A comprehensive approach to analyzing your client's long-term care costs - Part Three

If you haven't read the first two parts of this blog, please do so before reading this final installment.


How do you know if you have properly prepared your client for the contingency of future long-term care costs? 

The best way to answer this is to answer the more general, more important question:  Is your client satisfied with the chances that your retirement goals will be reached (including the all-important goal of not outliving your assets), taking into account his/her range of future costs of long-term care? 

To answer this question, it is necessary to combine the desired goals, with the range of costs of long-term care and with the following strategies and balance sheet items:

1. Spending strategy.  What is your client's planned spending for living expenses, vacations, new cars, etc.?  Include medical costs and prescription drug costs (Jack P Paul Actuary, LLC can assist in planning for these two items).
2. Investment strategy.  This includes, but isn't limited to the composition of the client's initial investment portfolio, the anticipated reinvestment/disinvestment of cash flows, the mix of qualified vs. non-qualified assets, and rebalancing strategies.
3. Insurance strategies.  Should there be a purchase of long-term care insurance?  Perhaps an annuity with a long-term care rider?  What about prescription drug plans?  Longevity annuities?  (Again, Jack P Paul Actuary, LLC can assist in determining appropriate insurance strategies).
4. Long-term care Plan of care strategy.  This was discussed in Part One of this blog.
5. Tax strategies.  When to take certain income, deductions, capital gains/losses are active decisions that should be incorporated into this analysis.  Other tax strategies are embedded in the investment strategy, such as when to use qualified vs. non-qualified assets and the tax implications of using one mutual fund vs another.
6. Existing and Future income.  Including earned income and income not included in the investment strategy.  This often includes decisions as to when to start taking Social Security Income.  (Again, Jack P Paul Actuary, LLC can assist in determining the optimum time/age to receive social security income).
7. Existing and future liabilities.  This includes credit card balances, house and car payments and other items.  Care should be taken to determine the time when balances become due and payable (for example, upon a death).
8. Estate and legacy strategies.  This includes leaving money in the will as a goal of the client.

These are all incorporated into programs which perform Monte Carlo testing on the investment rates, mortality and morbidity rates (morbidity includes health care, long-term care, and prescription drug rates of use) and which incorporate the above eight items, to calculate the probabilities that the client will meet his/her goals. 

After these probabilities are computed, iterations are performed and the programs rerun, to determine a set of realistic, achievable strategies that arrive at an acceptably high probability of success of the client goals.  Most often, the most important strategy is the spending strategy, in terms of affecting the probabilities and in terms of the client's future lifestyle.  There is often a tradeoff between the amount of money that the client would like to have available to live on, and the chances of meeting his/her goals. 

In summary, future long-term care costs are an important consideration for those nearing or at retirement.  The methodology presented in this three-part series allows these costs to be planned for in a comprehensive, analytical way, customized to the client.

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This article copyright by Jack P Paul Actuary, LLC 2012

A comprehensive approach to analyzing your client's long-term care costs - Part Two

If you haven't seen Part one of this three part series, please read that before you read this post.

Part Two - How insurance affects the range of long-term care costs:

The second major step in analyzing a client's future long-term care costs is the analysis of how insurance affects the range discussed in Part One of this blog.  Long-term care insurance affects the range of long-term costs in significant ways.  Premiums are payable, which increase the total cost, and eliminate any chance of having zero cost for long-term care for your client.  Of course, the insurance pays for some of the long-term care costs, up to the policy limits.  It is important to note that the policy assumed here is a tax-qualified one, which means that not all long-term costs will be covered by the insurance.  For example, if a policyholder can't perform only one of the Activities of Daily Living, the policy would not pay for long-term care benefits. 

Here is a chart of how the long-term care range of costs displayed in Part One now looks with the purchase of a representative long-term care policy.  The policy has a $200 benefit amount per day maximum payable on a reimbursement basis, a 4 year pool of benefits, a 90 day elimination period and a 5% compound inflation rider.  For comparison purposes, the present value of costs are displayed both with and without the insurance policy:

The probability, on a present value basis,
that the long-term care costs will not
exceed the Specified Amount                      Specified Amount             Specified Amount
                                                                      without insurance              with insurance
10%                                                                $0                                       $24,000
20%                                                                $0                                       $35,000
30%                                                                $0                                       $42,000
40%                                                                $0                                       $47,000
45%                                                                $0                                       $49,000
50%                                                                $0                                       $52,000
55%                                                                $1,000                                $54,000
60%                                                                $4,000                                $56,000
65%                                                                $10,000                              $59,000
70%                                                                $19,000                              $61,000
75%                                                                $34,000                              $65,000
80%                                                                $55,000                              $73,000
85%                                                                $89,000                              $84,000
90%                                                                $141,000                            $103,000
95%                                                                $276,000                            $144,000
98%                                                                $486,000                            $274,000
99.5%                                                             $1,288,000                         $1,053,000

The addition of insurance changes the probability distribution significantly.  Due to the premiums payable, there will always be long-term care costs that need to be paid.  On the other hand, the costs that will be paid under the higher cost scenarios are considerably less with insurance than without.  For example, the amount of assets that must be set aside to ensure that, with 98% probability, that the client's long-term care costs will be covered is $486,000 if the client does not purchase the long-term care policy described above.  That $486,000 reduces to $274,000 if the client purchases the policy, a 44% reduction!

The details behind the chart show that 84.8% of the time, the amount needed to be set aside to cover the client's long-term care costs (in other words, the present value of the client's future long-term care costs) will be less without the insurance.  Also, the "loss ratio" for this policy is computed to be 61%.  That means that, on a present value basis, for every dollar the client gives to the insurance company, 61 cents will be paid out in benefits.  This assumes the client always keeps the policy in force until benefits are exhausted and does not let it lapse.  Some would judge this to be a lot of money - 39 cents on the dollar - to spend for the protection.  The next paragraph is my argument for why long-term care insurance gives effective protection.

One of the strongest arguments for the purchase of long-term care insurance is as follows:  The client can choose to purchase or not purchase insurance.  If the client purchases insurance, there is an 84.8% chance that he/she will pay more than if he/she hadn't purchased it, and a 15.2% chance that he/she will pay less.  However, the amount that he/she will overpay if insurance isn't purchased could be more than $232,000 on a present value basis.  The amount that he/she will overpay if the insurance is purchased is considerably less - up to only $70,000 on a present value basis.  This is what insurance should do - protect against large losses.  Long-term care insurance does this effectively in many cases. 

This information is derived from performing stochastic testing on long-term care liabilities and associated insurance.  Stochastic testing can be used to analyze a wide range of policies and features from different carriers.  Differing elimination and benefit periods, maximum benefit amounts, inflation riders and many other policy features can be examined.   Stochastic testing provides information to the client that is not available using any other method.  Similar testing can be done for annuities with a long-term care rider.  The range of costs vary significantly by issue age, mortality and morbidity profiles and plans of care and other considerations.  When performing stochastic testing it is best to use customized information for the case under consideration.

By using stochastic testing, a client's range of long-term care costs both with and without various insurance alternatives can be examined.  The major question remains to complete the comprehensive analysis:  How do you know if you have properly prepared for the contingency of future long-term care costs?  The answer is in part three of this series, which is the next blog. 


This article copyright by Jack P Paul, Actuary, LLC 2012

A comprehensive approach to analyzing your client's long-term care costs

Here is the first of a three-part series.  Here I explain a comprehensive approach to analyzing and providing an effective way to plan for your client's possible future long-term care costs.  This approach will allow you and your client to see the true risk of possible future long-term care costs, to see how the risk can affect your client's total financial picture, and how to best address the risk, through spending and insurance strategies.  Note that the client could be either a single person or a couple.

PART ONE: THE RANGE OF POSSIBLE FUTURE LONG-TERM CARE COSTS

The first major step is the analysis of how much your client will spend on long-term care costs.  This is not answerable as a fixed number.  The best that can be done is a probability distribution of your client's future long-term care costs.  A probability distribution, as used here, is a chart that states the chances that the future long-term care costs will not exceed different amounts.  The costs could be either the present value of future costs, or the total dollar amount of future costs.

Here is an example of what the chart could look like.  This chart expresses the costs on a present value basis.  One way to think about this present value basis is to consider the numbers in the chart as the amount of assets that should be set aside to fund future long-term care costs.  It is important to note that this is just a sample chart for illustration purposes only - the numbers do not apply to any specific person, although this chart does suggest the general shape of the distribution.

The probability, on a present value basis,
that the long-term care costs will not exceed
 the Specified Amount                                                                      Specified Amount
50%                                                                                                    $0
55%                                                                                                    $1,000
60%                                                                                                    $4,000
65%                                                                                                    $10,000
70%                                                                                                    $19,000
75%                                                                                                    $34,000
80%                                                                                                    $55,000
85%                                                                                                    $89,000
90%                                                                                                    $141,000     
95%                                                                                                    $276,000
98%                                                                                                    $486,000
99.5%                                                                                                 $1,288,000

This chart shows that there is an over 50% chance that no long-term care costs will be incurred. It shows that there is an 80% chance that the costs will be $55,000 or less on a present value basis. It shows that, most of the time, the costs will be managable.  However, there is a chance that the costs will be very high. 

This chart allows the client to understand just what the potential risks are.  This chart is used as the cornerstone of the client's plan to manage long-term care costs.  Note that the chart is before any insurance or other solution is applied.   

Another chart, if the client would understand it better, is the range of total dollar costs that could be incurred.  That chart would display higher numbers on the right hand side of the chart, as there would be no discounting for interest.

In constructing this chart for your client, it is critical that it be based on the client's actual mortality and morbidity profiles.  The mortality measures the probability that the client will live to various ages (yes, the future long-term care costs are very dependent on how long the client may live).  The morbidity measures the health of the client with respect to needing future long-term care.  The better morbidity the client has, the lower the chance of needing long-term care, all other things being equal.  The morbidity and mortality profiles are determined by analyzing questionnaires that the client (with the help of the financial planner) fills out.  Note that these profiles are very useful to understand the client, over and above their use in a long-term care analysis.  The client probably would be happy to know this information. 

The chart is also dependent on the level of care desired.  Does the client have a nursing home in mind - perhaps one near where the residence is - that has a good reputation, or that the client knows someone else who was in that nursing home?  Would the client need a private room in a nursing home, or would be satisfied with a semi-private room?  Does the client wish to remain at the residence and use full time home help, no matter what the client's needs are?  A questionnaire can be filled out to address these issues; perhaps a visit, if desired, with a social worker or long-term care expert would help the client explore the level of care desired.  If desired, national, regional or local average costs of care can be used instead.

The chart is further dependent on the amount of unpaid help the client can receive.  Is the other member of the couple, if any, able to help provide care if needed?  For how many weeks/months/years?  Until the client is how old?  Are there children or other possible unpaid helpers?  It is very important to be realistic here - can the children really be relied on to help?

A technical note -  the chart that expresses future long-term costs on a present value basis is also dependent on the interest rate used to discount the costs.  This rate should be the average earnings rate, net of tax, that the client can expect on the client's portfolio.  The higher the rate the client can expect to earn, the lower the costs in the chart.

END OF PART ONE  - PLEASE PROCEED TO PART TWO


This article copyright by Jack P Paul, Actuary, LLC 2012