Is a Long-Term Care ‘Hybrid’ Policy Right for You?
Stand-alone long-term care insurance policies have been waning in popularity, owing to a combination of skyrocketing premiums and difficult claims experiences by consumers. In their place, so-called hybrid long-term care insurance products have been coming on strong.
Sales of these combination products, which bundle long-term care insurance with life insurance or an annuity, began to eclipse sales of stand-alone policies starting in 2014, according to research from the Society of Actuaries. Sales of hybrid policies have continued to outstrip those of traditional, or stand-alone, policies in the ensuing decade.
In contrast with stand-alone long-term care insurance policies, which someone might pay into for years but never use, buyers of hybrid products get something out of the deal either way: a death benefit (in the case of hybrid life/long-term care products) or lifetime income (for hybrid annuity/long-term care products) as well as some long-term care benefits if needed. That optionality is a key factor behind hybrids’ growing popularity.
The products are complicated, however, not least because you often buy them with a lump sum, inviting questions about opportunity costs. Would you be better off setting up your own long-term care fund?
Here are some of the key considerations to bear in mind if you’re evaluating one.
Long-Term Care Hybrid Basics
There are a couple of key subtypes of products that bundle life insurance with long-term care. The original hybrid policies added a long-term care rider onto a permanent (whole) life insurance policy. Newer, so-called linked-benefit policies combine life insurance with long-term care coverage; the life insurance is generally secondary to the long-term care coverage.
The internal mechanics of these two product types vary, but with both, insured persons can tap long-term care benefits if they’re unable to complete two or more activities of daily living, such as bathing or dressing. Those long-term care outlays reduce the eventual death benefit but can’t typically exceed the amount of the death benefit. (Policies may offer a “continuation of care” rider for an extra charge, which would allow the policy to continue covering long-term care expenses even if the death benefit were already spent.) An annuity with a long-term care rider would function in much the same way, with long-term care payments reducing the amount that’s available in lifetime income.
Weighing the Pros and Cons
As noted above, the fact that hybrid products provide a benefit whether you end up needing long-term care or not has been a key selling point. Consumers don’t seem to struggle too much with paying home insurance premiums that they might never need—or at least they didn’t before natural disasters jacked up premiums in some areas—but many have balked at the idea of paying ever-higher premiums for long-term care coverage they may never need. Hybrids provide protection against that possibility.
In addition, underwriting standards are generally less stringent for hybrids than for stand-alone long-term care insurance. And because you purchase a hybrid with a single premium or fixed premiums over a preset period, like five or 10 years, purchasers should be able to sidestep the premium increases that have bedeviled buyers of stand-alone long-term care insurance.
However, hybrids are substantially more complicated than stand-alone policies, with multiple configurations, bells and whistles, and payment options. That makes it difficult to comparison shop and assess the insurance company’s “take” from the transaction. In general, any time you move away from an insurance product that is pure coverage for a single outcome (stand-alone long-term care insurance) and into one that provides coverage against multiple scenarios, you’re going to pay more for that flexibility.
Hybrids are also at a disadvantage to stand-alone policies taxwise: While premiums on long-term care insurance policies are typically deductible up to the IRS’ limits, premiums on hybrid policies typically aren’t. (Long-term care benefits themselves, whether from a stand-alone policy or a hybrid policy, aren’t typically taxed.)
Any type of long-term care insurance outlay courts inflation risk, too: While you can typically buy coverage that adjusts benefits at a specific percentage to address rising long-term care costs, that inflation protection will increase the premium amounts in a meaningful way.
For example, a 55-year-old woman purchasing a linked-benefit hybrid policy with $180,000 in long-term care benefits, a death benefit of $120,000, and a 3% annual inflation adjustment would pay a single premium of $76,740, versus just over $54,000 for the same policy without the inflation adjustment, according to the American Association of Long-Term Care Insurance. Moreover, actual long-term care inflation has been outstripping the 3% or 5% inflation adjustments that are typically available on long-term care insurance policies: Costs for assisted living facilities increased by 10% between 2023 and 2024, according to CareScout/Genworth, and skilled nursing expenses increased by 7% over that time frame.
Would You Be Better Off Investing on Your Own?
Perhaps most importantly, because you typically purchase a hybrid product with a lump sum or a series of fixed payments rather than making ongoing premium payments, there are opportunity-cost considerations that aren’t as significant for stand-alone long-term care policies. If someone has the funds to sink into a hybrid, might they be better off retaining control of the money and investing it?
One of the key advantages of forgoing insurance and investing on your own is that you have all the flexibility in the world. As a self-funder, you could use the money for long-term care (your own or your spouse’s), leave it for heirs after your death, or spend it on something else during your lifetime.
The opportunity cost of the hybrid relative to the self-fund depends on a few key variables. One is all but unknowable: your proximity to needing care. As Wade Pfau points out, the person who purchases a policy and needs care shortly thereafter would have a higher internal rate of return than the one who purchases such a policy at age 60, uses a few years’ worth of long-term care benefits at 88, and then passes away. The long-term care benefits available on a hybrid are typically a multiple of the premiums paid in, so the person who uses more benefits earlier is the “winner” in this scenario. Moreover, the younger you are when you have a long-term care need, the less you would miss out on the compounding opportunities in the self-fund.
Another key consideration when evaluating opportunity cost is what the money to buy the hybrid would otherwise be invested in. If you have the funds available in a money market account that’s barely beating inflation, the opportunity cost of steering the money to a hybrid is obviously less than would be the case if you held the funds in a balanced portfolio that included some growth potential and inflation protection. That consideration goes hand in hand with the time horizon consideration: The more aggressively invested the self-fund, and the longer it’s left undisturbed, the better the decision to forgo insurance.
The same general thesis applies if you already have a permanent life insurance policy but you’ve “outgrown” it because you no longer have dependents and have substantial investment assets. You already have the “sunk cost” in the whole life insurance policy. In that instance, you could convert the policy to a hybrid policy using a tax-free exchange called a 1035 exchange. Would you buy the long-term care hybrid from scratch today? Maybe not. But you’re converting an asset with limited utility for you—the pure life insurance—into one with at least some utility.
Finally, one of the biggest considerations in any long-term care insurance decision is peace of mind. Does having assets earmarked for long-term care through an insurance policy give you more comfort in spending from your portfolio? Would having long-term care insurance make it more likely that you or your family would pay for care if you or your spouse needed it? As with so many major financial decisions, this one can’t be boiled down precisely to dollars and cents.
Source: https://www.morningstar.com/retirement/is-long-term-care-hybrid-policy-right-you