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Financial planning for the risk of long life; how to cope with the rising cost of getting old.

RICHARD J. BERGSTROM, JD, CFP, is an attorney in private practice in San Dimas, California. He is also professor of finance, real estate a law at California State Polytechnic University, Pomona.

ERIC J. MCLAUGHLIN, Phd, is associate dean of the College of Business Administration, California State Polytechnic University. He is also professor of finance, real estate and law.

Financial planning for the risk that clients may need long-term healthcare is perhaps the most complex economic issue of the 1990s. It is the fervent desire of most Americans to live out their years independently, in their own homes, without becoming a burden to their children. Community support services, such as Meals on Wheels, may prolong the ability to remain independent. However, CPAs' clients still ask who will take care of them when they can no longer care for themselves and when family and community support systems are inadequate. Should long-term care (LTC) or professional assistance be needed, whether at home or in a long-term nursing-care facility, who will pay the cost?

COMMON MISCONCEPTIONS

The American Association of Retired Persons (AARP) has reported 79% of its members incorrectly believed a long-term nursing-home stay would be financed through Medicare. In general, society today believes private insurance or the government will cover the cost of catastrophic illness. Until relatively recently, few individuals were aware neither the government nor private insurance would protect them from the financial risks of living a long life.

Undoubtedly, there are many others who believe employer-provided health insurance, which often continues into retirement, will cover the cost of long-term nursing-home care. Individuals fortunate enough to have an employer who provides "medi-gap" insurance might also assume the issue of LTC is solved. These assumptions are seriously flawed, however. The reality is most Americans have little or no economic protection for living a long life. As a last resort, those willing to take a "pauper's oath" and give up virtually all their resources can throw themselves on the mercy of the state and become eligible for public assistance in the form of Medicaid.

THE CAUSE OF THE RISK

Financial planners today often define people aged 65 to 75 as the young-old," and those aged 75 and older to be the old- old. " As life expectancies increase, the long-term healthcare problem is exacerbated by an explosion in population growth. According to the U.S. Department of Commerce's 1989 population profile of the United States, the number of people 65 and over is projected to increase from over 31 million (12.5% of the total U.S. population) to 65.6 million (22%) by the year 2030. The largest growing population in the United States today is individuals over age 85.

The dream, or at least the preference, of most people is to remain independent and not need professional nursing care at home or in a nursing facility. The U. S. Department of Health and Human Services reports, however, 7 out of 10 elderly persons living alone are at risk. One of every two Americans commencing their young-old years actually may be forced to leave their homes and enter a nursing-care facility. Prudent financial planning, therefore, dictates the cost of this alternative be considered in advance.

THE COST OF LONG-TERM HURSING-HOME CM

The current cost of long-term nursing-home care ranges from approximately $25,000 to $75,000 per year, depending on the amenities provided, the extent of care required, the age of the recipient and the location of the facility.

It is also important to bear in mind what the costs of a facility might be over an extended period. A facility today charges, for example, $25,000 per year. Predicting a conservative yearly inflation rate of 4%, in 30 years this care facility will cost in excess of $81,000 per year. A 6% annual inflation rate would increase today's costs from $25,000 to well over $140,000 per year. It should be noted, however, that for more than a decade the actual annual healthcare inflation rate has been approximately 11%. If this rate holds true in the future, today's $25,000-per-year facility will cost a phenomenal $570,000 per year in 30 years ! LOMG-TERM HEALTHCARE PLANNING

Most families either ignore long-term planning or wait until the need for such care is inevitable. It is often later discovered Medicare is not designed to provide assistance to meet LTC needs and Medicaid is designed primarily for those who have already exhausted their financial resources. It comes as a shock to most people to find they may have to face depletion of their estates before qualifying for Medicaid.

Individuals with large estates can allocate income-producing assets sufficient for "self-insurance." The best way to be self-insured is to begin saving in the early adult years. Once individuals reach their young-the U.S. Department of Commerce's 1989 population profile of the United States, the number of people 65 and over is projected to increase from over 31 million (12.5% of the total U.S. population) to 65.6 million (22%) by the year 2030. The largest growing population in the United States today is individuals over age 85.

The dream, or at least the preference, of most people is to remain independent and not need professional nursing care at home or in a nursing facility. The U. S. Department of Health and Human Services reports, however, 7 out of 10 elderly persons living alone are at risk. One of every two Americans commencing their young-old years actually may be forced to leave their homes and enter a nursing-care facility. Prudent financial planning, therefore, dictates the cost of this alternative be considered in advance.

THE COSF OF LONG-TERM NURSING-HOME CARE

The current cost of long-term nursing-home care ranges from approximately $25,000 to $75,000 per year, depending on the amenities provided, the extent of care required, the age of the recipient and the location of the facility.

It is also important to bear in mind what the costs of a facility might be over an extended period. A facility today charges, for example, $25,000 per year. Predicting a conservative yearly inflation rate of 4%, in 30 years this care facility will cost in excess of $81,000 per year. A 6% annual inflation rate would increase today's costs from $25,000 to well over $140,000 per year. It should be noted, however, that for more than a decade the actual annual healthcare inflation rate has been approximately 11%. If this rate holds true in the future, today's $25,000-per-year facility will cost a phenomenal $570,000 per year in 30 years ! LONG-TERM HEALTHCARE PLANNING

Most families either ignore long-term planning or wait until the need for such care is inevitable. It is often later discovered Medicare is not designed to provide assistance to meet LTC needs and Medicaid is designed primarily for those who have already exhausted their financial resources. It comes as a shock to most people to find they may have to face depletion of their estates before qualifying for Medicaid.

Individuals with large estates can allocate income-producing assets sufficient for "self-insurance." The best way to be self-insured is to begin saving in the early adult years. Once individuals reach their youngold years, self-insurance becomes an option limited to those with large estates composed of income-producing assets. For example, a couple aged 65 to 75 who today could set aside about $1 million of income-producing assets could probably insure their remaining estate from depletion due to long-term nursing-home costs, assuming inflation and the escalating costs of nursing-home care do not require premature depletion of principal. Principal reduction, however, is likely since an annualized yield of 8% would generate only $80,000 of income to pay for LTC.

Even such self-insured couples, however, should realize the standard of living in a long-term nursing-care facility of their choice could be substantially lower than their expectations. Should both husband and wife need long-term nursing care and choose a nursing home with a relatively high degree of comfort and service, annual nursing-home costs could be in excess of $120,000 per year.

Facilities vary greatly in terms of comfort, care and physical amenities, as well as the ratio of available staff to patients and the qualifications of the staff providing the services. Higher ratios of registered nurses and licensed vocational nurses result in higher per-patient costs for nursing-home services. Therefore, depending on the rate of inflation, the age at which care commences (for one or both spouses), the longevity of the survivor and the quality of the LTC facility desired, even more substantial resources may be necessary.

Even if some people have sufficient assets to self-insure and others have little income and few assets but are adequately protected by Medicaid, the reality is the great majority of Americans fall between these two extremes. This group, lacking adequate private LTC insurance and the assets needed to self-insure, faces the very real risk of devastation of their estates in the event they are unable to live independently.

Apparently it does not take long for this devastation to occur. The Long-term Care and Personal Impovekshment Report by the U.S. House of Representatives Select Committee on Aging concludes 7 in 10 elderly individuals who go into nursing homes find their income depleted to the poverty level after only 13 weeks. Two-thirds of elderly Americans lose all their assets within one year of long-term nursing care.

STRUCTURING AN ESTATE TO QUALIFY FOR MEDICAID

Faced with the threatened devastation of their estates, many Americans have begun to consider drastic and often hazardous legal strategies in an attempt to preserve a portion of them. Their goal is to structure the holding and disposition of assets to qualify themselves for Medicaid while preserving those assets for their heirs. A thorough examination of the intricate Medicaid rules regarding eligibility is beyond the scope of this article. However, the strategy employed essentially is one of structuring ownership of property to categorize it as "noncountable" or "inaccessible" under the Medicaid rules.

The definition of noncountable assets varies from state to state. Basically, however, noncountable assets include a home used as a primary residence, $2,000 in cash, an automobile, personal jewelry, household effects, prepaid funeral expenses, a burial account and life insurance policies with no cash-surrender value (term life insurance).

There are a number of circumstances under which assets might be deemed "inaccessible." Essentially, inaccessible assets are those that are, for one reason or another, unavailable because they have been placed beyond the reach of the Medicaid applicant. For example, these assets may have been given away or placed in a "Medicaid trust. "

The strategies to make assets inaccessible all involve the loss of control over income and principal. Creating irrevocable Medicaid trusts is precarious; in fact, it can cause an individual to be disqualified from receiving Medicaid benefits. Congress has passed legislation making inter vivos (lifetime) transfers to discretionary trusts available to the beneficiaries of such trusts. The trust assets are deemed accessible even though the trustee is given discretion not to use such assets for the grantor's benefit (and in fact does not do so), and the trust is irrevocable and has been structured for purposes other than enhancing Medicaid eligibility. While it would be an exaggeration to say "structuring an estate to qualify for Medicaid" has been eliminated by recent legislation, it has certainly become more risky and should be attempted only by specialists familiar with applicable federal and state laws.

Why are Americans engaging in such transactions? For many people, all their income and assets could go to cover nursing-home expenses-medicaid will pay only when these assets are exhausted. While LTC insurance is becoming more widely available, policies vary as to coverage and cost and have proved of only limited usefulness due to restrictions on benefit eligibility and other factors. For some, however, a well-chosen LTC policy is a better alternative to losing their life savings to a nursing home. (For more information on selecting an LTC policy, see the sidebar on pages 54-55.)

HEALTHCARE INSURANCE OPTIONS

The critical misunderstanding people have about healthcare insurance is their failure to recognize most insurance coverage is based on discrete "events. " An event starts immediately on hospitalization and rehabilitation and terminates on the patient's recovery or the lapse of a specific period of time. The need of individuals for prolonged custodial care does not fall within these traditional definitions. A separate insurance policy, therefore, is required to cover the need for custodial care.

Rising costs for both Medicare and Medicaid have resulted in legislative actions that have reduced benefits and increased patient copayment responsibilities. Today, Medicare covers only a small portion of the real costs of hospitalization. A recent study at the University of California at Los Angeles by Dr. Shoshanna Sofaer examined selected cases in which a financial obligation remained after Medicare had paid its portion of the bill. In many of the medical examples cited, the patient's post-medicaid responsibility equaled 50% of the total medical bill. Many of these costs were associated with the care required after discharge from the acute-care setting.

To protect an individual from this significant financial liability, insurance policies labeled "medi-gap" were designed and marketed to provide the missing healthcare coverage. Before 1985, roughly 100,000 medi-gap insurance policies were sold in the United States. By 1989, the number of policies sold had risen to over one million. Unfortunately, many of these policies were woefully inadequate. The typical policy covered, at best, only 5% to 10% of a patient's portion of the bill after Medicare.

The distinction between medical care and custodial care is the most important "gray" area in insurance planning. LTC insurance was available in the 1970s and 1980s, but it basically terminated coverage when a patient improved to the point of requiring only custodial care. Certain cognitive impairments, such as Alzheimer's disease and Parkinson's disease, were specifically excluded from coverage (although some states are enacting legislation prohibiting such exclusions). The single largest factor that limits the value of the pre-1990s long-term insurance policies is inflation protection. Most early policies have almost no coverage value; inflation has eroded their "real" healthcare purchasing power.

In the 1990s, many state legislatures attempted to reform the healthcare insurance industry because many carriers, for marketing reasons, presented their policies to clients as providing all-encompassing care when, in fact, home healthcare was not included. As a result of new legislation, policies offered in the last few years have improved dramatically, with some providing for daily nursing-home benefits, inflation-adjustment options, length of coverage, deductibles, as well as home healthcare benefits.

HEALTHCARE INSURANCE POLICY COSTS

As with most life insurance policies, the earlier coverage is sought, the lower the premium, because the time value of money is used by the insurance companies. As exemplified by the Sofaer study, the policy that costs $13 per month if bought at age 40 costs $139 per month if purchased at age 65. Thus, by the age of 75, the policyholder who started at age 40 would have spent $5,640 on premiums while the policyholder who started at 65 would have spent $16,680 on them.

Financial planners ideally should guide clients into long-term healthcare policies when they are in their 40s or early 50s. Unfortunately, most individuals wait until they experience a medical need in their 60s or 70s before exploring LTC insurance. By then, it is typically too expensive to be a practical option.

LIVING LONGER

The cost of getting old in the United States is increasing as more individuals live longer. The healthcare services required by the elderly are often among the most expensive, using technologies and procedures unknown just a few decades ago. Medicare, designed to cover the acute-care costs of those over 65, cannot keep up with the increasing elderly population and annually growing costs.

Changes are slow in coming to the healthcare insurance industry, but legislative pressures are providing some stimulus. Currently, if long-term health insurance is sought by a client, early purchase can significantly lower the total lifelong cost of the policy. The client should be advised to review carefully the policy for provisions for daily nursing-home benefits, inflation-adjusted payouts, deductible size, length of coverage and, most important, home healthcare benefits. As suggested above, the need to know whether coverage is limited to a maximum number of days per year is essential.

ALTERNATIVES

As discussed above, the alternatives to LTC insurance include using private savings for nursing-home care or designing personal asset holdings to become "inaccessible" to qualify for government-provided care. Other alternatives include joining a continuing-care retirement community or purchasing a life insurance policy that can be converted to cash after a number of years. Each of these options requires careful and advanced financial planning; CPAS' clients typically need to take action between ages 40 and 50. To wait until the need exists for extended custodial care for someone aged 65 or older is tantamount to destroying the financial reserves from a lifetime of work.

EXECUTIVE SURVEY

* THE COST OF GROWING old in the United States is increasing dramatically. As Americans live longer, they face the risk they may require expensive long-term healthcare.

* NEITHER PRIVATE insurance nor government programs (Medicare, Medicaid) generally provide coverage for the cost of a catastrophic long-term illness. Most particularly, this includes the cost of nursing-home care.

* WITH MOST AMERICANS wanting to remain financially independent as long as possible, advance planning is required to anticipate the costs of growing old. Options include self-insurance, structuring assets to qualify for government assistance or purchasing long-term care (LTC) insurance.

* NURSING-HOME CARE is expensive. With healthcare inflation in the range of 11%, the future cost is likely to grow even more, making advance planning even more important.

* THE IDEAL TIME to acquire LTC insurance coverage is when the insured is in his 40s or 50s. Waiting longer will increase premiums, possibly to the point where coverage is too expensive to be practical.

* BY FAILING TO PLAN for the cost of future healthcare, individuals run the risk of destroying the financial reserves from a lifetime of work.

SELECTING LONG-TERM CARE INSURANCE COVERAGE

PETER D. FLEMING, CFP, is a senior editor with the Journal.

Mr. Fleming is an employee of the American Institute of CPAS and his views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.

Because more than 100 insurance companies offer long-term care (LTC) policies, the features and benefits of this coverage can be confusing even to the most experienced professional. To make it easier to evaluate this coverage, it's important to understand the basics of how LTC insurance works. Here are some of the factors that need to be considered in selecting a policy to meet future needs.

Company rating. Since LTC insurance often is purchased by those who don't plan to use it for a number of years, make certain the company issuing the policy is stable and will still exist when the insured needs to draw benefits. Consider policies only from companies with an A + rating from A. M. Best or an AA rating from Standard and Poors. Also cheek the company's overall reputation and any conditions under which they have refused or canceled coverage.

Policy provisions. An LTC policy is only as good as the coverage it provides. Make certain carrier restrictions do not limit the ability to make a claim under reasonable circumstances. In evaluating policy terms, here are some key questions:

* Does the insured have to be hospitalized before he or she can collect LTC benefits? Today, many patients go directly from their own homes to nursing homes, but many policies use a hospital stay as proof the insured is really sick. The best policies do not require hospitalization before paying benefits. In fact, some states have outlawed prior hospital stay requirements.

* What levels of care does the policy provide, and what benefits will it pay for at each? Generally, there are four levels of care: skilled, intermediate, custodial and home care. Recommend the policy that pays equally for all four levels. Also, make certain the insured doesn't have to receive skilled care before becoming eligible for intermediate care or custodial care before becoming eligible for home care and so on.

* How long does the insured have to wait before benefits begin? LTC insurance is designed to protect the insured from the financial drain of a long illness. For this reason, it may be appropriate to select an elimination or waiting period of up to 100 days and self-insure for shorter periods. Longer elimination periods reduce policy premiums.

* How long do benefits continue?

Time spent in the nursing home averages two to three years, so avoid policies that provide benefits for less than three years. Also, make sure the care provided at one level is not tied to the length of benefits at the previous level.

* What triggers the benefits payments? Look for policies that pay benefits when the insured is unable to perform two of the five "activities of daily living" (ADLs). These include bathing, dressing, eating, mobility and going to the bathroom.

* Are diseases such as Alzheimer's or Parkinson's covered? The policy should specifically include coverage for these conditions.

* Does the policy provide inflation protection? It should, as healthcare inflation has been running at 11% for more than a decade.

* Is the policy guaranteed renewable? Also, if coverage is provided through a group policy, make sure the individual has the right to continue coverage if he or she leaves the group or the group coverage is canceled.

* Are preexisting illnesses covered? If so, what waiting period, if any, applies?

* Can the policy be upgraded without penalty if better or more comprehensive coverage is needed later? Alternatively, the insurance company may provide better coverage under a newly created policy.

* Do policy benefits change as the insured gets older? The best policy provides full coverage regardless of age.

* Cost and amount of coverage. The LTC coverage cost varies based on the age of the insured, the amount of the daily benefit and the duration of coverage. Premiums should be guaranteed for the term of the policy. With the cost of nursing-home care averaging about $100 per day, a policy should provide daily benefits of at least this amount. Since costs vary by region, the amount of coverage should reflect where the client lives.

Typical policy. A listing of all the companies offering LTC insurance and the terms of their policies is beyond the scope of this article. However, a typical policy offered by a major, A + -rated carrier offers coverage to those between the ages of 50 and 84. Annual premiums for a 50-year-old seeking an $80 daily benefit with a 100-day elimination period, 3 years of benefits and no prior hospitalization would be about $170. The same coverage for a 65-year-old would cost about $490. In both cases, the daily benefit is adjusted annually for inflation by 5% of the original amount until age 85. Custodial care must be provided in a skilled or intermediate care facility and home care is included.

Alternatives. There are other insurance alternatives to a LTC policy. Some insurance companies have begun offering to prepay death benefits on life insurance policies in the event of a catastrophic illness, such as AIDS or cancer. While some companies have made this offer on existing policies, others make it an optional rider on new coverage. Most experts agree taking advantage of the option may make sense on existing policies if no other alternatives are available to pay for long-term care. Avoid depleting insurance proceeds that surviving family members will need in the future. Buying conventional LTC coverage, however, is considered preferable to buying newly issued life insurance with an LTC option.
COPYRIGHT 1991 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:includes related article on selecting long-term care insurance coverage
Author:Fleming, Peter D.
Publication:Journal of Accountancy
Date:Sep 1, 1991
Words:3961
Previous Article:Tax shelters in the 1990s; rumors of the death of tax shelters may be greatly exaggerated.
Next Article:Managing risk in audits of financial institutions; how CPAs can identify high-risk areas in savings and loan audits.
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