In the mid-1990s, my client Irma Kaye (not her real name) and her son reviewed various long term care insurance options and benefit choices. Her story demonstrates the value of comprehensive LTC insurance, when it’s affordable.
At the time, Irma was healthy, busy with her social life and enjoying her independence. The accepted protocol then was to select a daily benefit slightly over the average cost of care, skip inflation and cover a couple years of care. Mother and son debated costs and coverage, settled on a 3-year benefit, and then called during underwriting to expand to unlimited with 5% simple inflation.
She later went on claim. In addition to receiving substantial insurance benefits, Irma has been able to choose high quality care close to her family. Moreover, she has maintained her considerable dignity, knowing she has not consumed assets planned for her family or been forced to rely on Medicaid LTC welfare programs.
In fact, her LTC benefits starting at $90 a day have evolved into a $500,000 claim over a 12-year period–and a total insurance benefit of $750,000.
How did this happen? By recognizing that taxes on liquidated investments spent on care, and loss of investment opportunity on those funds, add to the care cost and to value of each dollar paid in claims. Specialized software helps compute this outcome.
Consider: Most people cannot pay $500,000 without dipping into retirement or other investment funds. Liquidation of these investments typically is a taxable event and may be quite expensive. For example, each dollar distributed from a qualified retirement plan is taxed at the client’s marginal tax rate. Federal and state taxes combined could be as high as 35% to 40%. In other words, for each dollar withdrawn to pay the cost of care, it will cost another 35 cents to 40 cents to pay taxes on the withdrawal.
Some advisors discount the value of LTC insurance, suggesting the client could tax deduct uninsured care costs. This is true, but the numbers tell a more accurate story. The tax deduction is limited to dollars above 7.5% adjusted gross income. Also, retired individuals typically take the standard deduction, which is lost if filing the long income tax form in order to deduct cost of care. The net effect, in most circumstances, is the tax cost of liquidating investments is greater than the tax deductions for uninsured care costs.
The income loss on investments used to pay care costs is the second multiplier making a care dollar more expensive and claim dollars more valuable than a dollar. The tax and investment loss would have expanded Irma’s care cost, if uninsured, from $500,000 by an additional $250,000 impact on family wealth.
With insurance, by contrast, Irma did not liquidate investments. The expanded value of her $500,000 LTC claim includes $250,000 retention of investment income and tax dollars, representing $750,000 in insurance value to Irma and her family.
The following outlines the assumptions used plus some comparisons, to place a price tag on decisions made at application.
Assuming a 10% tax will be paid if Irma withdraws $500,000 from her investment portfolio, this will add $50,000 to the $500,000 paid to care providers, if Irma is uninsured, for a total payout of $550,000. If the investment assumption is a 4% after-tax rate of return, this would be lost on the $550,000 (paid to care providers and in taxes). This loss would add $200,000 to the financial impact of the uninsured care event, for a total impact of $750,000. (The $200,000 represents the lost investment opportunity related to the $550,000 in care costs and taxes for the 12-year claim period.)
The future price tag of decisions made at application can be huge. For example, if Irma had selected a 3-year benefit, the claim payments would have been $110,000 versus the $514,000 paid to date. So, the value of the unlimited decision is $404,000 in claim payments–which expands to $600,000 when adding tax and investment opportunity cost onto the $400,000.
Real world inflation is always compound. Simple inflation is an invention of LTC insurance industry to help contain premium cost and claims exposure. In Irma’s case, the simple option reduced claim payments and added $35,000 to out-of-pocket costs. When including the tax cost and reduced investment income, the simple inflation decision versus compound cost Irma about $50,000.
From a planning standpoint, Irma’s story is primarily looking backward. Looking at today and forward, her care cost is now $180 to $300 or more for semi-private nursing homes or an 8- to 10-hour home care visit. Inflation at 5% doubles that cost in about 15 years. For today’s boomers, Irma’s $500,000 claim demonstrates that decisions at time of application may have future multimillion-dollar price tags.
Bottom line: Help clients understand the future impact of insured versus uninsured care events. This will help them make appropriate decisions on benefit selection, premiums and remaining out-of-pocket costs at time of care.
Ralph D. Leisle, CLU, ChFC, CASL, is president of LTCi Decision Systems, a Littleton Colorado software development and LTC consulting company. His e-mail address is rleisle@LTCia.com