Long-Term Care Insurance 101

By Lorelei Laird

NEW YORK (Learnvest)—These days, people are living longer than ever. A 2011 study by the Society of Actuaries found that, since the 1960s, life expectancy has increased between 1.5 and two years each decade.

It's a good thing that more and more of us can expect to live well into our golden years. Yet, there's a flip side that a lot of us don't like to talk about: How healthy will we be when we're 90?

According to the 2010 U.S. Census, 70.5% of Americans are disabled by age 80. Although it's not fun to think about, we don't want to be a tremendous burden on our loved ones if we wind up needing a nursing home or other long-term care.

That's what long-term care insurance is for. And there are reasons you need to know about it well before the wrinkles set in.

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Reasons to Consider Long-Term Care Insurance

In addition to sparing your family the expense of caring for a long-term disability, long-term care insurance can keep you from draining your savings and ending up fully or partially on Medicaid. That's a good thing because, while there's no out-of-pocket cost for Medicaid, the benefits are not extensive enough to cover many things that would affect your quality of life, like a private room at a nursing home. Medicaid benefits have also been cut recently, leading to cutbacks at nursing homes and influencing some providers to stop accepting Medicaid entirely.

With long-term care insurance, you would have more money to draw on, so you could pay for nicer care and wouldn't be limited to providers that accept Medicaid.

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Long-term care insurance can also help protect your assets and your family's inheritance. For example, if, heaven forbid, you developed dementia, you'd likely need round-the-clock care. The Metropolitan Life Insurance Company found that in 2012, a semi-private room in a nursing home cost $222 a day, or $81,030 per year. A private room cost $248 a day, or $90,520 a year.

Just a few years of that could quickly deplete a middle-class couple's savings, leaving little or nothing behind for future generations.

How Exactly Does It Work?

Long-term care insurance generally kicks in if you need help with at least two or three activities of daily living, like bathing, eating, using the toilet, dressing, walking and so on. If you're dealing with a cognitive disability, your eligibility might be determined by a mental test score instead.

Once you're eligible for benefits, most insurance plans pay a specified amount per day to cover the costs of dealing with that disability. That could mean a nurse helping out in your own home, an assisted living facility or a full-service nursing home. Some policies let you apply the per-day payment to any kind of care you like. Others only permit you to use the money for "qualifying expenses," as defined by the policy.

Almost all long-term care insurance plans have a waiting period, or elimination period, when you must pay for your own care. Most plans' waiting periods are 90 to 100 days, according to the American Association for Long-Term Care Insurance, but it can vary. A shorter waiting period makes the plan more expensive, because that means you have to cover fewer of your own expenses.

Once you are eligible for benefits, you will be paid a certain daily dollar amount (most people opt for a policy that offers $100-199 per day), for the term specified in your policy, which ranges from less than three years to a lifetime. If you live past the benefit period, you're on your own. Not surprisingly, the more years and the higher the cost a plan covers, the more expensive it'll be. Some plans reimburse you for actual expenses incurred, so if your actual daily or monthly costs are less than what your plan provides, you can extend your benefits until the pool of money runs out.

Because of all these rules, it's vital to scrutinize each policy before you buy it, keeping in mind your specific needs. Nancy Anderson, a certified financial planner™ with LearnVest Planning Services, believes that even a basic policy with a short benefit period is helpful because it provides some protection against the tremendous costs of a disability.

Two Main Types of Long-Term Care Insurance

Most long-term care insurance plans are "tax-qualified," which means benefits generally aren't taxed as income, and you can claim your premium payments as a medical expense on your itemized federal income taxes.

There are also non-tax-qualified (NTQ) plans, though they're falling out of favor. These are typically more expensive, but because they don't have to meet certain provisions for tax qualification, they have less restrictive benefits rules: There's usually no waiting period and there's often a lower threshold for triggering benefits. Rather than taking a cognitive test or proving you have trouble with multiple tasks of daily living, you just need a doctor to state "medical necessity." If you get an NTQ plan, make sure to choose one that allows your own doctor to decide medical necessity; otherwise, a doctor paid by the insurance company might deny that there's a necessity.

And that means you'd have to pay for your own care, even though you already paid the insurance premiums, or fight the insurer in court before you get covered. This LA Times article explains the bad consequences for one family when benefits were denied.

All the same, it's unclear whether benefits paid out for NTQ plans count as income (and therefore are tax-free). As of May 2013, the Treasury Department has not yet ruled on that question, so theoretically, holders of NTQ plans could face a ton of unexpected taxes if the benefits are deemed to be income.

You will most likely choose between tax-qualified plans, just because there are few NTQ plans being sold. The ones that are being sold are substantially more expensive. An NTQ plan might be worthwhile if you are willing to spend lots of money on a plan that has fewer restrictions on when you can claim benefits—just remember the tax status of their benefits is still being debated.

Do You Need Long-Term Care Insurance?

Generally speaking, long-term care insurance is most important for the middle class. According to Consumer Reports, people whose net worth is below $200,000 or $300,000 (not including a house) likely can't afford the premiums and will probably end up relying on family, friends or Medicaid in any case. On the other end of the spectrum, people with a net worth of $2 million or more probably don't need long-term care insurance because they can likely pay for their own care.

Insurers are choosy, too. The older you are, the more likely you are to be turned down—and the more expensive the policy will be if you are accepted.So, generally speaking, long-term care insurance is probably only worthwhile if you're somewhere in the middle.

One exception is if your circumstances make you especially likely to need long-term care insurance. If so, Anderson says it's worth saving up even if you have a lower net worth: "People who have a higher probability of needing long-term care might want to make it part of their budget. For example, those with a family history of Alzheimer's, or folks who may not have another family member who can care for them."

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Some critics argue that long-term care insurance isn't a good deal for the money. According to a study by the Kaiser Family Foundation, over a third of people in nursing homes will be discharged within 3 months, which wouldn't have exhausted the typical waiting period. Those who do exhaust their waiting periods usually still have to pay for some of their own care.

Also, if you drop your plan for financial reasons, some state laws require insurers to offer a "nonforfeiture option," giving you reduced benefits based on the premiums you already paid. In other states, you could end up with nothing to show for years of premiums. If you live in one of those states, that alone might make long-term care insurance a bad bet.

Because insurance is a gamble, consider your family history, your own health history and your state's laws. A financial planner, like the ones at LearnVest Planning Services, can help you decide what's best for your circumstances.

Where to Get a Policy

Most people get long-term care insurance directly through an insurance company or broker, though a few employers and professional groups offer it as a benefit. Your policy costs will depend on your health, your age when you apply, how many benefits you want and the insurer. For reference, according to a 2009 study, the average annual premiums for a typical policy were $2,800 for a 55-year-old, $4,500 for a 65-year-old and $9,600 for a 75-year-old.

Make sure you're clear on all the rules and loopholes before you sign up. For example, it's common to see exclusions for drug and alcohol abuse and self-harm. It's less common, but possible, to find policies that exclude common illnesses, or require a certain number of days in a hospital before you can claim benefits, which might be hard to meet. Another thing to check is whether the policy will only pay for caregivers; some plans exclude the cost of medications and medical supplies!

Insurers are choosy, too. The older you are, the more likely you are to be turned down—and the more expensive the policy will be if you are accepted. People with pre-existing health conditions like HIV or Parkinson's are likely to be turned down, and insurers' ability to discriminate based on pre-existing conditions is unaffected by the Affordable Care Act (also known as Obamacare) because the law only applies to health insurance. (For more on the best age to buy long-term care insurance, see our tips below on how to get the best deal.)

When buying a policy, decide how much of your savings you can put aside to pay for your own care. Keep in mind the average cost of care where you live (the 2012 MetLife Market Survey of Long-Term Care Costs breaks it down by area), as well as the waiting period in which you'll need to cover your own expenses. Experts suggest saving money to make up the difference—for example, $50 a day for three full years, if your benefit is $50 per day less than the cost of a nursing home. This smaller amount of savings is likely more achievable than saving for the full cost of nursing home care.

Anderson recommends trying to get the best policy you can afford, prioritizing the types of care you're most likely to need. "If you have a family history of illnesses such as Alzheimer's, it's even more important," she says. "If cost is an issue, a basic policy with a 3-5 year benefit that includes inflation protection and assisted living and home care would give you at least a base level of protection."

Tips to Get the Best Deal (and the Best Care)

1. Buy a 'Partnership Policy' If You Have Limited Assets

In many states, you can buy a "partnership policy" designed to work with Medicaid. Normally, to qualify for Medicaid, you have to be totally destitute. A partnership policy typically pays out a lower dollar amount per day (say, $150) for a relatively short period (say, three years). Then, if you need more care and you turn to Medicaid, your state will ignore some of your assets when determining your Medicaid eligibility. Exactly how many of your assets are protected depends on your state's plan, but it's often the dollar amount of the payments you received from the insurance.

Anderson says a partnership policy is a good idea for people at the lower end of the middle class who want to protect savings or investments that would quickly be exhausted by long-term care bills. It's not useful if you have nothing to protect, and may not be the best choice if you have lots of assets. You cannot choose this option after you sign up for a different kind of policy, so it's important to make this choice from the outset.

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2. Index Your Benefits to Inflation, If You're Buying Young

If you're buying long-term care insurance decades before you expect to need it, consider paying extra to index your benefits to inflation. That way, your benefits will cover the current cost of care when and if you use them (rather than receiving a 2013 payout to cover 2043 costs). Inflation protection is considered so important it's required on many partnership policies. When you buy your policy, you should be offered, or ask for, a rider called inflation protection or indexing to inflation.

An alternative to indexing to inflation is to choose a guaranteed-purchase option or future-purchase option, two names for the same thing: a low-premium, low-benefits plan with the option to add benefits later. (Page three of this AARP fact sheet explains this option.) This lets you wait until you can afford more coverage before you have to buy it. The bad news is your premium increases significantly if you keep accepting the option for more coverage, and if you turn it down often enough, you may be required to resubmit your health information and risk rejection. For this reason, the guaranteed-purchase option is better for older buyers who don't expect to wait long before claiming benefits.

Anderson strongly recommends indexing benefits to inflation, because "it pays for itself in just a few short years. I've never heard anyone regret that they got the inflation protection when the time came to fund their long-term care."

3. Buy Young ... But Not Too Young

Younger, relatively healthy people can get a better price for long-term care insurance, locking in the premium price (though insurers can still raise prices for groups of customers with the same kind of policy). Buying young also decreases the chance you'll be rejected because of a pre-existing condition, and ensures you'll have care if you happen to be disabled in middle age. At the same time, because long-term care insurance costs thousands a year, it's a purchase best made when you're old enough to afford it and don't have competing priorities like a child's college education. According to the American Association for Long-Term Care Insurance, very few policies are sold to people under 45, with more than half of all policies sold to people ages 55-64.

Remember ...

Even if you decide not to buy long-term care insurance, you should have savings in case you become disabled in your later years. This ensures you'll get the care you need, and protects your assets—for your own sake, and for your family. With nursing home costs at more than $200 a day and home health aides at $21 an hour, you'll need to save a lot. Anderson gives us some tough love: "A savings account won't cut it." She strongly suggests some type of investment that typically beats inflation, such as the stock market or real estate. Although it's not exactly the most fun thing to think about how you might become disabled later in life, taking these important steps now have the potential to protect you and your loved ones for many years to come.

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