A Financially Secure Future

EXECUTIVE SUMMARY

THE HIGH COST OF A NURSING HOME STAY CAN bring financial ruin to even the most well-funded retirement. Failure to plan for long-term-care needs can spell disaster for clients neither poor enough to qualify for government aid nor wealthy enough to pay for it themselves. Today, a 65-year-old has a 43% chance of requiring long-term care. AGE AND FINANCIAL RESOURCES ARE THE TWO primary factors in deciding whether someone should buy LTC insurance. While there are no hard and fast rules, CPAs can use the $50,000 average annual cost of a nursing home stay as a starting point. A client with $2 million in assets probably can afford to pay his or her own way. On the other hand, LTC insurance generally is too expensive for a client with less than $75,000 in assets or an annual retirement income of less than $40,000. LTC INSURANCE PAYS FOR CARE THAT RANGES FROM help getting dressed and bathing to basic medical services that may include skilled or intermediate nursing and custodial, hospice or adult day care. These services can be provided at home or in a medical facility. Daily benefits range from $40 to $300, usually after a waiting period of up to one or two years. FINANCIALLY SECURE CLIENTS MAY OR MAY NOT need LTC insurance depending on their willingness to self-insure against future long-term-care needs and their desire to preserve their estate. On the other hand LTC insurance is critical for older clients with limited assets. For younger clients buying LTC insurance protects against the expense of a future nursing home stay at a lower cost than other options, such as self-insurance. CPAs CAN HELP CLIENTS SHOP FOR THE RIGHT policy. Consumers should compare the LTC policies of several companies and verify the financial stability of the company they are considering. Make sure the client buys a policy that provides the coverage he or she is likely to need based on his or her medical history and other factors.

DELTON L. CHESSER, CPA, PhD, is Roderick L. Holmes Professor of Accounting at Baylor University in Waco, Texas. His e-mail address is Del_Chesser@baylor.edu . WALTER T. HARRISON JR., CPA, PhD, is professor of accounting at Baylor University. His e-mail address is Tom_Harrison@baylor.edu . COLLEEN T. BARRY, CPA, is a manager in assurance business advisory services for PriceWaterhouseCoopers in Houston. Her e-mail address is colleen.barry@us.pwcglobal.com .

hat can ruin a well-planned retirement faster than a declining stock market? The answer for many is an uninsured catastrophic illness or infirmity. A couple who work 40 years to accumulate a $300,000 net worth—hoping to retire in comfort—can become penniless in fewer than 3 years if years if one spouse gets sick and enters a nursing home. The cost of a three-year nursing home stay, plus a few extras, can easily top $300,000. This tragedy occurs more often than you might think. While many people will need long-term care, few plan for it.

Elderly couples—those 65 years and older—who need long-term care represent a growing segment of our society. The Census Bureau reports that by 2050 one in five Americans may be classed as elderly. The 75-plus age group will have the greatest need for health care, particularly long-term care, and thus its members must manage their finances carefully to meet these costs and enjoy an independent lifestyle during retirement.

Clients rely on their CPAs to help them plan for the future. Many accounting firms offer a package of integrated services—income taxes, investments, estate planning and retirement income. CPAs who provide such services should not neglect to include the critical area of long-term care. Failure to plan for its cost can spell disaster. Here are some guidelines to help CPAs figure out who does and does not need LTC insurance.

Long-term care is expensive. Over half of single people who enter a nursing home are impoverished within one year; the same is true for couples within a year after a spouse enters a nursing home.

A 65-year-old has a 43% chance of requiring long-term care. One in five Americans over age 50 may need such care in the next year.

People age 65 or over who enter a nursing home typically stay two to three years. Annual costs can average $50,000—or double that in places like San Francisco or New York City.

LTC insurance provides the greatest financial security for people with household income between $40,000 and $250,000. Medicaid covers those with less income and the wealthy have less need for insurance than middle-income earners.

Two things appear certain: The cost of long-term care will continue to rise substantially and federal and state governments will keep tightening eligibility requirements for aid. These facts should spur CPA/financial planners to recommend clients plan for long-term-care needs. As a first step, accountants should identify those clients who can benefit from LTC insurance.

A 65-year-old woman with $2 million in assets can pay her own way. However, she may wind up giving the bulk of the money to caretakers instead of leaving it to her children or a favorite charity. At the other end of the spectrum, individuals with less than $75,000 in assets ($150,000 for a couple), or with annual retirement income of less than $40,000, should not buy LTC insurance because it’s too expensive for their budget. The vast majority of the population falls between these two extremes.

Eligible candidates don’t have to be age 65. People with a family history of heart disease or cancer should consider getting LTC insurance early while they still can qualify. Younger clients often can get LTC insurance as part of their employee benefits package. To protect against economic hardship during an extended illness, both dual-income and single-income families should consider LTC insurance.

For people under age 65, the advantages of purchasing insurance include:

Lower premiums.
Easier medical qualifications.
Relatively low future rate increases.
Availability of inflation options.

LTC insurance offers policyholders a unique range of services. Most policies provide home-health care, personal care and adult day care in addition to nursing home care. After identifying clients who can benefit from such coverage, CPAs should schedule individual conferences to

Review the general provisions of LTC insurance policies.
Estimate the cost of long-term care.
Evaluate the benefits of LTC insurance.
Suggest a possible course of action.

OVERVIEW OF LTC INSURANCE
CPAs should help their clients understand the relationship between Medicare and LTC insurance; many misunderstand what Medicare covers. The American Association of Retired Persons reports that 79% of its members erroneously believe Medicare will pay for a long-term nursing-home stay. The facts are that

Medicare covers a maximum 100-day stay in a Medicare-approved nursing facility.

It covers extended periods of home-care visits only after a physician confirms in writing that the patient needs skilled nursing care or physical, occupational or speech therapy. Its supplemental policies do not cover most long-term-care costs. CPAs should remind clients that Medicare does not cover extended stays in a nursing facility or unlimited home-care visits. When Medicare coverage ends, the client must pay with personal financial resources, insurance or some combination of the two. LTC insurance is like any other. It transfers some risk but not all. Sadly, the financially dependent person may lose his or her choice of care provider and suffer a loss of dignity. The CPA/financial planner can help clients minimize this risk. In general the need for long-term care arises from illness, disability or incapacity. Care ranges from help getting dressed and bathing to basic medical services that may include skilled or intermediate nursing and custodial, hospice or adult day care. These services can be provided at home or in medical facilities. Exhibit 1, at right, defines some basic terms related to long-term care. Advertisement Most LTC policies do not cover mental and nervous disorders, alcoholism, drug addiction or self-inflicted injuries (Alzheimer’s is covered). Fortunately, a client’s preexisting conditions do not usually result in restriction or denial of benefits. Therefore, people with a medical history still should seek coverage. They may qualify. The types of facilities covered and the amount of the daily payment for services vary significantly among policies. Most require that care be administered in a state-licensed facility. Many insurance companies offer policy riders that expand the scope of services covered. CPAs can help clients identify the range of desired benefits based on individual circumstances. Daily benefits range from $40 to $300; the benefit period runs from one year to a lifetime. The elimination period (the waiting time before benefits begin) ranges from zero to 365 (or even 730) days and usually applies only once during the insured’s lifetime. The insured can add inflation protection for an additional premium. Clients can select a plan to fit their budget. The more affluent can opt for a policy that covers a wide variety of services; the more frugal may select a plan with limited care.

Exhibit 1: Long-Term-Care Definitions Activities of daily living (ADLs) includes eating, bathing, dressing, moving about (mobility), transferring (for instance, from a bed to a chair), using the toilet and maintaining bladder and bowel continence. Adult day care includes personal care, therapy and nursing assistance at a facility during the daytime hours. Benefit period is the length of time the insurance company will pay benefits, ranging from two years to life. Custodial care facilities are licensed by the state to care for patients who require someone to assist them with daily activities on a regular, but not necessarily continuous, basis. Daily benefit ranges from $40 to $300 or more per day, based on expected costs of nursing homes and other long-term-care facilities in the area. Elimination period ranges from zero to 365 (or even 730) days. This is the actual period of time when no benefits are payable for long-term-care services. Clients should choose the number of days they can afford to self-insure. Home health care is medically necessary care, including nursing services and physical, speech, occupational or respiratory therapy provided at home. Hospice care is devoted to pain and symptom control for the terminally ill (life expectancy of less than six months). Care can be provided at a hospital, hospice center or at home. Personal care refers to assistance from another person with walking, bathing, eating and other routine tasks. This care is provided by aides who are not medical professionals but are trained to help with these activities. Respite care furnishes personnel from a local home health care agency to take a caregiver’s place for a short time. Skilled nursing care is 24-hour supervised medical care and an alternative to acute care where hospitalization is necessary. Example: observation for complications or worsening of a condition.

THE COSTS AND RISKS OF LONG-TERM-CARE OPTIONS
To illustrate how a CPA can advise clients on long-term-care needs this article presents three scenarios that describe hypothetical clients of different ages and financial circumstances. In all three insurance premiums as well as personal payment for long-term care qualify as medical expenses for purpose of itemizing deductions. Benefits paid are assumed to be nontaxable.

Scenario 1: Financially secure client may or may not benefit from LTC insurance. Consider George, a 65-year-old client. An evaluation of his need for LTC insurance assumes

$200,000 is available to invest.
These investments earn a 6% rate of return.
George will enter a LTC facility after 10 years.
The length of his stay is three years.
The daily cost will be $150 while George is in the facility.
Medical and related health-care costs will rise by 5% annually.
The annual LTC insurance premium, payable at the beginning of each year, is $2,000.
The insurance policy has a 30-day elimination period.

George has two options:

Option 1: Purchase a LTC policy.
Option 2: Self-insure a future stay in a LTC facility.

Exhibit 2, below, provides a detailed analysis of these options. The data show that after one year in a LTC facility, the insurance policy provides George with only a $20,800 ($345,300 – $324,500) advantage over self-insurance. This small difference may not spur him to buy the policy. But after three years of professional care, the advantage grows to $146,000 ($388,000 – $242,000). Most clients are interested in preserving $146,000.

If George wants to self-insure and also keep his accumulated wealth of $358,200, he must earn 21.3% annually on his assets during the three years of long-term care. This return is unrealistic under current market conditions and tilts the decision in favor of purchasing LTC insurance.

If George is lucky, he will never need long-term care. But he should consider what would happen if he did not use the LTC facility, but continued to pay the $2,000 annual premiums. Under this scenario, at the end of year 13, a 6% annual rate of return produces a $426,600 balance for self-insurance compared to $386,500 for buying the insurance and never using it. In this case self-insurance provides a $40,000 advantage. When making a recommendation, CPAs should advise clients of the risk and expected returns of self-insurance.

George is fortunate; he can meet any future health care costs. Whether or not he purchases an LTC policy depends on his willingness to self-insure against future long-term-care needs or whether he wants to ensure he has an estate to leave to his family.

Scenario 2: Older client would be wise to purchase LTC insurance. Next consider the benefit of LTC insurance to Charlotte, an older client with a small amount of money conservatively invested at low rates of return. Assume Charlotte is 70 years old and is assessing the benefit of LTC insurance under the following assumptions:

$120,000 is available to invest.
The investments earn a 5% rate of return.
Charlotte will enter an LTC facility after 10 years.
Her stay in the facility lasts five years.
The daily cost when entering the facility will be $140.
Medical and related costs will increase by 8% annually.
The annual LTC insurance premium, payable at the beginning of each year, is $3,800.
The insurance policy has a 20-day elimination period.

Lucy may recognize long-term care is expensive but probably has not thought much about the overall cost. Her CPA/financial planner might ask her to consider a basic question, “How much do you have to save annually to pay for one year in a nursing home 25 years in the future?” Under our assumptions, the expected annual cost for one year will be about $183,000. To accumulate $183,000 over 25 years, Lucy must save $3,300 annually while earning a 6% return.

For much less, about $1,000 a year, Lucy can purchase an LTC policy that will cover this same risk. This $1,000 premium also insures a multiple-year stay. If Lucy requires a three-year confinement starting 25 years from now, the total cost would be approximately $576,500 under our earlier assumptions. She would need about $543,500 at the start of her confinement to cover these costs. Funding this amount requires an annual annuity of $9,900 for 25 years earning 6%. In comparison, an annual $1,000 premium would meet the $543,500 need at a much lower cost. Lucy and clients like her should buy LTC insurance.

Other options. The CPA’s objective is to make clients aware of the options available to meet the financial challenges of long-term care. One option is to use the proceeds from a traditional individual or group life insurance policy that pays accelerated death benefits to chronically or terminally ill individuals needing long-term care. These accelerated distributions, however, reduce any death benefits payable. The CPA/financial planner should also advise the client to see if his or her employer will provide LTC insurance. Often, employer-provided insurance is less expensive than independent coverage. The client needs to ensure, however, that he or she can continue the policy at retirement or when leaving the company. Purchasing a new policy later may be quite expensive.

SELECT THE RIGHT POLICY
For clients who expect to purchase LTC insurance, the CPA/financial planner might offer these shopping tips:

Don’t let the insurance representative determine the selected coverage. Decide for yourself what you need.
Compare the policies of several companies.
Verify the financial stability of the insurance company you are considering.
Make sure the policy provides the coverage you need.
Be honest about your medical history.
Have the premiums deducted from your bank account to avoid disruption due to a missed payment.

After the client has narrowed the choice to two or three policies, the CPA can help select the one that best meets his or her needs. Exhibit 3, below, identifies factors clients should consider in deciding on an LTC insurance policy. For an independent rating of LTC policies of various companies, clients can refer to A.M. Best Company’s ratings ( www.ambest.com/index.htm ) and to Consumer Reports ( www.consumerreports.org ).

LOOKING AHEAD
A graying America creates new health care needs plus new opportunities for CPAs to advise clients on how best to cope with those needs. A pressing desire of the elderly is to spend their last years independently. Therefore, long-term care is a critical issue the accounting profession needs to help clients address head on. As CPA/financial planners meet this new market demand, they can take pride in helping people preserve their dignity during vulnerable times.