Too many people wait to buy long term care insurance until it becomes unaffordable. A new generation of hybrid products could help buck this trend, says Wojciech Dochan
Long term care (LTC) insurance has been around in the UK since the early 1990s. Despite strong encouragement from reinsurers, keen to push the development and promotion of risk-based products, and the successes of certain specialist IFAs, LTC insurance sales have yet to take off.
According to Datamonitor, there are currently just 36,000 policies of all kinds in force. Women dominate the market - they account for nearly 60% of regular pre-funded plans - perhaps reflecting their longer average life expectancy and the fact that they tend to be younger than their male partners. Although sales are increasing slowly - they are predicted by Datamonitor to climb from 4,895 in 2000 to 5,900 by 2005. But the figures are still woefully below those for other products.
However, recent research conducted by BUPA into the attitudes of existing customers revealed the demand for LTC cover certainly exists. As many as one in three of those questioned expressed concern about what would happen to them when they became too old and infirm to cope on their own. They had good cause to worry, with more people living longer, but not necessarily in good health. The challenge lies in converting the demand and the statistics into sales of LTC policies.
One of the problems with the pre-funded product is that would-be buyers tend to leave the decision making until after they have retired. Although increasing age may stimulate reflections of morbidity as well as of mortality, the difficulty is that premium rates tend to escalate sharply for those in their 60s and beyond. Another consideration is that household income tends to fall sharply when a pension has to take the place of the salary.
Early birds
So how can we encourage more people to start providing for the future costs of their LTC at an earlier age? One solution is to provide a product that starts by offering one type of healthcare insurance cover and then switches over to LTC cover at or around retirement age.
What form should the 'start-off' protection take? Critical illness (CI) cover is one solution. On attaining a certain age, the nature of the risk is altered from the diagnosis of any one of a long list of named medical conditions, or the performance of certain surgical procedures to the inability to carry out two or three activities of daily living (ADLs).
CI cover will normally pay out a lump sum assured. But a regular payment benefit will almost certainly be more appropriate for meeting the costs of LTC. It is possible to arrange CI cover, which pays out a series of tax-free payments on similar lines to family income benefit (FIB) life assurance. FIB is a form of decreasing temporary cover, the benefit being payable from the date of the insured event until the end of the policy term. The need for financial help with care costs, on the other hand, will normally last for the remainder of the insured person's life, which may be anything between a month and several years.
An alternative solution is to use income protection (IP) cover, rather than CI cover as its base.
The plan starts off providing IP cover, normally based on an 'own occupation' definition. For applicants and policyholders who are engaged in more physically demanding types of work, however, a more stringent 'own occupation' and 'any other occupation for which you are suited by way of education, training experience and status' description may apply.
A third definition - based on the inability to carry out a set number of ADLs, such as handling money and taking medicine, without the continual assistance of another person - is used for those who do not work and earn.
A standard IP plan
In many ways this is a standard IP plan. Initially it is designed to replace earnings lost through incapacity. The benefits are payable free from personal taxes and can be arranged to rise in line with price inflation, and naturally premium costs will escalate.
There are two ways in which this variation on the IP product theme stands out. The first is that an applicant can ask for the cover to continue for the rest of their lives, rather than cease at their intended retirement age, so the policy is whole of life, rather than term. The second is the post-retirement definition of incapacity changes to one based on inability to perform ADLs, which are usually washing, dressing, moving, transferring, feeding and continence. These are different from the ones that apply at earlier ages.
Under current fiscal legislation, the benefit should be payable as a tax-free income - whether paid to a care provider, policyholders themselves, or people with the power to act for them - rather than as a lump sum. IP changing into LTC insurance could be seen to have two advantages over CI cover changing into LTC insurance. First, the payments should continue for as long as they are needed: from the end of the selected deferred period until the person insured eventually dies. And second, they should more closely match the actual costs of care - the benefits would, for example, be expressed as a percentage of pre-retirement earnings, with subsequent increases to keep in line with price inflation.
Consider the following hypothetical case study: John Nash, a 45-year-old office manager, applies for IP cover, for an initial benefit of 50% of his salary at the time. He chooses whole of life cover with the starting premiums fixed, rather than renewable or reviewable, throughout. However, as the cover is to be linked to price inflation, any increases arising from indexation will be based on the premium rates prevailing at the time. The deferred period is to be 13 weeks.
Five years after his plan has started, John is involved in a serious car accident and suffers multiple fractures with some damage to his lungs. As a result, he is unable to return to work for six months, and for his first six months back in the office, he is only fit enough to work part-time.
The IP plan pays John a full 50% of his pre-disability salary for the three months from the end of the 13-week deferred period until he is able to resume his old duties initially for just a few hours each day. He then receives a proportionate benefit for the six months leading up to the time he is declared fit enough to take up the reins again in full. IP claim payments cease when full salary recommences.
John continues paying the premiums over the rest of his working career and into his retirement. Fortunately, his pension is generous enough to enable him to do this without prejudicing his standard of living. When he is into his mid-70s, John, who is now divorced, suffers a severe stroke. This leaves him so seriously disabled he has to be admitted to a residential nursing home, where he is likely to spend the rest of his days.
John cannot carry out any of the six post-retirement ADLs and his son, acting for him, makes a claim on what is now an LTC insurance plan. After the deferred period of 13 weeks, the combination of Government assistance with the costs of nursing care, John's pension income and the LTC insurance claim payments are more than sufficient to cover the balance of the nursing home fees. This means the value of his house and other assets are available in full to be passed on to his children and grandchildren after his death.
Raising awareness of the need for pre-funded LTC insurance well before retirement age poses a difficult challenge for our industry. Hybrid products that incorporate LTC cover are one way of meeting it.
Wojciech Dochan is head of product development at BUPA Insurance
Cover notes
• Sales of pre-funded LTC insurance are low - with many people waiting to buy until age ratings make it unaffordable.
• Whole of life IP policies that turn into LTC cover at retirement age switch the incapacity definition to become entirely ADL-based.
• CI policies that turn into LTC cover also switch to ADL definitions on retirement, but often pay a lump sum benefit rather than an income.
