Inflation Protection for LTCI

Know the various options before you sit down with your clients.

By Kirk Okumura

The cost of long-term care has doubled over the last 15 years, increasing by approximately 5 percent per year. Undoubtedly, it will increase in the future. Thus, designing a long-term care insurance (LTCI) plan for your clients requires you to help them assess and put in place an appropriate strategy to guard against the erosive effects of inflation on their maximum daily benefit (MDB). We will look at the various inflation protection options and when they may be most appropriate.

Self-insure: Self-insuring the inflation risk is fraught with many of the same problems as not purchasing LTCI in the first place. Consider an insured, aged 50, who purchases a $100 MDB that reflects 100 percent of the current cost of care. In 30 years, when care is most likely needed, the cost will most likely have quadrupled (assuming a 5 percent rate of inflation). That means that the policy will cover only 25 percent of the cost of needed care.

Purchase additional coverage: Another option is to purchase additional LTCI at a later time. However, this will entail paying an additional, higher premium (because premiums are age-sensitive) as well as facing the risk of being rated or declined. For example, if the client were receiving benefits, he would not be eligible for additional coverage.

Buy “excess” coverage initially: A third strategy is to purchase an MDB amount in excess of the actual current cost of care. While purchasing excess coverage seems to work fine in the short run, it is not typically a good strategy for younger clients. Despite its shortcomings, however, buying excess coverage may work for prospects age 80 or older, since many of these people will not survive more than 10 years.

Future purchase options/guaranteed insurability rider: Some policies offer future purchase options that allow the insureds to periodically increase the amount of the MDB without evidence of insurability. Of course, the corresponding premium for the increase in additional coverage is based on attained-age and is added to the initial premium.

The amount of the increase may be a fixed-dollar amount, such as $20; an amount based on a specified percentage of the MDB; or an amount based on changes in an index, such as the Consumer Price Index. The frequency with which purchase options may be exercised varies by insurer, but typically they are available every one, two or three years. Some insurers have an aggregate limit on the total amount of benefit increases that can be purchased by exercising options or an age beyond which purchase options are no longer available. Failure to exercise an option or a series of options over a specified period of time will typically terminate the right to exercise any future options.

The cost of buying LTCI with future purchase options starts out much lower than the same amount of LTCI with an inflation rider. Over time, however, the total amount of premiums from the LTCI policy with purchase options will increase substantially as options are exercised. Eventually, the total premiums from the policy and the exercised options will surpass the level premium required to buy an LTCI policy with an inflation rider, other things being equal.

Automatic inflators: In most cases, a prefunded “level premium” inflation rider is the best choice for inflation protection. These riders automatically increase the MDB by a specified amount without evidence of insurability and without increasing the initial premium. The one drawback to them is that automatic inflators cost more initially, making affordability an issue.

Inflation riders can either be compound or simple. Affordability issues aside, compound inflators are usually the best and most cost-effective inflation protection strategy. They are arguably a necessity for younger clients. Simple inflators could be a viable strategy for clients 75 and older who have no family history for longevity.

Keep inflation top of mind
As you help your clients meet their long-term care needs, you need to make sure that you help them understand and address the problems posed by inflation. Not properly addressing the inflation problem could potentially cause irreparable damage to your clients’ financial, and consequently, their physical well-being.

Kirk Okumura is an LUTC author and editor. You can contact him at Kirk.Okumura@TheAmericanCollege.edu.