All retirees must plan today for the possibility that they will experience significant long-term care health expenditures. Large unplanned expenses, such as those relating to long-term care, have the potential to wreak havoc on a retirement income plan.
The unknown cost of health care is among the most significant risks to any retirement plan. All retirees face the possibility of a debilitating illness that will require advanced and costly care over a long period of time. This risk is a source of anxiety for retirees, yet most are unwilling to accept the variable costs and potential loss of premiums paid under conventional health-based long-term care insurance products. And few have taken steps to understand the complete range of long-term care insurance product features and options available to them. A different generation of protection, such as life insurance and long-term care or annuities and long-term care, create a hybrid product consideration. A hybrid product protects against long-term care expenditures while also providing a guaranteed death benefit, which guards against the possibility of lost premiums. This new class of hybrid products is central to our analysis, in which we simulate multiple long-term care scenarios to demonstrate the impact of a hybrid product, a traditional health-based long-term care policy and a self-funding approach. In scenarios where no long-term care event is experienced, premiums paid using a traditional health-based policy are simply lost, while a hybrid policy provides a death benefit. In scenarios where a long-term care event is experienced, insurance helps dramatically reduce the net costs to a household.
Long-term care insurance provides value when health expenses are high. At the 90th percentile of long-term care costs, an unprotected retiree — one who is self-funding protection against a long-term care event — will be exposed to risk of over $1 million in assets. In contrast, a retiree holding a long-term care insurance policy will be exposed to roughly one-third the risk of out-of-pocket expenses and premiums. With long-term care insurance — like all insurance products — a retiree trades a premium expense for protection against a loss.
In this case, the loss due to high health expenses can have a devastating impact on legacy values and income security. Outcomes for a conventional long-term care policy and a hybrid policy are similar under the 90th percentile costs, assuming that premiums on a conventional policy do not increase. Despite these similar outcomes, survey evidence suggests that individuals are much more attracted to a product that provides protection against significant health expense as well as a death benefit, and provides both without the negative features of variable premium costs and the potential for lost premium dollars.
By Wade D. Pfau, Ph.D., CFA, and Michael Finke, Ph.D., CFP®