Long-term care costs, like most health-related costs, have been rising steadily for many years, and this trend is expected to continue. LTCI policyholders run the risk that his daily or monthly benefit and lifetime maximum will become inadequate to cover the increased cost of services in the future. Consumers can add optional provisions that protect against inflation -- for an additional premium. Inflation protection can be one of the most important features of an LTCI policy, especially for those purchasing coverage many years before they expect to need benefits.
For tax-qualified policies and those governed by the NAIC Model Regulation, an inflation protection option must be offered, although a purchaser may choose not to take it. For group coverage, this option must be offered to the group policyholder (usually an employer), but it is not generally required that it be offered to each individual group member (although some states require this as well).
Automatic Inflation Protection
With automatic inflation protection, benefit amounts are increased every year at a set rate with no action by the insured required and with no corresponding increase in premium. There are two common versions:
· The 5 percent simple rate. Benefits are increased each year by 5 percent of the initial amount. For example, a daily benefit of $100 would rise $5 each year (5% of the $100 daily benefit). The daily benefit would be $105 in the second year, $110 in the third year, $115 in the fourth year and so on, reaching $200 in 20 years.
· The 5 percent compound rate. The increase is compounded, like interest in a savings account. In other words, each year there is a 5 percent increase based on the previous year's amount. This leads to a snowballing effect -- in the early years of the policy the increases are not much greater than with the 5 percent simple option, but in later years they are substantially greater. For example, a daily benefit of $100 would rise to $105 in the second year, $110.25 in the third year, and $115.76 in the fourth year. But after 20 years, the daily benefit amount would increase to $265, or an annual difference of $23,725 over the simple rate.
The simple rate option costs less, since in the long run it results in significantly smaller benefit increases. However, as noted, during the early years of the policy benefit increases are almost as great as with the compound rate. Therefore, the simple rate option is probably sufficient for a person who is likely to need benefits fairly soon, such as someone who is already elderly when the policy is purchased. On the other hand, the compound rate provides better protection when the need for the benefit is not expected to occur for 15 or more years, as is the case with younger buyers of LTCI.
Some insurers have introduced additional automatic inflation protection options, ranging from 1 percent to 6 percent, simple or compound. In most LTCI policies, automatic inflation increases continue for the life of the policy, however, some policies impose a cap on benefits of double the original amount, and others stop automatic increases after 20 years or when the insured reaches a specified age (such as 80 or 85). These limitations provide lower-cost alternatives to lifetime automatic increases.
An automatic inflation protection option generally also increases a policy's lifetime maximum benefit. The same rate usually applies to both the daily or monthly benefit and the lifetime maximum, but in some cases the maximum is increased at a lower rate. (For example, an insurer might offer a split rate, with the daily benefit increasing by 5 percent and the lifetime maximum by 3 percent.)
Guaranteed Purchase Option
Another kind of inflation protection is the guaranteed purchase option (GPO) (also called the future purchase option, or FPO). This feature gives the insured the right to purchase additional coverage to keep up with rising costs. At set intervals (such as every year or every three years), the insured has the option of increasing benefit amounts. He does not have to reapply for coverage or submit evidence of insurability, as would an insured without the guaranteed purchase option. If an insured chooses to increase his benefits, his premium is also increased. The increase in premium is based on the amount of the benefit increase and the insured's age at the time of the change.
Some policies include the guaranteed purchase option at no additional cost; others charge a higher premium simply to have this option, whether or not the policyholder ever elects to raise benefits.
A policy with a guaranteed purchase option usually has a lower premium than a comparable policy with automatic inflation protection. But the GPO offers less-effective inflation protection for those buying a policy at a relatively young age. Over a long time, the benefit increases needed to keep pace with inflation result in larger and larger premium increases, eventually making the policy unaffordable. Automatic inflation protection, on the other hand, gives the insured a known, budgetable premium.
In addition, the GPO is subject to certain limitations. If an insured declines a certain number of opportunities to increase coverage, most insurers stop offering them. And most insurers will not allow GPO benefit increases after the insured triggers benefit payments.
Non-forfeiture options allow an insured who stops paying premiums and lets her policy lapse to receive something for the premiums she has already paid. This could be a cash payment or continuation of coverage for a limited time. Non-forfeiture options are available for an additional premium.
Under the cash surrender value option or return of premium option, a cash payment is made.
· If the insured surrenders (terminates) the policy during her lifetime, the cash surrender value option returns the total amount of premiums paid over the life of the policy less any claims paid. (This option is not available in TQ policies.)
· The return of premium option is triggered by the death of the insured. A payment, based on premiums paid and other factors, is made to her estate or designated beneficiary. Some insurers require the policy to have been in force for at least 10 years before the death of the insured.
Under the shortened benefit period option, an insured who quits paying premiums retains the right to benefits equal in amount to the total premiums she has paid (without interest), or 30 days of benefits if this is greater, provided the policy was in force three years or more. The name "shortened benefit period" is used because the policy remains in force but the lifetime maximum benefit is reduced to the amount of premiums paid.
Marianne purchases a $100 per day policy for an annual premium of $1,500. Ten years later, after she has paid a total of $15,000 in premiums, she lets the policy lapse. She is entitled to $15,000 in benefits. Two years later, when she enters a nursing home, she is entitled to receive the policy's daily benefit ($100) for 150 days.
The extra premium charged for non-forfeiture options can be quite substantial, depending on the age of the insured and the type and amount of non-forfeiture benefits selected.
Most newer LTCI policies generally provide “contingent non-forfeiture benefits” at no extra charge (some states require them). These provide benefits to insureds who let their policy lapse due to large premium increases. In order for an insured may receive contingent non-forfeiture benefits, the insurer must increase the premium above a specified level set forth in the policy.