Don’t let inflation erode long-term care

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Inflation may pose the single biggest threat to the value of a long-term care insurance policy.

If your long-term care, or LTC, policy doesn’t have some element of inflation protection, time can erode the care you’ll be able to afford later in life.

“Inflation is probably one of the most misunderstood concepts relative to long-term care, but it’s probably the most important concept relative to long-term care,” says Christopher Matz, vice president of sales and account management for long-term care at Prudential Financial.

Beth Ludden, senior vice president of long-term care products at Genworth Financial, agrees. “You’re buying this product to protect an unknown risk that becomes more and more likely as you age and has a very high cost associated with it. You should make sure that the policy you purchase is going to have as much value as you can get,” she says.

Fortunately, LTC policies today feature several ways to fight the erosion of inflation. However, options vary widely by insurer.

In terms of growing your benefit, the pool of money that will be available when you need it, you can choose from these options:

Simple inflation

As its name implies, this option simply adds a set percentage, usually 3 percent or 5 percent, to the daily benefit amount. For instance, if your benefit amount is $100 per day at “5 percent simple,” that amount would grow to $105 the first year, $110 the second year and so on.

Advantage: It’s easily calculated and provides some inflation protection.

Disadvantage: This relatively slow grower won’t catch up if you’ve underpurchased long-term care coverage initially.

Best suited: For those over age 60 who want some inflation protection at minimal additional cost.

Compound inflation

This option adds an annual percentage to the benefit amount based on its compounding value. In the above example, coverage would grow to $105 the first year, then 5 percent of $105 the second year and so on.

Advantage: “This is your biggest bang for the buck,” says Matz. “You’ll do some catching up if you underpurchased initially, and in years when inflation is low, it’s going to grow exponentially.”

Disadvantage: It will cost around 24 percent more than a simple inflation rider, Ludden says.

Best suited: For buyers aged 50 to 60. “As a rule of thumb, at 5 percent compound, your benefit is going to double in 15 years, whereas 5 percent simple will double in 20 years,” Ludden says.

Consumer Price Index, or CPI

This option adjusts your benefit amount based on U.S. Consumer Price Index data.

Advantage: Offers inflation protection at a lower premium than compound inflation coverage.

Disadvantage: A bit more volatility both ways. “If your CPI policy is trending at 3 percent, in years where there is less than 3 percent growth, your rate is still based on a 3 percent growth rate,” says Matz. “But when there is negative growth, as were seeing today, you’re actually paying for something that you’re not getting.”

Best suited: For those who purchased sufficient coverage initially, as the index may not keep up with the higher inflation trends in qualified health care services.

In terms of paying for long-term care coverage, you can fight inflation in these three ways:

Guaranteed purchase option

Also called “future purchase” or “pay as you go,” this option allows you to purchase additional benefit amounts every two or three years on a guaranteed basis, meaning no underwriting costs.

Advantage: Allows you to add coverage to your policy as your needs or income change.

Disadvantage: You’ll likely pay based on your current age, with the price increasing as you get older.

Best suited: For younger buyers whose income prohibits a larger initial purchase.

Automatic inflation

Your premium automatically adjusts upward based on inflation.

Advantage: “With automatic, the rate initially looks to be far greater than with guaranteed purchase, but cumulatively over time, automatic tends to be less expensive than future purchase,” says Matz.

Disadvantage: Relatively higher premiums.

Best suited: For younger buyers and those who don’t want to mess with guaranteed purchase options.

Large initial purchase

Often overlooked by cost-conscious buyers, a larger initial LTC purchase can be the best defense against inflation.

Advantage: You lock in your rates at your current age, and make that benefit pool available now. This is in case you need it following an auto accident or sports injury.

Disadvantage: First, you’ll need the lump sum. Then there’s the opportunity cost of locking that much money up in LTC insurance versus other investments.

Best suited: For young buyers. “Under the other two ways to pay, it’s going to take you on average 12 to 14 years for your benefit to double,” says Matz. “Whereas if you just bought double initially, over time that is going to be far less expensive than if you were paying for inflation under the other two options.”