A New Kind of Long-Term Care Insurance

More than 400,000 long-term-care insurance policies were sold in 1992, according to figures published by The Wall Street Journal. These are the policies that help seniors cover the costs of nursing home stays at the end of life. At least 400,000 additional policies were purchased each year in the subsequent ten years, peaking at about 750,000 in 2002.

Then sales collapsed, and never again reached the 400,000 level. Last year, reportedly only 66,000 such policies were sold. The need for long-term-care insurance has never been greater. What happened to the market?

Actuarial errors

A series of actuarial errors were made when long-term-care insurance was first introduced. The most important of these was the “lapse rate,” the number of policies that will be terminated without ever paying a benefit. This occurs either because the insured stops paying premiums or the insured dies without making a claim. The actuaries chose a fairly conservative lapse rate of 5%. At that rate, if 1,000 policies were sold in year one, only 400 would be in force 20 years later. As it turned out, the buyers of long-term-care insurance thought of their purchase as an investment, not as insurance, and so the lapse experience was closer to 1%, which implies that 800 of every 1,000 policies still will be in force after 20 years. That led to far higher payouts than projected.

Two more errors compounded the damage. The first is that medical advances have lengthened life expectancies, which, in turn, increases the likelihood of making a claim on a long-term-care insurance policy. The second is that the actuaries generally assumed a 7% rate of return on the invested premiums on these policies. That assumption was fine in the 1990s, but interest rates have been at historic lows since 2008. When long-term-care policies are priced today, the projected rate of return on premiums is likely to be 2% to 3%, which drives premium costs still higher.

Hybrid insurance

The new approach in this area combines life insurance with long-term-care insurance. An estimated 260,000 such policies were sold last year. There is wide variation among such policies, but they may offer:

• a death benefit;
• guaranteed level premiums;
• a return of premium feature should the buyer have a change of heart;
• fully paid up insurance after 10 years.

When the product offers more, it will cost more. In an example published recently in The Wall Street Journal, coverage for a couple in their mid-50s came to over $32,000 per year for 10 years, a total of $320,000. That compares to some $8,500 per year for a traditional long-term policy, in which the premiums must continue to be paid. After 30 years, the traditional policy will require $255,000 in total premiums, assuming no premium increases, so the disparity is not as large as it may at first appear.

What’s more, the minimum death benefit of the hybrid policy was $180,000 per spouse, which will be larger than the total premiums paid.

Still, the hybrid policy requires most of the premium payment early. For this couple, the policy will be paid up when they are in their mid-60s, and they may well not make a claim for another 20 years. Such coverage will be most attractive for individuals with high current income, sufficient to comfortably cover the premiums, who want to protect a large estate from being eroded by private nursing home costs. Maximum coverage in the illustration was $1,371,891 per spouse.

Look to the future

If you already have a long-term-care policy, you probably want to hang on to it. For the most part, those who have purchased these policies have profited from them.

The poorest seniors may have the costs of their long-term care picked up by the government through Medicaid. The wealthiest may be able to cover the costs without insurance—even though a year’s stay in a nursing home can easily cost $100,000 or more.

For everyone in the middle, planning is necessary. Despite the price increases, long-term-care insurance will prove to be an important part of the plan for many affluent families.