Archive for the Risk Management Category

Talking with Mom and Dad Before it’s Necessary

Posted by  |  Comments Off

Talking with Mom and Dad Before it's NecessaryAccording to a 2006 survey of 1,000 people by Home Instead, Inc., an Omaha-based provider of in-home elderly care, as high as 42% of adults between the ages of 45 and 65 say that having ‘the talk’ with their parents is the most difficult discussion of their lives. Deciding when aging parents can no longer live on their own, and what their next step should be is often an agonizing one – for parents and for their adult children.

According to 2008 federal data, however, it is a crucial step because:

  • Approximately 70% of people over 65 are expected to need some long-term care services.
  • More than 40% of people over 65 are expected to spend at least some time in a nursing home (the average is three years).
  • And 20% of people over 65 are expected to need long-term care services for more than five years.

Putting together a planned strategy with your parents can be a great way to start the discussion. It can give Mom and Dad a way to define and explain their goals and needs. The strategic plan can define the factors that determine when it is appropriate to get in-home help or make the move to assisted living.

Timing May Be Crucial

While many seniors do fine at home, others need long-term care facilities or something as simple as a visiting home aid. Either way, it’s important to start such conversations early. The rule of thumb is “the 40-70 rule”, which means if you’re 40 or your parents are 70 then it’s time to start talking.

Concerns about dementia, of course, will put additional pressure on the situation. People with dementia are eventually unable to make decisions in their own best interests. In addition, they may begin to misinterpret what other people are trying to do for them. Seniors with dementia may become paranoid, depressed or so confused as to be incapable of taking care of themselves.

Having the talk with your parents before the danger of dementia is crucial to their safety. Plus, having a strategic plan in place takes some of the pain out of the decision-making process if that time comes.

Considering the Options

While some busy working adult children may feel pressure to push their parents into choosing the most efficient option, taking the time to discuss the options and encouraging their parents to stay independent as long as possible is nearly always the better choice. Not only is this the less costly option, it also keeps the elderly parent in familiar surroundings.

Parents may resist their offspring’s efforts to relocate them for a variety of reasons. It’s important for adult children to recognize that their parents have their own reasons for wanting to stay in their homes. Some parents worry their children and grandchildren will miss the family home. In some cases, they fear their close friends or siblings will be left alone. Spending the time to figure out what those reasons are will help everyone find the right solution, not just the most expedient one.

Not all elderly parents have to move into assisted living immediately either. In some cases, when elderly parents show signs of not taking care of themselves well, they may simply need some in-home help with cleaning the house or keeping up with the bills. When one parent dies, the other may show signs of not caring for themselves well. The surviving spouse may simply need more regular contact with friends and a social support system to stay motivated and engaged.

Life Insurance – an Investment for Life

Posted by  |  Comments Off

Life Insurance - a golden egg or waste of money?While most people understand the primary idea behind life insurance – wage earners spend a little each month on a life insurance plan so that if they die, their dependents can enjoy some degree of financial security without their income – most do not understand the whole picture. For example, do those who are financially secure need life insurance?

Most individuals will say no, but the experts say, yes!

Traditionally life insurance is an investment because of the death benefit. Unlike equities, life insurance is a (some would say heavily) well-regulated industry that guarantees eventual payout assuming the client pays the premiums – an advantage that may not have sounded important a few years ago, but is likely more appreciated by everyone studying their equity portfolios today.

Life Insurance Advantages

In general, financial advisers see life insurance as a long-term investment useful to most of their clients. Life insurance has three primary advantages over other types of investments:

  • certainty
  • liquidity
  • favorable tax treatment

Let’s go over each of these advantages in a little more depth.

The question about certainty, that is whether life insurance will pay out or not is invalid, of course. The real question is how much the policy will pay out. As you well understand, the sooner the insured dies, the better the return on investment – this is the perverse truth about life insurance, and it’s true even for the types of policies used as investments, those that are whole life insurance policies. These require the insured to pay relatively higher premiums while they are young – to offset, of course, a potential payout if it becomes necessary. With these policies, part of each premium (the monthly cost of the policy) is isolated as cash value. This cash value is eventually used to keep premium costs lower as the person grows older. These cash values grow tax-free over the life of the policy and continue to remain so unless the owner makes a withdrawal while they are alive.

Life insurance is considered liquid because the insurance company is obliged to pay the proceeds as soon as a claim is filed. It’s also considered liquid because life insurance, in general, sidesteps probate. Liquid cash always has an advantage because it can be used immediately to buy things and it’s of particular advantage for an estate. Without that liquid cash, heirs may be stuck trying to pay estate taxes and may be forced to sell substantial property or other assets in order to pay them. So, having the balance of the life insurance proceeds can often mean significant savings for the insured’s heirs.

Lawmakers see life insurance as a hedge against catastrophic loss rather than a true investment and so it has retained, over the years and over the passing administrations, significant tax advantages. Specifically, all of the cash value collected in a permanent life insurance policy grows tax free. This includes the cash value in policies that move away from the classic life insurance model and instead serve as a wrapper for equity investments. This wrapping method can be especially useful for wealthy or affluent investors who invest their money in hedge funds, because short-term trades don’t benefit from low capital-gains rates. In almost all cases, life insurance can be passed on to heirs tax free as well. With federal estate taxes slated to return in the near future, those who want to avoid that particular tax may find setting up a special life insurance trust with a trusted individual as trustee will give them additional tax benefits. With the buyer/insured no longer in direct possession of the policy, it is not included in their estate and the proceeds of the policy can be distributed free of tax.

Other Advantages of Life Insurance

Life insurance policies also help those in the position to make large donations or gifts during their lifetime. In most cases, such transfers are subject to a gift tax, but an additional advantage of a life insurance trust, is that it accumulates cash over a rather long time. That is, over the life of the insured. When properly drafted, a life insurance trust can benefit from an annual contribution up to $13,000 for each beneficiary without being subject to gift tax. Those annual contributions are allowed to grow tax free and can eventually become a fairly significant sum. With the proceeds passing on without being subjected to additional income, estate, or gift taxes, it’s an excellent method for distributing comfortable sums of cash to your heirs. Of course, the key to this method is getting started early.

When you are making large contributions to a life insurance trust later in life, the gift tax will not be too great because the amount of the gift isn’t the amount the policy will eventually pay out, but rather the amount needed to pay the premium for a particular term. Also, the gift tax can be reduced even further by implementing some complicated planning techniques. Instead of paying the gift tax yourself, for example, you might loan the money to your life insurance trust to do that for you. This is only useful when interest rates are at favorable rates because you wouldn’t normally want the trust to have to make big interest payments (and interest-free loans are strictly limited under the tax code). With interest rates currently at rock bottom, you could loan the money to your trust for very little.

If you loan the insurance trust the money to purchase the policy outright, you could avoid the gift tax altogether, but that would require a larger and potentially costly loan.

Short-term Life Insurance – useful or no?

While the benefits of long-term, or permanent, life insurance are clear, the benefits of short-term policies is more debatable as it eliminates many of the advantages held by long-term life insurance. One of the advantages of permanent life insurance is that you can still indirectly access the policy’s current value – even after you have formally given it to a trust. This is because the trustee can always borrow against the cash value of the policy and loan you that money. If you don’t pay the money back, the depleted cash value may mean insufficient funds to completely pay the premiums on the policy in later years, which ultimately reduces the payout. On the other hand, individuals setting up life insurance trusts can take comfort in knowing their money is available if they absolutely need it – a technique that is not the case for many estate-planning techniques.

Some investors ‘overfund’ their life insurance policies with more cash value that is needed. Some experts consider this a useful investment technique because it avoids income taxes, and others aren’t so sure because there are other forms of financial planning that are far less cumbersome and don’t involve the charges imposed by many insurance companies. Rarely, however is an estate plan created without a life insurance component. With estate taxes set to return to over 50% soon, affluent investors would be well served to look into life insurance for a life investment.

What does it cost to own a mutual fund? More than you’d like.

Posted by  |  Comments Off

How can investors know the real cost of a mutual fund?Executive Summary of article:

  • “… the average investor can’t begin to get an understanding of the costs due to the lack of information.”
  • Studies show that the average mutual fund costs between 2% and 3% per year.

According to Morningstar, Inc., most U.S. stock funds pay an average of 1.31% of assets to the portfolio manager each year in addition to other operating expenses. Other costs related to the buying and selling of securities are not reported in the expense ratio and those expenses can make a fund 2-3 times as expensive as advertised.

What exactly are the costs of owning a mutual fund?

There are four primary costs that affect a mutual fund’s price. These are:

  • Bid-ask spreads. These represent the gap between the lowest price at which a seller is willing to sell and the highest price the buyer is willing to pay. When the fund does a lot of trading on less-liquid holdings, such as small stocks, these costs can add up quickly.
  • Broker commissions. These are the commissions paid to the brokers who operate the fund. The SEC requires three years of these costs to be disclosed in a fund’s statement, but the SEC does not require them to be factored into the expense ratios.
  • Market-impact costs. These last two are often the largest component affecting trading costs. They occur when a large trade changes the price of a security before the trade is completed.
  • Opportunity costs. Opportunity costs occur when the impact of a trade inhibits a fund manager filling an order on their desired terms.

This results in either a less-favorable price or fewer shares transacted.
While it’s very important to look at the expense ratio before purchasing a mutual fund, it’s also important to understand that that number is not going to capture all the costs.

What do the experts say?

Richard Kopcke, an economist at he Center for Retirement Research at Boston College recently co-wrote a study about the fees and inherent trading costs of retirement funds, such as 401(k)s. Kopcke’s study reviewed the 100 largest U.S. stock funds held in retirement plans as of December 2007 and found that annual trading costs averaged from 0.11% in the quintile with the lowest costs up to 1.99% of assets in the quintile with the highest costs. The median was 0.66%. Kopcke’s conclusion was that the average investor can’t begin to get an understanding of these additional costs due to the lack of information.

Another study updated last year by Richard Evans, associate professor of finance at the University of Virginia’s Darden School, put the average trading costs of thousands of U.S. stock funds at 1.44% with an average of 0.14% in the lowest quintile and 2.96% at the highest. Evans’ conclusion was that high trading costs tend to have a negative impact on fund performance. On average $1 in trading costs decreased net assets by 46 cents in this study.

Stephen Horan, head of professional education content and private wealth at CFA Institute, a non profit association of investment professionals estimates that trading costs for stock funds total 2-3% of assets annually although conservative reported estimates put these costs closer to 1%. According to Horan, these transactional trading costs are very real and unfortunately, the expense ratio just does not capture all of the costs.

How can this be happening in these times?

One reason trading expenses are unreported is due to the complexity. That complexity leaves fund companies in disagreement about how to calculate the costs. Even fund experts have trouble coming up with estimates that are similar.

Of course, another reason is that fund firms aren’t all that anxious to disclose their costs either. The SEC tries to revisit this issue every few years, but it still hasn’t come to a conclusion or established a set of rules.

All of this leaves investors in the dark about the true cost of their mutual funds.

Where are we on the disclosure debate?

In 2003, the SEC indicated to Congress that trying to include all trading costs in the expense ratio would produce a number that was not comparable, and it would vary from fund to fund. There simply isn’t an agreed-upon methodology on how to quantify implicit transaction costs such as market-impact costs. Therefore, requiring fund managers to disclose total trading costs would result in investor confusion.

While nearly everyone agrees that investors are entitled to and should have that information, until the methodology is developed there will be a lot of larger companies who pay trading-cost consultants to estimate their trading costs, but midsize and small investment managers who can’t afford to pay accountants will continue to wait for the methodology to be developed.

Get Clues from the Turnover

Meanwhile, investors can get clues from a standard albeit imperfect measure of how much trading the fund is doing. This is called the turnover, and it shows at what rate stocks are being replaced in the fund. This is an imperfect measure because some stock funds that have a lot of new money coming in don’t have to sell to generate cash. In this case, their turnover rate would be zero even though the fund is likely buying a lot of stocks.

Last year, the SEC voted to require fund companies to disclose one year of turnover and move that information to the front of a prospectus. Turnover of more than 100% can indicate that the hidden trading costs may be on the high side. Of course, there can be a number of factors that impact turnover during a given period and turnover can vary over time. Still, it’s a clue as to the hidden trading costs that are undisclosed.

Minding the Safety of Your Bonds

Posted by  |  Comments Off

Image of bank vault door One of the easiest mistakes to make with municipal bond investments is to take a ‘set it and forget it’ approach to your investment. The perceived security with regard to municipal bonds has led many investors – and unfortunately, some of their financial advisers as well – into taking this approach. Let’s talk about some things that we can do to mind the safety of your municipal bonds.

Just like minding your health, let’s commit to regular checkups.

Some of the most risky bonds are ones that meet their payments only when the issuer sees economic growth. With economic growth effectively stalled for the most part, dozens of municipal bonds have defaulted in recent years specifically because the housing developments were never finished. Debt prediction based on growth is very tricky to get right even in a healthy economic climate. It’s downright impossible in this economic climate.

Let’s also commit to sticking with the basics.

Not all municipal bonds are equal when it comes to repaying investors. Bonds issued by established government entities are usually safer overall because when the issuing government gets into financial trouble, it has the ability to cut expenses or raise taxes to pay back the debt. Of course, this depends on whether their tax base – the local community – is able to sustain their current taxes, as we talked about in No Quick Turnaround, but it’s important to recognize that while tax payers will gripe about the taxes, they aren’t likely to suddenly stop paying them as long as they are employed.

Let’s commit to doing our own homework too.

Making time to review the business section can help us learn whether a bond-financed project is in trouble. While this kind of media attention doesn’t make the headline on our news station, it does show up in the local newspaper. Of course, we can also satisfy our curiosity about a project by taking a first-hand look at it, if it’s close enough to visit, or by making a simple phone call to ask how things are going.

Here at Private Advisory Group, we want to ensure the safety of your investments. By working together, we can keep your funds growing safely so they’ll be there when you need them.

No Quick Turnaround

Posted by  |  Comments Off

City image with traffic The relative security of municipal credit, long seen as a more sound investment than corporate bonds, has been bolstered by the fact that bond investors strictly avoid future investing in a town that defaults on their municipal debt. If the town ever wants to raise money again, it can be very hard and very expensive to do so after a default, and so municipal bonds have been perceived as relatively sound.

There is an understandable lag between the time that economic distress in the communities shows up in municipal finances, and financial advisers and investors have recently begun to see that these once stable investments are starting to look a little shaky. For individual investors, it can be hard to know when a municipal bond is in jeopardy. You have to look pretty hard to find that interest payments are going unpaid. When it finally becomes newsworthy as we’ve all seen the recent media headlines announcing a variety of government-issued bonds, both foreign and at home, it happens when the bond is nearing bankruptcy or default status.

As real estate values steadily plummet and high unemployment continues to rob cities of their tax revenue base, a number of municipalities are starting to renege on their debts. Since July one year ago, 201 municipal bond issuers have missed their interest payments – up from 162 in 2008 and a significant increase from 31 in 2007. While at least some of these failing bonds are not of the caliber most investors want to buy, their failure is still enough to inspire second thoughts among experienced financial professionals.

Municipal bonds can lose value even without a default. In fact, according to Bloomberg (June 2, 2010), Warren Buffett, whose Berkshire Hathaway Inc. has been trimming its investment in municipal debt, predicted a “terrible problem” for the bonds in coming years.

“There will be a terrible problem and then the question becomes will the federal government help,” Buffett, 79, said today at a hearing of the U.S. Financial Crisis Inquiry Commission in New York. “I don’t know how I would rate them myself. It’s a bet on how the federal government will act over time.”

If a city or town faces financial difficulties, as so many are now, buyers won’t pay as much for its debt. According to Barclays, nearly 13 percent of municipal bonds that are currently active are trading at less than their face value – this is up from 7 percent before the recession. Rising interest rates can also hurt ‘muni’ bonds, and many believe interest rate increases are coming. While falling prices aren’t a huge problem for investors who hold their bonds until their maturity, those who need to sell a bond may experience an unfortunate loss if prices stay depressed. While no one is predicting a total municipal bond crash the likes of which we’ve seen with the stock market, all of these signs are good reason to pause before investing.

Will someone please tell me when bonds become the Next Big Thing?

Posted by  |  Comments Off

Stop watch with S&P 500 In the first ten months of 2009, investors plowed $313 billion more into bond funds than they took out … that’s a staggering shift in the investing market considering that over the same time investors also withdrew about as much money as they put into their stock funds. In a remarkably short period, a good many of the bond funds are now yielding around half what they did just a year ago.

We understand that many investors, scared by the realities of the economic market woes and fears of losing their nest eggs, are just looking for some safety. Bonds, the once dull and staid investment product, are now being heavily advertised as the safe refuge for your money. Investors have also gotten a huge push from the financial industry lately as everyone started touting diversification through bonds right after the latest crash and bonds have continued to be pitched – even as bond yields are flattening out or dropping.

We’re not opposed to bonds as a whole, they have their place in many well-considered, diversified financial portfolios. What we are concerned about is the lemming-like about face investors seem to have taken toward stocks and we believe that many investors are being lured into some pretty bleak investments simply for the sake of ensuring a risk-free portfolio.

We’re also concerned with a few facts that are not well known by many investors. The first of which is that while returns on any corporate, municipal, or Treasury bond looks better than say a bank account, it’s important to understand that many bonds these days are carrying a lot more risk. Plus, when investment professionals look at the frenzied buying on the bond market and the high demand for fixed income, it starts to look a lot like a bubble.

A bust in the bond market isn’t as obvious as a stock-market crash, but it could still have a nasty effect on investor’s nest eggs. If interest rates are to rise, for example and many analysts believe that’s likely, bond prices could suffer. Even prices on so-called ‘safe’ Treasury and municipal bonds could fall 30 percent or more if interest rates slip higher in the next few years. It’s important to understand that bonds are not the end of all investor risk – even with government funds, investors can still lose money in bonds.

Of course, if a bond’s price falls, the investor can choose to simply hold and collect the interest it pays and wait. Doing so could mean holding a bond for years, perhaps even decades. While a 4.7 percent annual interest on a current 20-year Treasury bond looks good right now when compared with a CD, it will seem ridiculous if interest rates rise and banks start to offer 7 percent CDs. Then, you could be stuck with a bond that doesn’t mature for a decade more and earning the lesser rate.

Still, the perceived safety of bonds and bond funds is a powerful draw for investors who’ve really been tossed around and shaken lately. If rushing willy-nilly into the bond market isn’t the answer, what is?

A well diversified portfolio is always the answer. Every investor’s portfolio should be unique to their age, their financial goals, their wealth status, and their current earning power, so each investor’s portfolio is as different as they are and it changes as you change. At Private Advisory Group, we want to help our clients manage their risk, and even a few of their fears, with a strong diversified portfolio that works for you.

Filed Under: Retirement, Risk Management

Generation Transfer

Posted by  |  No Comments

As children grow into adults, there are many skills that are
important for them to learn. These ‘life skills’ are not often taught
in schools or through other educational avenues available to kids and
teens, so it becomes another responsibility of the parents,
grandparents, aunts and uncles to teach kids accountability, the
value of hard work, the importance of individual success. Before they
become fully independent, young adults need to learn especially how
to manage their personal finances.

The earlier the individual learns solid personal financial
practices and commits to investing, the more financially sound that
individual will be in the future. Responsible investing is the direct
result of understanding how money works and it’s vital that we take
the time to educate the younger ones we love how to handle this
correctly so that they avoid common pitfalls – probably the
same ones you and I made when we were younger!

One useful way to productively teach responsible investing and
personal money management is by creating a workbook based on the five
topics discussed below. Of course, the depth of teaching is up to you
and it should be relative to the student’s age, but these lessons are
designed to teach the basics of financial responsibility to anyone of
any age.

Lessons for Gaining Financial Responsibility

  1. Establish and keep an accurate budget. This may be
    among the biggest challenges for young adults – even for our
    nation’s population in general. Excessive spending is rampant, and
    many people feel powerless in the face of rising debt, but debt has
    a lasting and negative impact on a person’s future savings and their
    current and future lifestyle. Debt causes unnecessary stress for the
    individual and it can damage close relationships and trust. Notice I
    said to establish and keep an ‘accurate’ budget. An accurate budget
    is sometimes the hardest of all because most of use live day-to-day
    and don’t spend a lot of time really analyzing where each dollar is
    spent. Plus, for a budget to be realistic, it must include regular
    and consistent efforts toward investing. Long ago, they told people
    to ‘pay yourself first’. This meant to set aside money for you –
    that’s investing. Before your young adult starts paying any regular
    bills, they should understand that they have to make enough money to
    pay themselves first so that that money is available for the future.
    This teaches your young adult (indeed, this works at any age) to
    live off less than they actually earn, and thus, to always be
    building wealth. Help your young adult set up a monthly budget for
    everything they regularly spend money on. One technique you can use
    to help your young adult see this is to help them set up at least
    two accounts: one for spending and one for saving for later. They
    can proceed to pay for things on their budget with the account
    designated for spending and watch the account for saving grow.

  2. Get financially organized. Keeping all important
    financial documents in systematic order can be done in a variety of
    ways, so it’s important to find the one that works for your young
    adult. Help them set up and keep their financial documents in a
    filing drawer or cabinet, or in a digital filing system when they
    are young. As young adults practice this fundamental skill, it will
    help them easily locate papers they need now and in the future. When
    it comes time to do taxes, they’ll be able to easily access the
    documents they need. Staying organized is one of those good habits
    that can save a lot of time and reduce stress as they move into
  3. Consolidate debt and destroy all credit cards. Many
    credit card companies and loan agencies made their early fortunes on
    18-year-old kids fresh out of high school as they headed into
    college or their first jobs. These young adults were ignorant of how
    credit cards and loans work, and there are countless stories
    (perhaps you were a victim as well) of young adults getting access
    to plastic and running up enough debt to bury them. A proper
    education can help your young adult avoid these devastating
    financial situations. Teach your youngsters the proper meaning of
    credit cards and loans. Instruct them to be wise and prudent when
    making large (and small!) purchases. Show them how interest rates
    can either be their friend or their enemy. This education will save
    them future headaches, sleepless nights, damaged marriages, and
    more, and it will show them how to take advantage of other financial
  4. Know your credit score. Early in my own career, when I
    worked as a paralegal helping individuals try to restore their
    credit scores, I learned what an important thing your credit score
    is. I spoke with over 40,000 individual Americans who had hammered
    their credit with unwise spending habits. By the time they came to
    me, it was late and they were trying to purchase a badly needed
    vehicle to get to work or a new house for their children.
    Regrettably, with a sub-prime credit score, you can barely finance
    an apple, let alone an automobile. So, teach your kids how the
    credit score system works. For information, check out common
    websites like

  5. Protect your identity from being stolen. Identity
    theft is the fastest growing crime in the world right now and it can
    be one of the most personally devastating occurrences that a young
    adult can experience. When I was in college, one of my best friends
    had her identity stolen by unwarily stating her social security
    number. The person who heard that number was able to drain her bank
    account and leave her stranded far from home with little more than
    the clothes on her back by that afternoon! Because her identity had
    been stolen, she had to drop out of school, move in with friends,
    and work two jobs for years until she finally recovered all that
    she’d lost. By keeping her social security number to herself, she
    could have avoided this ordeal. Teach your youngsters to examine
    their financial records and shred anything that may reveal clues as
    to their identity to someone rooting through the trash. Show them
    how to safely purchase items online, and how to be wary of luring
    e-mails that fall into their in boxes. Teach them to check their
    accounts regularly for any sign of misuse or abuse and to call their
    financial institutions when anything that seems odd occurs.

Money can be a powerful resource when it’s managed responsibly but
without the proper understanding and tools, your young adult can face
serious financial disasters. Remember that better understanding and a
richer education leads to more informed decision making down the
road. Some financial stress is inevitable, but your young adult will
be able to think their way through it and make smart decisions when
they are armed with the right information.

You can find more information on managing risk at our website. If
you have a question about this blog post or want us to examine a
particular topic in the future, please let
us know

Filed Under: Retirement, Risk Management

Why The Affluent Need LTC Insurance

Posted by  |  No Comments

Surprising economic times can reveal fault lines in previously solid assumptions. The conventional wisdom was that the wealthy would pay for long-term nursing care out-of-pocket and middle-class and upper-middle-class Americans should buy long-term-care (LTC) insurance. These HNW individuals would have the income stream to cover skilled staff for in-home care or full facility care regardless of the length of convalescing, if necessary.

In fact, wealthy Americans with a very comfortable standard of living and adequate resources to cushion from portfolio shrinkage have expressed concern about the expense of healthcare in the future. In a 2008 survey by Northern Trust, the cost of health care came in second after inflation eroding income as the chief concern of Americans with a minimum net worth of $1 million (not including primary residence). The truth is that more people need to consider those costs. Those who reach age 65 will have about a 40% chance of entering a nursing home, according to the U.S. Department of Health and Human Services. For those who do enter a nursing home, about 10% will stay there five or more years—a long time to be paying for nursing care out of pocket.

Moreover, even the published averages of nursing care and in-home care can be misleading when you consider the likely high service expectations of wealthy families. Average rates buy you rooms in facilities that your affluent client may perceive as more Motel 6 than the Four Seasons. For a high-end care facility such as one in Boston associated in with Harvard Medical School with its own hospital on the grounds and highly trained staff, the yearly costs are well over $100,000, or more than $270 per day. In New York, however, $398/day is just the average cost, according to the 2008 Cost of Care Survey from Genworth Financial. According to the survey, the five-year annual increase in the average cost of private or semi-private room in a nursing home is 4%.

The Actual Cost of Self Insuring?

Affluent families won’t be challenged to pay such fees, but the real impact may not be in the checkbook but in the legacy. A recently retired business owner who sold his stake a couple of years ago and invested in the stock market that’s limping along in the current economic crisis may look to pull cash out of his portfolio to pay for care at the worst possible time. Any subsequent recovery of his portfolio will be diminished by the principal he withdrew.

To pay for long-term-care costs directly, HNW families would typically hold onto invested assets to generate the required income. The client keeps those assets, thereby not transferring them out of his or her estate. Self-insuring therefore limits the ability of HNW investors to transfer assets before death in an effort to minimize transfer taxes for the family, according to an economic analysis of long term care by David Cordell, the director of finance programs at the University of Texas in Richardson, Texas, and Thomas Langdon, associate professor of business law at Roger Williams University in Bristol, Rhode Island.

For example, let’s assume the income and principal from a $1 million investment account would pay the costs for any required care. If the investor died without requiring long-term care and otherwise spent the annual income, the $1 million that remained at death would be subject to estate tax. With Congress unlikely to repeal the estate tax in this economic climate, the exclusion amount will go down to $1 million in 2011, leaving any estates larger than that amount subject to estate taxation with a top rate of 55% for assets above $3 million. The cost of keeping that account in the estate for potential long-term care could be the cost of the estate tax. If the client had not spent the income from the account and let it grow, even more taxes would be owed.

The alternative would be to buy an LTC policy starting at about age 55. Paying the premium allows individuals to use that $1 million account for other purposes, such as philanthropy or estate planning, for example. LTC insurance can then be thought of as a financial options contract, according to Cordell and Langdon. Wealthy individuals buy LTC coverage as a hedge against the risk of self-funding any required care. If they pay the annual premium from other sources (about $12,000/year for a 55-year-old male for lifetime coverage at $400/day nursing home benefit), that $1 million can be transferred out of the estate to allow it to grow free of estate tax.

Getting Back Premiums

Return of premium options come in two basic types. The less expensive one aimed at younger policy buyers is based on age at death, usually before 65 and sometimes at a shrinking percentage after that year. For the client who bought a policy at age 45 and dies suddenly at 55 without receiving any claim payments, the policy would pay 10 years worth of premiums to the beneficiary. If the same person dies suddenly at age 70, the policy would pay 50%, with the rider terminating at age 75. The additional cost for this enhancement is in the range of 8% over the regular premium.

The second type of rider returns all of the premiums, less any paid claims, regardless of the insured’s age—typically as long as the policy has been in force for at least 10 years. For a client who purchases a policy at age 55 and passes away at 70 without any claims, the beneficiary would receive 15 years worth of premiums. The added premium for a 55 year-old buying a policy would be in the range of 25% to 34%, with the rider cost increasing as the “age at the time of purchase” increases.

While the after-10-years benefit is expensive, the net cost to the client becomes the interest lost by not being able to invest the annual premiums. This factor can also make the policy attractive for wealthy clients who bear the responsibility of caring for parents or other older relatives. The returned premium becomes part of the beneficiary’s gross income.

As the owner of a closely held business (S-corp, LLC, partnership, or sole proprietor), the client can deduct the cost of long-term-care paid through the business entity, up to the IRS’s inflation-indexed limits for that year. If the client owns a C-corp, select employees can participate in a group LTC plan and have the business pay the premiums. In both cases, the business-paid premium is deductible. The return-of-premium feature can be especially useful when the business is paying the premium. The refunded premium can still go to the client’s beneficiaries—or it can go back to the company to recover its payments for the policy.

Not a Simple Proposition

LTC policies have many moving parts—the amount of the benefit, deductible days, benefit limits, inflation type, plus various riders. Seemingly small changes in the policy can effect major results 10, 20, or 30 years in the future when the benefits are needed. They are best analyzed by the client’s advisors to understand the full, long-range economic impact. One option on all policies, for example, is the amount of inflation to grow the benefits—5% simple or the more expensive 5% compound, for example. While annual nursing costs grow at a compounded rate, a policy with benefits only growing by a simple percentage will fall far behind in a couple of decades, requiring the client to cover more of the costs out of pocket.

Extended nursing care can have a strong impact even on HNW families. When creating any new comprehensive financial plan for HNW clients or reviewing an existing one, LTC insurance should be considered as a tool to lessen risk. Rather than depending on self-funding, strategically designed LTC policies can mitigate financial exposure and provide coverage for relatively reasonable sums through the use of return of premium riders.

An option on some long-term-care policies—return of premiums at death—works well for individuals who are concerned about risk protection but unhappy about paying for a product they may never use. Not all companies offer it and not all states allow it. The client’s designated beneficiary will receive a portion or all of the premiums paid, less any benefits paid by the insurance company.

Lewis Schiff is the principal of Advanced Planning Group, a private wealth specialist for advisors and their top clients. His latest book, The Middle-Class Millionaire, was published in February 2008. He can be reached at