According to conventional financial planning wisdom, high-net-worth individuals should self-insure for long-term care expenses.
You may be surprised to hear this from Commonwealth's Insurance department, but there's some truth to the idea. That's right: For select clients, it makes sense to self-insure for long-term care. But it's certainly not right for every high-net-worth client.
Helping clients navigate the many questions and challenges surrounding long-term care with empathy is one of the most valuable services you can offer as a financial advisor. To determine if self-insurance is the right choice for a particular client, I suggest taking the following four steps.
1) Check Your Assumptions
Sometimes, the decision to self-insure is based on faulty assumptions. For example, advisors may assume that every client with $1 million in assets (or $2 million, or another arbitrary number) should self-insure for long-term care without discussing the issue with those clients. Or clients may assume that they have plenty of assets to self-insure, without understanding the cost of a lengthy care event. These assumptions are risky, potentially setting your clients up for losses that can't be recouped.
2) Look at Income, Not Net Worth
Although it might seem intuitive to use net worth as a gauge for a client's ability to self-insure, income is a more accurate indicator. People use income to pay for long-term care expenses, so determining whether or not to self-insure should be a question of liquidity, not solvency.
Advisors may rationalize that clients can sell assets from their portfolios to pay for long-term care, but liquidating assets can be quite expensive. Just as important, it can jeopardize clients' overall financial strategies.
Long-term care expenses are paid from household income. As the income is drained, clients reallocate liquid assets—such as brokerage and retirement accounts—to pay for their monthly needs. Of course, these transactions have consequences. Think of the tax ramifications and penalties for liquidating 401(k)s, IRAs, stocks, and bonds. Plus, without these assets to drive it, your clients' future retirement income also takes a hit.
Next, consider the challenges of converting illiquid assets, such as real estate, into liquid assets. It may not be possible for clients to liquidate these assets, or they may take a substantial loss on the sale or face tax consequences. Imagine how difficult—and stressful—it may be for a client to sell a vacation home, for instance, in order to finance unexpected health care costs.
3) Determine How Much Income Is Necessary
Costs for long-term care vary depending on the geographic area and the level of care needed. In Massachusetts, for example, the average monthly nursing home bill is $8,700. It's safe to assume that some clients' care may total more than $10,000 per month.
Let's say that a client, Bob, has a monthly retirement income of $16,000. This income supports his and his spouse's lifestyle, including their home, activities with family and grandchildren, hobbies, and charities. If Bob needs long-term care services at a cost of $10,000 per month, only $6,000 remains to support the spouse's lifestyle.
Can Bob spend an additional $10,000 per month—perhaps indefinitely—and still meet all of his other financial obligations?
In Bob's case, the answer is "no." He should consider other sources of long-term care funding, such as a long-term care insurance policy, to cover part of the future costs.
4) Consider a Range of Solutions for High-Net-Worth Clients
After evaluating how it could impact their income, lifestyle, and obligations, some of your high-net-worth clients may decide that self-insuring isn't for them. If this is the case, consider the following solutions.
Traditional long-term care insurance (LTCI). Traditional LTCI can be structured to take all of the risk off the table, with lifetime coverage, or to eliminate some of the risk, with a five- or six-year plan, for example.
Life insurance policy with a long-term care rider. For clients who want to self-insure for long-term care but don't want to reposition a large sum of assets, life insurance may be a good alternative. A life insurance policy allows for annual premiums rather than single premiums, and, because the policy is underwritten, the death benefits tend to exceed those from linked-benefit products.
Linked-benefit products. For the client who is concerned about paying premiums and then never needing long-term care, linked-benefit products, which combine the features of LTCI and universal life insurance, may be especially attractive. By repositioning an existing asset, the client can leverage that money for long-term care benefits, a death benefit if long-term care is never needed, or both. The policyholder maintains control of the assets, freeing up retirement assets for other uses.
Let's consider another fictitious example. Nicole is a high-net-worth client. She's 65 and married, and she previously declined LTCI because she feels that she has enough money to self-insure—$200,000 in CDs that she calls her "emergency long-term care fund." You know, of course, that if she ever needs long-term care, this $200,000 won't go far, and she may have to make up the shortfall with other assets.
If Nicole repositions $100,000 to purchase a linked-benefit policy, she could gain:
- A death benefit of $180,000 (income tax-free)
- A total long-term care fund of $540,000 (leveraging her $100,000 more than fivefold!)
- A monthly long-term care benefit of $7,500 (which would last for a minimum of 72 months)
- A residual death benefit of $18,000 if she uses her entire long-term care fund
Care coordinators. Many clients who need care prefer to stay in their homes but may not understand the challenges of setting up home care. Both traditional LTCI and linked-benefit insurance provide policyholders with care coordinators who can help facilitate this transition. In effect, care coordinators offer a very high-level concierge service, which can make a difficult time a little less stressful. It's a valuable benefit to consider when deciding whether to self-insure.
Self-Insurance Isn't for All High-Net-Worth Clients
Some of your high-net-worth clients may be able to self-insure for long-term care expenses, and some may not. Even clients who are in a position to self-insure may choose to transfer the risk when they see the leverage they can gain with insurance.
Remember: in theory, LTCI protects assets, but in practice, it provides income to pay for care, allowing clients' portfolios to continue supporting their lifestyle and obligations—and keeping their retirement plans on track. Some people call LTCI liquidity insurance. I call it part of sound financial planning.
Have you evaluated self-insurance for any of your high-net-worth clients? Please share your experience by commenting below.