I attended the Financial Planning Association’s annual NorCal conference in San Francisco on May 29-30. The conference was excellent. Deborah Rauser gave a talk about Long Term Care insurance. The argument against LTC is that someone could self-insure and thus avoid the cost of premiums. The argument in favor LTC is that the need to liquidate $150,000 a year of assets to pay for LTC means that one’s portfolio is disrupted, their taxes will go up and they lack peace of mind. My opinion is that a key part of tax planning for affluent retirees is to keep appreciated assets and sell them only after death thus the basis is stepped up and no income tax is due on the gain. In Community Property states like California when one spouse dies the basis of the Community Property is stepped up to Market Value at death, even though one spouse is still alive. Thus if someone can avoid selling assets until death they can save on income taxes. Meanwhile the funds used for self-insurance will be taxed thus inhibiting the compounding of net worth. So self-insuring for LTC (meaning no purchase of insurance) means that one has an increased risk of not getting the best tax treatment regarding basis step-up an one is wasting money paying annual taxes on the compound growth of dividends and interest in the nest egg used to self insure. To get an LTC policy the insurance company requires that one is healthy with a good health history however the underwriting is less strict than other types of health qualified insurance such as Life, Disability, or Health insurance, since some health problems don’t cost an LTC insurer that much since the patient has a high chance of suddenly dying instead of spending years getting LTC. Medicare and health insurance don’t cover long term use of LTC. Remember LTC is care, not cure and health insurance is for seeking a cure. So to be properly insured one needs LTC, health insurance and if working, Disability insurance. In California some people pay $150,000 a year for care in a skilled nursing facility and could run up a $500,000 tab which could be paid for by selling $650,000 of stocks and paying a tax of $150,000 on the sale of stocks. The decision to self-insure means that with a smaller nest egg one will have less available for the other spouse’s retirement needs. Regarding the huge cost increase in LTC premiums that may be due to a huge decline in the lapse rate and to very low interest rates. These hurt insurance company profits, so they had to restructure their pricing.
I posted an article written by the FPA “With premiums increasing should you get LTC insurance?”
Investors should seek independent financial advice.
One of the most important parts of financial planning is to have adequate insurance. When someone is hit by a catastrophe then they may need to sell their investments to pay for the rebuilding of damaged assets. Selling investments during a market crash instead of holding on until a recovery is not a good idea as it could result in selling at a loss during a temporary dip. Also selling investments to fund the cost of recovering from a catastrophe could incur tax on the capital gains.
A basic rule of thumb is that if someone can’t afford to self-insure against a catastrophe then they need to insure against it. The temptation by consumers is to rationalize that a catastrophe won’t happen to them so they fantasize that they don’t need insurance. One should ask oneself how badly would one be hurt if they were uninsured when hit by a crisis rather than use a probability theory that the hypothetical value of the insurance payoff is less than the cost of the premiums.
An insured person may be able to use the insurance company to get leverage against vendors after a catastrophe by telling vendors that they must reduce prices and conform to insurance company standards in order to get paid.
When dealing with a catastrophe the insured may find that some insurance companies offer poor service at a time when the insured has lost a lot of energy and confidence. So the insured may find it difficult to get the energy and discipline to pursue their insurance claims. Then the insured would not get the full reimbursement due. So it is important to get an insurance contract with a company that offers reasonable service, rather than the cheapest insurance policy. The opportunity cost of taking time off work to deal with a recalcitrant insurance company could be a substantial portion of a year’s wages in the case of some painfully complicated catastrophes. Insurance companies may have narrow profit margins and may be tempted to make it difficult for a crisis victim to get their claim fully reimbursed.
When suffering from a catastrophe if the victim receives rapid, full insurance reimbursement with minimal conflict with the insurance company the victim may have a greater feeling of control over their life and a greater feeling of emotional recovery from their crisis.
This feeling of emotional recovery can lead to better investment decisions as an investor can regain his lost confidence and begin to feel comfortable with taking riskier higher return investments instead of hiding in the safety of low yielding cash. By contrast, an insured person who encounters a difficult experience getting reimbursed would be likely to not trust risky investments and thus may be tempted to hide in the safety of low yielding cash rather than take risk to earn a fair return on investments. So the implications of having a bad experience with an insurance claim go beyond the math of the cost of merely hiring a contractor to rebuild a burned down home or the cost of hiring a doctor to heal a hospital patient.
Investors should seek independent financial advice.