Life is filled with risks. While stock market, economic, or political risk is widely discussed in the press, there are other risks that financial advisors and clients must consider. One of the biggest and most uncertain risks has to do with the future high-cost medical care that is not covered by insurance. This is the care you may need if you have a prolonged physical illness, disability, or severe cognitive impairment. These limitations can prevent you from performing basic activities such as bathing, dressing, and eating. Help for these types of needs is called long-term care and can result in the biggest expense shock a retiree can face.
Long-term care costs cannot be predicted because our life expectancy and health is uncertain. Most of us know family members that needed very little or no long-term care assistance. At the same time, we probably know others that have spent hundreds of thousands of dollars or even drained all of their assets to pay for long-term care costs. It is hard to estimate what long-term care will cost you, and it is also easy to justify never needing long-term care services. Estimating long-term care costs is difficult, not only due to the uncertainty of our future, but also because long-term care services are very diverse (i.e., long-term care is much more than just nursing home care). Ideally, you would know the cost of different potential services, and then try to estimate these costs with your advisor based upon your own potential need.
The chart above is a hypothetical illustration of how your lifestyle expenses (in red) and long-term care expenses (in blue) may be visualized over time beginning at age 70. This can be done using information about your current and anticipated lifestyle and after discussing the type of care you may need based on your life expectancy, family history, and preferences for care. As you can see, the basic lifestyle expenses start high and drop over time as you become more sedentary and especially once you begin in-home care. Then we can see an even larger drop at the time assisted living begins (because it is assumed you sell your home and these home related expenses drop away). Notice how the long-term medical expenses begin at age 88 with in-home care, then move to assisted living, and finally nursing care.
Of course, because all of this is highly uncertain, things may unfold differently as shown below where you follow the same progression but require far more high cost nursing care:
Finally, you may need very little care at the end of your life as shown below.
You may want to believe that the scenario above (very little care) will apply to you and you may be right. According to what is considered the most rigorous research on long-term care incidence, Peter Kemper, Harriett L. Komisar, and Lisa Alecxih show that 42% of men and 21% of women will require no long-term care. However, the affluent (like our clients) will likely have a higher incidence of need due to a healthy lifestyle and longer life expectancy than the averages.
Once the expenses are illustrated, they can be used in our financial security modeling software to see if the odds are high that you can pay for this without running out of money. If everyone is comfortable with the estimates and results, then self-funding may be the plan.
LONG-TERM CARE INSURANCE (LTCI)
The million-dollar question is: how much of the blue area in the graphs (long-term medical care) do you want to insure away? Long-term care insurance is purchased to remove some or all of these largely uncertain medical costs, to protect assets, or to provide peace of mind. Naturally, you are trading an uncertain and potentially large risk (i.e., LTC) for a series of smaller more certain risks (i.e., the premium)!
As you can see below, this hypothetical client elected to buy insurance and insure away a majority of the long-term care costs. The blue area below contains both the LTCI premiums and the now reduced long-term care costs. It is not eliminated, because they elected to insure only a portion of the costs. By electing to buy LTCI, they have created much more certainty about their financial future.
Should You Buy LTCI?
There are general rules of thumb such as only buy LTCI if your liquid net worth is above $400,000 and below about $1.5 million. The truth is you need to consider your circumstances, potential need/costs, and ability to afford the premiums. Most clients are able to self-insure when we build their expected LTC costs into their retirement model (similar to above). At the same time, since they can afford to self-insure, they can also afford the LTCI premiums. In other words, it is really just a choice about the amount of risk to retain versus the peace of mind of insuring the risk away.
In short, purchasing LTCI is a very personal decision driven primarily by your ability and desire to self-insure. Each individual or family must look at the risks, costs and benefits, and then determine if LTCI would be a more palatable way to pay for these uncertain medical costs, and some peace of mind in the process.