Yes, Even Low Inflation Matters

Nearly every day for the first two years of my banking career, from 1987-1989, I bought a Tampa specialty, a Cuban sandwich, for lunch. I remember being annoyed when the price increased from $1.99 to $2.49 in 1988.

Last year, the little cafe in my office building had a sign – “Cuban sandwiches are back! $6.99.”

$6.99! This means Cuban sandwich inflation for the last 30 years has averaged 2.45%, and the price has more than tripled.

Inflation and Long-Term Care Costs

My mom and I recently reviewed her long term care insurance. She received a letter from the insurance company giving her options of whether to pay a higher premium and accept an increase in the daily benefit, or keep the benefit and the premium the same. This is fairly common with long term care policies and, ever since she bought the policy in 1999, when given the choice, she has elected to pay the higher premium to raise the daily benefit.

In 1999, the policy came with a lifetime benefit cap of $182,000 and a daily benefit cap (for care in a facility) of $99.67. Because she has agreed to increases all along, she now has a lifetime benefit cap of $489,000 and a daily facility benefit of $267.79. The average daily cost for a nursing facility is now $250. In 1999 it was $112. ​That’s an average inflation rate of 3.3% over the past 18 years.

Yes, inflation matters, even when it has been at historic lows since 1999.

My mom was 59 years old when she bought this policy. She benefitted from many years of static premiums, while the daily benefit continued to increase anyway.

Nowadays I meet with Baby Boomers trying to make the decision about whether to buy long term care insurance. But I have to remind them that our brains don’t calculate compound inflation rates very well. Right now it costs $250/day for a facility. Inflation is low, at about 2%. Annual premiums for long term care have indeed risen – a 59-year-old woman with standard underwriting might pay as much as $9,000 or $10,000 per year now for a lifetime cap of $456,500 ($250/day x 5 years maximum).

Kahneman and Oversimplification

For most non-math-oriented people, as documented by Daniel Kahneman in Thinking: Fast and Slow​, when a math problem is too complex, such as in compounding inflation rates, our brains substitute a simpler math problem and use that answer. So the normal answer in our heads to a question about compound interest is to substitute simple interest and add on a guess.

Without looking or calculating, make your best guess: “What does $456,500 compounded at 3% inflation grow to in 20 years?”

In the financial planner’s office, thinking about long term care insurance, the answers tend to be on the smaller side.

Here are a few figures:

$456,500 in 2017, age 59, at 3% inflation for 20 years = $824,490 at age 79

$456,500 in 2017, age 59, at 4% inflation for 20 years = $1,000,248 at age 79

$456,500 in 2017, age 59, at 5% inflation for 20 years = $1,211,230 at age 79

Yes, today you might be buying $456,500 of long term care coverage. But, in 20 years, if you keep paying premiums, chances are you will be paying for $1,000,000 in coverage. And it will only buy what $456,500 buys today.

Inflation isn’t that high right now, but that doesn’t mean it can be ignored all together in your financial plan. Make sure all of your assumptions – whether it’s insurance coverage, or the cost of your favorite lunch, include inflation.

Holly Donaldson

Holly Donaldson, CFP® runs an hourly and fee-for-service financial planning practice virtually from her Tampa Bay, Florida office. She also works with clients throughout the U.S. (except Texas) interested in retirement and tax planning advice without product sales or investment management. Holly is the author of The Mindful Money Mentality: How to Find Balance in Your Financial Future (Porchview Publishing, 2013) and publisher of the award-winning monthly e-letter, "The View From the Porch."

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