How Does Long-Term Care Insurance Inflation Protection Work?

Updated

How would you like to see a big-time music act in concert up close for $15? Would you like to buy a brand-new Honda Accord for $8,845? Maybe fill up that Accord with gas for $1.12 per gallon?

Unfortunately, those prices are no longer available. You can now see the concert for $90, buy the Accord for $24,000, and get your gas for $3.75 per gallon. Why the price difference? The one-word answer: inflation.

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It would be a dream come true if our incomes rose and the cost of living went down, but we are living that dream in reverse. Incomes are not rising nearly as fast as the cost of living. Inflation in America is on the rise, and our purchasing power is dropping.

As long-term care costs rise, so will the premiums for buyers of long-term care insurance. Insurance companies are paying out more in claims every year as our population ages, and they’re raising rates to remain profitable and still be able to offer this insurance.

The big question insurers are facing is, “Can our policy benefits keep pace with long-term care costs and remain affordable?” Financial planners advise paying premiums for long-care insurance, but what good is it if the cost of care outruns the benefits?

Buyers of long-term care insurance do have a measure of protection when it comes to fighting the effects of inflation on long-term care. Let’s answer some questions often asked about this and take a look at how it can be done.

Do Long-Term Care Insurance Policies Account for Inflation?

Generally, no. Long-term care insurance policies don’t account for inflation. Inflation protection is neither a common or automatic benefit on most policies. Inflation protection on a long-term care policy is a “rider” that needs to be added at an additional cost to have the policy benefits keep pace with the rising cost of care.

What is Inflation Protection for Long-Term Care Insurance?

Inflation protection for long-term care insurance is a feature that can be added to a policy to keep up with increasing long-term care costs. It’s sometimes called an automatic benefit increase rider, and its purpose is to increase your policy benefits every year that the cost of living increases.

Why is it Important to Have Inflation Protection

The average cost for a semi-private room in a nursing home is about $97,000 in 2021. The average length of time spent in a nursing home is 44 months. When we do the math, we find that an average long-term care stay would amount to nearly $350,000 should you need care today.

Very few people end up using their long-term care insurance as soon as they get it. They buy it now because it’s more affordable when they’re younger, when the need to make a claim is very likely going to be 15, 20, or 30 years away.

The cost of long-term care provided in facilities increases 3% to 5% annually. That means that a 60-year-old today can expect to pay $800,000 – 1,000,000 in 25 years, when it’s most likely they’ll be receiving care. 

What Are My Choices When It Comes to Inflation Protection On My Long-Term Care Insurance Policy?

When you purchase your policy, you should ask the agent what type of inflation protection is best for your needs. Typically, you’ll have four to choose from:

  1. Simple inflation protection
  2. Compound inflation protection
  3. CPI compound inflation protection
  4. Indexed linked inflation protection

Let’s look at each.

Simple inflation protection

This offers simple interest on the original daily benefit only. 

For example, with 3% simple interest, a daily benefit of $200 will increase by $6.00 per day every policy anniversary date, meaning a 55-year-old policyholder’s $200-per-day benefit will be worth $350 per day when they turn 80 years old. 

With 5% simple interest, a $200 daily benefit increases by $10 per day on the policy anniversary date every year, and will pay out $450 per day at age 80.

Compound inflation protection

This option is far superior to simple inflation protection.

Sometimes known as the "8th wonder of the world," compound interest has a snowball effect, increasing your benefits at a more significant pace than simple interest because it pays interest on interest.

This is particularly important for individuals in their 40s, 50s, and 60s, when filing a claim is very likely 20-30 years away.

For a 55-year-old policyholder, a $200-per-day benefit with 5% compound inflation will be worth $677 per day at age 80.

For a 55-year-old policyholder, a $200 per day benefit with 4% compound inflation will be worth $533 per day at age 80.

For a 55-year-old policyholder, a $200 per day benefit with 3% compound inflation will be worth $418 per day at age 80.

CPI compound inflation protection

This option is offered by very few insurance companies today. Annual increases in daily benefits are tied to the Consumer Price Index (CPI). 

Keeping in mind that the CPI has averaged about 2.4% from 1983-2020, this type of inflation protection won’t keep up with the increasing cost of long-term care.

Someone buying a policy today will be better off choosing a policy with a fixed guaranteed compounded percentage of 3%, 4%, or 5%.

Index-linked inflation

Indexed universal life insurance with a long-term care rider is sometimes sold as an “Indexed Universal Life Long-Term Care Insurance” policy. They are typically marketed and sold by long-term care insurance agents using illustrations with interest rates based on non-guaranteed interest crediting percentages. 

This means that the insurance company reserves the right to change the crediting elements within the policy.  Advisors familiar with long-term care insurance recommend that people buy a long-term care policy with guaranteed inflation protection only.

Many policies don’t contain any inflation protection, or simply give the policy owner a "future purchase option" to buy more coverage in the future, at a higher price.  

When comparing policies, don’t confuse "Guaranteed Purchase Options" or "Future Purchase Options" or "CPI Offers" with guaranteed inflation protection. They’re not the same thing.  

Note: Many financial advisors do not recommend index-linked inflation.

Tips For Finding a Good Long-Term Care Insurance Policy With Inflation Protection

Shopping for the right long-term care insurance policy with inflation protection takes time and effort, but it will be well worth it later in life. Here are three tips to help you find a policy that will meet your needs.

Buy sooner rather than later

Long-term care insurance premiums are figured the same way as health, life, and disability insurance: the older you are, the more expensive the coverage will be. 

This makes sense, considering that the younger you are, the longer you’ll be paying premiums to offset future claims. Unfortunately, many younger policyholders also let their policies lapse from non-payment, meaning that the premium payments paid are pure profit for the insurance company since no claims can be filed. 

Work with an independent agent, not a captive agent

Captive agents represent only one insurance company, meaning that they will only show and recommend their company’s policy; you won’t have any other companies or policies to compare with theirs.

Independent agents can give you comparisons and pricing of different long-term care insurance providers. They tend to be more objective than captive agents since they aren’t obligated to sell one company’s products.

When you’re pre-planning for long-term care, have the agent show you at least three different policies so you can compare features and rates. Do your best not to buy on price alone; the lowest-priced policy may not afford you the protection you need.

Know your budget

Whenever you buy any type of insurance from an agent, it’s best to begin with a budget in mind. This allows the agent to select policies within your price range, which is to your advantage as long as you’re not skimping on benefits.

Knowing your budget also increases the odds that you’ll continue paying your policy premiums as long as you need to. It’s very disheartening to pay premiums for years, only to let the policy lapse because you can no longer afford it.

And, keep in mind that your long-term care insurance policy rates are not guaranteed. This means that the insurance company will be raising your rates in the future as long-term care costs continue to climb. You’ll stand a much better chance of paying higher premiums later if you start with a reasonable premium when you first apply for coverage.

Final Thoughts

It’s helpful to avoid an “all-or-nothing” approach when you buy a long-term care insurance policy for yourself or when you're buying long-term care insurance for parents.

You’ll save a lot of premium dollars by selecting a policy with a longer elimination period (90 days vs. 30 days), a shorter benefit period (5 years vs. lifetime benefits), and a reasonable daily benefit rate ($180 - $220 per day).

And, remember to add the inflation protection with a 5% guaranteed compound interest rate when choosing your long-term care options.

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