Level vs Nonlevel by David Wolf

Level vs. Non-Level Premium Inflation What to Consider When You’re Considering Buying The inflation protection option you choose when purchasing a Long-Term Care Insurance (LTCI) policy is the most important component of your purchase. For the average-aged buyer (age 57), the inflation protection is the bulk of the policy’s value. (It is not the policy’s daily benefit at the time of purchase that is of most

significance. Rather, it is the future inflated daily benefit when the policyholder is 80-90+ that is critical, since the odds of using the policy for physical or cognitive frailty is exponentially greater in older age.) Your inflation choice is worthy of thoughtful consideration due to the magnitude of its impact on your purchase’s future value.

Level Premium vs. Non-Level Premium Inflation protection options fall into one of two categories: Level Premium Automatic Inflation and Non-Level Premium Inflation. Level premiums indicate the premium stays level and benefits automatically increase each year by a guaranteed percentage. While initially more expensive, these premiums provide predictability with regard to the premium expense each year. Non-level premiums, on the other hand, require you to buy additional coverage periodically over the life of the policy in order for your benefits to increase. These premiums are initially lower than level premiums but increase dramatically over the life of the policy if you attempt to buy all of the additional purchases offered. Unfortunately, few policyholders are prepared for the high expense of these additions and either stop buying them or drop the policy entirely, as they can no longer sustain the increasing premiums.

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Non-Level Premium Options Non-level premium inflation options are o en referred to as Guaranteed Purchase Options (GPO), Future Purchase Options (FPO), or Automatic Additional Purchase Options (AAPO). Under each of these options, you have the right to buy additional coverage at specified points in time (annually, bi-annually, or triannually). Purchasing every additional coverage option offered could produce the same growing benefit as a level premium Inflation option, in terms of the increasing daily/monthly benefit. However, the premium

requirements differ dramatically. Initially Guaranteed Purchase Options allow for additional purchases of coverage (usually at 5% compounded) at enticingly low prices. Unfortunately, over time these additional purchases become exponentially more expensive, since they are each purchased when the insured is older.

Level vs. NonLevel Premiums

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Guaranteed Purchase Options (GPO, FPO, AAPO)

Level: Automatic 5% Compound

X-Axis: Years

Non-Level: 5% Guaranteed Purchase Option

Y-Axis: Dollars

For example, a typical annual premium for a married 50-year-old with 3 years of coverage on a level premium automatic inflation protection (5% compounded) might be around $3000, level for life. The same coverage, issued instead with a 5% compound GPO, would begin around $1050. This is less than one-third the cost of the level premium inflation option. By age 65, the premium for the GPO-based policy is roughly equal to its level premium counterpart. (This assumes each Guaranteed Purchase Option is purchased). However, by age 85 (the age at which many claims are filed) the GPO-based premium is around $30,000 per year. Three years later, it is over $42,000 a year; and at age 90 it exceeds $52,500. This is a significant financial burden at the time when continuation of coverage becomes most important. Marketers of LTCI Guaranteed Purchase Options (or other similar non-level premium options) often â&#x20AC;&#x153;sellâ&#x20AC;? this product under the notion that the insured should buy the additional inflation increases only in the early years while it is inexpensive. These same marketers also advise the client to stop buying the increases when they become unsustainable due to cost increase. This is faulty logic, as inflation compounds exponentially in a curved line. Thus the compounded increase in the first 15 years is significantly less than the increase in the following 15 years. The insured is encouraged to stop purchasing when the inflation curve is hitting the steep incline. As a result, the individual is dramatically under-insured in later years when coverage is needed. Unfortunately, the vast majority of the time, the consumer does not understand these differences as they are not fully disclosed by the marketer at the time of purchase.

Level Premium Automatic Inflation Options Up until a decade ago, level premium automatic inflation protection was only offered as either “5% compound” or “5% simple.” Compound inflation protection compounds the daily/ monthly benefit off the previous year, creating a compounding curve of growth. Simple inflation does not compound but instead increases the benefit each year by an “equal” amount. For example, $100 inflating at “5% simple” would increase the benefit each year by a set $5. Since inflation is innately compounded, many carriers have stopped offering “simple” inflation as an option. In the last decade Long-Term Care Insurance carriers are offering many more compounding

choices. Some carriers have added compounding inflation at every percentile up to 5% (1%-5%). Still others have broken these down even further in quarter percentiles (1%, 1.25%, 1.5%. . . up to 5%). (Note: These finite adjustments of compounding inflation are mostly designed for competing marketers. One agent can underprice his or her competition with a small adjustment in the inflation guard.) Another approach is to tie the compounding inflation to the Consumer Price Index. (Note: Historically, the Consumer Price Index has averaged about 3% in the last three decades.)

Our Advice It is best to not get caught up in ALL the choices. The most common options are the 3% and 5% compound (level premium) inflation options. (Most every carrier has these two options available.) These common options allow consumers to compare “apples to apples” while evaluating their purchasing decision. For more insight into these two level premium inflations options read The LTCI Inflation Debate: 3% vs. 5% Compound Inflation Protection.