Time Value of Money: the Magic of Compound Interest applies to both options
We’ve all watched the magician, “Nothing in the hat. Nothing up my sleeve.” What the magician really means is, Look over here. Voila! We watch raptly and are amazed with the results, even when we know it’s sleight of hand or a visual trick.
The current sleight of hand in marketing LifeCare CCRCs is to emphasize the rapidly rising cost of nursing care, projecting forward costs and especially the worst case scenario.
It’s all true. Nursing home costs are rising more rapidly than prices or inflation generally. A year in a nursing home is frighteningly expensive. Though the price varies a lot by state and facility. And there’s no necessary connection between cost and quality. But to emphasize the future potential cost of nursing care inflated with future rising prices is only telling half the story.
The magic of compound interest is on both sides of the question. You also have to look at the time value of the money you will be spending to avoid the future cost of nursing home care.
The cost of your low monthly fees increases over time. Most of the LifeCare communities we’ve reviewed recently report fee increases between 3% to 5% year-over-year, and there’s rarely a contractual or regulatory limit on future fee increases. The only protection against higher rate increases that residents typically have is transparency of the CCRC’s financial reporting and resident involvement through a finance committee or similar process.
The $4,000 monthly fee today equals $48,000 in annual fees. But 15 years from now inflation makes the annual cost of monthly fees $72,604 to $95,307. This is assuming a 3% low-end estimate and a 5% high-end estimate of inflation. Again there’s no guarantee of what future inflation will actually be. We can only go on the recent history of fee increases.
Playing the odds, you’re likely to pay the LifeCare monthly fee longer than the alternative future payment of full skilled nursing care. The average end-of-life stay of those in long-term care is about 2.5 years, with probability of needing long-term care at about 35%. Only a quarter of those needing long term care need 3 or more years. Almost half of all those receiving long term care, before the end, need less than 1 year of care. But we’ll use the average to estimate the probable cost. Taking the probability of a long term care stay by the average length of stay, you can expect 10-11 months of long-term care. We’ll round up to a year to make the math easy. Now this year will be at the expensive end of the time value of money. But if a 75 year old has a remaining life expectancy of 13 years, there will be 13 years of monthly LifeCare monthly fees versus 1 year of long term care 12 years in the future.
There’s also the foregone income from your initial buy-in. Rather than your portfolio benefitting from the time value of money, it is the LifeCare community that has the income until returning whatever percentage of return of capital (if any) is promised — commonly 90%. Of course the higher the buy-in, the more foregone income from your portfolio that could have been used to buy nursing care and the more money in the LifeCare community’s pocket.
Which is more expensive when you watch both sleeves?
So that begs the question. Which is more expensive when you watch both sleeves? According to Genworth, a leading seller of long term care insurance, the average inflation rate for nursing care is between 3% and 5% depending upon semi-private vs. private room. This is the same range we observe in LifeCare monthly fees. For the following illustration we assumed an $300,000 initial buy-in, 90% return of capital at the end of the contract, and a 6% investment portfolio return (or cap rate).
|75 year old paying 13 years of LifeCare||The 75 year old paying 1 year of long term care in year 13|
The difference? Between $776,500 and $1,006,000 more expensive for LifeCare based on probabilities. For the statisticians among you, this doesn’t address the distribution of probability or include any so called confidence factor. It plays the center of the odds.
Of course you have to live somewhere, so it’s not an apples-to-apples comparison. You have to ask if the value of the lifestyle and protection against the low probability catastrophic long term care extended stay is worth the LifeCare premium.
We’re still doing research and work, but we have a financial model that answers three key questions:
- Projects your expected LifeCare costs at your entry age based on your life expectancy at that entry age
- Projects a 10-year total cost for LifeCare to allow apples-to-apples comparisons between LifeCare communities
- Projects costs if you live to 100-years old, of which approximately 14% of current 62 year-olds are likely to do so
If you’re interested in a custom report, fill-out the form below and we’ll get back to you.