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Copyright © 2003, Greenwich Financial Management Inc., a registered investment advisor. Securities offered exclusively through Purshe Kaplan Sterling Investments of Albany, NY, a NASD member firm.
This booklet is meant to help you and your family to understand the basics of personal insurance. It gives guidance on how to use insurance: to protect your family financially against the risk of death or disability of an income producer or care provider; to save on taxes; to provide the medical care that you may need; to provide valuable group benefits if you are an employer; to protect your dignity and independence in old age; and to plan for your estate and the passage of wealth to your children. It will help you to understand which potentially catastrophic risks you need to insure against, while urging you to avoid wasting money on insurance that you can survive quite well without. The discussion will cover life, disability, long-term care and health insurance, as well as aspects of Medicare and Medicaid. You may wish to keep this booklet as a reference together with your key insurance documents and binders.
Understanding the Types of Life Insurance
Concerning life insurance, we will discuss the insurance you might obtain for yourself as well as group benefits you may enjoy at work or offer to your employees. It is first necessary to review the basic types of life insurance.
People often are confused about the differences among term life, whole life, standard universal life and variable universal life. How do you choose? The differences are not hard to explain.
First, some terms: the "policyholder" is the owner of a life insurance policy; the "premium" is the periodic payment, in advance, to keep a policy in force; the "insured" is the person whose death is insured, which may or not be the same as the policyholder; the "beneficiary" is named by the policyholder and receives the "death benefit" if the insured dies while the policy is in force. Insurance companies "underwrite" the risk of insured persons using such general criteria as sex, height/weight, prior conditions and known risky behaviors; they also administer (especially for larger policies) individual medical examinations.
There are two periods of life insurance: term and permanent. Term insurance contracts afford the policyholder life insurance coverage on an insured person for a defined period. The contracts are typically renewable without further underwriting until the insured reaches a certain maximum age, such as 75. As for term life, you're out of luck after that point if you're not dead yet. Many policyholders abandon term life as they grow older and premiums skyrocket. "One year term" means that the rate resets upward every year. "Ten year term" means that the rate is locked for the first ten years, jumps in price at that time, then increases incrementally in each year thereafter (and similarly for "twenty year term," etc.). Some term life policies are convertible into permanent policies, usually whole life, at the rates prevailing when converted.
With permanent insurance, in contrast to term life, the policyholder can maintain coverage until the death of the insured, assuming premiums are paid as required; the premium payments are exactly level or relatively level. In effect, you pay much more in early years than you would with term life, in exchange for the benefit that your premium doesn't keep going up (exponentially) as it does with term life, and for the equity you develop in your policy, called "cash value." Whole life and universal life policies can develop this cash value, but term life by definition never will.
There are in turn two kinds of permanent insurance, depending upon who takes the risk concerning overall rates of mortality and administrative expenses. In "whole life," the insurance company takes the risk that death rates or administrative costs may exceed actuarial expectations, and obliges itself contractually to accept a level (or "constant") periodic premium payment from the policyholder in return for providing a certain death benefit. In "universal life," the policyholder takes the risk that mortality rates or administrative expenses may go up, and in the case of at least one reputable insurance company, the policyholder also has enjoyed a benefit if mortality or administrative expenses go down (mortality rates have been declining historically, owing to better sanitation and nutrition and advances in medicine and pharmaceuticals). Universal life contracts are much more flexible than whole life, allowing many variations in contributions over time.
Finally, there are two kinds of universal life: standard and variable. In standard universal life, the cash value of the policy is guaranteed to advance at a certain minimum rate, assuming the expenses stay the same; the insurance company makes the investments itself (primarily in bonds and bond-like instruments) for the group of policyholders. In variable universal life, the policyholder decides on investments from a menu of mutual funds or variable annuity sub-accounts (held in segregated custody for the benefit of the policyholder) and can make periodic changes; here, the policyholder takes the mortality risk and all of the investment risk with the goal of superior performance.
Term Life
Term life is the most basic form of life insurance. It has a defined termination date, as opposed to permanent life (whole life or universal life). It is in that sense temporary.
With term life, again unlike permanent life, the premiums increase according to age. A common form is one year term. At the end of each year, the policy comes up for renewal, and the premium rises. In ten year term, the premium is held constant for ten years, after which it will rise sharply in year eleven and incrementally each year thereafter; likewise with 20 and 30 year term, etc.; however. The annual premium on ten year term is usually lower than for one year term, and it's level for nine additional years-you can generally drop coverage earlier if you wish; however, to qualify for the best rate if you renew after ten years, you generally will have to face a fresh underwriting.
Term life policies typically offer an option to renew. This option could be valuable if your health status were to deteriorate while the policy is in force; you might not be eligible for a new insurance policy anymore, or only at a much higher premium. Term life normally carries a maximum age of renewal, usually around 75 years old.
Notably, the death benefit from any life insurance policy, including term life, does not create taxable income for the beneficiary. However, term life, unlike permanent life, never develops "cash value." Therefore, it lacks the benefit of accumulation of the cash value amount without taxation; there is no investment aspect. Also, because there is no cash value, there is no store of equity to borrow from if desired in the future. However, for all people, but particularly for young people, term life insurance is the cheapest way to obtain any given level of death benefit. Sometimes a blend of term and permanent insurance makes the most sense.
The increases in the cost of term life each year are not steady; instead, they grow exponentially larger as the insured ages. These increases mirror the actuarial risk of death. For this reason, the term life premium, which could seem cheap when you are thirty, may be forbiddingly costly when you are sixty; in addition, the cost of converting to permanent life will be much greater by then.
If you have a life insurance benefit at work, it is almost certainly term life. Under federal tax law, the first $50,000 of term life insurance coverage given to you as an employee is not taxable. If your employer provides you with additional free coverage, income will be attributed to you and reported based on its "imputed" value. Your employer may also give you the option to purchase additional term life through payroll deduction. This insurance, if given without underwriting examination, is typically more expensive than you could purchase on your own, assuming you are a good risk candidate. This is because of "adverse selection"; those employees who have the highest risk of death may be more likely to exercise the option, and the insurance companies price this risk into the group coverage. Also, if you leave your company, you may be offered the right to convert your term life to permanent life insurance and pay premiums thereafter to keep it in force. The pricing of this option is usually unattractive to employees in good health, also because of the adverse selection problem. You would be better off to check on obtaining a policy underwritten to your particular case.
Frequently, a group benefits package may also include some employer paid accidental death insurance, and it may also include optional extra coverage for such occurrences. Sometimes there is also a double indemnity feature if you die accidentally while performing duties related to your job (such as business travel, etc.). This benefit costs very little for employers to provide, and it could be useful to have in addition to regular life insurance. You might ask, why be insured more for one type of death (accidental) than for others? A reasonable answer could be that the death will likely happen suddenly, possibly while the victim is young, and other planning measures may not be in place yet.
Insurance companies have different strengths. Some are better at term life, some at whole life, some at disability; others may be marginal or unacceptable for any purpose. Your agent should help you make the best tradeoff of premium cost, credit rating/financial strength, and policy features. To achieve this result, you will need to deal with a "general agency" rather than one captive to a particular insurance company.
Whole Life
With term life, the premiums you pay increase exponentially as you get older, until such point, normally around seventy five years old, when the insurance company will no longer offer you the option to renew. Because of these characteristics, term life should be viewed as a temporary solution to the financial problems presented by the risk of death, and one with an ever-increasing cost.
With permanent insurance, your premiums do not increase as a function of age, and you normally would intend to keep the policy in force for your entire life. There are two kinds of permanent insurance: whole life and universal life. We will discuss whole life in this column and universal life in the next.
The key idea with whole life is level premiums (even though whole life policies can also be designed otherwise). When you enter into a whole life contract, in effect you are agreeing to two different things. First, you are agreeing to pay for term life coverage at stipulated rates starting at the face amount (say, $100,000) and decreasing each year until reaching zero in the future (often at the age of 100). Second, you are agreeing to pay an extra premium that will be put into a pool of investments (together with the premiums of other policyholders) bearing a minimum guaranteed rate of return (generally, a relatively low rate such as 3-4% currently). At the minimum rate of return, this investment aspect of your policy, the so-called "cash value," will come to equal the original face amount of the policy in the future (at that same future date, say when the insured reaches 100). So the decreasing amount of term insurance and the increasing amount of cash value complement each other, with the total staying the same in the base case (in our example, a total of $100,000). Because of the power of compounding interest, whole life premiums are much lower if you start when you are young.
If the investments made by the insurance company fall below the minimum guaranteed rate, it doesn't impair your policy's face amount of coverage, as long as your insurance company stays solvent (as discussed in our previous column on credit quality). If the investments are more successful than the guaranteed rate of return, your cash value will outperform the base case. If the insurer is organized as a mutual life company, "dividends" may be declared and paid to the policyholders. Dividends normally represent a return of previous premiums and are not taxed. These dividends may be used in three different ways: as a cash payment back to the policyholder; to reduce or eliminate ongoing premiums; or to purchase "paid-up additions" of additional death benefit.
In whole life policies, sales and administrative charges are normally front-loaded in the first two years. Also, in later years, the surrender of a life insurance policy could lead to taxation if the cash value has grown beyond total premiums paid. Therefore, it makes more sense to take out term life rather than permanent life if there is any question in your mind that you might discontinue the policy in the future.
With whole life, unlike universal life, the insurance company bears all the risk that mortality or administrative costs may rise. The premiums paid for any given amount of life insurance will correspondingly be higher than with universal life, with the excess possibly returned in the future by way of the dividends.
With any permanent life contract, there is generally a provision where the policyholder may borrow from the cash value. Such borrowings reduce the amount of death benefit pro rata until repaid. Borrowing from the cash value of your life insurance policy will generally be the cheapest source of funds available, as the nominal interest you pay is usually fully credited back to your cash value (or sometimes with the subtraction of a small spread such as ½%). Because of this free or almost free borrowing feature offered under most policies, the cash value of your life insurance policy can be part of an emergency safety net. When you take out a permanent life insurance policy, make sure you understand the loan features!
Universal Life
Universal life and whole life are the two major forms of permanent life insurance, as opposed to term life. Universal life has a very flexible structure, allowing for wide fluctuations in premium contributions throughout the life of a policy, as long as payments are adequate or cash value sufficient to keep the policy in force.
With universal life, there is no fixed agreement by the insurer as to the scheduled "cost of insurance." The cost of insurance has two components: administration and mortality (death benefit). Because the policyholder takes the risk that these scheduled costs may increase, premiums on universal life death benefits may be significantly lower than for whole life (though whole life policy holders may potentially recover the higher premium costs in their cash values or through dividends). Moreover, universal life contracts generally offer maximum cost of insurance clauses that put bounds on the risk.
How big is the risk that the cost of insurance will increase? Administrative costs are probably moving slightly downward over time owing to the progress of technology, but not that significantly. However, the cost of the death benefit, the so-called "mortality cost," merits focus.
Measured mortality costs for insurance companies in the United States have been declining over a long period. Current average life span is 77.2 years; in 1900, it was 47.3 years (source: National Center for Health Statistics, "Health, United States, 2003.") Better sanitation and public health practices, decreases in infant mortality, improvements in medicine and discoveries in pharmaceuticals have all contributed to this dramatic improvement. New developments in science, including the decoding of the human genome, promise to further reduce mortality and increase average life span. Indeed, scientists have begun to discover how caloric restriction, and perhaps other means mimicking caloric restriction, can slow the aging process itself in simpler animals and potentially in human beings. So although there is the risk that U.S. mortality rates could spike upward, owing to a terrible microbial menace, say, or an unthinkable thermo-nuclear catastrophe, the demographic trend is generally very favorable.
I don't know of any insurance company that contractually obligates itself to pass on to policyholders decreases in the cost of insurance. Nevertheless, one insurance company, Pacific Life, does have a historical record and a stated policy of sharing with its universal life policyholders decreased mortality costs. According to examples I have studied, passthrough of decreasing mortality costs could have a very large favorable long-term impact on cash value. Pacific Life has a credit rating of "AA" rating (the fourth highest of eleven "investment-grade" ratings) on its long-term debt and claims paying ability from S&P, and its variable investment options are reasonably broad. (My own firm can offer life insurance from virtually all licensed carriers, including Pacific Life. It is always worthwhile to compare rates across carriers, giving due consideration to premium rates, credit quality and features.)
Universal life comes in two flavors: standard and variable. Standard universal life offers a minimum annual rate of return, and the insurance company decides on the investments, which are usually mostly bonds. With variable universal life, the policyholder makes choices from a menu of mutual fund sub-accounts or variable annuities, and there is no guaranteed minimum rate of return. These option choices can be revised, like a 401-k. Many of my clients prefer to have this kind of control over their investments. However, poor investment performance could lead to the need for increased premium contributions. Agents should show illustrations for variable policies giving a variety of investment outcomes, from low to high rates of return.
Keep in mind that insurance companies are regulated by state insurance commissioners, who may allow premium rates to rise above contractual levels if they conclude that an insurance company's financial viability is threatened. However, this rarely happens.
Because of its flexible characteristics, universal life is most often chosen as the vehicle for investment or tax shelter oriented policies. Such policies often include premiums up to the maximum amounts allowed under tax law, with the intention of developing large cash values that accumulate without taxation.
Use of Life Insurance as an Effective Tax Shelter
There are significant tax benefits related to life insurance. Virtually every serious exercise in tax and estate planning considers life insurance as a component. We will discuss here four potential tax benefits you can obtain through life insurance policies. Each is considered uncontroversial and well-accepted by law.
The first large tax break regards the "death benefit," which is the money payable to the beneficiary of a life insurance policy in force when the insured person dies. The death benefit, paid in a lump sum, is entirely exempt from income tax. The benefit can be very helpful when there is estate tax to pay and assets are tied up in illiquid investments, especially where the family desires to hold onto those assets or sell them at the best time and price. If the beneficiary decides to annuitize the death benefit, then the future interest portion but not the principal will be taxable.
The second tax benefit is growth of the cash value of the policy without income tax (since a Tax Court decision in 1963). The cash value is the equity in a whole life or universal life policy. The growth of the cash value is untaxed, and no federal tax report goes out to the policyholder or the IRS, even though the investments made by or on behalf of the policyholder might otherwise lead to realization of ordinary income or capital gains. This benefit does not apply, however, to term life, which does not develop cash value. So-called "dividends" normally represent premiums paid earlier on a whole life policy; these are not subject to income tax either.
A third advantage is that the policyholder may also borrow against the cash value of a life insurance policy, to the extent of any premiums paid to date, without tax effect. [Limits: where borrowing exceeds premiums paid, or when the policy is deemed a "modified endowment contract" (MEC). We usually structure tax shelter oriented policies to include periodic premiums equal to the maximum non-MEC amounts.] Typically, interest paid is credited back to your policy's cash value, so the borrowing is effectively free or of minimal cost.
A fourth benefit is exemption from estate tax on the estate of the insured, when the future proceeds to a beneficiary (or beneficiaries) are transferred to an irrevocable life insurance trust (ILIT). A properly structured trust places the property outside probate and the estate tax system. Exception: if you transfer property to an ILIT, but die within three years, the transfer may be subject to estate tax as made "in contemplation of death." (Alternatively, your intended beneficiary could apply for and purchase insurance on your life, assuming that person has an "insurable interest.") Your trust and estates attorney may establish "Crummey powers" within the ILIT to allow your contributions to qualify for the $11,000 per person ($22,000 for a married couple) annual exclusion from gift tax. However, the cash value of an existing policy transferred to an ILIT could still be subject to gift tax or reduce your lifetime exclusion. Frequently, ILIT's provide a tax-efficient way to transmit wealth upon death to the next generation.
A tax disadvantage of permanent life insurance is the deductions from each premium payment that may be made to offset federal, state and local taxes imposed on the premiums and paid by the insurer. These can total up to about 4%. A second disadvantage is the sales load that will be deducted from the premium. The sales load is often negotiable, particularly on larger policies, but often only if you show the savoir faire to bring this up. Giving a percentage commission break on larger premium amounts makes sense, in the same way that there are "breakpoints" and "rights of accumulation" in mutual fund sales that offer investors a sales load discount for volume purchases. With universal life, an adequately funded policy should show some significant "cash value" (relative to premium paid) even in the first year. Be sure to read the prospectus and understand the fees. It is valuable to ask for an illustration breaking out all the charges over time. Often part of the sales load is bundled in the early years of a policy as part of the mortality charge, which you can see step down later. Another valuable illustration shows the internal rate of return on your life insurance policy, considered as an investment (depending on your age at death, the mortality charges and the success of the underlying investments).
Background on estate taxes: For tax year 2004, under the federal Unified Estate and Gift Tax, up to $1.5 MM is excluded from a person's estate (minus amounts used up during that person's lifetime, for example, by gifts); this excluded amount is scheduled to increase in future years up to $3,500,000 in 2009, and the maximum marginal estate tax will drop from the current 48% to 45%. The estate (but not gift) tax is slated to cease in 2010, then returns back to a $1,000,000 exclusion and maximum 55% rate in 2011, under a crazy-quilt "sunset" provision that Congress enacted. Unless you expect to die exactly in 2010, not planning for estate taxes could be costly.
Disability Insurance for Individuals
Disability insurance protects you against the risk that you will be unable to work for an income.
You need coverage if disability would be a financial catastrophe for you. Here is a test. First, determine what amount of income you would need to preserve an adequate lifestyle in the event of disability. It's prudent to include some saving each year, as a hedge. Against this needed income, subtract your expected income. The first component is any disability insurance income you can already count on. The second is other reliable income, including that of a spouse, rent, interest, alimony, dividends, etc. Do not include retirement income, such as regular social security payments or pension, unless you are close to retirement age or would qualify upon disability. On investments, use a conservative multiplier, such as 5% annual return on your investments. The difference between needed income and expected income is your disability insurance requirement. If you leave a large gap unaddressed, you face the risk of serious hardship if disabled. This situation particularly faces many self-employed people without any group disability benefits (to be discussed in the next article). On the other hand, some individuals and families have enough wealth to self-insure against disability risk.
Insurance is founded on the principle of indemnity, which provides that you are secured against loss-but not more than your loss. The principle of indemnity helps protect insurers against "moral hazard"-the risk that an insured person might cheat to get a windfall. A digression: some life insurance contracts provide for a doubling of the death benefit in the event of accidental death-think of the great Billy Wilder movie, "Double Indemnity." Although it is difficult to monetize the value of a human life, insurance companies do put a cap on the insurable value of a life policy, based on income and wealth. In the same way, insurance companies cap the amount of disability income an individual may carry, and any other disability policies in force must be declared when applying for new disability insurance; you cannot normally obtain disability insurance for more than about 80% of your recent annual income.
Social Security Disability Insurance may pay benefits to you and certain members of your family if you have worked long enough and contributed to the Social Security system. Supplemental Security Income pays federal benefits based on need. See http://www.ssa.gov/disability/ . Social Security pays benefits only for total disability, not partial. It does not cover short-term disability. The waiting period is one year. The definition of disability is strict. It is very difficult to obtain the federal benefit, especially if you have a college education and the disability does not affect your mind; the government apparently figures that you can do something with it to make a living. In the best case, if qualified, total benefits for a family may amount to a couple thousand dollars per month.
Leading providers of disability insurance with decent credit ratings [strengths shown in parentheses] include Berkshire (white collar, high income), Principal Financial Group, Met Life, Assurety (substandard risk and blue collar), Mass Mutual, Fidelity Security (substandard risk), and Lloyd's of London (surplus coverage). Avoid poorer and unknown credits. [See the article on "Asssessing Insurance Quality Credit Quality at our Website," www.GreenwichFinancial.com .] It's good to have your agent shop around for quotes; don't just sign up with the guy who knocks on the door.
Make sure your disability contract covers the risk that you cannot continue in your current occupation. Otherwise, you might be denied benefits if you can still do menial work. Keep in mind the value of a cost of living rider, with compounding, despite its higher cost; inflation is almost a certainty.
Disability is a major risk, and therefore it is not cheap to insure against. You can secure a lower annual rate if you start a policy while young. You can save money by expanding the elimination period before you can collect disability and by not over-insuring. Keep in mind the principle of covering catastrophe, not inconvenience.
Group Disability Contracts
If you are an employee of a company with a decent benefits package, you may have some disability coverage provided to you free, and you might have the option to purchase additional coverage.
Disability insurance is the kind of topic people avoid thinking about until they need it. But then it's too late. It's wise to do some homework to protect yourself and your family, particularly if you do not have enough wealth to cope without employment income for long periods.
Group disability policies are not normally individually underwritten. This means that you won't fill out a health questionnaire or be subject to a medical examination and lab tests to get it. The insurer instead relies on an average estimate of risk based on the group characteristics and certain objective features of each individual, such as age and sex.
There are two kinds of group disability: short-term and long-term. Short-term generally covers the first thirteen to twenty-six weeks of disability, while long-term covers a period afterward, but normally no longer than to age sixty-five. Because today's long-term disability policies almost never cover you beyond retirement age, it's necessary to plan for retirement separately, including the likely need to make ongoing contributions to a retirement plan out of disability income.
New York State requires all employers to provide short-term disability coverage after thirty days of employment. Cash benefits are one half of your average paycheck or $170, whichever is lower. New Jersey has a State Short-Term Disability Program. The State of Connecticut does not require employers to provide this limited protection.
A good disability contract covers your being unable to work in your existing occupation. A weak contract covers only your being unable to work in any occupation. Notably, many group contracts limit the "own occupation" definition to the first two years of disability benefits-after that, good luck! You have a right to ask your human resources manager to give you a copy of your group contract for review.
You should also find out which company offers your group disability plan and how strong their credit rating is. (See the article on assessing the credit quality of insurance companies at our Website, www.GreenwichFinancial.com .) Leading short-term disability insurers, by market share, include UnumProvident, Hartford, Met Life and Prudential. Leading providers of long-term disability insurance include Unum-Provident, Hartford, Cigna, Met Life and Prudential. Be sure to check with your agent on claims paying reputation; UnumProvident's reliability was seriously questioned in a recent (11/17/2002) CBS "60 Minutes" feature.
Sometimes professional associations offer group disability insurance. If the premiums seem strikingly low, there is usually a catch, typically that the benefits decrease with age. It also is worthwhile to find out if the carrier has the option to drop the association's coverage.
My firm often works with companies to provide executives with individual portable disability policies. These policies are available at group pricing, at perhaps a 40% discount to what the executives could obtain on their own.
Employers are able to deduct group disability premium expenses, but any benefits received are taxable to the beneficiary. If you purchase optional disability insurance at work, you may be given the option to pay for it using pre-tax dollars through a Flex Spending Account. The disadvantage is that any disability benefits stemming from these pre-tax contributions also would be taxable. On the other hand, individuals often fall into a lower tax bracket while disabled. Benefits from an individual disability policy paid for with post-tax dollars are not taxable.
Under federal tax law, a business cannot deduct wages paid to a disabled employee. Many small businesses fail to anticipate or plan for this problem. A good workaround is to establish a qualified sick plan (QSSP) under Section 105 of the Internal Revenue Code. QSSP's, although qualified under ERISA like retirement plans, are allowed to favor certain employees or groups over others without jeopardizing the plan. Because QSSP's can engender large liabilities, both objectively and under GAAP accounting, they are normally fully funded by group disability insurance. If a QSSP covers more than 100 employees, it must be filed with the Department of Labor.
The important thing is to determine what benefits you actually have at work, as this is probably an important part of your financial security umbrella. If you are not sure how to interpret the documents you are given by your human resources department, or if you are advising a client on such matters, you might want to consult with a firm that specializes in employee benefits.
The Cost of Long-Term Care
To evaluate your need for long-term care insurance, you first need to get a handle on the costs. Long-term care quotations in this article represent typical pricing, not recommendations. Next week we will discuss Medicare and Medicaid as funding sources for long-term care, and the following week, private long-term care insurance.
The costs of long-term care are highest in the northeastern part of the United States, and particularly in Fairfield County and the New York metro area. For the Waveny Care Center, in New Canaan, the cost is $310 per day ($113,150 per year) for a semi-private room and $340 per day ($124,100 per year) for a private room. At the Nathaniel Witherell Home, which is owned by the Town of Greenwich, the cost (as of a scheduled March, 2004 increase) is $281 per day ($102,565 per year) semi-private and $320 per day ($116,800 per year) private. These nursing home charges include full room and board, but do not include the costs of prescriptions or physician's services. The annualized amounts illustrate how these daily rates add up.
There is a website, by the way, www.memberofthefamily.net , which reports on nursing homes with state survey violations.
Home care with a visiting nurse or health aide service is often a desirable alternative to nursing home care. Probably nearly everyone would prefer to be cared for at home if possible. Moreover, one risk with institutional care, no matter how immaculate, is the possibility of infection from other patients or caregivers. Greenwich Hospital Home Care (863-3883) gave the following quotations for at-home care: private nursing, $132.75 per visit; therapy, $158 per visit; care by a Certified Home Health Aide, $25 per hour, or for blocks of four hours or more, $20 per hour. If you should need live-in care by a Certified Home Health Aide, a typical deal is to charge for about 10 hours per day at $20 per hour, the assumption being that the caregiver does not have to get up more that once or twice per night to attend to the patient. You may also contact a nurse's registry, which is basically a referral business whose member/owners are nurses. The Greenwich Nurse's Registry (869-4050) provides three levels of assistance, generally for a minimum of four hours of service per day (but with exceptions): Certified Nurse Aide, $16-$17 per hour; Licensed Practical Nurses, around $35 per hour; Registered Nurses, up to $50 per hour, depending on qualifications. Patient Care (629-4780), in Greenwich, specializes in providing Certified Home Health Aides and can also provide Certified Nurse Aides. The cost is about $21 per hour, or $200 per day, with no set minimum number of hours; Patient Care emphasizes that they have two Registered Nurses on duty all the time, for supervisory purposes. Patient Care handles only private pay and private health insurance cases. A companion company, Priority Care (203-840-8312), in Norwalk (among other places) handles Medicare and Medicaid cases.
For some, staying in Greenwich, or at least in the New York metropolitan area, is very important. Family, friends, place of worship, social clubs, and trusted medical providers may be nearby. These relationships can be of critical importance to wellness. For others, and particularly for those facing economic pressure or uncertainty, relocation to a less expensive area may save hardship or preserve more estate value to pass on to children or charity. Long-term care nursing facilities may cost 70% or less of the rates quoted above in certain parts of Pennsylvania, Western New York or Maine, for example, or farther afield, in some parts of the Midwest and South.
A cost-saving and desirable alternative to nursing homes may be an assisted living or adult care facility. These facilities typically require that patients can at least get dressed and eat with some assistance. Dementia cases may be accepted, but not if at the "wandering" stage; incontinence may also be acceptable. For example, the Bristol Home, in Buffalo, NY (a venerable establishment in an older urban neighborhood), which is non-profit and enjoys an endowment, offers private rooms for $62 (without bath) to $67 (with private bath) per day. For more ambulatory and cognizant clients, assisted living facilities may offer apartments or townhouses adjacent to a center offering meals, recreation and full-time nursing staff.
Medicare, Medicaid and Long-Term Care
The system of government support for long-term nursing care in this country looks first to your private insurance. The safety net providing for those who lack any private long-term care insurance, or enough of it, falls into two categories: Medicare and Medicaid.
Medicare is funded by part of the social security tax, which is contributed by both employers and employees. There are now over 41.7 million beneficiaries. Enacted in 1965, Medicare is one of those pay as you go programs that has never been put on a sound actuarial footing. You are eligible for Medicare: if you are at least 65 years of age, and you or your spouse worked for at least ten years under Medicare covered employment; if you are younger than 65, but you have received Social Security Disability benefits for at least two years; or if you have End Stage Renal Disease (a disease Congress has favored). You may also qualify if you did not meet covered employment requirements but pay a monthly premium under Part A. For eligibility, see www.medicare.gov .
The Medicare Part A deductible of $876 is the beneficiary's only cost for up to sixty days of Medicare-covered inpatient hospital care. However, for extended Medicare-covered hospital stays, beneficiaries must pay an additional $219 per day for days 61 through 90 in 2004, and $438 per day for hospital stays beyond the 90th day in a benefit period. From: www.hhs.gov . Medicare Part B covers physicians' and surgeons' expenses, with many exclusions (such as outpatient drugs) and deductibles. Although there is a monthly premium for Part B (which may be subsidized), it's a great deal, and there is 95% elective participation. Medicare is preferably supplemented by private Medicare Supplemental Insurance ("Medigap"), standardized under ten programs of increasing inclusiveness called A through J. See www.kff.org (the Kaiser Family Foundation).
Unfortunately, Medicare's help is based on a medical intervention model, not long-term care. Potential recipients must first be hospitalized for at least three days (this requirement no doubt leads to some needless hospitalizations) and then enter a Medicare approved nursing facility within thirty days. At a maximum , Medicare will then pay in full for the first twenty days and will pay minus a $109.50 per day deductible for up to 80 more days. Medicare may also pay for some home health care (including durable medical equipment), hospice care and blood. The home benefit is unlimited in length, but must be approved by a physician, subject to oversight and renewal every sixty days. Patients under home care typically may be able to receive a total of four to ten hours a week total of subsidized professional care, although the nominal maximum is 35 hours. I am told that Medicare assistance is frequently cut short when the aid is no longer deemed medically necessary, although the patient may well have significant continuing needs for nursing and custodial care.
Medicaid is a program funded by the federal government together with the states to meet the health needs of indigents. It will only pay nursing home costs if the resident has almost no assets or income. Moreover, assets and income of married couples must be declared jointly. The cost of nursing care will deplete most estates quickly. Until you have spent down virtually to nothing, Medicaid will not pay. Moreover, even though a recipient or recipient couple may be allowed to keep a house and one car, Medicaid will have a first claim against the estate of the recipient or of the surviving spouse for Medicaid expenses. On the other hand, Medicaid pays all costs of residence in eligible facilities, and it also pays all chargeable medical costs from approved providers.
The Kennedy-Katzenbaum Act (1966) made it a crime to transfer assets with the intention of defrauding Medicaid. However, if carried out in a proper and timely fashion, there are legally sound ways to transfer assets into trust to meet future needs of recipients. These include Medicaid Qualifying Trusts. There are also Special Needs Trusts, worth thinking about if you are not extremely wealthy and you have a child with special health care or custodial needs. For wealthier families, different kinds of trust structures make sense to lessen or eliminate the bite of estate taxes, to bypass probate, and to lessen the risk that litigious plaintiffs may attach assets.
Long-Term Care Insurance
Given the limitations of the Medicare/Medicaid system, as discussed last week, long-term care is one of the most under-insured of risks.
If you do need coverage, how much is enough? A sufficient amount in the Northeastern metro region is probably about $325 to $350 per day. A smaller amount, say half, could cover the risk of needing limited care at home care or residency in an assisted living facility, as opposing to a nursing home.
It makes sense to take out long-term care insurance in your fifties, rather than waiting longer. Premium costs increase about 30% between fifty and sixty, and they can double between sixty and seventy. Also, if you wait until you have a serious health problem, such as a heart attack, stroke, metastatic cancer, advanced diabetes, or the beginning of Alzheimer's disease, you won't be insurable.
Many people seek long-term care to protect independence and retirement income. Desire to conserve assets to pass on to children can also be a factor. The financial advisor must explore the family dynamic. Is there a living spouse able to provide most care? Are children nearby and likely to be helpful? Long-term care is a particular issue for women. Three out of four elderly residents of nursing homes are women, and women who reach the age of 65 have a better than 50% chance of needing extended care before they die. (Source: Insurance Marketplace Standards Association, "Long-Term Care Insurance" (2003)).
Leading providers of long-term care insurance include John Hancock, General Electric Capital Insurance, Prudential, MetLife and Unum. Unum is particularly known in the group insurance market, but its claims paying reliability has been questioned.
An important contract feature is what triggers benefits. A prevalent test is inability without substantial assistance to perform at least two Activities of Daily Living (ADL), including ambulating, eating, bathing, dressing, continence, toileting and transferring (getting in and out of bed). One of the earliest signs of disability from aging is often impairment of cognitive abilities. The most favorable policies will include consideration of such cognitive changes. Avoid any medical models based on required prior hospitalization. A second feature is who determines impairment. It is desirable that this be determined by your own physician or by a third party independent physician. However, in most policies, the insurer reserves the right to demand an examination by its appointed doctor. A third feature is whether payment is by reimbursement (submission of qualifying expenses) or by indemnity (a flat payment per day if you qualify). Indemnity is better but also typically about 20% more costly. Indemnity may make sense if the recipient will lack help in submitting claims. Fourth, make sure the policy covers care at home, not just in a nursing facility. Some policies will also reimburse for certain equipment necessary to set up home care. Good policies also cover a blend of forms of care, such as adult day care and at home custodial assistance. A fifth feature with monetary value is "waiver of premium," meaning you don't have to make premium payments while you are receiving benefits.
Most long-term care policies include exceptions for drug addiction and alcoholism. Insurance companies won't protect you against such risks. I looked at one contract that excluded participation in a "felony, riot or insurrection," so take it easy.
There are several ways to lower the premiums you will pay:
- You can lengthen the period of "elimination," an initial uncovered interval. Some policies pay from day one, but all cost less with longer elimination periods; the option usually ranges between one to six months. Protect yourself against financial catastrophe , not inconvenience. But make sure you will have enough liquid assets in store to pay for such an uncovered period (figure up to $10,000 per uncovered month).
- You can decline inflation protection, though I don't recommend it. Inflation protection may be based on the CPI index, on a set rate such as 5% increase (simple or, preferably, compound), or on a doubling period. Unfortunately, none of these scales may keep up with the high rate of inflation in nursing home costs.
- You can shorten the benefit period; instead of life coverage, you may choose a limit of, say, three years. Nationally, the average stay in a nursing home is 2.8 years.
- You can consider insuring for a lower daily benefit, as some protection is better than none.
The federal Insurance Portability and Accountability Act (1996) specified that within certain limits, premiums paid for "qualified" long-term care insurance plans can be itemized as "unreimbursed medical expenses." An employer generally will be able to deduct the cost of providing long-term care insurance to employees, even if the benefit is limited to executives. Like health insurance, benefits paid by "tax-qualified" long-term care insurance are not taxable as income-an important advantage. Indemnity plans currently may be tax-qualified up to a maximum of $230 per day, inflation indexed.
Although there is a great need for group long-term care, most group plans are deficient. In particular, most do not offer an inflation clause. Where the insurance is not underwritten (health exam, tests, questionnaire), it tends to be a bad economic deal for healthy workers--but it can be a good deal and the only one available for those unwell people at high risk of needing long-term care.
Long-term care is regulated by the states. The agent who can offer life insurance is usually also licensed in health and disability, though it is most helpful to find someone with specialized expertise in long-term care. It pays to shop around; don't just take the insurer that comes knocking at your door or hooks up with your professional association.
Health Insurance
Group health insurance comes in three major types. The old-fashioned type, called in its robust form Major Medical, reimburses individuals or their doctors for private medical bills. The rate of repayment is generally 80% for the first $5,000 of family medical expense in a given year, and 100% beyond $5,000. Owing to the cost to the employers, Major Medical is almost extinct. The two chief alternatives are HMO's (Health Maintenance Organizations) and PPO's (Preferred Provider Organizations). In both HMO's and PPO's, there is a preferred directory of physicians in your region. If you use the services within this network, your doctors' bills are covered, minus a co-pay (usually ranging from $5 to $25 per visit). HMO's usually require that you go to a "primary physician" first to be referred to a specialist. A PPO, by contrast, allows certain reimbursements "out of network," normally with a percentage deductible (such as 20% of fee). With all group health plans, there is a required open enrollment period for employees annually. [In a "Point of Service" plan, you can go out of network like a PPO, but you have a primary physician as with an HMO. I find the channeling system through a primary physician to be a nuisance.]
Often, when employers offer a choice between an HMO or PPO, the PPO has an added charge. It is worth paying for the PPO. In the event that you face critical illness, you will want to consult with the very best specialists available, who may well be out of network.
In some cases, a group plan may offer integrated dental, orthodontic and vision benefits together with health.
Most HMO and PPO programs offer a pharmacy card benefit. A "10/20/30" card requires a co-pay of $10 for generic drugs, $20 for brand names and $30 for "exotics." The plan "formulary" defines which drugs fall under each category.
As to group health plans, states such as New York and New Jersey operate under a "community rating" regime. This means that for groups of up to 50 covered employees, there is equivalence of pricing, regardless of characteristics such as average age, sex, prior conditions, claim experience or hazards. Such a scheme obviously benefits riskier groups at the expense of others. However, above 50 employees, companies nevertheless are allowed to seek preferred rates based on superior risk characteristics. In Connecticut, insurers are permitted to underwrite all groups and individuals for a variety of statistical risk factors, which often leads to lower rates.
Under the federal law called COBRA (1986), you have a right to continue health insurance for an interval after you leave a job, but your former employer need not subsidize the rate. The Health Insurance Portability and Accountability Act (HIPPA) (1996) defines certain conditions under which individuals who were formerly covered by a group health plan have a right to purchase individual health insurance, which in some cases may be purchased through their state's high risk pool. To be eligible, you must have had at least 18 months of creditable group health coverage, with no breaks in coverage of 63 days or more, you must have accepted any COBRA benefits offered and used them up, and you must not have alternative coverage from a private health plan, Medicare or Medicaid. So if you want to be protected by HIPPA, don't let 63 days or more elapse after your COBRA coverage expires! HIPPA also limits the length of application of exclusions for prior medical conditions by group health plans.
In all states, insurers must post their plans and rates with the state's insurance commissioner. Group insurance brokers can only offer these posted rates; there is no discounting. It's also worth noting that you will pay the same amount whether you use a group insurance broker or go directly to an insurance company. Knowledgeable brokers may add value by advising employers on such matters as overall plan design, outsourcing of claims, total third party administration, cafeteria plan options, and other matters. Self-insurance, with an insurance company or other third party processing the claims, is called the Administrative Services Only (ASO) model. Depending on a host of demographic factors, groups as small as 50 to 75 employees may want to consider the ASO model; be sure to get expert guidance. It's certainly prudent for a small business employing the ASO model to obtain a stop-loss reinsurance policy above certain loss limits per occurrence and overall.
In the Tri-state region, insurance companies active in health insurance include United Health, Oxford Health Plans, Anthem (in Connecticut), Horizon Blue Cross Blue Shield (NJ & NY), WellChoice (NY & NJ), Aetna, Cigna, GHI (NYC), HIP, and HealthNet (formerly Guardian).
Health insurance for individuals is pricey. In Connecticut, a healthy individual may pay $450 per month, and a family about $1,200, with a typical co-pay of about $25 per doctor visit. Out of network, expect a deductible of at least $1,000 and co-pay of 30% of any bills, with both annual and lifetime maximums. Group rates, for groups as small as two, are much better, but there must be a verifiable employment relationship. Insurance companies are increasingly steering away from coverage for affinity groups and professional associations, owing to the risk of adverse selection of unhealthy participants, and the insurers reserve the right to cancel existing contracts based on poor claims experience.
The New Medicare Drug Benefit
The Medicare Drug Benefit idea has a long and tortured history. With the recent enactment of the Medicare Act of 2003, we have a flawed, gap-toothed realization of this long-sought dream. [See Medicare Act, 68 Fed. Reg. 69840 (Dec. 15, 2003).]
The new law unfolds in two stages. In the first stage, which is transitional, all Medicare beneficiaries under Part A or B (about 42 million seniors and disabled people) will have the right to purchase drug discounts cards, which will provide a discount on prescriptions of about 10% to 25%. These cards will cost a maximum of $30 per person per year and should be available (from a host of competing private companies) starting in April of this year. At www.medicare.gov , you will soon find comparisons of the competing plans, their drug "formularies," and the maximum costs posted under each plan for particular drugs sold in your area. In addition, for those with income below $12,390 ($16,720 for couples) in 2004, the enrollment fee will be paid by the government, and the card will provide up to $600 in federally subsidized prescription assistance.
Beginning in January of 2006, Medicare Part D will take effect; Part A or B beneficiaries will have three options:
1. To stay in traditional Medicare and not sign up for the drug benefit
2. To stay in traditional Medicare and also enroll in a stand-alone Prescription Drug Plan (PDP)
3. To sign up for a Medicare Advantage Plan (MA-PD).
Failure to enroll when initially eligible could result in substantial penalties if you enroll later, based on an actuarial calculation of uncovered back months; it's unclear if pre-existing conditions will be penalized. The initial enrollment period will be from November 15 th 2005 to May 15, 2006. There will be an annual option to change plans; this enrollment period will run from November 15 th to December 31 st .
The annual premium for the new drug benefit under the second option is expected to be $420 in 2006. There will be an annual deductible amount of $250. After you reach the deductible, the plan will cover 75% of drug costs up to $2,250. After that point, enrollees pay all costs up to $3,600. This uncovered interval between $2,250 and $3,600 is the notorious "gap." After $3,600--apparently considered a catastrophic expense under the legislation--the plan pays 95% of the cost of all prescriptions.
Since enrollment in a PDP will cost $420, and there is a $250 deductible, after which there is a 25% co-pay, the breakeven point is $810 in otherwise uncovered prescription expenses per year, or $67.50 per month (all numbers given are for 2006).
There is a handy Medicare Drug Care calculator at http://www.kaisernetwork.org/static/kncalc.cfm (the Kaiser Family Foundation). You input one number, which is your expected annual drug cost. The calculator then determines: your out of pocket costs under the PDP; your costs including the $420 annual premium; and the percentage costs paid out of pocket (not including the annual premium).
The third option, MA-PD, will have a varying cost. The MA-PD is more likely than the PDP to offer supplementary benefits. See www.tn-elderlaw.com/telb/040106.html . Because of the complexity of the patchwork solution Congress has enacted, the $250 deductible, the co-pays, and the yawning "gap," the private insurers will enjoy an opportunity here. Those with existing "Medigap" insurance with a prescription drug benefit will be guaranteed issuance of Medigap A,B,C or F; their existing plans cannot be renewed. Under the Act, the federal government will subsidize employers and union plans that already provide a retiree drug benefit to encourage them to continue it.
My firm will be recommending to its Medicare eligible clients to enroll in either a PDP or MA-PD plan in order to receive the valuable catastrophic coverage.
The Act envisions the development of competing private Medicare plans, starting in 2010, some structured as traditional fee for service plans and others as HMO's. The Department of Health and Human Services needs to work this out in regulations; the scheme could bog down in a variety of ways.
The Act changed other aspects of Medicare. New Medicare beneficiaries will be eligible for a voluntary free physical. All participants can seek free screening for cardiovascular disease and some at-risk participants can receive free diabetes screening. There is also a new program intended to help those with chronic illnesses manage their diseases.
In this presidential election year, both political parties are touting the new Medicare drug benefit as an important advance.
Assessing the Credit Quality of Insurance Companies
When you purchase insurance, you are seeking to transfer a risk you face to other people in return for your payment of cash premiums. To feel protected against risk, you want to be assured that your insurer will pay your valid claims in the future. The likeliness that a company will meet its liabilities is called credit quality.
There are two aspects to payment of claims. The first is willingness to pay, the second, ability to pay. Willingness to pay is particularly relevant to an insurance policy where there is some room for argument about whether there is a valid claim and for how much. For example, if you suffer a collision, how much will your insurer pay to repair or replace your car, and how promptly? In personal insurance, analogous problems come up with disability: are you fully disabled, partially, or not all? In life insurance, there isn't much dispute about whether the insured is dead or not. (Although suicide as cause of death can be an issue, when barred from recovery under contract, usually for up to two years after inception; missing person status can be another issue.) The ability to pay is the key question.
The longer an insurance policy is likely to stay in force, the longer a view the policyholder must take of an insurer's credit quality. In a permanent life policy insuring a woman now 30 years old, the event insured against, death, may not happen for 50 or more years. It's hard to predict how a company will be doing in five years, let alone fifty. Nevertheless, default by life insurance companies on the claims of policyholders is relatively rare, and there are numerous published measures of insurance company credit quality available.
The insurance business is regulated by the individual states. Each state has a Commissioner of Insurance. One crucial goal of state regulation is to verify the ability of insurance companies operating in each state to pay claims now and in the future. The key credit measure the states concern themselves with is "regulatory surplus," which is the stated excess of assets over liabilities. For a variety of reasons, a company may show a significant regulatory surplus even though its solvency is questionable. A very good resource for state regulation of insurance companies is the Website of the National Association of Insurance Commissioners, www.NAIC.org ; with their Consumer Information Service, you can check on the licenses, consumer complaints and financial status of each insurance company operating in your state. The NAIC's Insurance Regulatory Information System (IRIS) provides analysis that assists the commissioners in detecting insurance companies that may face financial problems. When an insurance company messes up, and goes into receivership, whether for rehabilitation or liquidation, the claims of insurance policyholders (aside from reinsurance) rank higher in priority than those of general creditors or shareholders, and usually are not impaired. Also, the different states have "guaranty funds" that protect claims by policyholders in the event of insolvency up to certain maximum amounts. In egregious cases, though, such as that of Executive Life Insurance and its aggressive junk bond strategy, some policyholders have had their claims impaired.
Insurance companies, like other large borrowers, pay fees to have their obligations rated by private agencies. Unfortunately, each agency has its own rating scale. With Standard & Poor's (S&P)( www.standardandpoors.com ), AAA is the highest rating for long-term obligations, then AA, A, BBB, BB, B, CCC, CC, C, and D (default); there are plus and minus gradations. Any rating of BBB- or above is called "investment grade" for bond investors. I recommend you consider companies with long-term ratings no lower than A equivalent for term life and AA equivalent for permanent life. Moody's ( www.moodys.com ; requires registration) three highest ratings are Aaa, Aa, and A, with descending gradations of 1,2,3. The four highest ratings of insurance company "financial strength" at A.M. Best ( www.ambest.com ), which specializes in insurance, are A++, A+ ,A and A-. Finally, Fitch ( www.fitchratings.com ) has an Insurer Financial Strength rating scaled like S&P. Generally, you pay more premium to be insured by a higher rated company. When you purchase insurance, your agent ought to apprise you of the credit ratings of your prospective insurer.
Insurance and Financial Planning
In concluding this primer for families on personal insurance and risk protection, it is important to note that the need for insurance is inseparable from financial status expected at the time an insurable event occurs. Some families, for example, may need large amounts of term insurance while the parents are young and little wealth has accumulated yet. Later, the same families may be able to fall back on smaller amounts of permanent life insurance that will meet the needs of liquidity and estate taxes at time of death. Then again, wealthier individuals may take out quite large permanent life insurance policies primarily to gain tax and investment benefits. For some families, self-insurance against the risk of needing full-time nursing care may be affordable, while for others this would present a catastrophic risk. Similar considerations affect disability coverage. On the other hand, because of the potentially stratospheric cost of modern medical care, virtually everyone seeks health insurance coverage regardless of wealth or income.
It is desirable therefore to look at risk and insurance in the light of a comprehensive financial plan, integrating portfolio management, tax planning, estate planning, education planning (if any is needed), and planning for charitable and other goals. Such a plan necessarily must be highly customized to your family's financial situation, economic opportunities and responsibilities, and willingness and ability to take risk. Viewed in this broader context, it is possible to make wiser decisions about risk insurance. There will always be tradeoffs between risks and rewards, and between competing or overlapping risks, but with this kind of planning in place, the tradeoffs can be made on a more informed basis and with a better understanding of their likely impact on the family.
Our firm offers a comprehensive risk analysis assessment with detailed cash flow projections that may be of help to you in planning for the well-being of your family and its financial assets. We would be happy to provide a free consultation to explain how it could help protect you objectively while also giving valuable peace of mind.
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