Understanding Inflation Protection
Without inflation protection, a benefit that would be adequate today might have much less buying power in future dollars. For example, 20 years from now, $100 of daily benefit today would only have the buying power at 3% inflation of $55. At 5% annual inflation, $100 would only be worth $38 in today's dollars 20 years from now.
The question is, what inflation rate for long-term care services should we anticipate over the next twenty or 30 years? At the end of this section I have included a chart which I derived from the bureau of labor statistics for the historical cost increase in urban nursing homes and adult day care costs. During the 1970's and 1980's these costs increased close to 10% a year. For the past ten or so years these costs have increased a little less than 5% a year. I understand the Centers for Medicare and Medicaid Services are projecting per capita costs for Medicaid long-term care to increase about five and a half percent a year over the next ten years.
As we look back over the previous century, the core inflation rate for all goods and services has been closer to 3% a year increase. The reason for the higher inflation rate for long-term care services is because these services have a high medical component and medical costs and services have been increasing year over year at a much faster rate than the core inflation rate.
Modern long-term care policies increasingly offer benefits for so-called homemaker services. These would include services from nonmedical aides to help not only with activities of daily living but also with such things as shopping, transportation, light housekeeping, laundry, cooking , and companionship. Since these services have no medical complement, they should increase in cost closer to the core inflation rate of about 3% a year. What this means to the policyholder is that a policy with a 5% yearly, automatic inflation increase should buy more homemaker services in the future than it does today.
One strategy often recommended by agents is to buy more benefit than needed and over time the larger benefit will compensate for the loss in buying power. This also helps with group policy enrollment since many employees don't understand the significance of inflation. For example, a $150 per day benefit without inflation protection, that costs $40 per month looks a look better to an employee than a $90 per day benefit with inflation protection that costs $49 a month. But which plan is better for the employee? Let's take a closer look. I ran rate comparisons for a 60-year old buying a 5 year benefit from 22 different companies then took an average rate for all 22 plans. First, I ran rates for a $160 daily benefit with no inflation protection. The average premium was $93.69 a month. Next, I ran rates for an $80 daily benefit with an automatic inflation protection rider that increases the benefit by 5% every year. The average premium was $88.95 a month. Surely, doubling the benefit at only about $4 more per month looks like a better deal and it should be more than enough to handle inflation. This is true if a claim is made in the next 14 years as the benefit with inflation protection has grown to exactly $160 a day when the insured is 74 years 2 months and 3 days old. But remember, the average claims age is 78. And what if the insured doesn't make claim until 83? At age 83, the no-inflation option is still stuck at $160 a day with a total lifetime benefit of $292,000 whereas the inflation protected benefit has grown to $246 a day with a total lifetime benefit of $448,442. I think this example shows it's wiser to buy inflation protection than to ignore it.
There are 3 types of inflation protection. The first, automatic 5% annually compounded, has been discussed above. The second is automatic 5% simple interest. Compounding means taking 5% of the previous year's amount and adding it on. Simple adds 5% of the original amount. For instance, 5% simple on a $100 daily benefit adds $5 per year. In 10 years the simple increase has pushed $100 to $150. In 20 years, $100 becomes $200. On the other hand, 5% compound has pushed $100 to $163 in 10 years and to $265 in 20 years. Beware of hidden limits on the increase. Some policies only allow the increase to double at which time it is frozen. Others put a time limit such as 20 years on increases. Still others have an age limit on increases. A good policy will not have limits.
The third type of inflation protection is an option to buy more coverage at periodic intervals without reapplying and without evidence of insurability. Most plans offer a 15% increase every 3 years. The addition to coverage is charged at the attained age rate and added to the existing premium. So if an employee elects this option every 3 years, his or her premium takes a corresponding jump. Many representatives tout this concept as a good way to get someone into a policy cheaply, then as the person's income goes up, the future premium increases are more affordable and at the same time the insured is keeping up with inflation. In theory it sounds good, in practice it's a bad idea.
First of all, most people forget or don't bother to elect the increases (I've seen this happen, firsthand, in numerous cases). And if they fail over the years to elect a certain number of consecutive options, the policy increase feature is rescinded. Thus individuals with this kind of inflation protection usually fail to have adequate protection when they're older. Second, if they do elect increases, they'll pay twice as much over the life of the policy than had they elected the automatic protection. I did a study of a 55-year old buying a policy with automatic inflation for $48.07 per month versus buying the 3-year periodic increase option for $29.33 per month. By the time of the second increase, in 6 years, the insured will be paying $63.75 a month. To age 75 the insured will pay a total of $32,592 with the periodic increase inflation option versus $14,421 with automatic inflation protection and end up with the same benefit at more than twice the cost
Understand Long-Term Care Insurance Benefits - Part I
Understand Long-Term Care Insurance Benefits - Part II
Understand Long-Term Care Insurance Benefits - Part III
Understand Long-Term Care Insurance Benefits - Part IV
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