Critical Illness Insurance

Critical illness policies were introduced in the United States in the mid-1990’s and pay a lump-sum upon diagnosis of one of a dozen or so conditions including Alzheimer’s (for people who need help with three or more activities of daily living and require permanent daily supervision as diagnosed by a board-certified neurologist), multiple sclerosis, heart attack, stroke when effects of the neurological injury last for at least 30 days, life threatening cancer (malignant and growing uncontrollably outside its original location) major organ transplant, paralysis, kidney failure requiring dialysis, blindness, deafness, and perhaps severe burns. Some policies even pay if you need help with three or more activities of daily living for at least 90 days, even if you don’t have Alzheimer’s. Some policies have a return of premium benefit, which means the premium will be returned to a beneficiary less any benefits paid out if the policyholder dies without receiving all of the benefits.

A partial benefit, perhaps 25%, is paid for conditions such as malignant cancer in one location, heart angioplasty and heart bypass surgery.

You may be charged a higher premium if one or more of your immediate family members (parents and siblings) have had any of these conditions.

Common issue ages are 20-64 but you can keep the policy as long as you live. However,
benefits usually reduce to 50% at age 65 or five years after the effective date if you were older than 60 when you purchased the policy.

The lump-sum benefit can be anywhere from $25,000 to $1,000,000, depending on how much you purchase when you buy the policy. One company recommends 3-5 times annual salary for employed people plus any outstanding mortgage balance.

Critical illness policies can be standalone or some are sold as a rider on a life insurance policy or annuity. If sold in the workplace, there may be only a few medical questions in order to qualify.

The lump-sum benefit of a critical illness policy can be used to cover the miscellaneous expenses connected to a major illness such as:

• insurance deductibles and co-pays
• travel expenses such as meals, lodging and airfare to seek additional medical treatment
• experimental treatment and/or drugs
• treatment outside of a managed care network
• child care or elder care
• salary replacement for time away from work
• household help like cooking, cleaning and laundry
• home modifications
• mortgage payments and other debts

The point is, the lump-sum benefit of a critical illness policy is a cash benefit that that can be used for anything.

Critical Illness Insurance vs. Long-Term Care Insurance

Can critical illness coverage be an alternative payment option for long-term care? Possibly, especially if you are not able to qualify for long-term care insurance and you are able to get a critical illness policy through your employer with simplified underwriting, which means just a few medical questions.

What are the pitfalls?

1. Access to benefits is tougher as even Alzheimer’s patients would have to need help with at least three activities of daily living. Long-term care insurance policies require help with only two ADL’s and there is no ADL requirement for an Alzheimer’s patient.
2. The critical illness benefit is a lump-sum cash benefit which can bring a strong temptation to spend it for things other than long-term care services.
3. A lump-sum cash benefit may be difficult to budget so that it lasts throughout a long-term condition – you might remember from Chapter One that the average lifespan of an Alzheimer’s patient is eight years but can be 3 – 20.
4. Benefits reduce at age 65, and a long-term care insurance policy is sometimes most needed at older ages.
5. $1,000,000 benefit will pay about three years of care in 30 years, and that may not be enough long-term care coverage for someone purchasing a critical illness policy at age 50 or younger.

A big pitfall is that the taxation of benefits is unclear since critical illness coverage was not addressed in the Health Insurance Portability and Accountability Act of 1996 (HIPAA). This means that critical illness policies fall in the same category as non-qualified long-term care insurance policies – the IRS could decide to tax the benefits at some point.

On the positive side, critical illness can be relatively inexpensive at younger ages, especially if it a rider on a life insurance policy, and the benefit would be invaluable if long-term care is needed at a young age. At any age, critical illness makes a good supplement to long-term care insurance as the money can be used for any need.

The above article is an excerpt from Long-Term Care: Your Financial Planning Guide, Kensington Books, 2003, by Phyllis Shelton, President of LTC Consultants, a Nashville, TN firm that provides live and web-based training and marketing materials for the long-term care insurance industry. She can be reached at information@ltcconsultants.com.