[Long post today: nearly 3000 words. Take the weekend to read it, and spend some time digging into the links. This analysis may not save your life, but it can certainly save your finances.]

A few weeks ago I received an e-mail from a representative of the nonprofit organization LIFE:

“As more and more Baby Boomers enter their retirement years, there are new financial concerns they need to consider as they plan the rest of their lives. One that’s often overlooked is long-term care. Nearly 70% of persons over 65 will require some form of long term care, and with 10,000 persons turning 65 every day over the next 19 years, this is becoming an increasingly important issue.

The reality is that the cost of long-term care continues to rise and it’s important that people have a sustainable plan in place to protect their assets and to avoid burdening their loved ones financially should they need care. And the earlier they start planning the better.”

I write about military financial independence but I’m also going through my family’s second generation of the long-term care experience. I’ve heard a lot of stories, read a lot of books, and had to learn way more than I want to know about the legal & financial issues. But why would one of the nation’s largest long-term care marketing organizations reach out to a retiree blogger who writes for “only” nine million military servicemembers and their families? Why not just appear on the “Today” show, Charlie Rose, and the Oprah Winfrey Network?

Maybe the media isn’t ready to listen yet. I’m near the trailing edge of the Boomers, and I have plenty of company– but we don’t talk about it publicly. When you gather my peers together it takes a while (and maybe a few frosty beverages) before you hear stories of their parents’ physical problems, our adult children’s struggles with an elder’s dementia, and the problems we all face with long-term care. It’s not only about our parents but about taking care of ourselves, handling the financial & logistical challenges, and wondering what burden we may someday place on our adult children.

I hope Debra Newman, Chair of the Board of Directors for the nonprofit LIFE Foundation, is doing hundreds of interviews. She has several decades of experience and she’s a frequent national speaker/writer on the industry’s issues. We all need to hear what she has to say about the long-term industry, and we need to make rational decisions about how we want to insure ourselves.

Why We Need Long-Term Care Insurance

Before I talk about the interview and dig into the finances, let me start with the big picture: we’re all gonna die. The human body appears to have a service life of about 12 decades, but there are many “material failures” along the way. First-world countries have largely figured out how to handle infant mortality, childhood diseases, and nutrition. (Implementing those solutions is a challenge for another post.) We’re starting to understand (or rediscover) safety, a healthy lifestyle, and prevention. (Whether we actually follow through is another challenge.) We haven’t extended humanity’s potential longevity, but we’ve certainly reduced the ways to cut it short.

Today, the leading causes of death past age 65 are heart disease, cancer, stroke, and respiratory disease. If you get past the top four then Alzheimer’s is next. (You could also hope for the next five of diabetes, influenza, renal failure, accidents, or infection.) If you have don’t have any genetic surprises and if you take care of yourself, then medical technology has shown that nine of those top ten causes of death may be largely avoided or treated. Even if you suffer from one of them, it’s quite possible to survive for years.

If you’re reading this blog then you have the skills and personal discipline to run this gantlet of risks. For every year that you do, Alzheimer’s becomes more likely.

I don’t have the medical answers on how this conundrum will play out for the Boomer generation. But from an actuary’s standpoint, you must have a life plan to handle these catastrophic probabilities. It’s just like fire insurance or auto insurance. Medical insurance can cover most of the costs of treating the top ten causes of death, but it doesn’t protect against the cost of caring for you when you can no longer care for yourself: especially Alzheimer’s. The only defense against that financial disaster is long-term care insurance.

“Luckily” the reality is also changing. The LIFE foundation’s statistics are scary, but they’re phrased to exploit fear and uncertainty. The author of “When The Time Comes” points out that today fewer than 5% of elders live in full-care facilities, and the nursing home population has actually declined for the last two decades. Only about 20% of our elders are using paid home-care assistance, even among the most disabled. There are way too many independent demographic & medical factors here to predict the future but it’s beginning to look as though most of us can age in our homes, perhaps aided by technology. If that’s the case then we might spend a lot less time in care facilities (which cost hundreds of dollars a day). Most of us may need long-term care someday, but most of the expenses may be manageable.

What’s Wrong with Long-Term Care Insurance?

The entire insurance industry figured out fire insurance and auto insurance long ago. We’re also grappling with medical insurance, although some of those risks may only be handled by governments. Long-term care insurance should be able to handle the financial catastrophe of full-time care. All we need to do is apply the actuarial lessons learned from the rest of the industry!

Not so fast. Long-term care insurance is a popular perennial topic on the Early-Retirement.org discussion board, and LTC problems are widely reported. Frankly, the industry has destroyed its credibility by misjudging the pricing of its products and the returns on its investments. Nobody is expecting to pay a flat rate to insure the rest of their lives, but the situation is even worse. A number of smaller insurers have failed (placing their burdens on state-administered trusts) and several larger insurers have pulled out. We don’t know how much money we’ll need to pay for our eventual long-term care, but apparently, the industry experts don’t have a clue either.

If you think that the Federal Long Term Care Insurance Program is there for us veterans, well… think again. FLTCIP v2.0 started a couple of years ago when every other insurer stopped writing new FLTCIP policies and left John Hancock holding the bag. Not only was the risk concentrated in just one insurance company, but premiums went up at least 25% across the board. This might reflect the actual costs more accurately (we’ll know in a few more years), but it certainly hasn’t inspired much confidence that the industry understands how to hedge the risks.

John Hancock is one of the world’s largest and best-funded insurance companies. Surely they can handle their financial responsibilities? Maybe, but so far their behavior doesn’t exactly inspire my trust in their leadership. I’ve written before about John Hancock’s claims process and their primitive financial technology. When the market leader uses payment processes straight out of the 1980s, and when other large firms are pulling out of the business or going under… why waste your money on LTC insurance? Self-insurance seems like the only alternative to the risks of rising premiums and bankrupt promises.

There are already plenty of resources for people to research long-term care insurance. The problem is when to purchase it and whether the policy’s inflation protection is worth the expense. By “when” I don’t just mean “at what age”– I also mean “When will the industry have a policy whose premiums and guarantees we can trust?” Insurance companies have let us down. How that can change?

I think Ms. Newman was expecting to have a 20-minute phone call about the basics. To her credit, she shifted gears and spent nearly 40 minutes discussing the industry’s credibility and their initiatives.

For starters, she said that the entire industry had completely misjudged their “lapse rates”. They’d assumed that ~5% of their customers would drop their long-term care policies every year, either from death (from other causes) or by canceling their policies. Unfortunately, the average long-term care customer (like an annuity buyer) applies an adverse selection bias. The people who buy long-term care insurance are generally wealthy enough to afford health insurance and smart enough to take care of themselves– so they live longer than the actuarial averages. Unlike the optimistic customers who buy fire and auto insurance and hope to never use it, long-term care customers buy LTC insurance because they’re pretty confident that they’re gonna need it.

Adverse selection has kicked in with a vengeance over the last decade. A 5% lapse rate each year meant that after a decade the insurance companies would be able to keep the premiums of the canceled policies and spread their expenses across fewer than two-thirds of their customers. But customers have taken care of themselves and lived longer (even with illnesses), so the actual lapse rate has been 1% per year– a decade of collected premiums has to stretch across 91% of the customers. Ms. Newman’s “good” news is that most of the policies sold over the last five years have been priced for a 1% lapse rate (which explains why they’re so much more expensive). Policies may be difficult to afford, but at least the company is more likely to be able to pay out.

Interest rates have been another problem. We’re all quite familiar with the low yields on today’s bonds and CDs, and we’re all tempted to chase yield. Insurance companies are no different, but in their case, they’re already squeezed by lapse rates and desperate for higher yields. However, we’ve already had four years of low bond yields with more to come, and insurance companies have not been able to generate their projected returns on their invested premiums.

As a result, they’ve either taken more risk with their investments, or they’ve been slowly losing more money with every drop in market interest rates. Both John Hancock and Genworth have had multiple downgrades in their regulatory ratings. Again Ms. Newman’s “good” news is that John Hancock is owned by a Manulife, a Canadian insurance company, so Hancock is required by Canadian insurance rules to maintain higher reserves and to account for their projected returns more conservatively. Hancock has still been downgraded, but hopefully, it’s not merely the last to exit the market.

My reading of years of Berkshire Hathaway annual reports also indicates that more than a few insurance companies have been victims of their own misconduct: underpricing policies to grab market share. (“We lose a little on each policy but we make it up on volume!”) Some of these companies eventually had to turn their policy guarantees over to trusts administered under state supervision. The states have been raising the funds for this by taxing the surviving insurers. This austere funding environment also implies that there won’t be much money left over for customer service, which might explain the consumer complaints. A typical example: Senior Health Insurance Co of Pennsylvania administers long-term care insurance policies originally sold by Conseco Senior Health Insurance Company and others. It’s a non-profit trust with $3 billion in reserve, but it’s also facing lawsuits over its conduct.

What You Can Do Now:

If you own a LTC policy that’s been turned over to a state trust, Ms. Newman’s advice is to stay with it and keep paying the premiums. She’s one of those customers, too– one of her personal disability insurance policies was taken over by a state agency, but 20 years later it’s still in force. Customer service may be miserable, but benefits are eventually getting paid. Stay informed on complaints and litigation, and plan ahead by giving yourself as much time as you can to do battle.

As for John Hancock’s claims payment process, her firm has 8000 people insured by them. She’s heard the complaints and she says a turnaround expert is working on the problem. I can’t see any progress from my side, but my father’s policy will (hopefully) payout for nearly two more years. I’ll keep you posted.

Ms. Newman says that she can’t predict the insurance industry 30 years into the future, but she can recommend ways to manage the risk of long-term care and its policies. Customers can make a “small mistake” or a big mistake with insurance. A “small mistake” is paying $48K of premiums and then dying without using any of the benefits– just like fire insurance or auto insurance. A “big mistake” is going without insurance and then spending hundreds of thousands of dollars on decades of care.

Another option is to hedge the worst-case risk without expecting to be covered for every expense. Buy enough insurance for 2-3 years of long-term care with a smaller inflation rider and the longest exclusion period you can find. Don’t try to cover a decade of care, and don’t try to pay for 5% annual inflation. Take preventive measures too. Develop healthy habits, be alert for an elder’s cognitive decline, and intervene early with therapy & medications. Don’t avoid the issue: start the intergenerational conversations now so that you all understand each other’s perspectives and won’t meet as much resistance when the tough decisions have to be made.

New Choices in Long-Term Care Insurance:

If you can wait before buying long-term care insurance, better policies are coming. One option is a joint LTC policy, where a married couple shares the benefits. Each would start out with a $250K limit, but if he needed more then his spouse could dip into hers (leaving her with less). The premium of one joint policy should be lower than the combined cost of two separate policies. This works out great as long as you’re the man who dies on the actuarial schedule. It’s not so great if you’re the woman who lives to be 110 years old and survives with Alzheimer’s for 20 years.

Hybrid policies are another intriguing option: annuities sold with life insurance and long-term care insurance benefits. (Scroll down to page 7 of the PDF.) The theory is that:

1. The owner buys a single-premium immediate annuity and accepts a lower annuity payout rate (which pays for long-term care benefits if necessary) or
2. The owner buys single-premium life insurance which also includes LTC benefits or
3. The owner could redeem the life insurance policy (but not the annuity!) to get their premium back.

This hybrid policy costs more money than traditional LTC policies (or it offers fewer benefits for the same price) but this time the guarantee is supposed to be more credible. Ideally, the price of a hybrid policy will be lower than the cost of buying two separate policies that offer the same benefits.

What about the Federal Long-Term Care Insurance Program? Ms. Newman’s first advice is that military pensions (and federal civil-service pensions) come with reliability and survivor benefits. If you’re among the 17% of military veterans who earn a pension, then you may be able to buy a smaller long-term care insurance policy. Your immediate family may also be able to purchase their own LTC policy from the FLTCIP, which could ease your own caregiver and financial burden.

In other words: Everything should work out fine, and this time we really mean it. I sure want to see the industry pull off a turnaround, and I wish Ms. Newman success. She’s knowledgeable, experienced, and articulate, but she’s trying to help the whole industry recover from a horrible credibility gap. We military are a skeptical, cynical crowd too, although LIFE’s campaign will probably be well-received by their clients. I think that LIFE is doing a great marketing job by breaking down the situation into “old bad policies, administered by states if necessary” and “new smart policies, problems solved”. It could restore trust, but I’m not sure how long that will take– or how long the effect will last.

What I’m Doing Now:

Let me anticipate a reader question: “Hey, Nords, what are you doing for long-term care insurance?”

Firs,t let’s address the part that nobody talks about. I’m a fairly pragmatic guy, and submariners are among society’s most notorious control freaks.  I’m keenly aware of the reputed benefits of an oxycodone cocktail. However, my grandfather and my father have spent some of their happiest years in dementia (as far as they can tell), and I’m optimistic enough (for now, anyway) to think that I’ll always be curious about tomorrow’s sunrise. I’m not enthused about euthanasia, although I reserve the right to change my mind.

In the meantime, I’ve certainly been scared straight: exercise and a low-carb high-protein diet (with chocolate-flavored lapses). I haven’t drunk alcohol in nearly two years, and it’s quite possible that my drinking days are behind me. Ohana Nords is also buying three spit kits from 23andMe. My daughter and I may be stuck with my genetic heritage, but I’m certainly going to face it head-on and look for ways to literally beat it to death.

Financially? I’m only 52 years old—I’m going to wait another decade to see whether Ms. Newman’s expectations come to pass. My spouse and I are military retirees so we don’t need any more annuities, but I’m intrigued by the idea of a single-premium life insurance policy with long-term care benefits. My spouse’s pension will take care of her for the rest of her life. Between my pension and a policy on me, I hope that we’ll have my situation covered.

What are you doing for long-term care insurance?  What problems have you had with your policy or insurer?

Related articles:
Jeff Rose: How much LTC insurance do you need?
Book review: When the Time Comes
How John Hancock pays a long-term care insurance claim
Book review: The 36-Hour Day
Bob DeMarco’s Alzheimer’s Reading Room (the Web’s best Alzheimer’s resource)
Financial lessons learned from caring for an elderly parent
Geriatric financial lessons learned