News & Views

1 April 2014

Care home fees: should you insure against living too long?

Annuities have become unpopular in recent years because of the ultra-low rates they pay and because – until the Chancellor’s Budget announcement earlier this month – most people were effectively forced to buy one with their pension savings.

Following the Budget, which abolishes any requirement to buy an annuity, most predict the sales of this form of insurance will decline.

But there is one area where annuities are increasingly popular, and that is as a way of paying for residential care.

So far this is a niche area where just a handful of insurers operate. The principle is that someone going into care pays a lump sum. In return, the insurer promises to pay an annual sum to the care home for as long as the annuitant lives there. There is an associated tax perk: provided the payment goes directly from the insurer to the care home, no tax is paid. Normally the proceeds of an annuity would be taxed at the annuitant’s rate of income tax.

As with all annuities, the policyholder is effectively gambling that they will live long enough for the exercise to be worthwhile. If the policyholder dies early on, the insurer wins. If, on the other hand, the policyholder lives for many years, they benefit most.

Care annuities are different from standard pension annuities in one other way. Because they are typically bought by older people – the average age of someone taking out one of these plans is 85 – their cost is based more on the annuitant’s individual health than on other, wider economic factors such as investment returns. By comparison investment return – particularly the yield on government bonds – is one of the biggest determinants of the price of ordinary annuities.
Because the majority of people going into care are very elderly, frail or in poor health, care annuities are generally far cheaper than pension annuities.

Care annuities, and how much they cost…

There are three main providers of care annuities: Partnership Assurance, Just Retirement and Friends Life. In most cases, policies are bought by the children of those going into care, or other trusted family members who have been granted power of attorney to act on their behalf.

Partnership Assurance said each policyholder was priced individually according to their health. “Most applicants will have had recent contact with their doctors or other clinicians and there will be good, up-to-date medical records,” said Nigel Barlow, a director at the firm. “So we are very unlikely to need anyone to undergo a medical.”

He said the average client aged 85 could expect to receive an annuity paying between 11pc and 20pc, based on their health. The income paid out by the policy would rise in line with general inflation.

Hence a £100,000 sum would buy inflation-linked yearly income of between £11,000 and £20,000, according to the annuitant’s health at the outset, paid free of tax directly to the care home.

Put it the other way around, if someone aged 85 going into a home wanted their annuity to meet yearly fees starting at £15,000 and then rising each year by the rate of inflation, they would pay between £78,000 and £111,000 for their policy, depending on their health.

If they were aged 90 on going into the home, with the same income requirements, they would spend considerably less – between £62,000 and £86,000.

Someone taking out a care annuity on the basis above, aged 85, would need to live for between five and seven years to “get their money’s worth”.

Someone aged 90, based on the lower cost of the annuity, would need to live between four and six years to achieve the same effect.

… and how that stacks up against the likely cost of care

It could be difficult to know how people going into residential care would respond to the move, said Mr Barlow. “There is a great variability of life expectancy in care. This is because people often go down very different paths. Some, on going into care, respond very positively to being looked after and properly fed and so on, and their health improves and enhances their lifespan. Others deteriorate as a result of the change, or were already in poor and ailing health, and so die quite soon.”
Other sources generally put the average time spent in residential care at two years, although this appears to be growing.

With residential care home fees now at an average of £600 per week – including accommodation, food and basic care but not any nursing – it would be reasonable to budget for a total bill of about £30,000 per year. The inflation applying to care home fees tends to outstrip wider inflation, and most specialist advisers recommend obtaining a policy in which the payout rises by more than wider inflation per year.

“In our experience, 5pc is nearer the real long-term inflation in care fees,” said Andrew Dixson-Smith of Eldercare Solutions, an independent advice firm specialising in care fees planning.

Mr Dixson-Smith helped Bill Harris, 87, buy a care fees annuity at the end of last year. Mr Harris, a retired director of an insurance business, had lived in Eltham, south-east London, for 40 years with his wife when last July the couple moved into a home. He explained: “My wife had been poorly for some time with limited mobility. Our home was no longer suitable, it had been modified to help care for her, but it was difficult.”

As part of preparing for the move Mr Harris, pictured left, had discussed financing with the home, which is part of the Sunrise group, and the issue of an annuity was raised. He said: “When we came here I thought my wife would live for a while and the last thing I wanted was any anxiety that the money would run out. I have four children and eight grandchildren and of course I wanted to leave them the house. But they said: ‘Do it.’ ”

Sadly, Mrs Harris died shortly after the move.

Mr Harris has no regrets about the annuity, however. “It makes up the difference between my income and the fees,” he said. “I still have other money set aside.”

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