Insurance, by and large, is tremendously beneficial to society.  It permits people to live life more fully knowing that a misstep will not bring financial disaster. It’s much easier to take that step out on to the high wire if a net will catch you.

In the last century, society changed in that aging persons are often no longer cared for on a daily basis by their children or grandchildren. We have developed mechanisms by which persons either age at home (and possibly receive care from relatives, or hired persons coming into the home) or relocate to communities designed to support persons as they age.

The chance, and the extent, we will need financial resources to pay for care from others is a risk which the concept of long-term care insurance was designed to address. In each of our planning clients we discuss how they would be prepared to face the cost of care should it become necessary later in life.

Before I elaborate, a brief explanation of how an effective insurance system works may be in order.  Persons familiar with insurance should skip ahead.

How an effective insurance system works

In order for an insurance system to work, the company offering the insurance needs to have accurate insight into two things: (1) the likelihood of disaster and (2) the extent of the disaster in case it happens.  They also need a large group of customers (the risk pool) across whom they spread the cost of this insurance.

Case in point: homeowner’s insurance.  Insurance carriers have a very good idea about all the ways your home could be damaged, be it by fire, burglary, or some other disaster.  Since they know how many homes will be damaged, but they don’t know which ones, they spread this cost across a risk pool of hundreds or even thousands of homeowners.  They also cap their exposure by placing a hard ceiling at how much they would be willing to pay in the event of loss.  In the case of a home that costs $500,000 to build, they know with certainty how big a check they may need to write.

If my example above, an insurance company may well charge $1,000 for one year’s worth of coverage (I’m making up numbers). Provided the chances of any given home being destroyed that year are less than 1 in 500 this is a good risk for the insurance company to take. Remember, to an insurance company no risk is a bad one if they have priced it correctly.

Even if the absolute risk is known, the incidence of the risk can still vary. Insurance companies are required to carry reserves in the event of a bad year for house fires.  The more the incidence varies, the greater the reserves that are needed to ensure solvency (claims get paid!) in bad risk years.  All states have laws and regulations that govern the amount of reserves an insurance carrier needs to have available to pay claims.

Some risks are too expensive to insure because if they come they will be in too great a scale to cover.  Consider floods, hurricanes or earthquakes.  These are different from fires in that if one of these strikes it’s not just one house that gets destroyed, but typically hundreds or even thousands, all in the same area at the same time. This is why insurance programs against these risks are backed by government guarantees, or are offered only by the government itself.

What works for my clients

In almost every case, it has been our advice and our clients’ decision not to purchase long term care insurance to diminish this risk.

Regardless, since our clientele are mostly affluent persons with a surplus of resources, our advice to them is to plan considerable cushion in their retirement in the event care is needed. Ultimately it may be their heirs who pay in the form of receiving a smaller inheritance than they thought.  This prospect has never caused any client of mine to lose a single night’s sleep.

My objections to long term care insurance

I think the reasons why have as much to do with the insurance as they do with our clients.

My biggest objection to it is that I do not believe the insurance industry has any real understanding of the risk pool, or the extent to which benefits will need to be paid.

The typical long term care insurance customer is an adult between 50 and 60 years of age who has probably watched one or more parents require some care.  What the insurance company needs to determine is (1) the chances a 50 year old will need care; (2) how much care she will need;  (3) when she will need that care; and (4) how much that care will cost.

Aging (and more specifically, the care of aging persons) is changing faster than any insurance coverage can track adequately. Every day in the USA for the next ten years, 8,000 persons will turn 65. Already, the medical care they require is nothing like that received by their parents’ generation. They are living longer, suffering from more chronic diseases, and consuming more health care resources than their parents did.

I believe that insurance companies are offering little better than SWAGs (Scientific, Wild-Ass Guesses) as to what the real cost of care will be for current elderly and the generations to follow.

Let’s be optimistic and assume the actual cost turns out to be lower. That means there will be a surplus of money pooled up to pay for care: who would get that? Most likely the shareholders of the insurance companies.

Or, let’s be pessimistic and say the actual cost of care turns out to be higher. That means the insurance companies would need to re-negotiate their policies (and thus the policy holders would lose the benefit of whatever bargain they made) or go to the government for a bailout. Or, I suppose, they could just close their doors and walk away.

Right now I believe we are in the middle scenario: most Boomers have made a bet that long term care is becoming #TBTF (Too Big To Fail), and that if care costs exceeded assets, no politician would risk alienating Boomers: the block of voters who turn out to the polls most reliably and consistently.  They may be correct.

Middle class Americans are in a much tougher bind.  The possibility of needing substantial care later in life is not a pleasant prospect for anyone. It should be at the top of financial risks for which a family needs to prepare, as so far no one else (through government policy) is offering to prepare for you.