Inflation is a crucial element in any long term contract. For instance, if we assume an annual increase in LTC costs of 5%, 30 years later, a 50-year old participant of a long-term care plan will face nursing home costs more than four times the initial purchased coverage amount. It is clear that there is very little value in such a benefit, particularly since inflation in nursing home costs runs in the range of 5-10%, by far outpacing consumer price index average for nursing home care which exceeds 5.0% for the beginning of 2007i.
For this reason, it is prudent for a long-term care plan to either provide a large daily benefit, or some variety of inflation protection. In fact, some plans such as the New York State Partnership for Long Term Care do not allow policies without such protection at most agesii. Commercially available long-term care insurance policies offer several different kinds of options for insuring against the risk of rising costs. Since working-age employees can face 30 to 60 years before experiencing LTC costs, these features are especially useful for an employer to consider.
Automatic benefit increases
Many policies offer benefit increases, where maximum daily benefit amounts and total maximum benefits increase annually. This increase can be simple, where the annual increase is a percentage of the original daily benefit or compound where the annual increase is a percentage of the current daily benefit amount. Compound inflation increases the daily benefit amount more quickly and to higher levels in the long run. Compound inflation also more closely mirrors how prices behave over the long term. Although premium is initially higher for this type of policy, it is level over policy lifetime and is not intended to increase, in contrast to the premium under the Guaranteed Purchase Option.
Guaranteed purchase options
Guaranteed purchase options also allow the participant to increase the maximum daily benefit amount to hedge against inflation in the cost of obtaining long-term care. The option to purchase additional daily maximum dollars without underwriting comes up every few years (usually two, three or five years) during the policy lifetime. Since the contribution rates for the additional coverage are determined based on the employee’s age at the time of the additional election, the marginal annual contribution for the additional coverage is higher than if the same amount of additional daily maximum had been purchased up front. If the participant declines the opportunity to elect additional coverage one or two times (depending on the plan design), the offer might not be made again.
In practice, however, these options are infrequently exercised, so that the inflation protection is not afforded. We have seen examples where the rate at which the upgrades are chosen is as low as 10%. On the other hand, if individuals do choose to purchase the guaranteed options on a regular basis, the total premium paid can grow to potentially unaffordable levels. This could cause individuals to stop paying premium altogether, so that the coverage is not available when they need it most.
Discretionary inflation adjustments
Most existing insurance contracts have a pre-determined method for setting the inflation increases in the benefits. This is because the insurer must set a price in advance for the benefits stated. While we expect inflation to occur, the level of inflation is not predictable. A pre-set level of 5% may be too much, resulting in over-insurance, or too little, resulting in under-insurance.
If the employer is in control of the benefits, it can make ongoing choices of upgrades in daily benefits to reflect actual inflation levels as they emerge. These decisions could be made relative to a benefit with no inflation adjustment in the base, or relative to a benefit with a low (2% to 3%) inflation adjustment, if the need arises. However, adjustments made in this fashion would need to be funded after they are made, so they do not work as well for retirees.
Why is true group long-term care so important?
- Many Americans will have no way to pay for long-term care services when they are needed.
- Insurance for long-term care will not become widespread if only available on an individual basis, which means that the change will need to come first from employers.
- Group coverage needs to include employer contributions to make it affordable to employees and vesting to make it affordable to employers.