Long-term care (LTC) insurance policies are, in my opinion, both a blessing and a curse. They’re a blessing because they can help cover critical, and expensive, care when a family might have no other financial options.

But they can also feel like a curse. That’s because of what many policyholders refer to as “the letter.” This is the renewal letter that policy owners receive each year. These letters provide a menu of renewal options, each of which offers some combination of premium increases or benefit cuts. But unlike most insurance policies, which might impose a modest, or at least manageable, increase each year, it’s not uncommon to see LTC premiums jump by 10%, 20% or more—sometimes much more.

As a result, the options in these letters generally range from unpalatable to unaffordable to downright depressing. And they are complicated. These letters often present a matrix of choices, with options along multiple dimensions, including:

• Cost
• Maximum daily benefit
• Inflation benefit
• Elimination period
• Benefit period
• Total lifetime benefit
• Cash payment to policyholder

Because there are so many variables, the renewal decision defies straightforward cost-benefit analysis, making it an agonizing annual dilemma for policyholders.

If you or a family member has one of these policies, how should you approach this decision? Before getting into the details, it’s important first to understand some background—in other words, why these letters are even necessary.

The fundamental problem in the LTC market isn’t hard to understand: When insurers created these products, they miscalculated and priced them far too low. There were three reasons for this:

• Healthcare costs have increased much faster than expected. Over the past twenty years, healthcare inflation has outpaced the overall inflation rate by almost one and a half percentage points per year. Compounded over time, the result has been a steep increase in the size of claims.
• Policyholders held on to policies much longer than expected. With a product like long-term care insurance, the most profitable customer is the one who pays premiums for a period of years then cancels before ever making a claim. LTC customers, however, didn’t cancel at nearly the expected rate. Genworth, the largest player in LTC, expected a lapse rate around 5%. But the actual rate has been an order of magnitude lower—just 0.7%.
• Interest rates have been much lower than expected. Since insurance companies invest a large part of the premiums they receive in bonds, this has been an increasing problem. In fact, the timing couldn’t have been worse. Interest rates have, more or less, been coming down since the early-1980s, which is precisely when LTC policies started to become popular. More than any other kind of insurance, this has been a problem for long-term care because these policies are intended to be lifetime commitments, and yet the longest term bond is just 30 years. So insurers weren’t able to fully protect themselves by matching assets and liabilities, as they normally do.

The result has been a disaster for insurers. Genworth alone has incurred billions in losses on its LTC business. Losses there have averaged $425 million per year in recent years. To stop the bleeding, insurers are doing everything they can to fix the pricing on these policies. That explains the sometimes brutal renewal terms.

As a consumer, if you’re on the receiving end of a renewal letter, how should you approach the decision? Here are three recommendations:

• Hold the line on benefits. All things being equal, a cut to benefits is more profitable to an insurer than an increase in premiums. That’s because claims can come in at any time. But premium increases are received only incrementally over time in the future. So an insurer would much rather that you accept a reduction in benefits. As a consumer, then, this should be the last thing you do. If you can afford it, pay to retain your policy’s current maximum daily benefit.
• Take it one year at a time. Many renewal letters will include language along the lines of: “Please be aware that over the next X years, we intend to seek additional rate increases…” and they’ll often include a staggeringly high number. The operative words here, though, are “intend to seek.” The reality is that rate increases must be approved by each state’s commissioner of insurance. And they hardly approve every increase that’s requested. The job of an insurance regulator is to achieve a delicate balance: They want to protect consumers from rising rates. But if they squeeze insurers too much, they’ll become insolvent. So the rate increases that your insurer seeks may not fully materialize. In other words, don’t let the prospect of future increases scare you into dropping your policy. Instead, take it year by year.
• Read between the lines. Some letters will offer buyouts—literally paying a policyholder to cancel coverage, or to reduce benefits to a level that is akin to canceling. I once saw a renewal letter that proposed cutting the total lifetime benefit of a policy to less than $5,000 in exchange for an up-front payment to the policyholder. It was an absurd option, but it was also very telling. If your insurance company’s actuaries are so eager to have you cancel, that likely means you’re getting the better end of the deal. The logical conclusion: In cases like this, you’re better off not accepting a buyout. If you can afford to keep up with the premiums, stick with it.

The key thing to understand here is that insurance companies have, in effect, been providing subsidies for years to LTC policyholders. And the fact that insurers are still taking losses on these policies tells you that these subsidies haven’t fully gone away. That’s thanks to regulators, who have been keeping a lid on price increases. If you’re a policyholder on the receiving end of a renewal letter, the increases probably seem jarring—and they are. But as aggravating as these increases are, the fact that insurers are still taking losses tells you that you, as a policyholder, are still getting the better end of the bargain. So just take these letters one year at a time.