen the result of a five-year stay that, of course, could be shorter or longer. Should they buy long-term care insurance?

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