- Inflation protection is a provision of some insurance plans that allows future or ongoing payouts to be increased upward in accordance with inflation.
- The purpose is to ensure that the relative purchasing power of money awarded as benefits does not decline due to inflation over time.
- Inflation protection on an insurance policy can be achieved in a number of ways, the most common of which are aimed at disability or long-term care coverage.
What does the term “inflation protection” mean?
Inflation-protected investments are those that safeguard investors from rising prices of goods and services over time. A portfolio that is inflation-protected, for example, will have assets that perform well when inflation is greater. An inflation-protected investment will include some sort of adjustment mechanism that ratchets the payouts up and down in response to the rate of inflation on a regular basis.
What are inflation-protected funds and how do they work?
TIPS (Treasury Inflation-Protected Securities) give inflation protection. As assessed by the Consumer Price Index, the principal of a TIPS increases with inflation and falls with deflation. When a TIPS matures, the adjusted principal or the original principal, whichever is greater, is paid to you.
TIPS pay a fixed rate of interest twice a year. Because the rate is applied to the adjusted principal, interest payments grow with inflation and fall with deflation, just like the principal.
TreasuryDirect is where you may get TIPS from us. TIPS can also be purchased through a bank or broker. (In Legacy TreasuryDirect, which is being phased out, we no longer sell TIPS.)
What is the rate of long-term care inflation?
When recommending LTC insurance to your customers, “default” benefits might make the process of choosing plan options easier, but is this always the best option for your client? The great majority of LTCI customers, for example, choose a 90-day waiting period before benefits begin to pay. This option works well as a modest deductible and as a way to coordinate with the way Medicare provides LTC payments.
The 3 percent compound benefit growth option is another popular choice in both traditional and linked Life/LTC sales. Buyers, especially younger buyers, prefer some type of inflation insurance to keep up with potential cost of care rises. In some cases, however, it may be appropriate to examine alternatives to the 3 percent compound.
First, some background information. Several regulations pertaining to LTC Insurance were included in HIPAA when it was passed in 1996, including a requirement that applicants be given a 5% compound inflation choice (even though the inflation rate in 1996 was 3 percent .)
The choice to make an option mandatory was unfortunate because many of the policies that featured an automatic 5% compound inflation option performed poorly for insurance companies, resulting in demands for in-force rate increases. As someone who owns a 5% compound inflation policy, I discovered that my benefit increased so dramatically in comparison to the actual cost of care that I was able to defray some of the in-force premium notices on my and my wife’s personal policies by simply lowering my daily benefit to a level that was more in line with the actual cost of care. Several carriers are addressing in-force rate increases by giving policyholders the choice of keeping their existing premiums while reducing future inflation rises.
Companies responded in a variety of ways when they discovered they were facing pricing issues. First, they imposed exorbitant pricing on 5-percent compound insurance, which deterred sales (even though the plans, by regulation, still had to offer this to consumers.) Second, they began to offer new inflation choices, the most popular of which was a 3 percent compound automatic inflation rise.
Although 3 percent compound coverage is much less expensive for carriers than 5 percent compound coverage, it still doubles potential benefits every 25 years and is a costly policy rider.
Companies have established some alternatives to 3 percent compound coverage in order to offer reduced premium plans.
Understanding these choices can assist an adviser in providing better LTC protection advice while keeping premiums low. A list of some alternatives is provided below, along with illustrations of how premiums and future benefits are affected. (Premiums for a married female are used in all scenarios.)
Option 1: Lowering the rate of inflation: One simple way to save money is to reduce the automatic inflation adjustment from 3% compound to a lower amount. Some carriers give inflation increases as low as 1%. These plans may still be eligible for LTC Partnership protection depending on the state. The impact of a 55-year-old buyer and a 65-year-old buyer selecting a typical LTC plan is examined in the scenario below. Clients can save a large amount of money by going to a cheaper premium, but they may be able to afford a higher initial monthly benefit in both cases. It can be helpful in this method if you know your client’s budget and can change the inflation rate to fit their budget.
Option 2: Limit the number of years of growth: Some plans will grow at a compound rate, but the number of years of inflation will be limited. One carrier, for example, provides plans that only inflate for ten, fifteen, or twenty years.
The impact of capping inflation for 20 years can be shown in the example below using a linked life/ltc plan.
For younger buyers under 55, keeping the “uncapped” inflation benefit, lowering the initial benefit amount, and letting compound interest work its magic may make sense.
The capped benefit may be more suited for the 65-year-old buyer, however, because to the premium savings. Note that with linked life/ltc plans, the cash value improves for a younger customer, with money available for LTC payouts.
Option 3: Medical CPI Rise: One linked life/ltc carrier offers a plan that adjusts benefits according on the amount of the Medical CPI increase. The plan includes a zero percent increase floor and a maximum yearly increase cap of 6%. A different methodology assures that the policyholder receives a compound adjustment of at least 2%.
Clients and advisers concerned about high medical inflation can acquire the rider for the same premium as a 3% compound – with a strong upside against inflation in the example below.
Here are a number of other inflation alternatives that have been utilized on products in addition to these:
Step-Rated: A step-rated option will increase benefits at a predetermined pace, such as 3% compound for life, but will also raise premiums at a 3% compound or ever-increasing rate. Some plans will keep both premium and benefit increases at the same level. This allows a person to buy a plan at a lower beginning cost while still having some influence over how their benefits and premiums rise.
Simple Inflation Coverage: Simple inflation just increases the value of the initial benefit if it is not met. Some life/ltc companies provide simple inflation coverage, which normally increases by 3% or 5% each year. For someone 20-25 years away from needing care, a 5% simple inflation choice is often equivalent to a 3% compound option.
So, what’s next? Consider other inflation protection choices the next time you’re examining graphics and need to meet a target premium for a customer. The power of your inflation protection option for the normal claim age may be shown in the majority of illustrations, which feature charts to indicate how the benefits will develop. In most circumstances, 3% compound inflation protection be suffice, but we enjoy the variety and innovation offered by LTC Insurance.
What is the significance of inflation protection?
Q: Why is it critical to have inflation insurance? To keep up with escalating health-care expenses, what level of inflation protection is recommended?
In 2020, the average cost of a nursing home will be around $97,000 per year. In general, people require care for 44 months on average, thus an out-of-pocket long-term care expense of approximately $350,000 might be incurred today.
The fundamental concern, however, is that most purchasers of this form of insurance will not need to make a claim for another 15, 20, or 30 years.
Long-term care costs at facilities have regularly climbed by 3% to 5% per year.
If expenses rise as expected, a 60-year-old today might expect to pay between $800,000 and $1,200,000 per year in 25 years, when a claim is most likely to be filed.
A $1,000,000 nest egg can quickly dissolve if you only need care for a “average” amount of time3 to 4 years.
To keep up with rising health-care expenses, you’ll need at least a bare minimum of automatic yearly 3 percent compound inflation protection on your policy.
Long-term care insurance benefits are automatically increased each year if you have a policy with automatic inflation protection, often known as an automatic benefit increase rider.
On an inflation-adjusted basis, a long-term care insurance policy without inflation protection loses value every year the real cost of long-term care rises.
In order to determine which sort of inflation protection is ideal for your needs, you must first distinguish between the many types of inflation protection.
What is an inflation-protected exchange-traded fund (ETF)?
Inflation-Protect Bonds ETFs provide investors with exposure to inflation-protected debt from both the United States and other countries. The bulk of these funds invest in Treasury inflation-protected securities (TIPS), which are Treasury securities that are indexed to the Consumer Price Index in the United States (CPI).
Is it wise to invest in inflation-protected bonds?
I Bonds are financial instruments that have very specific regulations, attributes, and predicted yields and returns. Understanding these should assist investors in making better investing decisions, so I though a quick, more mathematical explanation might be helpful.
Current inflation rates, which are equivalent to 7.12 percent, forecast inflation rates, and the length of the holding term can all be used to estimate expected returns on I Bonds. Let’s begin with a simple example.
I Bonds are presently yielding 7.12%. Because interest is paid semi-annually, if you buy an I Bond today, you will receive 3.56 percent interest in six months. The following is the scenario:
If inflation stays at 7.12% throughout the year, these bonds should keep their 7.12% yield and you should get another 3.56 percent interest rate payment in the second half of the year. When you add the two interest rate payments together, you receive 7.12 percent for the entire year, which is exactly what you’d expect. The following is the scenario:
If you cash out the bond after three months, you will be charged a 1.78 percent interest rate penalty. When I subtract the penalty from the above-mentioned interest, I get a year-end estimated return of 5.34 percent.
The inflation rate for the second half of the year is the sole real variable in the above equation. For the first half, inflation and interest rates have already been set at 7.12 percent and 3.56 percent, respectively. The penalty is determined by the interest rate paid in the second half of the year, which is, in turn, determined by inflation. As a result, we can condense all of the preceding tables and calculations into the following simple table.
The technique can likewise be extended to various forward inflation rates. The following are the details.
Returns are higher when inflation is higher, as can be seen in the graph above. If inflation is low, returns are still reasonable because investors can lock in a 3.56 percent interest rate payment if they buy now, regardless of how inflation evolves. Investors would receive 4.06 percent in interest payments in 2022 if inflation falls to 2.0 percent, which is the Federal Reserve’s long-term goal.
If forecast inflation rates remain constant throughout time, the table above can be extended to span different holding periods. Although this is not a realistic assumption given the volatility of inflation rates, I believe the study will be useful to readers. The following are the more detailed results.
When inflation is low, the best gains come from buying bonds, receiving the guaranteed 3.56 percent interest rate, and selling them quickly. If inflation falls, there’s no benefit in owning an inflation-protected bond.
When inflation is high, the best profits come from keeping bonds for a long time, allowing you to receive as many (high) interest rate payments as possible while minimizing or eliminating the penalty for holding for a short time. When inflation is strong, there’s little value in selling an inflation-protected bond.
Importantly, investors have the option of deciding how long they want to hold these bonds, thus the most rational course of action is obvious: hold the bonds until inflation falls, then sell. This, of course, is quite reasonable. When inflation is high, inflation-protected securities are profitable; when inflation is low, they are not. As a result, when inflation is high, as it is now, it makes sense to acquire inflation-protected securities and then sell when inflation falls. It’s a common-sense approach, and the math adds up.
Is it wise to invest in inflation-protected funds?
TIPS, unlike other bonds, adjust payments when interest rates rise, making them a desirable investment choice when inflation is high. This is a decent short-term investment plan, but stocks and other investments may provide superior long-term returns.
Does the cost of life insurance rise with inflation?
Adding an inflation rider to your life insurance policy raises your premium, but it also protects you from rising living and medical expenditures, as well as end-of-life expenses, during the course of your policy’s tenure.
Does life insurance take inflation into account?
You can’t, which is the tough part. Sure, you can perform the math up front and figure out what your policy’s eventual total should be in the long run, assuming a somewhat higher inflation rate than the predicted 3%. This strategy, on the other hand, will not be able to undo the damage done to your policy’s planned benefit. Whatever you do, your investment will suffer a setback, leaving you with a lower payout than you expected or forcing you to significantly raise the amount of money you put into your policy. You do, however, have some other options for preventing your life insurance from succumbing to the ravages of inflation.
What you can do for your life insurance
Inflation is unavoidable, but there are a few tactics you may employ to help ensure that your life insurance policy’s long-term vision is preserved:
- Indexation: Some life insurance companies will let you use this option, which ties your premiums to a variety of inflation-related measures like the Retail Price Index and the Average Earnings Index. As a result, as inflation happens organically, your policy keeps pace with the economy, keeping its long-term cash value over time. The hitch is that indexation is normally required to be turned on right at the start of your policy. You can lose access to this option after your plan starts. So think about whether you want to include it in your plan before signing on the dotted line.
- A policy rider is a clause incorporated into your policy that provides additional protection or includes a tailored benefit that is not included in a regular plan. In this instance, some life insurance companies will provide an option at an additional cost, of course that protects against inflation, typically by offering a monthly benefit that increases each year to counteract economic conditions. Even now, long-term care insurance firms are more likely to include such a clause, but life insurance companies are following suit. Check with your insurance provider to see if such a feature is available on your policy. It’s always easier to make these choices when you’re starting a fresh plan.
- Boosts in coverage on a regular basis: This option is less sophisticated than the other two, as it simply means regularly injecting additional coverage into your policy to keep up with inflationary needs. The specifics of how you choose to do so are, of course, entirely up to you. Perhaps you’d like to contribute more money to an existing plan or perhaps buy a new term policy to prolong your coverage farther into the future. This may be a more dependable alternative than adding the inflation rate into your long-term life insurance needs in one fell swoop, as it allows you to course-correct along the way.
An uncertain road
Estimating the impact of inflation on your life insurance plan over time, even though it seems fruitless at times, is an important aspect of planning your financial future. Your policy is intended to safeguard your family while you are away, and it is difficult to fortify the structure of your policy to give the best possible security without doing your utmost best to assess the threats that await you. Inflation protection is critical to the long-term viability of your strategy, so don’t put off implementing the appropriate steps.