Low and medium income households at greater risk
by Vickie Bajtelsmit and Anna RappaportThe following extract from the report report ‘Managing the Impact of Long-Term Care Needs and Expense on Retirement Security Monograph’ is reprinted with permission from the Society of Actuaries The entire paper can be viewed here.
Retiree financial well-being depends on many factors, some of which are within an individual’s
control and others that are not. Decisions related to lifetime savings and wealth accumulation,
retirement timing, benefit claiming, and income sources can positively (or negatively) influence
retirement outcomes. In contrast, systemic and personal shocks due to unexpected inflation,
adverse investment performance, longevity risk, health and long-term care (LTC) costs are more
difficult to plan for. In general, financial strategies such as increased wealth accumulation and/or
the purchase of insurance will be necessary to reduce or hedge these low-frequency, highseverity
risks. Without advance planning for these risks, the probability of a financially secure
retirement is quite low.
In this paper, we focus specifically on LTC risk, which we define as the household’s risk of
having insufficient funds to cover the cost of LTC in retirement, including health-related costs,
support and services. In addition to describing this risk in more detail and discussing the pros and
cons of different financial strategies for managing the risk, we also provide simulated estimates
of the effect of LTC risk on wealth needed to support a successful retirement based on our own
research and that of others.
Our simulation model forecasts post-retirement cash flow needs stochastically, incorporating a
broad range of post-retirement risks. This methodology allows us to evaluate the distributional
characteristics of wealth needed at retirement and the probability of success for typical U.S.
households based on the many possible life paths that could occur. In previous papers, we have
used this model to consider the effects of certain risk mitigation strategies (Bajtelsmit, Foster and
Rappaport, 2012) and retirement timing decisions (Bajtelsmit, Foster and Rappaport, 2013b). In
this context, LTC risk is a particularly difficult problem for typical households because it is a
low-frequency, high-severity risk and future costs are difficult to estimate. Furthermore,
insurance products are rapidly evolving, making it more difficult to assess and compare financial
strategies for dealing with this risk.
A general conclusion from our previous research reports is that retirement strategies that focus
on making small adjustments to spending or retirement age are insufficient to outweigh the tail
risks associated with health, LTC and longevity. Households with greater financial resources
may be able to pay for LTC costs directly, although this may require sacrificing other goals such
as bequests to family or philanthropic objectives. However, low- and middle-income households
in the United States are more likely to experience LTC-related financial difficulties because most
have not purchased insurance or set aside sufficient funds prior to retirement. The purchase of
LTC insurance at later ages is quite expensive and may not be feasible for those with limited
retirement wealth. Without insurance, any period of extended LTC provided in a facility will
rapidly deplete household funds.
Dangerous to focus on average outcomes
An important takeaway from simulation models in general, and ours specifically, is that it is
dangerous to focus on average outcomes. The amount of wealth needed to be highly certain of
having sufficient funds to meet retirement needs is much greater than the amount needed on
average. The primary reason for this is that retirees are subject to significant tail risk from
shocks, such as an unexpected longevity, extended LTC, or steep declines in asset values during
retirement. Although relatively uncommon, when they do occur, these events can rapidly deplete
retirement wealth, making it more likely that an individual will run short. This is perhaps most
pronounced for LTC risk, where the majority of households have near zero out-of-pocket costs
and a small percentage have extremely large costs. Using an average estimate for retirement
planning results in significant errors in estimates for both groups.
LTC insurance is available in the market but is not widely owned, currently paying for less than 10 percent of all LTC delivered in the United States (Munnell et al., 2009). However, this share is expected to grow in the future as the market and product alternatives expand and as more current policyholders reach peak claiming ages. LTC insurance varies with regard to the amount of coverage, how benefit eligibility is determined, the maximum period of benefits, and the events that trigger benefits. Variations in these benefits are beyond the scope of this paper, as is an analysis of such benefits.
Approaches to LTC insurance include stand-alone policies and policies that combine LTC risk with other risks. For example, some life insurance policies and annuity contracts have built-in LTC benefits or allow for chronic and/or terminal illness riders to be added for an additional premium amount. Some continuing care retirement communities (CCRCs) include a form of insurance in some of their contracts and a method for pre-funding LTC. A discussion of CCRCs is beyond the scope of this paper, but there is more discussion of this topic in the paper, “Improving Retirement by Integrating Family, Friends, Housing and Support: Lessons Learned from Personal Experience,” also in this monograph.
Because paid care is so expensive, LTC is often provided in the home by friends and families.
Advance funding or insurance solutions might provide access to more complete care options, but
these solutions are not always feasible, particularly for low-income households. When income
and assets are insufficient, households commonly spend down assets and apply for Medicaid in
order to pay for care purchased in the marketplace. Our research suggests that middle-income
households could benefit the most from LTC insurance, provided that the premium costs do not
adversely impact wealth accumulation (Bajtelsmit, Foster and Rappaport, 2012; Bajtelsmit,
Foster and Rappaport, 2013b). Higher income/wealth households can afford to pay for LTC
services directly. A more in-depth analysis is needed to determine the optimal strategies for
particular household types.
In the sections below, we first provide a brief background on LTC risk and discuss the pros and
cons of pre-funding versus insuring this risk. We summarize other studies that provide estimates
of funding needs for LTC and then describe our own simulation model and results.
Overview of the Risk
All individuals, their spouses, and family members are exposed to LTC risk. Anyone can
experience a problem that requires LTC, but it is much more likely at older ages. Most care is
provided at home by family or friends, and even if care is provided outside of the home, the
support of family and friends is often needed. Although most care needs are manageable for
family caregivers, when an individual needs help with multiple activities of daily living (ADLs),
in-home provision of care can become an all-consuming task to those providing the care (APNORC,
Many people are affected by the need for long-term support services. The 2011 U.S. Census
Bureau American Community Survey estimates that:
- Eight million people experience difficulty with self-care (i.e., completing all “activities of
- Thirteen million adults experience difficulty with living independently.
- Fourteen million children and adults have difficulty remembering, concentrating or
- Twenty million children and adults experience difficulty with walking or climbing stairs
(Kaiser Family Foundation, 2013).
For people with long illnesses, there may be a gradual decline leading to the need for increasing
care over time. This is particularly true for those with diseases such as Parkinson’s and
Alzheimer’s. People may need assistance of some type long before they qualify for benefits in an
LTC insurance program. It is important to note that in this study, we define LTC risk more
narrowly to include only events that require institutional care and we assume that LTC insurance
covers only this type of care. Although this is more simplistic than reality, it allows us to focus
on the management of the most serious LTC financial risks faced by retirees’ households.
Read the entire report here.