A successful retirement has as much to do with saving money and investing well as it does with managing risk. And when it comes to managing risk, you have four options – absorb the risk, avoid it, reduce it, or transfer it.

The order of operations is to avoid risk when you can. Take measures to reduce risks where possible and absorb the small risks that don’t have a large financial impact. The large catastrophic risks should usually be transferred to an insurance company (i.e. buy an insurance policy).

Long-term care events tend to be good risks to insure. The cost of a long-term care event is exorbitant, but so are policy premiums. This makes navigating the best course of action difficult. We’ll break down what you need to consider when you determine how best to manage a long-term care event.

How does long-term care insurance work?

A long-term care insurance policy covers the cost of care when someone needs help with their physical needs. This care is usually needed most in the final years of life. A policy is triggered when you have a cognitive impairment, such as Alzheimer’s or dementia, or cannot perform two of the six activities of daily living (eating, bathing, dressing, mobility, continence, toileting).

Policies can be used to cover custodial care or skilled nursing care. The distinction between the two can become important. Custodial care does not require licensed caregivers and is necessary for things such as bathing, dressing, and some household duties like cooking and laundry. Custodial care is not covered by Medicare or private health insurance policies.

Skilled nursing care may include things like physical therapy, wound care, injections, and other services that require licensed and trained medical staff. These services may be covered under Medicare Part A hospital insurance if care is given in an appropriate facility, but this is temporary. Only the first 90 days are covered. Insurance or your own checkbook will be needed for any additional days.

How much does a long-term care event cost?

A lot. But that’s a simplification. Costs vary wildly depending on what part of the country you are in and the level of care you need. The Genworth cost of care report can help you piece together a good estimate in your area. In the Washington, DC area for 2020, a home health aide costs about $4,300/mo on average while a private room in a nursing facility costs about $13,000/mo on average.

The length of time of a long-term care event also comes with some wide divergences. The US Department of Health and Human Services Administration on Aging produced research indicating that the length of stay in an assisted living facility is 29 months. The average stay in a nursing home is 27 months. It is not uncommon for people in assisted living to graduate to a nursing home. The total cost of care could be upwards of $300,000. This is steep.

How are policies designed?

Daily vs Monthly benefits, COLAs, and Elimination Periods

Policies are customizable and flexible. They are generally sold with a daily benefit or a monthly benefit. Daily benefits pay up to a maximum amount for care each day. This works well in care facilities where charges are levelized and consistent with the daily maximum.

But home care is a little fickler. A caregiver may only be needed on certain days of the week and the duties they perform on those days may vary. Some days may have more services than others, and those days could incur charges that exceed the daily maximum. This is where a monthly benefit works better. These policies cap benefits each month as opposed to each day. This allows for greater flexibility as to the timing of the care.

Long-term care policies are usually sold with a waiting/elimination period, which is the length of time you are required to wait before you’re eligible for reimbursement. The period is chosen by you at purchase with longer elimination periods costing less than shorter elimination periods. Medicare Part A frequently covers the first 90 days of skilled nursing care, which makes a 90 day elimination period on these policies the industry standard.

You should also pay attention to cost of living adjustment riders, which will increase the level of benefits received over time as a hedge against inflation.

Duration, Indemnity vs Reimbursement, and where you receive care

The most robust policies will pay for home care, assisted living facilities, and skilled care facilities. But some may only offer one or two of these care settings. Some policies will pay half as much for home care as they will for skilled nursing care. Ensure you think through your preferred care setting carefully.

Policies are usually sold with a benefit that runs for a certain amount of time. For example, you could get a policy with a $150/day benefit that will pay for three years. This policy will pay a maximum of $150 x 365 x 3 = $164,250. That policy is capped at the total dollar value of $164,250 and not by the three-year period! The policy would last longer if the care provided costs less than $150/day. The maximum amount a policy will pay is based on the total pool of money. It is not based on a maximum length of time on claim.

The pool of money concept is important when looking at indemnity and reimbursement policies. Most policies will pay benefits on a reimbursement basis. This means that if you have a $150/day benefit but only spend $120, then the policy will pay out $120. The $30 difference between those values isn’t lost. Its extra money that stays in the total pool of funds you have available. It just allows your policy to last longer.

Indemnity policies work differently. These policies will pay the stated daily maximum regardless of the actual cost of care. If we carryforward the example from above, the policy would pay $150/day even though the care only costs $120/day. The ‘extra’ $30 is cash that can be saved or spent.

Other Key Provisions

Policies are almost always built with a waiver of premium provision. This means you stop paying policy premiums if/when you go on claim.

Third-party notifications don’t impact the policy per se but are nice to have. This feature allows the insurance company to notify a third party of your choosing (often times a child or advisor) if you forget to pay a premium. This can help prevent a lapse in the policy if the non-payment is due to a cognitive impairment.

Lastly, long-term care policies are written on a guaranteed renewable basis. This means that the insurance company can’t cancel your policy if they underwrote it poorly and have high claims. But they can raise premiums. If you know one thing about long-term care policies, it’s probably that.

The often unaffordable cost of long-term care insurance

Long-term care policies first came to market decades ago. Insurance companies scrambled to sell them and tap into what seemed to be a new and lucrative market. But they grossly underpriced their policies. Elder care costs exploded, people lived far past the insurers’ original mortality expectations, and people didn’t let their policies lapse! The confluence of these factors killed many insurance companies and nearly destroyed several others. They buckled under the weight of the promises they made to their policy holders.

So, prices have increased. Not just on new policies, either. Prices jumped significantly for everybody and often times by double digits. Long-term care insurance is something that is now often out of reach for the people who can’t afford to be without it, and unnecessary for the people with the means to afford it.

Practically speaking, a partially insured solution may be the new normal going forward. Greater levels of care may be provided by children or other family members with only skilled nursing care being paid for with a long-term care policy.

Medicaid and Partnership Policies

Medicare is the Federal government funded health program for those aged 65+. Medicaid is a state government funded health program for those with little means. Long-term care services are not covered under Medicare but are covered under Medicaid.

There are to qualify for Medicaid. To encourage people to plan ahead and stay off of Medicaid, many states created long-term care partnership programs. These programs all have their own flavors but work on the same basic premise. In Maryland, Medicaid will disregard any assets you have up to the amount of benefits in a qualified long-term care partnership policy.

For example, Medicaid will disregard $200,000 of assets if you have a qualifying long term care policy with $200,000 of total benefits. Partnership programs turn long-term care policies into asset preservation tools. You may be able to preserve an inheritance for your kids despite a lengthy nursing home stay.

Other Medicaid Planning Techniques

Ethicists beware – qualifying for Medicaid can be achieved by those with means. Medicaid has a five year look back period. Any gifts or transfers made during in the last five years are roped back into the applicant’s estate when determining eligibility. This rule exists to keep people from gifting assets at the last minute just before applying for Medicaid.

But if planned correctly you can gift an estate away and qualify for Medicaid. However, this is difficult in practice, particularly with retirement accounts, and brings up a host of other issues around trust and control that are arguably even thornier than the problem of paying for long-term care in the first place! Be careful pursuing such an aggressive gifting strategy.

Conclusions and Parting Thoughts

Aging gracefully is challenging in the US. The chances of you or your spouse needing care are high, as are the costs of that care. Long-term care insurance can play a role. But it may not be a silver bullet – it too tends to have a high price tag. A partially insured solution, state-funded care, and informal caregivers such as family members could all play a role. The most important thing is that you manage this risk in a way that works for you.