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
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