What You Need to Know About

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					Insurance Products


                         What You Need to Know About
                         Long-Term Care Insurance


                                                                                                                            By Paula Hogan




                        Custodial care is not a topic
                     that any of us deals with easily.                                                                         staying at home
                   First of all, no one likes to think about                                                                   as long as it
              incapacity. It’s hard enough when the health                                                                     makes sense for
              of your parents begins to fail, but the idea                                                                     the insured, or
              of planning for one’s own incapacity is, for                                                                     living in a facility
              most people, literally unspeakable.                                                                              when full-time
                   Secondly, our intuitive sense about the                                                                     care becomes
              nature of aging and the available modes of                                                                       appropriate.
              care is outdated. Most people equate cus-                                                                             In addition
              todial care with nursing home care and                                                                           to nursing-home
              think they have only a small chance of                                                                           fees, excellent
              needing nursing home care. But the nature                                                                        long-term care
              of aging is changing as longevity increases; the amount of          policies pay for homemaker and companion services, mod-
              time we spend in adulthood has more than doubled in the             est home renovations to facilitate handicapped living, adult
              last century. It is now typical to need some part-time, in-         day care, and assistance—in the insured’s home or in a
              home assistance in early old age, with sporadic periods of          facility—with bathing, dressing, eating, continence, toileting,
              full-time care in an assisted-living facility interspersed. Then,   and transferring.
              farther into old age, there may be a need for full-time care              A useful way to think about long-term care insurance
              in an assisted-living facility, and toward the end of life some     is that in exchange for an annual premium, you get access to
              full-time care in a nursing home.                                   a large pot of money that you can use to pay for care, either
                   However, the frightening prospect that many face to-           in your home or in a facility, and with no tax liability on the
              day is that custodial care is expensive and can easily drain        benefit payments. Usually, there is a waiver of premium
              financial resources. Because of this, the decision to buy long-     once care begins and a spousal discount for couples. Also,
              term care insurance has become an important financial               some portion of the annual premium may be tax-deduct-
              planning issue.                                                     ible.
                                                                                        Buying coverage earlier rather than later not only cap-
                                   Long-Term Coverage                             tures a relatively lower premium, it also protects against the
                                                                                  possibility of becoming uninsurable. You can buy inflation
                  Most people do not realize that long-term care insur-           protection by purchasing an inflation rider that will make the
              ance offers good value. In contrast to the old nursing home         benefits grow, for example, at 5% compounded each year.
              policies that many of us still have in mind, long-term care         Premiums are not scheduled to increase from year to year.
              insurance has evolved into a product that supports people                 However, there are strong inflationary pressures in this

          12             AAII Journal
industry, and insurers do have the abil-       Table 1. 2004 Caps for Deducting LTC Premiums                          term care insur-
ity to raise rates by class of insureds if                                                                            ance.
they gain approval from the regulators.             Attained Age                           IRS Eligible                    The smallest
Thus, insured persons should anticipate              at Year-End:                    Premium Deduction:               tax advantage,
the possibility of a price increase during           40 or younger                              $260                  which is admit-
their lifetimes. However, policies are               Ages 41–50                                 $490                  tedly available to
guaranteed renewable—once you are                    Ages 51–60                                 $980                  only a small por-
insured, the company cannot change                   Ages 61–70                              $2,600                   tion of taxpayers,
the benefits.                                        71 and older                            $3,250                   is that premiums
                                                                                                                      can be deducted
              The Costs                                                                                               as a medical ex-
                                              vides is access to a “bucket” of money pense on Schedule A of the federal tax
     Premiums increase with age and           equal to $360,000 (or $5,000 per return to the extent that the premiums
also vary by health status but interest-      month × 12 months a year × six years) exceed 7.5% of adjusted gross income
ingly not by gender. Premiums are also        that you can use with no income tax and after being capped by the IRS
expensive—as expected, given the high         liability to pay for custodial care ex- maximums. These IRS maximum fig-
and growing cost of custodial care.           penses at the rate that makes sense for ures are adjusted annually and are also
   • For example, a single 69-year-old        you, but not faster than the inflation- used to determine how much of a
     in excellent health would currently      adjusted $5,000 per month benefit level. person’s long-term care insurance pre-
     pay about $6,000 to $6,500 a year             Note that the 5% per year inflation miums can be paid with funds with-
     for a typical policy from one of         protection means that both the monthly drawn from a Health Savings Account.
     the top carriers. (A typical policy is   maximum benefit payment and the re- The IRS maximums for the 2004 tax
     assumed here to offer $5,000 per         maining “bucket” of money at your year are listed in Table 1. Long-term
     month of benefits, a six-year ben-       disposal grows at 5% per year com- care insurance premiums may also be
     efit duration period, 5% per year        pounded.                                         deductible in full or in part on your
     compounding of benefits, and a                                                            state income tax return.
     90-day elimination period [the num-              Amount of Coverage                            Further means of deducting pre-
     ber of days for covered services                                                          miums are available for workers, de-
     before the policy pays] for facility          How much coverage to purchase pending on the type of firm where you
     care and a zero-day elimination          is a judgment call, but most people work. Check with your tax advisor for
     period for home health care.)            only insure a portion of potential ex- detailed information, but be aware, for
   • For this same coverage, a healthy        pense. As you decide how much cov- example, that sole proprietors can take
     48-year-old would pay about              erage to purchase, remember that most, the IRS maximum premium deduction
     $2,500 per year; and                     if not all, of your income will still be referenced above as an above-the-line
   • For the same coverage, a healthy         available to pay for care.                       deduction for themselves and their
     75-year-old would pay $10,000 to              Also, what you now pay in income spouses on the front of the IRS 1040
     $12,000 per year.                        taxes will likely be at least partially avail- tax form, as can partners whose part-
     It’s true for all of us: The language    able if you need care. That’s because nership pays for long-term care insur-
of long-term care insurance policies is       custodial care expenses are tax-deduct- ance coverage, as long as there is “a
confusing. The policies use the language      ible medical expenses to the extent that written plan providing for the medical
of traditional insurance products for a       they exceed 7.5% of adjusted gross coverage.”
non-traditional, new service.                 income. In full-time care, the result is              Sole proprietors and partners can
     For example, if you buy a $5,000         that funds formerly used for income get full deductibility of premiums if
per month, six-year policy it could—          taxes are in effect often redirected to they offer coverage as an employee
and almost certainly will—last longer         long-term care costs.                            benefit to their staff and also have their
than six years. What these terms mean              And finally, if you move into an spouses work in the business. C Cor-
is that you may draw up to $5,000 per         assisted-living or nursing home facility, porations can deduct premiums paid
month for care as long as the pot of          the proceeds from the sale of your in full as ordinary and necessary busi-
money lasts. If you are in full-time care,    former home will also be available to ness expenses, since employer-provided
the policy will run out in six years. But     pay for care.                                    long-term care insurance qualifies as an
if, as is more likely, you draw funds                                                          accident and health plan within the
more slowly than $5,000 per month                          The Tax Angle                       meaning of the tax code. Coverage can
(for example, part-time care at home),                                                         also be offered on a discriminatory
then coverage may last for many years.             There are some potential income basis, i.e. with eligibility determined by
     Thus, what this policy actually pro-     tax–advantaged ways to purchase long- employee class. Thus, a professional

                                                                                                                       May 2005        13
                                   Insurance Products

 Table 2. Distinguishing Features of a Good Long-Term Care Contract

      Contract Feature                      Excellent Contract                 Less Than Satisfactory Contract
     How easy is it to satisfy the         Insured must satisfy the           The insured may be required to satisfy
     elimination (the number of            elimination period only once       the elimination period multiple times
     days for covered services             while the policy is in force.      because days of care count toward the
     before the policy pays)               There is no requirement for        elimination period only if they are
     period?                               consecutive days of care           sequential or occur within a specified
                                           and no limited period in           time period.
                                           which it must be satisfied.
                                           Plus, a day of home care
                                           will equal 7 days of care for
                                           purposes of calculating the
                                           elimination period.
     How is “need           for   care”    “Hands-on assistance or            “Actual hands-on physical assistance”
     defined?                              standby help or reminding.”        from someone who is “continuously
                                                                              present.”
     Who sets the care plan?               The insured may choose             The insurance company requires the use
                                           who develops the care plan.        of its own care manager.
     What      conditions    are           A    few    clearly   defined      Ambiguous language such as “conditions
     excluded from coverage?               conditions,      such      as      primarily due to mental disorder,
                                           “alcoholism, drug addition,        including depression and anxiety, or to
                                           or chemical dependency,            substance abuse or dependency.” This
                                           except for an addiction to         language leaves open the question of
                                           [prescribed medicine].”            whether the insurance company will pay
                                                                              for care subsequent to the broken hip
                                                                              from a fall after an evening cocktail.
     How are          benefit     levels   As a certain dollar amount         As a certain dollar amount per day. (If
     specified?                            per month.                         the benefit level is $150/day, and you
                                                                              use $300 on one day and $100 the next
                                                                              day, the benefit for these two days will
                                                                              be $300 versus the $400 of actual
                                                                              expenses.)
     When    is       the    premium       Whenever there is a day of         Waiver only for in-patient care or if a
     waived?                               care that is covered or that       specified number of days of care occur
                                           counts       toward      the       within a set period.
                                           elimination period.



service firm structured as a C Corpo-         beyond employment, and for which             purchase coverage is with a partner,
ration might choose to pay premiums           there is a group discount (which is of-      under an individual contract, purchased
for the senior professional staff in full;    ten available when several individual        with pretax dollars through a group
for other staff members, they may offer       contracts are purchased together).           eligible for a group discount. Partners
just the ability to pay premiums via          Group discounts are particularly ap-         can be spouses, non-spouses in a long-
aftertax payroll deductions—but with          pealing because they remain in place         term committed relationship, two sib-
an attractive group discount offered by       even after the insured leaves the group,     lings living together, or a parent and
the insurance company. Employers can          for instance by retiring. Also, in the       child living together. The key is that you
also offer their staff the ability to pur-    current marketplace, individual cover-       live with someone who could and
chase coverage for dependents, such as        age tends to be more comprehensive           would help to take care of you.
parents, in addition to spouses.              than group coverage with little cost              Note that it is increasingly com-
     One appealing aspect of long-term        difference if the insured is relatively      mon to choose to pay premiums on an
care insurance coverage as an employee        young and healthy, or is applying with       accelerated “quick-pay” basis—for ex-
benefit is that it can be structured so       a partner and so is eligible for a partner   ample, by paying higher premiums
that each insured person is covered by        discount. Thus, in the current environ-      through age 65 or for a specified 10-
an individual contract that is portable       ment the most cost-efficient way to          year period. The advantage of such

14     AAII Journal
quick-pay modes of premium payment          appealing in retrospect if, as seems rea-        who can afford to pay long-term
is to make full use of tax advantages       sonably possible, future contracts omit          care expenses with private funds,
during one’s peak earning years, to         such potentially attractive features as a        but who do not want to do so.
complete a major fixed payment be-          lifetime benefit duration or have more           Precisely because they are wealthy,
fore retirement and, perhaps most im-       managed care language inserted in them           they are also able to choose to pay
portantly, to avoid premium in-             in order to keep costs down for the              long-term care insurance premiums
creases that might occur beyond the         insurance companies. (Managed care               and get the “pop-up” portfolio
specified payment period. “Quick-pay”       language can include restricting benefit         that long-term care insurance pro-
premium levels are substantially higher     payments to a “reasonable and cus-               vides to pay care expenses with
than the pay-as-you-go premiums that        tomary level” as defined by the insur-           pretax dollars.
are due until the insured dies or needs     ance company or requiring that the plan        • Children caring for parents:
custodial care, and so are only suitable    of care be specified by the insurance            Adult children buying long-term
in particular instances.                    company instead of by a neutral out-             care insurance for their parents as a
     Unfortunately, there are no gift tax   side professional.)                              cost-effective way to uphold fam-
planning strategies that are relevant for                                                    ily values.
purchasers of long-term care insurance.            Who Should Buy It?                      • Spouses in second marriages:
Gifts of long-term care insurance pre-                                                       Spouses in second marriages who
miums beyond the amounts eligible to            Who should buy long-term care                require in the prenuptial agreement
be taken as itemized deductions are         insurance? There are a variety of good           that they each maintain long-term
subject to the annual gift exclusion        candidates, including:                           care insurance in order to preserve
amount, currently set at $11,000 per          • Parents trying to protect them-              individual assets for children from
person per year.                                selves and conserve funds for                a prior marriage.
                                                heirs: People who can afford to            • People worried about managed
  When Should It Be Bought?                     pay for some but not a lot of                care: And finally, people who look
                                                custodial care with private funds,           at the long-term care industry and
     When to purchase long-term care            but who are worried about outliv-            anticipate that managed care trends
insurance is an important decision, with        ing their money, or are concerned            might shift from acute to custodial
several trends pointing to the wisdom           that their children’s inheritance will       health care purchase coverage in
of purchasing earlier rather than later—        be diminished by custodial care              order to maintain choice.
for instance, in one’s 40s and 50s in-          costs. If they cannot pay premiums
stead of at the more traditional pur-           out of regular income, these people              What to Look For
chase ages of 50s to 70s.                       pay premiums with cash from the
     Purchasing earlier rather than later       portfolio, not regular income. They          What should you look for in a
not only captures a relatively lower            view long-term care insurance as         long-term care insurance policy?
premium, it also protects against the           portfolio insurance.
possibility of becoming uninsurable.          • Couples with one spouse in               Insurance Company Rating
Potential tax advantages support pay-           poor health: Couples where one                First of all, it may be many years
ing premiums when earnings are high,            spouse is unwell and who want to         before the long-term insurance com-
which is usually before retirement age.         free up personal funds for the           pany is asked to provide benefits. Con-
Furthermore, long-term care insurance           spouse with medical problems but         sequently, purchasing coverage from a
can be an important complement to               still preserve financial security for    strong insurance company is impor-
disability insurance, which at best of-         the healthy spouse.                      tant. An evaluation of company strength
fers partial replacement of family in-        • Executives seeking peak earn-            should include the financial strength of
come but not replacement income plus            ings protection: Executives en-          the insurance company—a high rating
reimbursement for custodial care ex-            tering their peak earning years who      by A.M. Best, as well as presence in the
penses for the breadwinner.                     have adequate disability insurance       market. Companies with a large and
     Financial professionals increasingly       but not so much disability insur-        growing book of business, everything
point to lowered expectations for in-           ance or wealth that they could pay       else equal, have more financial resil-
vestment returns, and advise that it is         for their own care in a nursing          iency, and more ability to negotiate
very appropriate to take an insurance           home and still maintain the family’s     substantial group discounts for their
approach to funding potential custo-            standard of living. (Of the people       insureds from care providers.
dial care expenses.                             receiving long-term care services
     Finally, some industry commenta-           now, 40% are under the age of            Benefits and Restrictions
tors offer the opinion that current long-       65.)                                         To estimate the amount of cover-
term care contracts may look relatively       • Wealthy people: Wealthy people           age you might need, investigate the cost

                                                                                                                 May 2005       15
                                Insurance Products
in your area, or the area you intend to      pound interest. Compound interest of-         Finding & Comparing Policies
retire to, or where your children might      fers substantially more protection and
live, since a common pattern is for          so costs substantially more than simple           Typically when purchasing cover-
older people to get care near family.        interest.                                    age, you work with an agent to get
     Make sure you understand the con-            The inflation protector increases the   quotes and comparisons for the cover-
ditions that must be met to qualify for      benefit from the first day of the policy,    age you need from several companies.
coverage. Typically, a policy will re-       not from the first day that benefits are     Be sure to work with an insurance agent
quire a cognitive or physical impair-        received. Unless you are highly sensitive    who is specialized in the long-term care
ment to qualify for benefits. And you        to cost and also far into old age and so     field and who represents several differ-
should know who decides whether or           not too worried about the impact of          ent companies. A good agent will help
not you qualify.                             long-term inflation, aim to purchase         tailor a contract to your particular cir-
     Also, make sure you understand          the 5% per year compounded inflation         cumstances and also steer you toward
how the benefits are specified. A long-      protection.                                  the company whose contract offers the
term care insurance policy can either             Also, a growing development is          best financial value for you given your
pay the full daily benefit regardless of     for companies to offer a pay-as-you-         health and financial circumstances.
the actual charges for long-term care        go method of inflation protection,                For your own protection, skip the
services, or it can pay the actual long-     where you buy incremental units of           marketing brochures and focus on read-
term care charge up to the maximum           insurance throughout your coverage           ing the actual contract—the only docu-
benefit purchased allowed by the policy.     period at rates current at that time. This   ment that matters.
Reimbursement policies generally have        can be a more expensive means of                  Everything else being equal in the
a different benefit amount for nursing       purchasing coverage, but might make          current marketplace, expect individual
home care and home care.                     sense for someone, for instance, who is      contracts rather than group coverage
     In addition, make sure you under-       buying early before income increases         to offer the best value.
stand the “elimination” or waiting pe-       and with the perhaps heroic assump-               When comparing one or more
riod. The usual range is zero days to        tion that rising income will cover rising    policies, ask for a “specimen” or
one year. However, some contracts            premiums. However, read the fine print       “sample” contract and take the time to
require that these days be satisfied se-     carefully. For example, if you can only      review several specific provisions.
quentially or within a specified time        purchase additional units through age             Contracts differ from each other
period.                                      65, you have no means of inflation-          in important ways. Table 2 shows some
     And of course you need to under-        protection for the potentially long pe-      distinguishing features of excellent con-
stand any restrictions or conditions that    riod from age 65 onward.                     tracts in the current marketplace.
are excluded from coverage and who                In general, remember that the key
is responsible for determining the plan      benefits of long-term care insurance                       Summary
of care.                                     are inflation protection and the ability
                                             to share risk across a large number of           Long-term care insurance, while still
Inflation Protection                         insured. If you skimp on inflation pro-      an evolving field, has become part of
     The usual inflation factor is 5% per    tection, you are potentially missing a       the standard insurance coverage that
year. Some policies figure this as simple    substantial part of the value of the long-   each individual must consider to pru-
interest, and others figure it as com-       term care policy.                            dently manage personal finances. !

 Paula Hogan, CFP, CFA, is the founder of Hogan Financial Management, a comprehensive fee-only planning firm based in Milwaukee,
Wisconsin. She also maintains a Web site at www.hoganfinancial.com.




16    AAII Journal

				
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