If Michael Kitces' site isn't on your reading list as an Investment Advisor, Financial Planner, Estate & Trusts Attorney, or as an individual curious what trends might impact your own retirement, then you probably aren't keeping up to date on trends in retirement planning.
In a post today, Kitces focus's on "Yet More Big Changes Underway in Long-Term Care Insurance Marketplace." The whole piece is fascinating, but what stood out as especially important to savers is that low interest rates have challenged the ability of the insurers to pay benefits. In Kitces' own words:
"The low lapse rates are further complicated by the current low interest rate environment. After all, insurance "works" because the insurance company takes in premiums, invests them for a (conservative) return, and then uses the accumulated premiums plus growth to pay future benefits. When interest rates fall from 5% to 1%, though, the 80% relative decrease in income results in far less money accumulated - especially when compounded over many years. In point of fact, this alone explains the bulk of premium increases on existing policies in recent years; the insurance companies simply don't have as much money as they expected to pay out current benefits, because the ongoing premiums have not been able to grow nearly as much as anticipated. And because the lapse rates have been so low, the insurance companies find themselves earning not only unexpectedly low and insufficient returns, but facing claims on a much larger number of policies."
Along with the actual insurance component, I like to think of Long-Term Care Insurance (LTCI) as a sort of 401K for Long Term Care. What Kitces' doesn't mention is that the return on accumulated premiums grows tax free which is why someone might want to save for Long-Term Care with Long Term Care Insurance rather than by saving in a taxable savings vehicle like Mutual Funds or a Seperately Managed Account at an Investment Advisor.
While tax advantaged, LTCI has a regulatory disadvantage. Insurance regulators force LTCI providers to invest in an overly conservative manner by rating companies based on the volatility of their excess reserves which has forced insurance companies to predominantly invest in Fixed Income. An 80% drop in interest income is not unique to the insurance industry. All Fixed Income investors have felt the effects of financial repression imposed by the Federal Reserves zero interest rate policies.
Low lapse rates are also likely a function of the low interest rate environment. With the return offered by competing investments dropping by 80%, the likelihood is very low that someone would switch out of LTCI that was purchase in a higher interest rate environment with a much higher expected return built into the benefit structure.
All in all, it looks like investors should look closer at other investment vehicles to fund their long term care needs and avoid the pitfalls of investing in what are predominately Fixed Income investment vehicles.