(BOSTON (CBS.MW) -- Most people do not perceive the risks of an extended stay in a nursing home to be a real and present threat to their financial security until they are older and the cost of buying this coverage becomes unaffordable.

For example, at age 50, the cost of a typical LTC insurance policy will run about $2,200 a year, but this will cost 3 times more, or about $6,300, at age 70. Others believe that this will never happen to them. Surely we will all die at some point, but surely not all of us will pass through a nursing home on the way out.

However, about seven million individuals over age 65 will need long term care. According to the Department of Health and Human Services, people age 65 and over face a 40 percent lifetime chance of entering a nursing home.

This risk is about 50 percent higher for women than men age 65 or older. Visit a nursing home and you will believe it -- it is typical to observe that most of the residents are women. For those age 85 and older, 22 percent are currently in a nursing home. The reality is that as lives are extended through medical advances and healthier life styles, the risk of requiring long term care is bound to increase for future generations.

Still others believe that they can self-insure against this risk by saving for it. Sure, in a perfect world, a 50-year-old could set aside the $2,000 per year for 29 years, earning five-percent interest, and would have about $126,000 at age 79.

This would pay for 10 years of LTC insurance premiums beginning at age 79 (or 2 years of out-of-pocket care). During this period, if they required long term care, the costs would be covered by their LTC insurance policy. At the end of the 10 years, or at age 89, they would take the "black pill" and pass away peacefully. There are four fatal flaws with this thinking:

1. There will be no pre-existing condition at age 79 that makes them ineligible for LTC insurance.
2. The cost of LTC insurance for an individual who is age 79 in 29 years is the same for an individual who is 79 today.
3. This individual will always save the $2,000 per year and earn a "perfect five percent" on their annual savings -- never more or less.
4. They will not live longer than anticipated.

These assumptions are unrealistic and incorporating these in any financial plan can be dangerous to your financial security.

The reality is that for a total cost of about $56,000 over 29 years (accounting for an annual five percent rise in premiums), an individual can protect their net worth from a potentially large financial risk.

The large financial risk

The national average cost of skilled care in a nursing home is about $70,000 per year, with the low being about $43,000 in Louisiana and the high being $140,700 in metropolitan New York. Over the next 25 years, this cost is expected to rise faster than the pace of core inflation as the dwindling supply of nursing-home workers confronts the increasing demand for their services by an older population that will double in that time period.

At this rate, a 45-year-old will have to stash away over $3,700 a year to have over $450,000, or enough to pay for two years of long term care costs at age 85.

A 55-year-old will have to stash away about $4,700 a year to have over $310,000, enough to pay for two years of long term care costs at age 85.

Who will pay your LTC costs?

Medicare, which picks up 11 percent of LTC costs nationally, only partially covers the costs of the first 100 days in a nursing home, and only provides this coverage if the skilled care is preceded by a stay in a hospital.

Medicaid, which covers 73 percent of LTC costs nationally, is the medical program for the poor and requires individuals to spend down substantially all assets and direct all their income to pay towards their long term care costs. Private LTC insurance currently picks up about 5 percent of LTC costs nationally with the remainder coming from the income and assets of the individuals who require the care.

Clearly Medicaid pays the bulk of LTC costs. The challenges placed on individuals who will rely on Medicaid is that they have to transfer assets out of their name in advance of anticipated long term care needs -- but doing so in an attempt to defraud the Medicaid system will result in criminal penalties for both the individuals and their advisers who assist this activity. Individuals who rely on Medicaid also lose control over their choices of the services, providers and the care they may desire.

Another, more troubling challenge is that placed on the long term care system. Nursing homes are faced with a growing demand for their services and, with over 70 percent of their residents on Medicaid, their costs are rising faster than the reimbursements they receive from the Medicaid system. If things do not change, this is a story with a very sad ending.

Who should consider buying LTC?

The individuals with more than $200,000 in assets or with incomes they need to preserve for their survivors financial security should consider this form of protection. Individuals with low income or fewer assets will deplete their finances quickly and qualify for Medicaid when confronted with long term care expenses.

Individuals 45 or over should consider this coverage as an option to protect their financial assets from this possible risk. Even if they decide not to buy this insurance, it a good idea to review the issue as LTC insurance and their features are evolving.

Also, this periodic review reminds an individual that the risk of ineligibility at a future date is the main consequence to delaying this decision. According to the American Council of Life Insurance, the average age of individuals who buy LTC policies is now 53, down from 60 a few years ago.

Although the cost of this coverage is lower for younger individuals, it's difficult to make assumptions on the possibility of this risk, define sources of retirement incomes, pensions, Social Security, etc.

Since the risks of long term care are greater for women, couples should allocate more available resources towards the cost of the females policy. Of course, taking into account the family medical history and gauging who is more likely to need long term care is an important consideration for coverage priority.

Features and Costs

Long-term care insurance policies offer a myriad of features and options from which to choose. The trick to keeping cost as low as possible is to choose only the most important options and accept some risk up front. Here are my guidelines:

1. Daily benefit amount. If the cost of long term care in your local area is about $73,000 annually, you might be advised to buy a policy that provides this level of benefit, or $200 per day. Instead, you should reduce this amount by all retirement income sources, such as pension, social security and annuity income, that you are willing to use towards this cost (co-pay).
2. Waiting period. Long-term care policies can pay benefits immediately or pay after a waiting period. Choose to assume the first 90 days of cost of long term care and you can reduce the costs of this insurance. With a little planning, assuming this risk should not be a problem.
3. Benefit period. Since a third of all nursing home stays are for two or more years, it's important to choose a benefit period that provides benefits for at least two to six years.
4. Cover most likely risks. When purchasing this coverage on a couple, I'll recommend the full coverage and longer benefit period for the female, who is typically the individual most likely to live the longest. Women age 65 or older have a 50 percent chance of needing long term care versus 33 percent for men age 65 or older. The strategy is to cover the most likely risk and spend the least where this risk is less of a possibility. Couples often mistakenly believe they need to buy the same amount of coverage for each.
5. Married discount. Actuarial statistics show that the first spouse to need long term care is typically cared for in home by the second spouse, therefore claims are filed later, if at all. For this reason, insurance companies offer a discount on premiums for married couples. Some even offer this discount for any two applicants of the same generation who share living expenses.
6. Increasing benefits. It's important to ensure that policy benefits will rise over time because the actual costs of long-term care surely will. Most policies offer the option to purchase a 5 percent benefit increase that is factored into the policy premiums. If you are under 70 you should consider compound increases.
7. Services covered. Ensure that the definition of services covered includes skilled and custodial care, delivered in a skilled care facility or at home. Also it's important to include home care services, home health aides, respite care which relieves family care givers for periods of time as well as the costs of an assisted living facility.

Certified Financial Planner Ray Martin writes on personal finance for CBS.MarketWatch.com and also appears on "The Early Show" on CBS. He is co-author of "The Rookie's Guide to Money Management."

© CBS Martketwatch

Back to Articles