Q: Why is it important to have inflation protection? What amount of inflation protection is recommended to keep up with rising health care costs?
The high cost of long term care is a huge issue of concern today.
The average cost for a nursing home in 2013 is approximately $87,000 per year. Generally people tend to need care for an average length of time of 3 years, thus an average long term care expense might amount to nearly $300,000 out-of-pocket should care be needed today.
The main issue, however, is that the need to make a claim for most purchasers of this type of insurance is most likely 15, 20, 30 years away. Or longer.
Long term care costs have typically increased an average of 5% on an annual basis.
If costs increase, as projected, a 60 year old today will expect to pay approximately $300,000/year 25 years from now when a claim is most likely to be made.
With simply needing care for an "average" length of time--2 to 4 years, a $1,000,000 nest egg will easily be eroded.
The Benefit of Having Inflation Protection
A policy with inflation protection, sometimes called a benefit increase rider, increases your benefits each year. A policy without inflation decreases in value, on an inflation adjusted basis, every year the cost of increases.
Differentiating between the various forms of inflation protection is critical in determining which type of inflation protection is best for your needs.
5% Simple Inflation Protection
Simple inflation protection is interest on the original daily benefit only. For example, with 5% simple interest a daily benefit of $200.00 will increase by $10/day on each policy anniversary. For a 55 year old applicant a $200/day benefit will be worth $450/day at age 80. Simple inflation is appropriate for individuals in their later 60's or 70's.
5% Compound Inflation Protection
Compound inflation is interest on interest. Sometimes known as the "8th wonder of the world," compounding interest has a snowball effect increasing your benefits at a more significant pace than simple interest. For a 55 year old applicant, a $200/day benefit will be worth $677/day at age 80. Over time, 5% compound inflation protection will provide quite a big difference in benefits than what 5% simple inflation protection will provide. 5% Compound inflation is important for individuals in their 40's, 50's and 60's where it can reasonably projected that a claim is at least 20-30 years away.
4% Compound Inflation Protection, 3% Compound Inflation
Recently introduced options by a few providers, these compound option factors will meet Long Term Care Insurance State Partnership Program guidelines while affording the consumer less benefit growth in exchange for lower premiums than 5% compound inflation protection.
CPI Compound Inflation Protection
Very few companies will offer inflation increases tied to the CPI index. With this option, your benefits will increase according to the annual increase of the Consumer Price Index. Please keep in mind that CPI has averaged about 2.4% 1983-2012. Long term care costs, and health care costs are not necessarily tied to the CPI index. A purchaser will likely be better off electing a fixed compounded percentage, 5% compound if at all possible. Even a 4% compound or a 3% compound option will probably yield higher benefit increases than a CPI based model.
Many policies do not contain any inflation protection, or simply gives the policy owner an "option" to buy more.
Please do not confuse "Purchase Options" with automatic inflation protection.
We often see this within policies offered to employees in group settings. For younger applicants, of which most employees in group settings are, the lack of automatic inflation is a big problem.
Where a Purchase Option might make sense is with older applicants in their middle seventies or later when it is reasonably determined that there is less time between point of application and the need to make a claim. Or even with applicants that have sufficient assets to co-insure part of the cost.
Inflation protection is pricey for older applicants. If you are in your 70's, you may consider buying coverage without automatic inflation protection. If keeping up with inflation is important to you one solution is to just opt to buy a higher fixed amount of coverage as a hedge factor.
Here is a chart comparing inflation protection. You can see why the 5% compound inflation factor is important if you are buying long term care insurance in your 40,'s 50's, or 60's.
|Age||5% Compound||5% Simple||Purchase Option|
The importance of buying coverage with inflation protection cannot be overstated. Either the issue of rising healthcare costs must be addressed by the plan, or an ever-increasing amount of co-insurance must be accepted in the future. If inflation protection is purchased it is important to understand the differences and the long-term effects of each option.
One cautionary note: Many group long term care insurance policies do not offer automatic inflation protection as an option. For this reason, a group policy might be problematic and are "ticking time bombs", so to speak.
Additionally, most employees enrolling in group plans are in their 40's, 50's or 60's. Thus, the lack of availability of a 5% compound inflation rider within the group policy is a significant issue considering the enrollees need this benefit more often than not.
More than any other benefit, we see the vast majority of long term care insurance mistakes revolve around the inflation protection benefit.
If you would like to learn more about the various long term care insurance inflation options and find out which policy option makes sense for you, please give us a call toll free at 1-800-891-5824 or simply complete our contact form and we will get back in touch with you.
We are here to answer your questions, guide you through your options and help you make good decisions.