19 December 2011
After my last post about how inflation can affect retirement, a reader contacted me with a question about using long-term-care insurance (i.e., nursing home, assisted living or in-home care) as a potential hedge against inflation. The question is interesting because it addresses a basic idea behind insurance outside of the actual benefits―paying now, but using it later. If inflation is a factor in all of our retirements, this concept could be compelling for a number of reasons.
- Lock in rates: If you expect inflation to become a larger concern in the future, then using today's dollars to buy a benefit that pays out in future (inflated) dollars is potentially a good move. However, there is always the risk that the insurance company will increase premiums, as we have been seeing lately. As insurers experience more claims this will be a moving target. Ironically, inflation could help insurance companies since many have been forced to raise rates due to weak performance of their portfolios―interest rates are so low that they cannot make enough in their bond investments and thus, they need to pass on higher rates to customers. Once interest rates start moving back up, they may not need to increase premiums on older policies.
- Lock in rates more: Most people want to keep premiums as low as possible. But with long-term care insurance, there is another route that might let you hedge inflation―the 10-pay option. Many policies let you pay premiums over 10 years and then be done. Of course, the premium is much higher than if you paid it for life, but once the 10 years are over, you have a policy that the insurance company cannot raise the rates on in the future. For those worried about inflation, this could be a good move.
- Compound inflation: Policies will typically allow for either "simple" or "compound" inflation increases. Simple inflation means policy benefits are increased annually (usually 3–5%) based on the initial benefit paid. Compound inflation means the benefit is increased based on the previous year's benefit; this method grows the benefit more. For example, say you had a policy with a daily benefit of $150. After 10 years, it would grow to $198 with a 5% simple inflation factor but $244 with a 5% compound inflation factor. If inflation is your concern, the compound benefit might be the better choice.
For those who believe inflation is not in the offing, consider that most people will look at long-term-care insurance in their mid-50s to early-60s. Most will not use it for 10 or 20 years, or even longer. Inflation might not be something that we fear in the next year or two, but over the next several decades it is something all retirees will have to address in their planning.
Most people look at retirement planning as an investment exercise but as this question shows, there are often other details that can add or subtract from the overall quality of retirement. Long-term-care insurance has many merits that I have not outlined above but let me add one big one―having it allows the family to make the decision to seek care earlier since they have a policy to help cover the costs. This can help in the quality of the entire family's time together at this phase of life. Evaluating insurance on cost alone misses the whole point. But evaluating costs in today's low-inflation environment might be a smart move.
About Jon T. Meyer, CFP®
