3 Ways to Make Long-Term Care More Affordable

Jason Stipp: I'm Jason Stipp for Morningstar. The decision about whether to purchase a long-term care insurance policy is a sticky one for many families. Joining me to offer some tips about making this difficult decision is Christine Benz, our director of personal finance. Christine, thanks for being here.

Christine Benz: Jason, it's great to be here.

Stipp: First, what are some of the primary benefits of buying long-term care insurance?

Benz: The big one is that long-term care, should you need it over an extended period of time, can be ruinously expensive. So, if you live in a high-cost metropolitan area, it's not unusual to need to pay $100,000 per year for care in some sort of a long-term care facility. So, that's a big issue. You would need a lot of wealth to be able to pay that money out of pocket--especially for couples where maybe you have a healthy spouse who wants to remain at home and needs assets for his or her daily living expenses and you're also paying the long-term care expenses over there. So, that is the big issue. Having that insurance, which could protect you against at least some of these costs, can provide a lot of valuable peace of mind.

Stipp: And, again, what long-term care insurance covers is something that Medicare does not cover. So, this is why people are so interested in buying this kind of policy potentially.

Benz: Exactly. Medicare covers some long-term care under very specific circumstances, but even then only up to 100 days' worth of care and only partially during those 100 days. So, you need to be very aware of the limitations of Medicare on this front.

Stipp: So, buying a long-term care policy is one way to cover those expenses, but these policies also have some drawbacks.

Benz: They do. And the big drawback is that this type of coverage can be very expensive, as insurers have had to deal with more difficult claims than perhaps they anticipated. The pricing has gone up; it's become perhaps more realistic, but it's harder for the consumer.

The other issue is that if you don't end up needing the coverage, this is money that you've spent on something that you didn't need to. You could have put it into your nest egg. So, those are the big drawbacks.

Stipp: Given this range of issues, you have a few tips to help with people considering a long-term care insurance decision. Your first tip is an interesting one and that is to procrastinate. Why might it help if you don't make a decision just right now?

Benz: Procrastination is almost never a good idea when it comes to your finances. Here, though, I think it's something that people who are maybe on the younger end of the long-term care purchaser spectrum might consider.

The reason is that we have interest rates that are very, very low right now, and that's partly what has caused long-term care premiums to be relatively high. The insurers just haven't been able to earn much on people's premiums coming in the door. I think that, arguably, in a higher-yielding environment that the pricing could get a little bit better for new purchasers.

I would only consider this strategy, though, if I were at the young end of the long-term care purchaser spectrum. So, people who are younger than age 50, maybe in their early 50s, perhaps very early 50s--you wait much longer than that, though, you do risk having higher premiums because there is a greater likelihood that you'll need that type of care. Then, you also risk encountering some sort of a health condition, which could disqualify you from this coverage type altogether. So, there are risks certainly with procrastinating, with deciding not to buy right now.

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Stipp: I know there have been issues in the industry as well about insurance companies getting out of the business. Is that a risk if you wait too long?

Benz: I think it is. So, we've seen a dramatic drop in the number of insurers offering this type of insurance. I think that you could see that number shrink even further because their claims experience has not been that great. It's simply not been a super profitable insurance industry to be in. So, I think we could expect to see reduced competition, which could lead to higher premiums for consumers.

Stipp: When you buy one of these policies, there are some levers that you can pull that will affect your coverage and how much you pay. So, your second tip involves some of those levers and how you can arrange them for maybe getting a policy at a rate that's more affordable.

Benz: That's right. For people who want this type of coverage but don't want to pay an arm and a leg for it, one thing to think about is perhaps to "skinny down" the coverage that you buy; purchase catastrophic-type coverage that will hold you or perhaps provide somewhat of a benefit should you need this type of care but won't cover you wall to wall.

You can look at what's called the elimination period. This is essentially a deductible for long-term care; so, it's the period of time when you will pay out of pocket before that insurance kicks in. You can look at extending that elimination period. You can look at paying for care, perhaps a lower daily benefit. You might not need the highest possible benefit. You can look at the inflation adjustment that comes along with that daily benefit. We have historically seen long-term care costs rising at a higher rate than the general inflation rate; but you may decide to stick with, say, a 3% inflation rate in terms of your coverage. Those are all things that can help bring down your cost of insurance.

You can also look at some of the statistics about usage of long-term care to help drive your decision-making. There is a variety of statistics on [the topic of the typical long-term care stay], but it's in the neighborhood of 2.5 to 3 years. You can insure yourself for a period roughly resembling that and any period beyond that you would be on the hook to pay out of pocket for.

Stipp: Obviously, some trade-offs with those levers, but if it looks like the wall-to-wall policy is just out of your price range, there are some options for you there. Your third tip is to keep in mind a tax-advantaged account that might come into play for covering some of these costs--that's the health savings account. How do these work and how could they help you with long-term care?

Benz: This would be something to consider for someone who has decided, "Well, I'm going to pay out of pocket for long-term care." It's certainly for people who have a fairly high level of wealth; it may be the way to go versus paying for the coverage.

If you are paying out of pocket or if you think that you're going to self-fund long-term care, I would definitely say to take a look at the HSA as an option. The reason being that you can put the money in on a pre-tax basis. It compounds on a tax-free basis, and as long as you withdraw the money and use it to pay for qualified health-care expenditures--and long-term care costs would certainly fall under that umbrella--that money is tax-free upon withdrawal. So, I see this is a really attractive vehicle.

The other reason I think [an HSA] can make a lot of sense here is that if you are going to self-fund long-term care, it's really important to segregate that money from your spendable cash. So, don't use it when calculating your withdrawal rate or anything like that. This is the money you're going to use toward the end of your life. From a practical standpoint, that HSA money needs to be segregated from the rest of your retirement assets. So, I think it can help a little bit on the mental-accounting front to make sure that you don't invade that HSA money that you are intending to earmark for long-term care.

Stipp: Another big benefit of the HSA is flexibility. So, if you pay premiums on an insurance policy, that money is locked into that premium for that policy; you're not going to get those premiums back. If you don't need an HSA, though, you have some options with that money?

Benz: That's the virtue of this type of practice for paying for long-term care. If you end up living to age 98 and being perfectly healthy the whole time and not needing long-term care at all, you can actually pull the money out of the HSA to pay for qualified health-care expenditures. Or, if you don't need the money for health care at all, you can pull the money out and it will be treated essentially as money being pulled from a Traditional IRA. It will be taxed as ordinary income at that point, but you'll still have it at your disposal to use for really any cost that you would like.

Stipp: Again, what are the limits on what you can put into an HSA every year?

Benz: They are pretty generous. For couples and families, it's about $7,000 per year. For individuals using HSAs, it's a little over $3,000 currently. So, it's very generous.

Stipp: When you put money in, do you choose how it's invested?

Benz: You do. And I'd like to see HSAs get a little better on this front. A lot of HSAs have transaction fees. So, for each amount of money that you're putting into some sort of stock or bond or cash holding, you're typically charged some sort of a fee at the time you get it invested. So, you want to shop carefully. Sometimes, if it's through your employer, you might not have a choice about the HSA options. But I expect to see, as these things grow in popularity, that consumers will get maybe a little more vocal about enacting better options within HSAs.

Stipp: Christine, a long-term care insurance decision is a tough one, but these are some great tools and strategies for helping investors make that decision. Thanks for joining me today.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.