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Self-Insuring for Long-Term Care

A reader writes in, asking:

“As I’ve read about the issues with LTC insurance, one of the topics that consistently pops up is self insuring. I understand the concept of self-insurance, but what I don’t get is how to go about doing it. How would you go about setting up a self insuring plan? How big should the payments be? Where should the money be kept? Should it be invested?”

As a bit of background for those not familiar with the term, to “self-insure” against a certain risk means to save money to be able to pay for the expense out of pocket rather than to buy insurance to cover the expense.

How, exactly, to go about self-insuring for long-term care costs is not something I’ve seen addressed by any authoritative source. What follows are my thoughts on the matter, but I’m very interested to hear what other readers think.

How Much to Save?

As far as the size of the “payments” (which would really just be additional savings contributions), I think a reasonable place to start the assessment would be with an amount equal to the premium you’d have to pay for a new LTC insurance policy. From there, however, you would need to adjust the amount upward to account for the fact that when you’re self-insuring, you don’t get to take advantage of risk pooling.

That is, to self-insure for long-term care, you would have to save as if you will need to pay for long-term care. In comparison, when using insurance, the cost is spread out among multiple people so that the premiums — after paying the insurance company’s operating expenses and profits — only have to cover the average cost per person after accounting for the fact that many people will not end up needing LTC.

Note: This is the reason why the conventional wisdom (which I think is on-target) is that people should buy a long-term care policy sometime between age 50 and 65 if they:

Alternatively, you can approach the question from the opposite direction: Look up the average annual cost for nursing home care in your state, then create a savings plan so that you’re confident you’ll have enough saved for a few years of nursing home care by the time you reach retirement age. (Note: The fact that most people cannot manage such a level of savings is why LTC insurance makes sense for many people.)

 Where Should You Keep the Money?

As far as where the money should be kept, I’m inclined to say that I’d put the additional savings in retirement accounts (if you have room) — with my reasoning being that:

  • In the event you don’t end up needing long-term care, it will generally be better to have funded your retirement accounts than to have saved in a taxable account.
  • There’s a high probability that if you do end up needing long-term care, it won’t be until after age 59.5. (Approximately 90% of long-term care insurance claims start when the policyholder is 70 or older.)

How Should You Invest the Money?

As far as how the money should be invested, I would probably invest it similarly to any other retirement savings during most of one’s working years. However, as you approach retirement age, I’d be inclined to move the money to something more conservative than a typical retirement portfolio — reason being that LTC expenses (while still “long-term”) are likely to cover a much shorter period of time than retirement. And there’s no way to know when they’ll start.

But again, I haven’t read anything authoritative on this topic, and I’m eager to hear what other readers think.

Editorial note: Thanks to my dad, Pat Heffern of AGIS Network, for providing relevant pieces of data for this article. (For those interested, their website has lots of eldercare and long-term care-related information.)

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Comments

  1. Hi Mike. I think your suggestions are quite good.

    One other idea which could be done as an alternative to a specific savings plan or in addition to – would be to focus on your overall finances.

    If the time comes to pay for long term care, the better off your finances are, the more options you will have – even if you don’t have a specific amount of money saved for that purpose.

    A 75 year who has a decent SS income, a house, no debt and some savings (even a couple of hundred grand) will have far more options than someone with less income, some debt and less savings even though the ‘saver’ is pretty far from rich.

    This idea could be applied to any type of future expense – college expenses, retirement etc.

  2. Might some sort of deferred annuity be the right way to deal with this? That is a way to pool risk.

  3. Mike – Thank you for addressing this important subject. My father is in a memory care home costing $6,000/month. Fortunately, we had bought long term policies for both parents. My dad is 80 years old and in excellent physical condition, so he could easily live 10 years ($6000 x 12months x 10 years = $720,000).
    Those of you who read my blog know I am a huge advocate of self-directed investing. However, this is NOT the right goal to save for. You are right that LTC insurance is the best choice for the majority of the middle and upper middle class. Only those unable to afford policies and those rich enough to truly self insure (several million in assets) should pass up the security of LTC insurance.

  4. Mike, I think I agree with everything you’ve said. Thanks for sharing your input.

    Bob, do you mean something like a deferred lifetime fixed annuity? I hadn’t thought of that. You’re right that it (like other lifetime annuities) provides one sort of risk pooling.

    On a related note, are you aware of any deferred lifetime annuities that are inflation adjusted? The only ones I’ve come across are not, which leaves a good deal of risk for the annuitant.

  5. RPS,

    I agree. That’s a valid concern. Unfortunately, I don’t know what anybody (aside from the very wealthy) could do to self-insure against that type of expense. Most people just wouldn’t have enough saved to be able to pay for a nursing home stay at a young age.

    (In other words, I think that’s one argument in favor of buying insurance rather than self-insuring.)

  6. re: Deferred annuities, they provide a source of income if you live a long time, and people who live a long time have more likelihood of needing long-term care, but it’s a very inexact pooling of the long-term care risk. I know of companies that offer these deferred annuities with fixed step-ups in benefits (e.g., 2% a year), but don’t know of any that adjust for actual inflation.

    I did an article about a year ago for Financial Planning Magazine on LTC insurance.

    http://www.financial-planning.com/fp_issues/2011_9/is-long-term-care-insurance-worth-it-2674824-1.html?zkPrintable=1&nopagination=1

    The key takeaway, based on some rough estimates, is that taking the LTC risk by self-insuring is about 6 times as risky as taking investment risk by investing in stocks.

  7. Joe,

    Thank you for sharing your article. I enjoyed your methods of analysis.

  8. Mark Brody says:

    Mike, nice article. One can choose to insure or not insure. “Self -insure” is just a fancy way of saying “not insure”. Companies can self-insure. Individuals can’t.

    One problem is that it is impossible to know when one might need care. Care may be needed tomorrow so to “self-insure”, that money must be available now. Even if we knew that if care was going to be needed, it was going to be needed in 30 years, “self insurance” would make no sense, because as you already pointed out, there is no risk pooling.

    Here’s an example:
    Assumptions:
    Care costs $6,000/month today and increases at 5% a year
    Investment returns = 5% after tax
    Care is needed starting in 30 years and is needed for 5 years
    Question: How much money does one need to save on an annual basis to pay for 5 years of care?
    Answer: Around $26,000/year

    Despite what I have written, that does not mean that people should buy long term care insurance. There are plenty of issues with LTCi. The product is awesome in concept, but not necessarily so great in reality. It is inappropriate much more often than it is appropriate.

If you want to discuss this article, I recommend starting a conversation over at the Bogleheads investing forum.
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