By FPA member Henry J Ramirez, JD, CFP®
Last Updated: March 15, 2010
A recent article entitled "What is the Distribution of Lifetime Health Care Costs from Age 65," written by Anthony Webb and Natilia Zhivan concluded that "…the main risk involved in assessing potential health care costs is nursing home care." The authors stated that less than 15 percent of American households approaching retirement have accumulated enough in total financial assets to cover the cost associated with extended long-term care.
The article goes on to say that households face a significant risk that could threaten their retirement security. When deciding how much to save for retirement and how rapidly to draw down their wealth during retirement, households must consider:
- What risk they are prepared to accept by having their assets substantially depleted by health care costs;
- Whether they are above or below the average risk of incurring exceptionally high costs; and
- Whether they should insure against health care costs by purchasing long-term care insurance.
The Nature of Insurance
Insurance, in law and economics, (according to Wikpedia) is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium. In other words, it can be thought of as a guaranteed and known small loss (the payment of a premium) to prevent a large, possibly devastating loss.
You purchase fire insurance to replace your home in the case of damage caused by fire. You purchase auto insurance to protect you in case you are sued in an auto accident or to help replace your car if it is demolished in a wreck. Life insurance is purchased to provide a family financial security in the event of the premature death of the wage earner. The proceeds from the life insurance policy will replace the lost wages due to premature death.
While most people readily see the value of managing risks in the case of their homes, automobiles and lives, they often times fail to see the same value when it comes to long-term care coverage. They mistakenly believe that Medicare/Medicaid will pay for all of their long-term care needs and/or that the present value of holding onto money that would be paid in premiums outweighs any future benefits they would receive. Medicare pays for only skilled nursing care and for a limited time. Medicaid will only pay if you meet strict financial guidelines and you may find that some nursing homes may not accept it, thus limiting your choices and could lead to quality of care concerns.
Unlike with their cars or homes, many individuals feel that there is no need to pay for insurance benefits that may never be used when it comes to long-term care. And, by default, choose to self-insure — potentially exposing themselves to significant risks.
Long-term Health Care Insurance: A Financial Risk Management Strategy
The cost of long-term care is high today and continues to rise. However, the cost to self-insure is more expensive than most people imagine. Many people base their decision of whether or not to purchase long-term care insurance on their perception of whether or not they believe they will ever need long-term care. In reality, purchasing long-term care insurance should be one of the key elements in any well-defined financial plan — one that has at its core, a strategy of comprehensive risk preparedness.
The Problem with Self-insuring for Long-term Care
The problem with "pay as you go" long-term care self-insurance is that individuals often need care sooner than they think they will and, according to statistics, will not have saved enough money to pay for the care they will require. As a result, personal assets are quickly depleted. When a long-term care insurance policy is purchased, an instant and accessible pool of money is created from which the costs of long-term care can be instantly drawn, thus protecting core financial assets. It is similar to how a life insurance policy creates an instant estate upon your death.
Long-term care insurance provides the protection and funds to pay for private nursing home or assisted living facilities. Almost all policies will pay at least a portion of home care services as well, with some long-term care insurance policies paying unskilled caretakers, including relatives who might assist in caring for elderly patients while the patient remains in the comfort of his or her home. In fact, insurance companies are increasingly realizing that individuals would rather stay in the familiar surroundings of their homes versus being institutionalized in a nursing home facility. They also recognize that home care is less expensive when compared to nursing home costs and are thus incented for incorporating provisions for home services in their plans.
The fact of the matter is that long-term care insurance is a good deal when you compare the cost of premiums paid against potential benefits. The reason is simple: sooner or later, most of us will require long-term care and the cost of the premiums paid is nearly always less than the costs of long-term care.
Nevertheless, it is painful for some investors to write that premium check every year. One way to provide the funds is to earmark a portion of the investment portfolio — say 0.5 percent to one percent each year and utilize the interest/gains to fund the premiums. The long-term care insurance would in effect provide portfolio insurance because in the event that long-term care services are needed (and the chances are high that everyone will eventually need some care), the value of the portfolio will not be affected because the long-term care insurance pays for the services. As a result, the portfolio's value remains intact to continue to fund wealth management objectives and remain available in the estate to leave as a legacy to surviving spouses, children, grandchildren and favorite charities.
In short, long-term care insurance should be viewed as an important component of risk management, wealth preservation and quality of care.
FPA member Henry J. Ramirez, JD, CFP® is a financial advisor with Wescott Financial Advisory Group. Henry is a member of the New Jersey Bar. He is active in several professional organizations, including the Philadelphia Estate Planning Council, the Financial Planning Association (FPA) and the American Bar Association (ABA). He has also passed the Certified Public Accounting (CPA) exam.