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The Affluentialist: Why The Affluent Need LTC Insurance

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Surprising economic times can reveal fault lines in previously solid assumptions. The conventional wisdom was that the wealthy would pay for long-term nursing care out-of-pocket and middle-class and upper-middle-class Americans should buy long-term-care (LTC) insurance. Advisors assumed that affluent clients would have the income stream to cover skilled staff for in-home care or full facility care regardless of the length of convalescing, if necessary.

In fact, wealthy Americans with a very comfortable standard of living and adequate resources to cushion from portfolio shrinkage have expressed concern about the expense of healthcare in the future. In a 2008 survey by Northern Trust, the cost of health care came in second after inflation eroding income as the chief concern of Americans with a minimum net worth of $1 million (not including primary residence). The truth is that more people need to consider those costs. Those who reach age 65 will have about a 40% chance of entering a nursing home, according to the U.S. Department of Health and Human Services. For those who do enter a nursing home, about 10% will stay there five or more years–a long time to be paying for nursing care out of pocket.

Moreover, even the published averages of nursing care and in-home care can be misleading when you consider the likely high service expectations of wealthy families. Average rates buy you rooms in facilities that your affluent client may perceive as more Motel 6 than the Four Seasons. For a high-end care facility such as one in Boston associated in with Harvard Medical School with its own hospital on the grounds and highly trained staff, the yearly costs are well over $100,000, or more than $270 per day. In New York, however, $398/day is just the average cost, according to the 2008 Cost of Care Survey from Genworth Financial. According to the survey, the five-year annual increase in the average cost of private or semi-private room in a nursing home is 4%.

The Actual Cost of Self Insuring?

Affluent families won’t be challenged to pay such fees, but the real impact may not be in the checkbook but in the legacy. A recently retired business owner who sold his stake a couple of years ago and invested in the stock market that’s limping along in the current economic crisis may look to pull cash out of his portfolio to pay for care at the worst possible time. Any subsequent recovery of his portfolio will be diminished by the principal he withdrew.

To pay for long-term-care costs directly, HNW clients would typically hold onto invested assets to generate the required income. The client keeps those assets, thereby not transferring them out of his or her estate. Self-insuring therefore limits the ability of HNW clients to transfer assets before death in an effort to minimize transfer taxes for the family, according to an economic analysis of long term care by David Cordell, the director of finance programs at the University of Texas in Richardson, Texas, and Thomas Langdon, associate professor of business law at Roger Williams University in Bristol, Rhode Island.

For example, let’s assume the income and principal from a $1 million investment account would pay the costs for any required care. If the client died without requiring long-term care and otherwise spent the annual income, the $1 million that remained at death would be subject to estate tax. With Congress unlikely to repeal the estate tax in this economic climate, the exclusion amount will go down to $1 million in 2011, leaving any estates larger than that amount subject to estate taxation with a top rate of 55% for assets above $3 million. The cost of keeping that account in the estate for potential long-term care could be the cost of the estate tax. If the client had not spent the income from the account and let it grow, even more taxes would be owed.

The alternative would be to buy an LTC policy starting at about age 55. Paying the premium allows the client to use that $1 million account for other purposes, such as philanthropy or estate planning, for example. LTC insurance can then be thought of as a financial options contract, according to Cordell and Langdon. The wealthy client buys LTC coverage as a hedge against the risk of self-funding any required care. If he pays the annual premium from other sources (about $12,000/year for a 55-year-old male for lifetime coverage at $400/day nursing home benefit), that $1 million can be transferred out of the estate to allow it to grow free of estate tax.

Getting Back Premiums

An option on some long-term-care policies–return of premiums at death–works well for clients who are concerned about risk protection but unhappy about paying for a product they may never use. Not all companies offer it and not all states allow it. The client’s designated beneficiary will receive a portion or all of the premiums paid, less any benefits paid by the insurance company.

Return of premium options come in two basic types. The less expensive one aimed at younger policy buyers is based on age at death, usually before 65 and sometimes at a shrinking percentage after that year. For the client who bought a policy at age 45 and dies suddenly at 55 without receiving any claim payments, the policy would pay 10 years worth of premiums to the beneficiary. If the same person dies suddenly at age 70, the policy would pay 50%, with the rider terminating at age 75. The additional cost for this enhancement is in the range of 8% over the regular premium.

The second type of rider returns all of the premiums, less any paid claims, regardless of the insured’s age–typically as long as the policy has been in force for at least 10 years. For a client who purchases a policy at age 55 and passes away at 70 without any claims, the beneficiary would receive 15 years worth of premiums. The added premium for a 55 year-old buying a policy would be in the range of 25% to 34%, with the rider cost increasing as the “age at the time of purchase” increases.

While the after-10-years benefit is expensive, the net cost to the client becomes the interest lost by not being able to invest the annual premiums. This factor can also make the policy attractive for wealthy clients who bear the responsibility of caring for parents or other older relatives. The returned premium becomes part of the beneficiary’s gross income.

As the owner of a closely held business (S-corp, LLC, partnership, or sole proprietor), the client can deduct the cost of long-term-care paid through the business entity, up to the IRS’s inflation-indexed limits for that year. If the client owns a C-corp, select employees can participate in a group LTC plan and have the business pay the premiums. In both cases, the business-paid premium is deductible. The return-of-premium feature can be especially useful when the business is paying the premium. The refunded premium can still go to the client’s beneficiaries–or it can go back to the company to recover its payments for the policy.

Not a Simple Proposition

LTC policies have many moving parts–the amount of the benefit, deductible days, benefit limits, inflation type, plus various riders. Seemingly small changes in the policy can effect major results 10, 20, or 30 years in the future when the benefits are needed. They are best analyzed by the client’s advisors to understand the full, long-range economic impact. One option on all policies, for example, is the amount of inflation to grow the benefits–5% simple or the more expensive 5% compound, for example. While annual nursing costs grow at a compounded rate, a policy with benefits only growing by a simple percentage will fall far behind in a couple of decades, requiring the client to cover more of the costs out of pocket.

Extended nursing care can have a strong impact even on HNW families. When creating any new comprehensive financial plan for HNW clients or reviewing an existing one, LTC insurance should be considered as a tool to lessen risk. Rather than depending on self-funding, strategically designed LTC policies can mitigate financial exposure and provide coverage for relatively reasonable sums through the use of return of premium riders.