As I contemplated the topic for my next article, I considered lifting the spirits of my readers with such topics as genocide, malnutrition, nuclear meltdown, and the performance of the U.S. Men’s National Soccer Team. But in the end, I settled on a discussion of long-term care. The decision was at least partly1 motivated by the fact that this last topic is the only one likely to directly affect most of us.2
Alas, the very likelihood of requiring long-term care (LTC) is what makes long-term care insurance (LTCI) a dubious offering. As noted by Michael Kitces and others, insurance works best when a large group of individuals contributes to a pool of assets to cover some large but improbable expense for those few unfortunates who experience it. In this way, each individual transforms an unlikely but potentially ruinous financial outcome into a manageable, forecastable expense.
But long-term care expenses aren’t a rare contingency. As the chart below, from the Department of Health and Human Services,3 illustrates, more than half of individuals age 65 and older can expect to experience a serious long-term care service need in their lifetimes.4
Long-term care needs are often met by unpaid individuals, usually family members or friends. (This can present its own set of struggles, for the caregivers as well as for those requiring care.) But even the need for paid LTC services will be experienced by the majority of seniors:
Motivation: The problem with long-term care insurance
Due to these high probabilities, LTCI has grown very expensive, and (as also noted by Kitces) it now feels more like prepayment of expenses than true insurance. Putting it differently, most retirees either can’t afford long-term care insurance or can afford to skip it.
Another issue is that LTCI policies are designed more like dental insurance than medical insurance: They cover expenses to a point, but then you’re on your own. Granted, the max payout is typically one or two orders of magnitude greater than what dental insurance covers,5 as LTCI policies typically cover perhaps $100,000 to $300,000 of lifetime expenses. But a multi-year stretch of highly expensive long-term care (e.g., five to 10 years of nursing home care) can cost multiples of that amount, potentially devastating the finances even of once-affluent retirees in the worst-case scenario. This is why I’ve identified long-term care as the greatest unsolved challenge in the field of goals-based retirement investing.6 This doesn’t make me Sherlock Holmes. Anyone who has requested a quote for LTCI knows we’ve got a problem.
Last year, here on Advisor Perspectives, I published an article called “My Dream Annuity.” The article led to multiple fascinating discussions for me, and I’ve subsequently learned of several extant and prospective solutions, not least the Stone Ridge LifeX Funds. With these heady outcomes as impetus, I thought I’d try my luck on another dream.
A better insurance: High dollar deductible LTCI
As noted above, most retirees will require some amount of long-term care, which attenuates the risk-pooling benefit of insurance. However, the charts above also make clear that a much smaller percentage of retirees require many years of long-term care, which circumstance is highly correlated with the financially devastating worst-case scenario.
This observation has led several observers (e.g., again, Kitces’s article) to call for “high-deductible” LTCI, to convert the product back into one that insures low-probability/high-impact outcomes. However, I employ quotation marks, because “high deductible” has heretofore been taken to mean long elimination period LTCI. That is, the deductible is defined in terms of how long a policyholder receives care—say, one to three years instead of the more common 90 days—before the policy begins to pay benefits.
But as an advocate for liability-driven/goals-based/safety-first investment techniques, this creates a problem. To put it simply, I can’t set aside “years” to cover my clients’ deductibles. But I can earmark dollars to do so.
The solution? High dollar deductible long-term care insurance: Instead of covering the first,7 say, $200,000-$300,000 of LTC expenses, my dream LTCI would treat the first $200,000-$300,000 of LTC expenses as a deductible and would cover everything8 above that.
For the goals-based financial advisor, the benefit of this arrangement should be clear: As with other goals, such as income, large one-time expenses, etc., we could set aside in advance assets designated to cover the LTCI deductible. Any assets ultimately not required for that purpose – i.e., for the fortunate majority who never require hundreds of thousands of dollars of paid care – would ultimately contribute to legacy.
This is not conceptually much different from present circumstances, wherein we often earmark otherwise unencumbered assets as “long-term care if needed, legacy otherwise.” But the huge difference between current LTCI and my dream LTCI is that the high but fixed9 deductible of the latter would allow for proper asset/liability matching. With my dream LTCI, it would become possible to immunize the long-term care liability, as we seek to do with other categories of expenses. Beyond the assets required for this immunization, extra dollars would be truly unencumbered, freeing us to invest them entirely in a manner appropriate to the clients’ heirs.
In addition to goals-based investing reasons to prefer a high dollar deductible to a long elimination period, consider the following examples of why such a policy would plausibly be a better product for a better price:
The possibility of a relatively common, say, $20,000/year service need for the first three years, perhaps followed by more expensive care needs as health deteriorates, will drive up the actuarially-demanded premiums for long elimination LTCI – unnecessarily, for someone who can cover a high lifetime deductible.
Conversely, if less commonly, an immediate need for three years of nursing home care at, say, $180,000/year, would add up to an enormous expense before a three-year elimination period would be exhausted, thus defeating the intended purpose of high (but not astronomical) deductible LTCI.
Why it should work, and why it might not
Of course, this concept only works if low-probability risk pooling sufficiently counteracts the higher maximum benefit to make such a product reasonably affordable. My theory is as follows:
Most policyholders would likely never receive any benefit. (Which is a good thing! Will you be sad if you never receive payment on your fire insurance? On your term life insurance? Your umbrella insurance? Exactly.)
The aggregate cost of LTC expenses beyond the deductible threshold should be (much?!) less than the aggregate cost of LTC expenses inside the threshold. That is, while a few older adults will incur upwards of millions of dollars of expenses, the majority who receive nothing (per #1) and those for whom benefit payouts are less than the deductible itself should bring the average payout down to a manageable figure for insurers, thereby bringing premiums down to a manageable level for policyholders.
I suspect item #1 is on solid footing, with evidence like the DHHS data above and, at least anecdotally, the relative rarity of worst-case outcomes. Item #2 is more speculative, but it seems reasonable, given both the low absolute levels in the “5 or more” columns in the DHHS charts and the rapid downward trend implied by the steep drop-off from zero to five years.
Regulatory hurdles could conceivably also impede the availability of this form of insurance. I would hope the state-by-state limits on elimination periods most often cited as obstacles to “high deductible” LTCI could be sidestepped by a truly high deductible insurance product where providers would presumably begin reporting expenses to the insurer immediately, to start accruing against the deductible. But I’m no expert in this area, and hope is not a strategy.
Finally, a sensible question: How does this help the many retirees who would go from not being able to afford the insurance premiums to not being able to afford the deductible? Unfortunately, it does not help them directly. Their fallback is Medicaid, just as it is now.
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However, it is at least conceivable that government-provided LTCI programs could be buttressed by popular adoption of my dream LTCI. As a market-provided insurance solution for worst-case scenario care, it would lower the expected total cost to government backstop programs – not least by offering a better approach to the problem for retirees who presently may be tempted to shift or hide assets to accelerate Medicaid eligibility.
Might the greatest unsolved problem be solvable? Research results to come…
A few next steps readily suggest themselves:
I will reach out to some actuary contacts about generating pro forma actuarial calculations. It should be possible to get a better sense of the financial feasibility of high dollar deductible LTCI. I’m cautiously optimistic.
I have also begun to reach out to industry contacts for discussions regarding opportunities and potential impediments to the development of real, live insurance products around this concept.
Meanwhile, I will do what I can to raise awareness of the concept in my industry, to ignite the latent demand that I believe should exist among RIAs. After all, a product that costs less up-front and better protects the asset base from decimation could be in many of our clients’ best interests, in a manner plausibly conveniently conflict-free.
This article is my first volley aimed at #3. When #1 and #2 are further along, expect me to be back with more!
Author: Nathan Dutzmann
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