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March 1993

Long-term-care financial strategies for the elderly. (Cover Story)

by Clapp, Alfred C., Jr.

    Abstract- More than half of the 31 million Americans over the age of 65 will need long-term-care (LTC) services, but very few of them have adequate LTC financial plans. Medicaid was established in the 1960s to help the poor and, later on, the middle class who cannot pay for their own medical expenses. Aside from Medicaid, another option for financing elder care is becoming a member of the Continuing Care Retirement Community or of other housing or hospital programs. About 2.4 million elderly Americans have chosen to purchase long-term-care insurance (LTCI) policies to fund LTC services. Most people buy LTCI in the hope that premium costs will be considerably less than the cost of LTC services that may be required in the future. LTCI is also cheaper than private medical insurance. The design standard provisions, terms and provisions, and taxation of LTCI are discussed. Other LTC funding strategies are also described.

Providing long-term care for the elderly through Medicaid is becoming a major cost to society. The costs of elder care continue to rise and public funds alone may not be the answer.

Few persons over the age of 50 have made adequate long-term-care (LTC) financial plans. Retirement, trust, and estate strategies often fail to provide for the sizeable costs of LTC.

What LTC arrangements have you developed for yourself, your parents, or individual clients? Do you appreciate that an elder may pay anywhere from $200,000 to over $1 million for LTC services?

LTC is a set of services delivered over a sustained period of time to persons who have lost some degree of physical or cognitive capacity. It is common for the elderly to suffer from a variety of illnesses which prevent them from performing activities of daily living (ADLs) without assistance. Any chronic or disabling condition which requires nonskilled, custodial care in the home or placement in a nursing home may trigger a need for costly LTC services.

Financial Facts and Needs of Old Age

Today, there are over 31 million people over the age of 65, accounting for 11% of the population. Of that number, about 50% will suffer from a cognitive impairment or have limitations in two or more ADLs, requiring LTC services. Currently, Alzheimer's disease is the number one LTC risk. Today, over 3.5 million senior citizens receive LTC services in their homes, and more than 1.5 million live in licensed nursing homes. Medicaid pays for over 70% of nursing home costs.

About 75% of LTC patients on Medicaid are single females. There are two reasons for this: First, women live an average of seven years longer than men; and second, for many married couples the husband is the first to become ill, and the couple's resources are depleted by the cost of his care.

By 2011, those over 65 will number 38 million and represent 14% of the population. Thus, the number of people potentially requiring LTC will increase as will the "dependency ratio" or the relationship between retired and nonworking people to FICA-taxpaying workers. By 2011, over 6 million elders will need LTC services.

Quantifying the cost of LTC is difficult. Statistics are limited, especially for home care, and those that are available are usually estimates. A high percentage of home care services for the elderly are provided by unpaid family, friends, or volunteer agencies. However, some trends can be projected for the future. We can anticipate that fewer families will provide personal care for their elderly relatives; there will be fewer available care givers; the cost of building new facilities will continue to climb; and it will be difficult, if not impossible, to curtail Medicaid expenditures.

Most elders prefer home care, as a nursing home is viewed as a last resort. The average duration of home care which might be eligible for LTC insurance (LTCI) payments is an estimated four years, while the average stay in a nursing home is an estimated two years.

In 1991, the nationwide average annual cost for nursing home care was about $30,000. In the New York area, the annual cost averages $70,000. Nursing home charges increased 8% a year in the past decade, and are expected to continue to climb at this rate.

Assuming home care and other supportive services cost as much as nursing-home care, the "real" current macroeconomic cost of long-term care nationwide is $150 billion annually.

By 2011, given the projected growth in the elder population and an annual 8% increase in costs, the "real" annual macroeconomic cost could exceed $839 billion. The accompanying chart shows this growth at both a 5% and 8% cost-increase rate. An individual paying privately for care could conceivably spend over $140,000 per year ($315,000 in New York) over an estimated five-year period between $400,000 to over $1 million in a lifetime.


Resistance to LTC planning is common. The professional advisor has to recognize the underlying reasons why clients avoid making practical plans. The decision process for aging parents, clients, or a person's own needs is often difficult, frustrating, time-consuming, and sometimes only as effective as the advisor's experience with the complex issues in elder care.

Half-truths and myths about LTC and its financing persist:

* The belief that the person will never need LTC services;

* The highly questionable generalization that home care costs much less than nursing home care;

* The fear that all nursing homes are terrible and abuse the residents;

* The myth of no difference in quality among nursing homes;

* Hope that retirement income, savings, and real estate assets will be adequate, and will not be depleted by LTC costs;

* The myth that Medicare and Medicare Supplementary (Medigap) insurance are significant LTC payers. Too few people understand Medicare coverage covers only 2% of LTC services and--more importantly--that uncovered LTC costs often exceed the costs of acute medical care;

* The hope that the government will pay for LTC, whether through Medicaid or through creation of some new comprehensive program. Yet it is unlikely that any expensive new government programs will be created in the near future--at least until budget deficits can be reduced; and

* The myth that private LTCI is not affordable and the related assumption, that since it is not affordable, it offers poor value.

The Role of Medicaid

Medicaid was created in the mid-sixties, as a Great Society program for the poor. Today, it functions as a program not only for the poor but also for the middle class who cannot afford to pay the high cost of nursing home care. This is because Medicaid pays for custodial care. Consequently elder-law strategies have been devised for people who are not poor by conventional definitions to qualify for Medicaid by spending down assets, transferring funds to family, or establishing trusts.

Medicaid expenditures are increasing dramatically. New York, the state with the most generous Medicaid payments, pays $6 billion a year for Medicaid benefits to its residents--half of which goes to nursing homes. As Medicaid reimbursement rates to nursing homes are far below the rates of private payers, Medicaid patients may not be accepted in more attractive nursing homes or may face a longer waiting period. New York State also provides better Medicaid home-care benefits than most other states. These expenditures are increasing at an annual compound growth rate of about 13%.

States are aware of the increasing cost of providing Medicaid benefits for LTC. They are already taking steps to make it harder to qualify for Medicaid, and we can expect more of these steps in the future.

Continuing Care Retirement Community (CCRC) and Other Housing

A CCRC is a life-care community for the healthy senior citizen enhanced with an on-premises nursing home facility. Typically, a would-be CCRC resident makes a down payment and is placed on a waiting list. Admission is usually conditioned on good health, purchase of a residence, and agreement to pay a monthly maintenance charge.

Nationwide, there are only about 250,000 CCRC residents (about 1% of the senior citizen population). Because it is difficult to finance new CCRCs, it is unlikely that the number of CCRCs will increase sufficiently to satisfy the LTC needs of the projected growing elder population. CCRCs may be too expensive unless sponsored by a non-profit organization.

Hospital programs offer another solution. With their elder-client base, access to medical professionals, and space for health and LTC programs, hospitals are offering programs including LTCI coverage at association discount rates. These programs will expand a hospital's patient community.

Further alternatives (some of which can be covered by long-term-care insurance) include--

* Congregate housing that does not include nursing home capabilities;

* Alternate care facilities for a small group of people needing nursing home care;

* Respite programs that take care of the elderly for short periods of time to relieve care givers;

* Home modification and installation of special equipment to meet LTC needs at home; and

* Adult day care programs.

LTCI Market and Background

LTCI is a product with a significant, but not unlimited, potential for growth. Currently, only 2.4 million senior citizens out of the total elder population of over 31 million own LTCI. The average age of those who have purchased LTCI to date is 69 years old.

The history of LTCI goes back about ten years when this coverage was introduced by AMEX Life (a subsidiary of American Express). The first generation contracts were inexpensive but restrictive, with an emphasis on nursing home care and little, if any, home care coverage. Many of these contracts have since been withdrawn from the market. Purchasers were often given the right to convert to an improved policy.

In the future, many persons age 50 and older will purchase LTCI either individually or through group business/associations; but coverage will still never become universal. Many of the recent second generation of policies have been greatly improved with standard provisions, home care benefits, and valuable, affordable coverage. However, possibly only 50% of elders may qualify or be able to afford more than a minimum level for Medicaid strategy purposes. After the age of 79, LTCI policies, if available, are so limited and restricted that the coverage is often not cost effective. Many senior citizens also have serious health problems, which may result in LTCI policies with higher premiums or being declined. Nevertheless the potential for growth in LTCI individual and group markets is very strong and will occur with an understanding of LTC strategies for the elderly.

Public-Private LTCI Partnerships in Connecticut and New York

The Robert Wood Johnson Foundation has successfully sponsored public/private LTC partnerships to encourage LTCI planning and financing and to reduce a state's Medicaid expenditures. The projects link insurance coverage and Medicaid eligibility. The first LTC partnership was implemented in Connecticut in 1991. An individual who purchases one of the LTCI policies pre-certified under the Connecticut Partnership can protect $1 in assets for every $1 of coverage purchased. Under this Medicaid protection, there is no protection for income, only assets. There is no minimum specified period for the coverage, and purchase of inflation protection riders (an expensive feature) is discretionary with the purchaser.

The New York State Partnership, implemented in late 1992, has the same goals as the Connecticut program, but has a different philosophy. The precertified New York State policies require a minimum purchase ($100 daily benefit for three years of nursing home treatment, plus a $50 daily benefit for six years of home care). If this level of coverage is maintained, the insured person will qualify for Medicaid after the private insurance is exhausted, irrespective of his or her level of assets. The New York plan includes a mandatory 5% inflation rider. The Partnership's link to Medicaid is effective only if the insured person continues to reside in New York.

Robert Wood Johnson projects are in the process of being implemented in Indiana and California. Other states are considering their own public/private LTCI partnerships to reduce both Federal and state Medicaid payments. However, the Medicaid cost reduction benefits from these positive endorsing LTCI efforts may be 10 to 20 years into the future until precertified and other LTCI coverage becomes more widely accepted by middle income elders as a primary way to avoid Medicaid dependency.

LTCI Design Standard Provisions

Today, major companies offer LTCI policies with many standard contractual terms and some provisions which differ between contracts. While there is no uniform nationwide standard for LTCI policies, the National Association of Insurance Commissioners has promulgated standards that have influenced most state regulators. Common features of LTCI policies include--

* Coverage for a fixed purchased benefit and number of years. This approach contrasts with the "reasonable and customary" full coverage philosophy of health insurance;

* Guaranteed renewability--i.e., the insurer does not have the right to cancel an individual's policy because that person's health has deteriorated. However, insurers do have the right to seek state approval for a premium increase for an entire class, and probably will after claims experience justifies some rate increase. While the risk of class- wide increases is an important one to disclose to everyone considering an LTCI purchase, states mandate minimum loss reserves, reasonable actuarial assumptions, product designs, and are reluctant to allow rate increases without ample justification;
















* Benefits are payable without a prior hospitalization requirement;

* Daily benefits available in varying amounts, ranging up to $250 a day;

* Coverage usually begins after a waiting period, e.g., 20-30 days or 90-100 days;

* Premiums are level and paid until an insured dies or a benefit is paid and a waiver of premium triggered. The annual amount of premium paid depends on the age at which the policy was purchased and the level/type of coverage;

* Inflation riders are common but options to purchase additional coverage are not;

* Home care custodial benefits are available as a percent of the coverage for nursing home costs; and

* Nonforfeiture features are usually available as riders, albeit at a significant additional cost. However, most policies now available do not include a return-of-premium feature, nor the ability to fund a policy on an abbreviated payment basis similar to the life insurance policies that are fully paid up after several years.

Most companies have adopted similar underwriting guidelines as those required for life insurance. LTCI is concerned about mobility, serious arthritis, and blindness. While attending physician statements often are ordered, medical examinations are seldom required.

Problems caused by alcohol, drugs, or mental illnesses are excluded from coverage. Alzheimer's disease and other dementias are covered by LTCI.

Individual LTCI Terms and Exceptional Provisions

Each LTCI company has its own special contract provisions. An educated buyer must review contracts to understand these differences before making a LTCI commitment:

1. The amount of daily/annual benefit coverage, years of coverage, amount of home care coverage, waiting period before benefit begins, and inflation rider options vary by contract.

2. Home care coverage is usually available at the 50%, 80%, or 100% level of the base nursing home-care coverage. This is the most important variable area. If home care is a priority, it is important to factor the different level of home care coverage into any comparison of premiums between different company proposals. A home-care rider has an incremental cost for the extra years purchased for this purpose which amounts to about 30% of the base nursing-home cost.

3. Contract provisions also vary in the following other respects but these differences are less substantive:

* Claims can be paid on either a reimbursement or an indemnity basis. In a reimbursement policy, an insurance company reimburses a licensed agency for custodial aid services or a nursing home up to but not more than a policy benefit limit. In an indemnity policy, the full coverage is paid directly to the insured. While a disability income approach recently introduced allows the insured to use the benefits paid for any purpose, this approach is relatively expensive. Disability policies also include LTC riders. As LTC costs are likely to be greater than the amount of coverage purchased, the three different payment approaches are not an important contractual, financial issue.

* The definition of activities of daily living varies, but inability to perform two or more ADLs is the usual qualification for LTCI benefit payments.

* Contracts also vary slightly on extra areas such as respite care or day care, reimbursement for certain home equipment, starting time period for a waiver of premium payments, and waiting time periods after an interruption in LTC services.

Cost/Benefit Value

The main reason to purchase LTCI is the expectation that premium costs will be much less expensive than the potential outlays for LTC services. Here is a typical example to highlight why LTCI is valuable.

Assume that a person aged 65 buys an LTCI policy, paying a level premium of $1,900 for 15 years. At age 80, which is the average age at which LTC services are required, the purchaser will have paid $28,500 in premiums for $500,000 worth of home-care and nursing-home benefits. This results in a 17.5 to 1 value ratio.

Of course, a person may purchase as much or as little coverage for as many years as are deemed at risk. However, the financial risk is greater for LTC services above the average required time, and it is made economically attractive to purchase more coverage rather than a lesser amount on a conservative basis. What other investment might an elder consider with a potential return of better than 10 to 1? And no one would be disappointed if, at the age of 80 because of good health, LTC services were not yet required and the value ratio ended up being lower.


Affordability is often cited as an issue and reason not to buy LTCI. This argument is often made politically to advocate universal LTCI coverage. However, it also has to be acknowledged that LTCI often costs less than private medical insurance. The amount of coverage may be geared to a person's budget and strategy. The younger a person is, the more affordable the coverage. As a financial planning benchmark, not more than 10% of after tax income should be devoted for health and LTC insurance purposes. Of course, an elder's children might also decide unselfishly to pay LTCI premiums.

The data in the accompanying table summarizes the average premiums for LTCI policies issued by three of the leading national LTCI insurers, on an approximate composite basis. The assumption is that the policies are purchased on an individual basis without a 10% spousal discount. The calculations are based on a $150 daily benefit ($54,750 a year or a total coverage over 10 years of about $500,000 with five years allocated for home care and five for nursing home care), assume different waiting periods, and compare policies without inflation protection with one with a 5% annual compound growth rate (ACGR) rider.

A shorter waiting period may reduce initial outlays for care in exchange for additional premiums. However, many persons prefer to save the extra premium by self-insuring for the initial transitional waiting period.

The above information also reveals that premiums increase on about an 8% annual compound growth rate basis. Purchasing coverage at an earlier age is not only less expensive but also eliminates any risk of not being able to obtain insurance coverage.

Inflation and Self-Insurance Role

Purchasing an inflation rider increases the cost of the coverage by 80% for a younger person and just over 50% for an older person. It is also evident that the younger a person is the greater the value of an inflation rider. Most LTCI assumes and will require self-insurance not only for the initial waiting period but also to cover LTC costs exceeding benefits paid. The accompanying table shows the potential increase in such costs at both a 5% and 8% rate for both the New York area and the U.S. The amount of this financial risk should be recognized, while at the same time considering financial plans that hedge against inflation risk.

The extent of inflation risk at various ages is a serious concern. The longer you live and require LTC coverage, the more important hedging against inflation becomes. Strategies such as the following should be combined with the consideration of whether to purchase a 5% annual compound growth rate inflation rider:

* Purchase initially more than the estimated coverage required;

* Consider using a less expensive LTC service or moving to a less expensive location/area;

* Be prepared and able to cover inflation either with investments or sale of a residence or less liquid assets; and

* Consider Medicaid strategies after an initial coverage time period.

Group LTC

The Conference Board's recent report, "LTC: A New Employee Benefit?" indicates that nearly all large corporations are considering LTC insurance as a natural, needed extension of their current benefit plans, and a complement to their health, disability, and retirement plans. However, with the high cost of existing benefit plans, interested employees (not employers) are paying for this benefit at the 200 companies who sponsored LTCI group plans through 1991. Although some plans provide LTCI as part of a flex-benefits plan, employees are usually paying the premium on an after-tax basis.

Many of the plans also permit the employees to purchase coverage for their spouses and parents. LTCI for smaller groups and parents are usually individually underwritten. Employees in larger groups may be covered without concern about being turned down based on prior medical history. Offering LTCI decreases workers' anxiety over caring for their parents--and increases worker productivity. By sponsoring a group, generally the employer can offer better coverage, more control, "clout," and a group discount. Given the need for LTCI, growing acceptance and understanding of this new type of insurance, a sizeable growth of group plans is expected.

Actuarial Assumptions in LTC Pricing

The pricing of LTCI products depends on the following actuarial assumptions: 1) mortality; 2) persistency (the length of time a policy remains in force without lapsing); 3) investment return earned by the insurance company; 4) expenses of marketing, compliance with government regulations, and operations, 5) morbidity (i.e., the length of time benefits are paid); 6) a state required minimum loss-reserve ratio; 7) a company's underwriting standards and experience; and 8) product profitability.

Considering the above actuarial factors, it is possible to understand the favorable cost benefit values and pricing of LTCI. A high percentage of individuals will either die or lapse their policies. With LTC services required on average at about the age of 80 and an estimated payment period of four years at home and two years in a nursing home, it is understandable that the premiums paid increase with age.

Taxation of LTCI

A strong case can be made for treating many LTCI policies as health insurance under IRC Secs. 104 (a)(3) and 213. Traditionally, the IRS has allowed a broad interpretation of the definition of "medical expenses," and the full cost of a nursing home stay (including meals and lodging) can be treated as a medical expense as long as the primary reason for institutionalization is a need for medical care, not the convenience of the patient or family. Given this treatment of nursing home expenses, it seems plausible that the insurance covering such expenses should also be entitled to favorable tax treatment, and that premiums should be included with the medical expenses that are deductible above a floor of 7 1/2% of adjusted gross income.

However, the IRS has not pronounced on the status of LTCI, and it is impossible to promise favorable tax treatment to a client who wishes to purchase LTCI. One reason employers are reluctant to add LTCI to the benefit package is the uncertainty of whether premium costs are deductible. Nor has Congress legislated on the LTCI tax issue--perhaps as a ploy to exchange favorable tax treatment for strict Federal regulation.

Living Benefits and Other LTC Financing Strategies

Senior citizens who own whole or universal life insurance policies and are expected to die in less than a year may be able to turn to two related financial strategies: living benefits (LB) and viatication. Under LB, a life insurance policy that contains an accelerated benefit rider can be accessed during lifetime with part of the death benefit paid out to the insured. New York State has regulations permitting insurers to add accelerated benefit riders to new and existing life insurance policies. Usually, there is no charge for the rider.

However, LB riders added to life insurance policies are not an attractive way to guarantee LTC coverage. The riders are restrictive and provide limited benefits. Life insurance and LTC insurance serve very different needs and purposes, and acceleration of benefits should not be viewed as an LTCI substitute.

Under viatication, a third party (not the insurance company issuing the life insurance policy) purchases the insurance policy outright, at a discount. The one-time owner now has cash, for use during a health crisis, but no longer has life insurance coverage.

In December 1992, the IRS proposed regulations which would permit the proceeds from LB to be considered non-taxable.

Other LTC financing strategies convert non-income producing assets such as homes into income streams. One such method is a reverse mortgage in states where they are permitted. For the charitably inclined elder, irrevocable charitable annuities or unitrusts may be considered. For younger married healthy couples between the age of 50 and into the 70's, the additional funds generated from a charitable trust may be sizeable enough to replace the assets donated through purchasing joint second-to- die life insurance for their heirs and still have incremental income for retirement or other purposes.

Personal Preferences and Overall Strategies

There are many significant concerns and issues about the care of the elderly. Prominent elder law attorney Peter J. Strauss, Esq., summarized some of the major issues:

* When a family advisor works with a team of other professionals (lawyer, social workers, doctors specializing in geriatrics, financial planners, accountants), it is not always clear who is the client--the older person? The entire family? Society as a whole?

* What are the ethical implications of Medicaid planning? Should middle- class people rely on Medicaid or look to the private sector?

* What, if anything, will the Federal government do to provide care and funding for care? Until and unless Congress and the Executive Branch act, the insurance industry has a critical responsibility and will be publicly and politically criticized.

LTC planning has to consider personal preference. A checklist of questions include:

* Have you taken appropriate legal steps to protect yourself with a will, power of attorney, living will and/or health care proxy?

* Do you understand the importance of LTC planning?

* What has been your LTC experience with family or friends?

* Where do your family and friends live?

* Would you prefer to live in your current home or would you consider moving?

The following strategies deserve to be given high priority by a CPA for clients, tailored to each person:

* Don't delay making adequate LTC plans for persons over age 50.

* Consider the need, value, use, and limitations of LTCI policies for LTC financial planning.

* For clients who are willing to relocate, explore the availability and pros and cons of CCRCs.

* Learn how the Medicaid system works, and the real consequences of becoming a Medicaid beneficiary in case this strategy is sensible (including need to transfer assets or place them in trust). With your interest and commitment to LTC planning, these insights and strategies may help you advise about pragmatic LTC plans.


AFLAC (American Family Life Insurance Company) AMEX (American Express)(*) American Integrity CNA(*) Finger Lakes Blue Cross Blue Shield Gerber Life IDS John Alden John Hancock Mutual Life Insurance Companies(*) Metropolitan Life Mutual of Omaha New York Life TIAA Travelers(*) UNUM

* Larger leading individual LTC insurance companies

Alfred C. CLapp, Jr., MBA, CLU is a financial retirement and estate advisor and principal of The Financial Strategies & Services Corporation, an elder financial management company. He is a frequent speaker, seminar sponsor, and author of long-term-care articles.

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