New Strategies for Covering Long-Term Care Costs

You've heard the scary statistics: About two thirds of Americans will need long-term care. The average annual cost of a private room in a nursing home is $87,600; the length of stay can run three years or more.

Do a few quick calculations, and it's easy to get very worried about the potential financial impact on your retirement plan. But recent research is shedding new light on the risks. The key finding: The odds of needing nursing-home care may be higher than previously thought, but the length of needed care is shorter. The new data has experts talking about the implications for revamping our current approach to insuring against the risk of high long-term care expenses.

'A Big Event for Some' A recent study by the Center for Retirement Research at Boston College (CRR) found that 44% of men and 58% of women will need care--somewhat higher than some previous estimates. But the average duration of a nursing-home stay is 0.88 years for men and 1.44 years for women.

"It's a big event for some people, not for others," says Anna Rappaport, an expert on long-term care who heads an actuarial consulting firm that bears her name. CRR's research also concludes that no more than 50% of men and 39% of women who use nursing-home care stay longer than three months.

That raises an interesting question about just how much nursing-home care is being paid for by Medicare. The program isn't designed to cover long-term care, but it does cover up to 100 days of skilled nursing care following a hospitalization. The data on this question is inconclusive, but "it seems likely that many of these short stays are covered by Medicare," states the CRR study. (The study is based on data from the National Long-Term Care Survey (NLTCS) conducted by the National Institute on Aging and Duke University, and also the University of Michigan's Health and Retirement Study.)

Long-term care still should be regarded as a significant retirement risk. A recent report by the Employee Benefit Research Institute (EBRI) attempts to quantify the potential impact of a major LTC cost on retirement success by comparing projected retirement-savings shortfalls for different bands of longevity, and by calculating the projected outcomes with and without long-term care needs. Ignoring nursing-home and home health-care costs decreased the shortfall projections by an average of 74%.

"The comparisons show how important it is to include long-term care costs in these calculations," says Jack VanDerhei, EBRI's research director.

The risk is tied closely to longevity. Twenty-one percent of men and women age 80 to 84 have at least a mild or moderate disability, compared with just 7% of those aged 70 to 74, according to the NLTCS.

Seeking Solutions The latest LTC utilization data comes at a time when insurance industry and policy experts are debating ways to improve the safety net for long-term care risk. The current system is a hodgepodge. Just 13% of households purchase commercial long-term care policies, according to the Health and Retirement Study; everyone else who needs nursing-home care is covered by Medicaid or self-insured.

The commercial LTCI market has been experiencing upheaval over the past several years. Many underwriters have stopped issuing new policies due to an inability to develop sustainable, profitable LTCI business. Among the players left standing, the industry's largest underwriter--Genworth Financial GNW--forecast weakened earnings due to continued losses in its LTCI business. The company's stock fell more than 5% the day of the announcement, and it's down by about half in the past 12 months.

Many policy experts view long-term care as one of the most important unsolved pieces of the nation's health-care puzzle. In 2013, a politically divided Congressional Commission on Long-Term Care offered up two visions for solutions reflecting the commissioners' ideological differences: Left-leaning members proposed expansion of Medicare to cover long-term care; right-leaning members advocated tax incentives and regulatory reforms aimed at stimulating wider use of private LTC insurance policies.

Some have advocated a middle-ground approach mixing private insurance with our large government-sponsored social insurance system--for example, opening the door for insurance companies to offer LTC coverage through Medicare Advantage plans. Another idea is to streamline LTCI plan offerings into a short menu of understandable options, and offer them through a tightly regulated federal marketplace, similar to how Medigap plans are sold today.

The Society of Actuaries recently published a series of papers examining ways managing the impact of long‐term care needs and expense on retirement security. Researchers evaluated everything from traditional LTCI policies to the extent to which seniors can depend on family and friends for support, tap home equity, and even have greater flexibility in tapping 401(k) and IRA accounts to pay for LTC.

Financial planner Michael Kitces stirred the pot recently by proposing to reform LTCI to cover only high-impact, low-probability events. He proposed that the industry begin offering two- or three-year deductibles instead of the three-month that is typical now. That would bring premiums down dramatically, permitting policyholders to use the significant premium savings that result to cover their care during the elimination period (the amount of time you wait for benefits to begin after filing a claim). That would require changed thinking in the industry, Kitces acknowledges--and also by states, which regulate insurance. Most states require LTCI elimination periods of no more than 365 days by law.

"Everyone fears these ultralong nursing-home events, but they are not the norm and don't happen as long as we think or thought they do," Kitces told me in an interview. "The stays tend to be a shorter event or series of shorter events bouncing in and out of care--and once people go into a nursing home, they don't stay there very long."

Hybrid Plans The only way you can get this type of coverage, he notes, is by using a hybrid life insurance/LTCI policy. These are universal life-insurance policies with an optional LTC benefit rider. "It's structured to pay benefits first from your own cash value and then from the insurance policy--so they function as high-deductible policies."

Sales for these policies rose 18% in 2013 (the most recent available annual sales), according to LIMRA, the industry research and consulting group. Meanwhile, sales of new traditional LTCI policies were down 30%.

These hybrid policies hold appeal because so many potential buyers of traditional LTCI dislike the idea of paying premiums on a policy they may never need. That view misses the point of an insurance policy, of course, which is to insure against a risk that may or may not transpire. But another appeal of hybrids is that they inoculate buyers from the risk of steep premium increases via a single upfront payment.

Kitces is skeptical about that argument. He notes that the underwriters control the cash value and are under no obligation to pay a going rate of return in a rising-rate environment--instead, they can simply underpay on rates for your cash value. "It's an emotional response," he says. "I don't want to pay $3,000 a year in premiums for a traditional policy, but I'll give an insurance company $100,000 for a universal policy and forfeit any growth for the rest of my life."

Certain situations favor hybrids. Simplified underwriting offers a route to coverage for people whose pre-existing conditions make them ineligible for traditional LTCI. That could become more significant as traditional LTCI underwriters toughen up their underwriting standards.

Genworth, for example, now considers not only the health of applicants, but also the health history of their parents, when underwriting policies. Favorable tax treatment also can make a hybrid policy compelling for some buyers.

Dealing With Rate Hikes The rate hikes on older traditional LTCI policies can be especially unnerving to policyholders. Insurance companies must go to state insurance regulators, and the requests often are eye-popping, running as high as 60% and rarely less than 20%. The final increases negotiated with regulators usually run in the 20% range. (For a historical look, check out this list of rate increases requested by insurers over the past few years in Iowa, posted at the state's insurance division.)

Rate hikes don't have to be a disaster for policyholders. If you are hit by one, don't panic or drop your coverage. If you've had your LTCI for a while, the premium almost certainly is much lower than what you'd pay on a new policy at an older age--even after a steep rate hike. What's more, the risk that new coverage would be denied due to a medical condition rises with age.

One way to cope with a large premium increase is to reduce your benefits. Your options include cutting back the daily benefit amount or increasing the elimination period. Another option is to cut the length of time that benefits are paid.

Kitces thinks LTCI premiums are stabilizing, mainly because the sharp increases in initial policy prices insulate buyers against the risk of rate shock down the road. Indeed, new policy prices for traditional LTCI have continued to rise; average prices jumped 8.6% last year, according to the American Association for Long-Term Care Insurance.

Kitces is holding to that view despite the tremors being sent through the industry lately by Genworth.

"It's a bit concerning, overall, but doesn't change my views around the pricing of policies today," Kitces says. "To the contrary, Genworth has had such a challenge hiking rates on existing policies that they seem more concerned than ever about trying to make sure they 'get it right' the first time, which means charging a premium high enough out of the gate that they won't need to raise it in the future, or fight with regulators about raising it in the future."

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work, and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.