The road to retirement just got rockier

Insurance companies finally are accepting that interest rates are not likely to increase substantially in the foreseeable future and are pushing up the costs of some key forms of insurance — long-term care coverage in particular — which will cause problems for many retirees and those nearing retirement.

They will have to make decisions about what to do about LTC policies — whether to keep them if they have them, or keep them but reduce the benefits to keep the rising costs down, or whether or not to buy them if they don’t have them. Financial advisers can help them make those difficult decisions.

The insurers rely on the interest they earn on the premiums customers pay on their policies to ultimately pay the promised benefits and make a profit, but that has become increasingly difficult in the past seven years as the Federal Reserve engineered low rates to try to stimulate the economy.

This has particularly affected long-term care and universal life policies.

NO MARGIN FOR PROFIT

With LTC policies, insurance companies expected to have a significant number of years to accumulate reserves against the costs of long-term care by investing the premiums at interest rates sufficient to provide a margin for profit. But the historically low rates over such a long period have made that almost impossible.

As a result, many insurance companies have stopped selling long-term care insurance. Others have increased premiums not only for new policies but also for existing policies, or have reduced benefits.

One John Hancock Insurance long-term care policyholder, who bought the coverage in 2002 when he was 59, had his annual premium increased by 77% in 2015 to $3,061, from $1,729 in 2014. He was given the choice of avoiding the premium increase by reducing the future annual inflation rate on the policy benefits from 5% simple to 3.4% simple.

Alternatively, he could cut the rate increase in half by reducing the inflation rate to 4.1% simple. His wife’s policy was increased by a similar percentage so that their LTC coverage now costs more than $6,000 a year.

However, the policy would pay a long-term care benefit of more than $83,000 a year after a six-month waiting period, so the couple decided to continue the policy, though it was not an easy decision. It is likely that this was not the last premium increase for the policies, especially if the Federal Reserve delays any expected rate increases or slows the pace of such increases.

Many long-term policy holders will continue to face the question of whether the policies are worth the cost and are affordable, and financial advisers have a vital role in these decisions.

Already many people have decided that long-term care policies are now costly luxuries they can do without. Sales of such policies fell to 131,000 in 2014 from more than 350,000 in 2004.

The decision is not a simple one. It depends first of all on an individual’s financial situation. Can he or she afford a long-term care policy that costs more than $3,000 a year, the cost of which might go up when the individual is living on retirement income?

IT’S COMPLICATED

Second, is the individual’s health, and family health history, such that he or she might spend a significant period needing nursing home or home health care? Does the individual’s financial situation make it likely he or she could afford such care without a long-term care policy?

The issue has become more complicated in light of new research by Boston College’s Center for Retirement Research showing that while the lifetime risk of needing nursing home care was 27% for men 65 or older and 44% for women the same age, the average nursing-home stay was only 10 months for men and 16 months for women.

In addition, the research found that half of all men’s nursing home stays, and 36% of women’s, lasted less than three months. Medicare will pay for up to 100 days of nursing home care following hospitalizations.

This makes for a complicated decision that should not be based on “gut feel,” but on rigorous analysis.

Many other individuals are being hit by low interest rates through universal-life policies. They had hoped the buildup inside the policies during their working years would pay the premiums when they retired. But the low interest credited to the policies by insurance companies in recent years means the inside buildup has not been enough to pay the premiums, leaving them to pay out of their retirement income.

Advisers should be able to guide clients who are affected through both of these costly problems.