Don't let inflation eat away
at your long-term care insurance benefits

BY LEE KAPLAN —
You're a healthy Baby Boomer about to buy long-term care insurance. You've compared several policies. You've researched insurance companies for financial stability, compared their elimination periods, calculated the maximum daily benefits, evaluated the lifetime benefits, looked into shared coverage options and noted the benefit restrictions. And, you're still standing.

Now, it's on to inflation protection. Here, you'll want to employ a multidisciplinary team of Nobel Prize winning economists and psychics. Because what you're called on to do is figure out the cost of home health care, perhaps 20 years from now, when you're likely to need it.

How much is enough?

While we've had relatively low inflation over the last 20 years, with an average rate of around 3%, there are signs now that inflation could be picking up, even as the economy is slowing. During this same 20-year period, however, the rate of inflation of medical expenses has been about 16% higher than consumer inflation as a whole. This gap could easily grow, as the aging population ages puts heavy demands on health care and related, non-medical home care.

How do you know how much coverage to purchase to meet your future care requirements? According to an estimate by the Minnesota Department of Health Services, the average hourly cost of a home health aide in Minnesota is $29. If that cost increases at a compound annual average of 5% (a common formula in long-term care insurance policy inflation riders), you'd need about $77 to pay for an hour of service in 2028. An assisted living facility that costs $3,000 per month today could run you more than $7,950 in 20 years.

But is 5% enough? The impact of inflation on your benefits will be significant and, at the same time, very difficult to estimate.

A wide range of inflation options

To make matters more complex, the long-term care insurance industry doesn't have a standard way of selling inflation coverage, where you pick your percentage and your benefits increase by that amount, compounded each year. In an effort to offer policies with lower premiums, at least at the beginning of a policy, some insurance companies have moved to providing inflation coverage that is less risky ... to them by shifting more of the burden of inflation exposure to you. In exchange, you'll usually get a lower initial premium rate.

For example, some companies offer simple (not compounded) benefit increases, where your payout increases by a flat amount every year, based on the starting benefit. The result will be significantly lower benefits over time, when compared with a compounded rate of inflation. Some policies adjust benefits in accordance with the Consumer Price Index (CPI), usually at a lower premium than the "5%" policies. However, in recent years, home health care has increased more sharply than overall consumer inflation, so that might not be adequate to keep up. On the other hand, during a period of very high overall consumer price inflation, this policy could do a better job of keeping pace than a constant 5% inflator.

Some policies cap the inflation amount you can receive once the original benefit limit has doubled. Some stop increasing for inflation after a specified period, say 20 years, or when you reach a certain age, such as 80 or 85. Still other policies might offer an inflated benefit rate for your daily or monthly benefit that is higher than the lifetime benefit inflation rate. For example, your average daily benefit could be on a 5% inflator, while your overall policy benefit could inflate by 3% per year. This further complicates the already difficult issue of figuring your inflation needs.

"Future Purchase" option

Another possibility is a "future-purchase" option (sometimes referred to as "guaranteed purchase"). Policies with this feature have lower initial premiums than those with automatic benefit increases, and you can purchase more coverage over time without having to qualify through medical screening. However, the premiums for increased coverage will be higher, compared with purchasing inflation coverage from the start, because the premiums will reflect the age at which you purchase these extra benefits. Still, the "future purchase" option, with its lower initial premiums, could help you afford at least some long-term care insurance if you can't initially meet the premiums of a full inflation-adjusted policy.

However, some "future purchase" options carry a higher initial premium than policies with no inflation coverage, in exchange for providing this flexibility, so be sure to find that out before signing up for one. There may also be a limited window of opportunity for increasing coverage; in other words, you might only be able to opt in for more coverage during the first 10 years or so of the policy, but not beyond that. So, this is another detail to check carefully.

Whatever other options you consider when purchasing long-term care insurance, be sure not to overlook inflation adjustment features. Inflation protection of your benefits is just one of many aspects of long-term care insurance, but it can be a big one.

(Posted: March 5, 2008)