Rich people pass on wealth to their children; poor people don’t. And increasingly, middle-class people don’t either. We know that this lack of inheritance in the middle and lower ends is a significant force behind rising income inequality over the last 30 years. Much of the “extraction” of net worth from middle-class families happens in the last years of their lives through cash transfers into the American “eldercare” system. Wealth that could have been passed on to surviving children instead goes to nursing homes and other healthcare that services older Americans.
And like healthcare costs in general, a review of several European countries indicates that it does not have to be that way. The wealth of older middle-class adults in the Nordic countries especially is more protected from this “economic vacuum cleaner.” Just as in the larger issue of healthcare costs, the middle class of America passes their relatively modest wealth on, not to their children, but into a vortex of “eldercare” costs. Each new generation, then, starts off adulthood at negative net worth after college costs (another problem that the Europeans have managed to avoid at the American levels) with no family wealth base on which to build.
Money is choice, and upper-middle-class Americans have multiple economic choices for protecting their estates from the high costs of their final years. For many lower-middle-class families, what little wealth that they do have is locked up in their home, which is an undiversified, illiquid asset. With little free cash available to pay medical bills, this is when Tom Selleck and the “reverse mortgage” industry comes knocking on your door. In-between these wealth mileposts are millions of middle-class families who often see whatever cash savings and retirement accounts that they have spent a lifetime tucking away depleted when one or both elderly family members requires long-term care.
Nailing down the extent of this transfer of wealth requires an economic analysis going well beyond this post, but let’s throw out some numbers to act as a starting point. Substitute your own, if you wish, and see where your numbers take you.
If you are turning 65 this year, you will have a 50-70% chance of needing some type of long term care before you die. The AARP estimates that, on average, those paying for this out-of-pocket will spend an average of $140,000. Of those who do enter long term care, 13% will need it for more than five years, which is financially devastating for anyone without substantial long-term care insurance. The average nursing home stay, the big cash-sucking side of long-term care, is over 800 days, and those costs can easily top $90,000 per year (or more for a private room).
There are about 1.5 million people in nursing homes in the U.S. at any given time. You can add hundreds of thousands more in various levels of “assisted living” arrangements. However, the large majority of seniors do not have any long-term care insurance, and traditional policies have been getting more difficult to get.
This makes that “consumer-financed” part of the nursing home cashflow worth about $135 billion per year, which gives some notion of the extent of wealth being vacuumed out of the estates of middle-class families.
Medicare Part A pays outright only for the first 20 days of skilled nursing care for seniors. For the next eighty days, there is a $176 daily co-payment required (or over $14,000 for that 80 days). Most Medicare Part B and Part C (Medicare Advantage) plans pay at least a part of this “coinsurance,” but some do not. And beyond that point you are usually on your own.
Long-term care (LTC) insurance has been available to help pay part of those costs beyond 100 days, but it has become increasing unaffordable or even unavailable to many seniors. John Hancock, historically one of the largest LTC insurers, exited the market in 2016 as the product became less and less affordable. Their reasons for leaving were “interesting” to say the least:
Rising claims, low mortality and lower than expected lapses have led to higher prices on many long-term care policies…Most insurers’ LTCi policies issued before the mid-2000s were priced too low, leading to dozens of long-term care companies abandoning the market. Companies that remained have been raising premiums on their in-force blocks and on new policies. (InsuranceNewsNet.com)
In other words, seniors are living too long and are not letting their policies lapse after paying into them for many years, which would allow the insurer to keep your money. And as long-term care costs rise, insurers put the squeeze as often as annually on policyholders. Pay a higher premium, they threaten, or there may not be enough money in your policy to pay the bills when the time comes. (Disclaimer: I am a long-time John Hancock customer with an ever-increasing premium bill.)
Because of that lack of availability and affordability, the percentage of people covered by these policies has continued to drop. Forbes has reported that by 2014, only 5% of adults aged 55-60 were covered by LTC insurance, and the number is certainly no higher today.
Some newer insurance options have opened up, but they are more tailored to the upper-middle-class market. You may be able to purchase a life insurance policy, for instance, that pays out either in a death benefit or in long-term care in various forms. But, of course, that gets actuarially much more expensive the older you get. One option is to convert an IRA into an annuity that pays the cost of the insurance policy, but that option basically eats up your IRA. The older you are when you hand over your IRA, the less coverage in excess of the IRA value you will get.
However, as someone who know the “probability math” well, I personally would not leave myself nor my spouse without LTC insurance coverage. The odds of needing it are high and the daily costs get that vacuum cleaner going at high speed.
Reverse mortgages (technically called “home equity conversion mortgages” or HECM) have grown to become a $7 billion business annually, dominated by American Advisors Group (AAG), the company behind the Tom Selleck pitches. This option is primarily focused on lower-middle-class seniors who own their homes but who have insufficient other liquid net worth or income. More than half of U.S. households have a net worth of less than $140,000, and much of that is often locked up in illiquid home equity.
AAG’s current advertisements, which run incessantly on the channels I watch (they obviously know my demographic), feature Selleck trying to frankly address the reputation problem plaguing the industry. The basic problem here is that it is primarily desperate seniors with insufficient liquid savings who resort to reverse mortgages, often because one of the homeowners has entered long-term care. This situation just rarely ends well. You don’t take out a reverse mortgage to go travel the world.
Medicaid, funded by a combination of federal and state funds, pays the costs for a minimal level of long-term nursing home care, but in order to qualify, you must have “spent down” most of your assets. Between state and federal spending, Medicaid expenditures for long term care annually top $119 billion per year.
While much of Medicaid goes for seniors who had little net worth to begin with, a significant portion is also spent on people who had assets, but who have “spent them down” to the $2000-$3000 minimum to qualify. In other words, if there were home equity or savings, it has likely already been “extracted” by the healthcare system by the time these seniors are resorting to Medicaid to pay the bills.
Aggregation and private equity ownership
Numerous small operators of nursing homes have found that managing these cashflows, especially if you are Medicaid-dependent, has been a failing business model. For providers who manage these cashflows correctly, however, and constrain operating costs (often through aggressive cost-cutting), the nursing home business can become a reliable “cash cow,” ripe for aggregation into large chains, as well as private equity (PE) ownership. Private equity ownership now encompasses an estimated 11% of nursing homes, with $5.3 billion invested since 2015.
Barrons recently featured one such PE-financed chain that has quickly ramped up to over 100 facilities, mostly at the Medicaid-dependent lower-end:
“Portopiccolo’s nursing-home strategy is a turbocharged version of a standard industry playbook, researchers and industry experts say. The firm often buys lower-quality facilities, which can be had at a discounted price, with an eye toward making renovations that can help boost overall occupancy and attract more-profitable short-term rehab patients whose stays will be covered by Medicare rather than the lower Medicaid reimbursements that generally cover long-term residents.”
The private equity business model adds several unique opportunities for profit, but at an institutional cost. A recent study reported that PE-owned facilities have shown a 10% higher fatality rate from Covid-19 than their competitors, perhaps due to cost squeezes in day-to-day operations.
The Covid crisis has put the lives of both residents and front-line staff (often poorly paid) across the country at a very high risk of infection and death. In one Florida county, 70% of the reported Covid deaths have been in nursing homes. As the Barron’s article notes:
“…Portopiccolo also stands to profit when its facilities enter into management contracts or other deals with entities that are also owned by the facilities’ parent company. While legal, these related-party transactions allow nursing-home owners to “spirit the money out” of their facilities, leaving the nursing homes with less cash for direct-care staffing…”
Other aggregation models have also arisen. The old religion-affiliated healthcare model has evolved into large, nominally non-profit businesses where management (but often not staff) make a lot of money. Forty-four Iowa nursing homes have been aggregated in recent years under one non-profit entity that reported $194 million in revenue in 2018, and paid their CEO a handsome $670,000 in salary and benefits.
The huge cashflows driving this “cash cow” business model come mostly from (1) government reimbursements, (2) the savings of middle-class older Americans and, to a lesser extent, (3) the LTC insurance companies.
Okay then, what is the solution to this drain on middle-class wealth? Just as in the conventional healthcare side of this, Americans are loath to look overseas, having preconceived ideas as to what these countries do. And their approach, of course, must be wrong. Part Two of this series, which has now been posted, takes a look at some options for getting to greater societal equity in the provision of American eldercare.
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