Understanding the Inflation Protection in Long Term Care Insurance

Inflation protection is one of the most important features of long term care insurance. Without inflation protection, the current value of the benefit will reduce its buying power in future dollars. For instance, the current rate of $100 for daily benefit would only have the buying power of $55 at 3% inflation. Twenty years from now, a 5% annual inflation affixed on $100 would be equivalent to $38 in today’s dollars.

The main problem is: What inflation rate should we expect over the next 20 or 30 years? During 1970s and 1980s the costs of inflation rose to almost 10 percent annually. In the past decades, the cost rose to about 3 percent. Long term care services have higher inflation rate because the medical costs and services have been ascending at much aggressive rate than the core inflation rate.

A lot of companies nowadays are selling modern LTC policies that offer services known as the “homemaker services.” The services involved in these policies not only focus on daily activities (bathing, walking, etc.) but on other activities such as shopping, laundry, housekeeping, and companionship. Since these services are not medically related, they should increase in cost closer to the core inflation rate of approximately 3 percent a year. It implies that a policy with 5% yearly will automatically increase, so the cost of homemaker services will be more expensive than it does today.

One strategy to make most out of it is to buy more benefits than needed; the larger the benefit you buy will compensate for the loss in the buying power. This is far advantageous to those who have purchased group plans.

There are three types of inflation protection. The first one is the automatic inflation with 5% compounded annually. The second is automatic with 5% simple interest. Compounding means taking 5% of the previous year’s amount; meanwhile, simple interest adds 5% on the original amount. For instance, a $100 daily benefit with 5% simple inflation should have $5 addition per year. The simple inflation will increase $100 to $150 in 10 years, and $100 becomes $200 in the next decades. Otherwise, the 5% compound boosts the rate of $100 to $163 in 10 years and to $265 in 20 years. Nevertheless, be careful of companies with hidden increase limits. Companies have different policies, so it’s best to know the company’s policy on the increase to prevent future problems. Some policies double at the time it is frozen. Other policies have time limit such as 20 years on increases or age limit. A good policy does not contain increase limits.

The third type of inflation protection is optional. It allows policyholders to purchase additional coverage at periodic intervals without reapplying and without evidence of insurability. Most plans come with 15% increase every three years. The additional coverage depends on the age and existing premiums. For example, an employee chooses this plan every three years, his or her premium will increase. Many representatives sweet-talk this option as surefire way to get more affordable policy since the premium increases over time. But the truth is…it looks good, but it’s definitely a bad idea.