A Three-Step Approach to Funding LTC Costs

Talking to your clients about long-term-care costs is probably one of the most important conversations you can have as they enter their retirement years.
With costs averaging about $80,000 per year, LTC expenses pose a significant risk to your clients’ financial security. By using a three-step approach that focuses on managing the financial risks, you can help your clients develop a rational plan for how they will pay for any anticipated LTC costs.
Step 1: This step determines how much of the LTC expenses your clients could afford to self-insure. For most retirees, there are three funding sources for these expenses: Social Security, any income from a traditional company pension, and the distributions from the client’s retirement savings. If those totals come close to the $80,000, then the client could think about self-insuring the costs.
Consider a hypothetical client with Social Security of $20,000 a year, a company pension of $10,000 and retirement assets of $1 million.
The Social Security and company pension will provide $30,000 of annual income. From the retirement assets, and assuming a distribution rate of about 5%, the client would have another $50,000 a year. In adding the three income sources together, the client has an expected income of about $80,000 and could consider self-insuring because his or her income equals the anticipated LTC costs of $80,000.
But what if this client is married? Now we have two individuals living off the same income streams. We also have the possibility that both spouses may need LTC assistance. While we can analyze statistics on LTC needs, they are not very helpful when addressing the probability that this specific client will require long-term care.
When trying to determine whether the client can self-insure, we should assume that both spouses may need care. If costs run $80,000 a year, the exposure for a married couple is $160,000. Because the clients’ income stream is only $80,000 a year, they should consider buying LTC policies to cover the additional potential costs.
Step 2: If the client cannot fully self-insure, this step can help the client determine how much of a daily benefit to buy given his or her financial assets and projected income. With this couple, you might suggest that each spouse considers an inflation-adjusted LTC policy of at least $110 a day. This would provide each spouse with about $40,000 of annual coverage, $80,000 in total, which is equal to his or her expected exposure.
Step 3: Now that you have identified the exposure and daily benefit, this step helps your clients determine how many years of LTC insurance coverage they should consider. But this is where it gets tricky.
Policies can range from two years to a lifetime benefit. While currently most LTC stays are less than three years, no one knows whether your client might need one, three, five or more years of care.
Certainly, if clients can afford and are willing to pay for a lifetime policy that provides them with full coverage, then this may be their safest bet. But clients generally have limited resources to spend on insurance premiums. They are often faced with the choice of buying a higher daily benefit with a shorter coverage period rather than buying a lower daily benefit with a longer coverage period. For many clients, it may make the most sense to buy the policy with the longest coverage period that they can afford.
While premiums will vary among insurers and underwriting issues can significantly affect rates, assume that for about the same premium your clients could buy either a $110 daily benefit ($40,000 a year) for three years versus a $70 daily benefit ($25,000 a year) for 10 years.
Which should they buy?
By selecting the $40,000 policy and combining it with their projected income streams, both spouses are fully covered for three years. However, they each have $40,000 of LTC exposure for years four through 10, which is a total of $280,000 per spouse.
By selecting the $25,000 policy and combining it with their projected income streams, both spouses are short $15,000 a year, but each spouse’s total exposure for the 10 years is only $150,000. Thus, opting for a lower benefit amount but a longer coverage period may be a better risk management tool for many clients.
It is clear that this is a difficult balancing act, and clients must decide what risks they want to bear. But you can assist your clients by using the three-step process to effectively weigh the financial risks. Focusing on the numbers will help your clients make informed decisions about how to allocate their limited resources and plan for a more secure retirement.