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Don’t Bet On Long-Term Care Insurance

Long-term care insurance is unlikely to reach old age. Plagued by adverse selection, an aging population and escalating costs, the product is unsustainable and does not merit your investment.

About 70 percent of people currently age 65 or older will require long-term care and more than 40 percent will need to be in nursing homes, according to an AARP estimate. On average, someone over age 65 will need three years of long-term care. The average for women is higher, at 3.7 years, than that of men, at 2.2 years. Government statistics indicate that 10 percent of those in nursing home care will need to stay five years or longer. By 2020, 12 million older Americans are expected to require long-term care. These are just some of the statistics insurance companies cite to persuade you to purchase a long-term care policy. They are also precisely the reasons you should not.

The statistics show that most people who are approaching retirement age will at some point require long-term care, which is not surprising. Technological advances have allowed people to manage infirmities and live longer. This, in turn, increases the chance of requiring care for cognitive reasons, if not for physical reasons.

If you are age 65, the federal Centers for Disease Control estimates that your life expectancy is 18.7 years, over which there is a good chance you will develop dementia. The probability of being diagnosed with Alzheimer’s disease nearly doubles every five years after age 65. Almost one of every two people over 85 may have Alzheimer’s, according to the CDC.

For any insurance product to be economical in the private market, the insurer must be able to spread the risk of loss across a pool of insured risks. Members of higher-risk subgroups should pay higher premiums (think of smokers buying life insurance), though in all cases the probability of the insured hazard actually occurring needs to be relatively low so the risks can be effectively spread.

This is not the case for long-term care, because an aging population is increasingly likely to need long-term care services. Insurers therefore may try to entice younger buyers, whose premiums can be used to pay claims made buy older and riskier insureds. This cost-shift eventually must backfire, however, as the younger buyers age and insurers are forced to raise prices sharply to cover the increasing risk.

In any event, insurers have had little luck shifting costs to younger buyers. The average age of an LTC purchaser in 2007 was 58, according to the American Associaton for Long-Term Care. Younger individuals are unlikely to buy long-term care insurance because they have more immediate financial needs, such as their children’s educations. They are reluctant to purchase policies that are based on current medical practices and are liable to be obsolete by the time they need care in 30 or 40 years. Even if younger people were inclined to purchase long-term care insurance, there may not be enough young buyers to offset the graying Baby Boomers in coming years.

As the pool’s risk increases with time, insurers are forced to raise premiums. The original premiums simply will not cover the growing losses. This “solution” starts a downward spiral. As premiums increase, fewer people are able to afford the insurance. Those who perceive themselves as low-risk based on their health and family histories are likely to abandon their policies for those with smaller premiums or a lower level of benefits. This leaves a higher-risk pool that will dictate even steeper premiums to cover expected losses. Insurers have nowhere to spread the risk, so they must spread the loss.

Steep premium increases are not uncommon. In 2008, the New York State Insurance Department approved premium increases of 12 percent to 15 percent for long-term care insurance policies. On the left coast, California approved rate increases of 8 percent to 73 percent for companies actively writing policies, with most between 20 percent and 30 percent. Last month the federal government’s long-term care insurance program for civilian employees announced that premiums would increase up to 25 percent for purchasers aged 65 or younger, with smaller increases for older participants — a move that will certainly fuel adverse selection.

In September 2008, Conseco demonstrated the potential for the complete failure of long-term care insurance. The company plowed more than $900 million into more than 140,000 policies to cover losses before it abandoned them to a trust administered by the state of Pennsylvania, where Conseco’s long-term care unit was based. The trust will pay claims from its capital pool of $175 million. Given the average age of the policyholders, which is 80, and the pool’s history of capital infusions, the trust is likely to become insolvent and require higher premiums, reduced benefits or ultimate reliance on the Pennsylvania state guaranty association to pay claims. This case shows that when the frequency and magnitude of losses become too great, the insurance model is unsustainable.

Private insurance works for events that are rare but which have catastrophic financial consequences. It cannot cover a widespread certainty such as the need for long-term care, especially when combined with severe adverse selection. Private long-term care insurance is fundamentally flawed. Fortunately, there are other ways to plan for possible long-term care needs.

Potential long-term care expenses, like any other risk you choose to bear on your own, should be built into your financial plan. When determining the amount you should save, consider your health and family history as well as the type of care and providers you prefer. Of course, assumptions about your possible needs and the cost of care may require revision, but that is the beauty of a financial plan. You can tinker with the particulars to meet changing conditions, but you may not be able to revise an insurance policy or qualify for a new, better-fitting one.

Building long-term care into your financial plan means that you may spend your assets to cover the cost, just like all your other retirement needs. This is the most common objection to forgoing insurance: What if there is nothing left for my spouse and heirs? The fear of failing to leave survivors with an inheritance, not of being unable to pay for care, is the real reason most people purchase insurance. Through Medicaid, the government will cover your care should you be unable to afford it, albeit perhaps not the most desirable care available. The catch is that you must deplete your own assets before you can qualify for Medicaid. Plus, Medicaid will seek reimbursement from assets left in your estate after your death, however meager they may be.

Long-term care insurance is flawed as inheritance insurance. It does not eliminate the risk of dying without leaving an estate because it only insures against asset depletion by one type of expense. However, life insurance can directly ensure that your loved ones have an inheritance, regardless of how you spend your assets during life. With life insurance, not only can you guarantee the amount your heirs receive, with proper planning, it can be free of income and estate tax. Your residual nest egg will not have such favorable tax consequences or a set value.

Your risk of needing long-term care is better managed with proper planning than with a faulty insurance product. A cash-flow projection can incorporate care and provide guidelines for saving and investing accordingly. Your plan has the flexibility to change with circumstances, and your care will not be limited by the boundaries of an obsolete insurance policy. Finally, if you do need care, you will have the required resources. If you do not, you have not spent your dollars propping up a broken model.