Inflation options: Growth, but at what cost?
By Julie Gelbwaks Gewirtz
Gelbwaks Executive Marketing Corp.
Throughout the last two decades, I've witnessed many different schools of thought when it comes to inflation in a long term care insurance (LTCI) policy. In the early years of selling, the average buyers were significantly older than they are today. Because of that, large numbers of policies were sold with no inflation at all. But over the past 10 years, I have seen significant creativity from carriers in the area of inflation choices, as well as a significant increase in buyers who purchase some form of inflation. My plan is not to debate what is right or wrong when selling LTCi to a consumer or at what age a person should purchase a certain type of inflation, it is to discuss in detail some of the choices that are being used throughout the industry today and exactly how they work.
Let's begin with the no inflation/inflation choice. This would be where the consumer purchases as high of a daily benefit as he or she can afford, and does not buy any type of automatic increasing benefit rider. Producers sometimes leave this out of the discussion and don't even consider it to be an "inflation" choice. But, truly it is -- if the benefit is large enough. Many times, this approach means substantially less premium, but does not qualify the under age76 market for a partnership benefit.
We then have the Guarantee Purchase Option (GPO), at times referred to as a Future Purchase Option (FPO), which can be called a periodic option or in some policies it is a policyholder offer that is linked to the Consumer Price Index (CPI). Just based on the variety of names used for this type of inflation, you can guess that there are a variety of definitions for how these work, depending on the carrier. Generally speaking though, at time of purchase, the consumer pays either a minor additional premium (approximately 2 percent to 6 percent more), or there is no extra cost at all to have this "guaranteed offer" made available to them. Then, once the policy is in force, every one to three years (depending on the product), they get an opportunity to buy more coverage by increasing the daily/monthly benefit limit in the policy.
With a GPO, there is usually no additional underwriting, but the cost involved is almost always linked to the new age of the policyholder at the time the offer is made. This can become very costly over time as the buyer ages. Some of these offers are for a set amount, such as 5 percent, 10 percent or 15 percent. Others are an amount that is connected to whatever the CPI was that year. Many of the contracts will discontinue the guaranteed offer of insurability if it is not accepted by the insured two times in a row. In most states, this will also not qualify the under age 76 market for a partnership benefit. Please remember though, that partnership is not for everyone. So, don't automatically discount certain types of inflation options for that reason alone.
Next, we have 5 percent simple inflation. This is an extremely common rider that has been available for many years and is found as an available option in the bulk of contracts for sale today. It typically adds 40 percent to 60 percent to the premium cost. Simple inflation automatically increases the original daily benefit by 5 percent every year. This will double the daily benefit in 19 ½ years. There is no cost along the way, no new age calculations, and no offers. Simple is simple. It just begins increasing that benefit when the policy is purchased and continues throughout the life of the policy. And with most products, it will even continue increasing at claim time. This option will qualify purchasers aged 61 years and older for partnership benefits.
One of the newer and more recently embraced entrants into the marketplace is 3 percent compound inflation. It is generally in the same price range as 5 percent simple, but for the younger folks, it can make a more compelling argument. The reason for this is because the compounding effect is more prevalent the longer you live. Three percent compound inflation increases the daily benefit amount by 3 percent annually on a compounded basis. So it's 3 percent of the new number each year (as opposed to 5 percent of the original number, as stated earlier with 5 percent simple inflation). This is really beginning to pick up speed in the LTCI world because of the fact that it is similarly priced to 5 percent simple and inflates the benefit in a very similar way, but qualifies people in most states for partnership at all ages, whereas simple does not. By the way, there are a few carriers out there also offering a 4 percent compound inflation rider as well, but they're very few and far between.
We are now seeing another very innovative type of compounded inflation rider taking hold. This is typically called an automatic CPI compounding (or just auto CPI). With this option, which is also many times priced similarly to 5 percent simple, the automatic increases in benefit are linked to the CPI. So, unlike the GPO that was mentioned earlier, this is a rider that will automatically inflate (on a compounded basis) the daily benefit each year based on the CPI number. There are no offers here. The payment of additional premium is up front when the policy is purchased, and continues to remain stable (just as most other simple and compound choices would) throughout the life of the policy.
An example of how this auto CPI works would be the following: This year, the CPI is at 3 percent, so my policy compounds at 3 percent. Next year, the CPI is at 10 percent and my policy compounds at 10 percent. With certain products, there is no limit on how high this can go and, if it ever goes below zero, the benefit will not be reduced. It will stay the same and then catch up in future years. The Auto CPI will also work like 3 percent compound inflation in that it will qualify people in most states for partnership at all ages, whereas simple does not.
And then we have 5 percent compound inflation, an oldie but goodie! As you might have assumed, this is the most costly inflation rider of them all. It can more than double the premium, but it does add a substantial benefit to the policy. Five percent compound inflation adds 5 percent compounded annually so the daily benefit doubles in 14 ½ years. If a 50 year old is trying to decide whether they should buy 5 percent simple or 5 percent compound inflation, they need to consider whether they are more concerned with the first set of 20 years (from 50 to 70), or the second set of 20 years (from 70 to 90). If it is the first set, then 5 percent simple is the way to go, but if it is the second, then 5 percent compound is the right buy, in my opinion. This is because, in the second set of 20 years, there is a dramatic difference in where the daily benefit will lay. In that example, the typical 50 year old would most likely say "the second set" and that is what the guidelines above are based upon. This type of inflation will qualify all ages (even in the original four states) for partnership. No worries there. But, the reason why carriers are coming up with so many new ways of compounding is generally because of the fact that the cost of a policy with 5 percent compound inflation can simply be overbearing. One more cost effective way to buy a compound inflation rider in this new, innovative environment is to buy it with a cap. This means, that at 14 ½ years, when the benefit has doubled, the policy stops inflating.
So many choices to consider, but remember, your client is depending on you for the best one. You're the advisor, so if you are unsure, find an LTCI specialist with whom to partner up.
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