Is Long-Term Care Insurance Worth It?The answer could be worth $5 million.

One of my clients asked me to review a proposal for long-term care insurance for him this past week, and the result was instructive.  I thought it would make a good post. 

First let me start with a few points:

Although I am not a fan, in general, of commission-based financial advising as a compensation model—I think the conflicts of interest are too strong to be truly fiduciary—, I have nothing against the people who work for insurance companies.  I think that most of them feel like they are doing the right thing for their clients, just like I feel like I do the right thing for mine.  But when your business is selling insurance, many financial problems start to look like insurance problems.

Insurance is a business—and a very profitable one. Why?  Because they structure the odds very strongly in their favor.  That is not inherently wrong, but you should at least remember that when you contemplate purchasing one of their products. 

The four pillars of risk management

Before we dive deeper into the specific product that I was asked to evaluate, let’s preface it with a small lesson in risk management. 

Life is full of risk.  You can’t avoid it.  The best we can do is manage it, and the best way to manage it is with a strategy. 

There are four basic elements of risk management:

1.      Risk Avoidance

2.      Risk Reduction

3.      Risk Retention

4.      Risk Transfer

Each has their place in a comprehensive risk strategy, and we all use each of them at different times and for various “risky” activities. 

We use risk avoidance when the activity carries a sufficiently high risk and the result of a bad outcome would be catastrophic.  Think of jumping out of an airplane without a parachute.  Or rock climbing without ropes.  Now some people actually do climb without ropes, but the general risk-averse population (read: sane people) would prefer to avoid taking that risk. 

Carrying on with the theme, risk reduction is what you do if you would still like to jump out of an airplane or climb a sheer rock face.  But instead, you use a parachute or climbing ropes with a harness.  Now, that same activity is significantly less risky. 

Risk retention means that you are willing to assume the risk of whatever it is that you are contemplating.  When should you be willing to do that?  When the possibility of a bad outcome is not going to be very damaging, but rather, a minor inconvenience.  A good example is purchasing insurance on many of the products that we might buy at big box stores.  If it is not going to truly hurt you that much financially, it’s better to say no at the checkout counter. 

For everything that you can’t either avoid, make safer, or ignore, there is insurance.  That is risk transfer.  You pay someone else to assume that risk for you.  When does it make sense to do that?  When the outcome would be devastating to us either financially, physically or emotionally. 

The only time a company is willing to assume that risk is when the probability of a bad outcome is relatively low. There are some things that are just not insurable, either because bad things happen too frequently or the outcome is so minor that no one would ever pay to transfer that risk.  For everything else, there is insurance. 

Here is one way to structure your thinking around managing risk:

Risk Strategy	High Frequency	Low Frequency
High Severity	Avoidance/Reduction	Transfer
Low Severity	Reduction/Retention	Retention

Evaluating the Long-Term Care Insurance Proposal

So, back to my client.  He and his spouse are healthy and in their mid-40s. They have a family member who is an insurance salesman and feels strongly about the product. He feels that it is in their best interest to purchase it.

Here are the terms of the proposal:

• It is a hybrid LTC/life insurance policy. 

• They could pay the premium as a lump sum, or over 5- or 10-years.  The lump sum would be the cheapest. 

• Once the total premium is paid, there are no further payments, and they own the product for their lifetimes. 

• If they don’t use the LTC portion, then their heirs inherit a life insurance benefit.  

• If they do need the insurance, the plan will pay for an inflation-adjusted monthly benefit for up to 6 years. 

• There is also a cash value that they can access if they choose to discontinue the policy.

  
  

So far, it sounds really good, right?  (Imagine it in a glossy brochure—that will help too). 

Let’s dive into the details and see if it truly lives up to the brochure:

I am going to use just the husband’s part of the policy for the demonstration but since the benefits are similar between the two spouses, you can essentially double the numbers:

• His lump-sum payout is $72,387.

• The death benefit is $144,000. 

• The cash value accumulates slowly, taking about 20 years to equal the initial payout (25 years if the installment path is chosen).  

• Any use of the long-term care benefit comes first from the death benefit.  In other words, if he uses at least $144,000 of long-term care, the life insurance benefit is no longer present.  If he uses $100,000, the  death benefit drops to $44,000. 

• Based on a 3% inflation rate, his LTC insurance value grows over time.  At age 80, it is worth $1,272,318.  At age 90, $1,709,889.  Remember, it is enough to cover 6 years of LTC.  If he needs more than 6 years, he will pay out of pocket for the remainder. 

  
  

It still feels attractive, though, right?  Over a million dollars of LTC insurance for a price of $72K?  Not bad. 

The alternative:  Invest the money

Let’s look at what would happen if he invests that same $72,387 in an S&P 500 Index fund.

The table shows the results using different rates of return and durations.  Of course, we know that the stock market does not produce steady annual returns, and future results may differ from historical averages. The purpose of this comparison is not to predict market performance, but to illustrate the opportunity cost of transferring this risk to an insurance company. But that said, the historical compound (geometric) return of the US stock market is about 10%—so these numbers are purposefully conservative.

Remember, the insurance company is not betting against the stock market. They are investing the same premiums in the same markets. The difference is that they invest more conservatively and keep much of the upside.

Dollar Value
	7% return	8% return	10% return
14 years (age 60)	$186,652	$212,615	$274,890
24 years (age 70)	$367,173	$459,019	$712,993
34 years (age 80)	$722,286	$990,988	$1,849,319
44 years (age 90)	$1,420,845	$2,139,468	$4,796,658
LTC cost in years
	7% return	8% return	10% return
14 years (age 60)	1.7 years	2 years	2.5 years
24 years (age 70)	2.5 years	3.1 years	4.9 years
34 years (age 80)	3.7 years	5 years	9.4 years
44 years (age 90)	5.4 years	8.1 years	18 years

Now, let’s put the risk in context.  The likelihood of needing some sort of paid help is high as you age.  Almost 50% of people require some.  The duration of that help on average is as follows:

Group	Average LTC duration
Men	~2.2 years
Women	~3.7 years
Overall average	~3 years

With the long-term care policy, he is covered for 6 years, likely more than he will need—even if he is in the unlucky half of the population that will need any.

Evaluating by scenario

Scenario One: He needs the average amount of LTC for a man (2.2 years). 

Investing: By age 70, he has more than enough to cover his needs if the market averages 7% or 8% growth. If he gets 10% growth, he is covered by age 60 (there is about a 1% chance that he will need LTC at that age). If he doesn’t need it until age 80 or 90 (more likely), he can easily cover his LTC and still have hundreds of thousands up to millions left over for his heirs. 

Insurance: His LTC needs are more than met, but he loses the $144,000 death benefit. 

Scenario Two:  He needs the full 6  years of LTC.

Investing: If he gets at least an 8% return in the stock market, his needs are covered somewhere in his mid-80s when he is most likely to use it.  With 10% return, he is covered in his mid-70s. 

Insurance: Needing care at an unusually early age strongly favors the insurance.

Scenario Three:  He doesn’t use any LTC (50% chance) and dies at age 90.

Investing: His heirs get anywhere from $1.4 million to almost $5 million.

Insurance: His heirs get the insurance death benefit of $144,000. 

What risk is this policy actually insuring?

It is not the risk of needing some help in your later years. That risk is fairly high.

The policy is really insuring against two things happening at the same time:

1. Needing long-term care unusually early in life

2. Needing it for longer than the average duration

   
   

The probability of both of those events happening together for a healthy man in his mid-40s is likely in the low single digits—around 1–3%.

You must also consider the possibility that the stock market significantly underperforms its historical average over the next forty years.

So the real question becomes:

Is that peace of mind worth potentially $5 million to your heirs?

A fair point about long-term care insurance

To be clear, long-term care insurance is not inherently a bad product. Insurance exists to transfer risks that would otherwise be financially devastating, and for some households that risk is real. A family with modest savings could see decades of work wiped out by a prolonged nursing home stay, and in that situation transferring some of that risk to an insurance company may be perfectly reasonable.

Likewise, for very wealthy families who want to preserve specific assets for heirs or avoid the uncertainty of future care costs, paying a premium for that certainty may be worth it.

Conclusion

The key question is not whether the product is “good” or “bad,” but whether the specific risk being insured materially threatens the success of the individual's financial plan.

In this client’s case, it does not.

So, in my view, the potential growth and retention of that initial investment outweigh the relatively small risk we just discussed.

Of course, the decision is not mine—but his. My job is simply to provide the analysis.

Insurance protects against catastrophic outcomes. Investing protects against missed opportunities.

If you were the client in this scenario, ask yourself: 

What helps you sleep better at night—and how much is that worth to you?

If you’d like help evaluating decisions like this in your own financial plan, feel free to reach out at www.targetedwealthsolutions.com.

Disclaimer: the material in this blog post is intended for general educational purposes only and should not be considered specific financial advice. You should always consult with your personal financial advisor to see how it might fit within your personalized financial plan.