A friend of mine from NYC, a handsome teacher by day who doubles as a construction worker by night (long story), asked me recently about long-term care insurance. Indeed, long-term care can be pretty costly, and many people need it for a prolonged period towards the end of their life.
On the face of it, the policy looked reasonable. The insurer is a big, stable company (John Hancock), and the hefty premium ($50,000) is still small compared with the expected expenses ($5,000 a month for 8 years = $480,000). Also, the insurance had an early withdrawal options (life insurance and cash value). What not to like?
As it turns out, a lot.
When you consider this kind of policy, here are a few questions you should ask yourself.
On the face of it, the policy looked reasonable. The insurer is a big, stable company (John Hancock), and the hefty premium ($50,000) is still small compared with the expected expenses ($5,000 a month for 8 years = $480,000). Also, the insurance had an early withdrawal options (life insurance and cash value). What not to like?
As it turns out, a lot.
When you consider this kind of policy, here are a few questions you should ask yourself.
- Do I trust it that the insurer will be there in 40 years when I need it? Probably yes, John Hancock is a big, established company. On the other hand, so was AIG.
- Do I have more important things to do with $50K now (such as putting a downpayment on a house)?
- What alternatives do I have? Investing $50,000 for 40 years with a balanced portfolio can yield $350,000 to $750,000 (these numbers correspond to 5% to 7% annual gain - plug in your own estimate of market performance, bearing in mind that historical averages are 9%).
- Is this benefit going to guarantee my long term care cost? The answer is no - the benefit is capped at 6 years, and the monthly payment ($6,458) might not be enough in 40 years. In fact, it's highly likely it will not be enough.
- What if I need the money for other needs, such as a costly operation? This insurance has a "face value", but it's equivalent to a minuscule return of 2% annually.
- What's the insurance benefit if I never use the benefit, say, if I live to 105 without any need for help, then die within a week? Again, the benefit turns into a pretty mediocre life-insurance (equivalent to investing the money with 2% annual interest).
But the biggest drawback of the policy is this beast called Inflation. People tend to forget about it, but over long periods of time (40 years in our case), an average inflation rate of 3% can wreck havoc in these kind of policies. Indeed, assuming 3% annual inflation rate, the guaranteed payment of $6,458 shrinks to just $1,980 in today's dollars. And a few years of 70s style high inflation will erase most of the value of the policy. Are you willing to take this risk?
The funny thing is that insurance is supposed to reduce risk. You take insurance to cover yourself against unlikely, catastrophic events. An ideal insurance will have a high deductible, small premium, and guaranteed coverage against an expensive, unforeseen disaster (read more about it in part 1 of this blog.) This is exactly NOT what's offered here.
The insurance my friend was offered is more similar to buying 40 year treasury bonds with 2% and keeping them intact. Any period of high inflation during the coming 40 years will erase your investment. Remember, long-term bonds, as well as long-term fixed rate investments are dangerous, volatile and potentially disastrous investments. Especially now, when the Fed is printing money as fast as they can, the long-term interest is low in historic terms, and the national deficit is running circles around the moon, assuming that there will be little to no inflation in the coming 40 years and committing to it is a very high risk move.
My advice to my friend was to put $50K in a well balanced investment fund (such as FFNOX or other index funds). You gain the flexibility - the money is in your hands, and you can use it any time. You're better protected against inflation (since a well balanced portfolio on average beats the CPI). And if you need the money for long-term care, you can end up potentially with more than the insurer's guarantee of $465,042. If you don't need long-term care, the money stays in your hands, and not in Mr Hancock's pockets.
The funny thing is that insurance is supposed to reduce risk. You take insurance to cover yourself against unlikely, catastrophic events. An ideal insurance will have a high deductible, small premium, and guaranteed coverage against an expensive, unforeseen disaster (read more about it in part 1 of this blog.) This is exactly NOT what's offered here.
The insurance my friend was offered is more similar to buying 40 year treasury bonds with 2% and keeping them intact. Any period of high inflation during the coming 40 years will erase your investment. Remember, long-term bonds, as well as long-term fixed rate investments are dangerous, volatile and potentially disastrous investments. Especially now, when the Fed is printing money as fast as they can, the long-term interest is low in historic terms, and the national deficit is running circles around the moon, assuming that there will be little to no inflation in the coming 40 years and committing to it is a very high risk move.
My advice to my friend was to put $50K in a well balanced investment fund (such as FFNOX or other index funds). You gain the flexibility - the money is in your hands, and you can use it any time. You're better protected against inflation (since a well balanced portfolio on average beats the CPI). And if you need the money for long-term care, you can end up potentially with more than the insurer's guarantee of $465,042. If you don't need long-term care, the money stays in your hands, and not in Mr Hancock's pockets.
Think I got it right? Got it wrong? Your comments are welcome!
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