Merritt Personal Lines Manual: Inflation Protection
Adequate levels of coverage purchased today may gradually erode over time due to inflation. The insurance industry has been exploring this issue as it relates to policy benefits, as well as premiums.
Typically, inflation protection appears in an LTC policy in one of two ways: as built-in inflation protection or as inflation protection by option.
Although inflation protection usually is offered as an optional benefit -- and adds substantially to the cost of the LTC policy -- it is a worthwhile expense. The cost of care is only going to increase in future years. Protection against inflation is an important consideration for the senior citizen. In addition, many states now have laws that require inflation protection as a standard provision in LTC policies.
Built-in inflation protection provides benefit increases for both the daily benefit and the lifetime maximum benefit. Inflation increases are guaranteed and occur automatically, without option and without regard to actual increases in the cost of living. Typically, the benefit increase equals a stated annual percentage. This percentage is either based on a simple interest rate or a compounded rate.
For instance, inflation protection often will provide an increase of 5 percent of the amount of the daily benefit each year. Thus, if you purchased a policy with a $100 daily benefit five years ago, you would realize a benefit 25 percent greater today. Following are examples of the simple interest rate and compounded rate concepts.
5 Percent Simple
The annual benefit increase is 5 percent of the original benefit amount for the first 10 policy years. The ultimate benefit then becomes 150 percent of the original benefit. If the inflationary period is 20 years, then the ultimate benefit becomes 200 percent of the initial policy benefit. Thus, an initial $50 daily benefit will become a $75 daily benefit after 10 years and a $100 benefit after 20 years.
| $50 x 5% = $2.50 | $2.50 x 10 years = an additional $25 |
| $50 x 5% = $2.50 | $2.50 x 20 years = an additional $50 |
5 Percent Compounded
The annual benefit increase is 5 percent of the previous year's benefit. The ultimate benefit becomes 163 percent of the initial benefit after 10 years and 265 percent after 20 years. Thus, an initial $50 daily benefit will become $81.50 after 10 years and $132.50 after 20 years.
$50 x 163% = $81.50
$50 x 265% = $132.50
Inflation options are another way to protect the purchasing power of the LTC dollar. With this approach, you are contractually guaranteed the right to purchase additional benefit amounts in order to keep pace with inflation.
For instance, say you are 65 and your policy has an initial $80 daily benefit. You are given the right to buy an additional annual benefit equal to 5 percent (simple or compounded) of the initial benefit amount. The option dates are every three years from the age of 68 to 80. The option amount is equal to 5 percent for each of the three-year intervals (or 15 percent). The following chart illustrates the effect this would have on your benefit.
Initial Daily Benefit: $80
| 5% Simple | 5% Compounded | |||
| Age | Option Amount |
Total Benefit |
Option Amount |
Total Benefit |
| 68 | $12 | $92 | $13 | $93 |
| 71 | $12 | $104 | $14 | $107 |
| 74 | $12 | $116 | $17 | $124 |
| 77 | $12 | $128 | $20 | $144 |
| 80 | $12 | $140 | $22 | $166 |
This option approach could be expensive -- both for you and for the insurance company. Because the option method guarantees you the right to purchase additional amounts of insurance regardless of your health, from the perspective of the insurance company, the "expense" becomes a matter of substandard risks purchasing insurance benefits at standard rates. This means, the older you are, the more likely you are to have medical problems, which affect your insurability. If you become less insurable but are guaranteed more insurance, the insurance company faces greater odds of paying you more money. (Insurance companies call this adverse selection against the insurer.)
From the consumer's perspective, policies that provide inflation protection will result in increased premiums. If you're retired and living on a fixed income, you'll be faced with increasing costs, since LTC policies do not guarantee the premium. This fact -- coupled with potential additional costs for the inflation protection -- may only add to your burden.
The following chart illustrates the difference in premiums that can be expected for an LTC policy with a $100-per-day nursing home benefit, a 90-day elimination period and a four-year benefit period.
Column A shows premiums for no inflation protection and Column B shows premiums for a policy with 5 percent compound-for-life inflation protection.
| Column A | Column B | |
| Age 60 | $325 | $700 |
| Age 70 | $950 | $1,750 |
| Age 75 | $1,550 | $2,400 |
What we may see in the future are LTC policies that pay reasonable and customary LTC expenses, similar to the way many hospitalization policies calculate benefits.
Such an insurance product would automatically keep pace with inflation, but it also probably would need to have a higher initial premium than most current LTC policies.
