What is a probability distribution (in simple terms) and how does PDRP Plus use probability distributions to express retiree future long-term care costs?
Simply, a probability distribution is a display of the different ranges of outcomes, along with the chance of each outcome occurring. For the simple example of a tossed coin, there are two outcomes, heads and tails. The chance of heads occurring is 50%, and the chance of tails occurring is 50%.
In PDRP Plus, the range of outcomes is based on the year by year long- term care costs of your client. There are literally millions of different possible outcomes, each with their own probability. PDRP Plus, through a rather complicated actuarial process, projects by year long-term care costs (referred to here as streams of costs). These streams of costs are present valued (the streams are discounted with interest to the projection start date) and these present values form the basis of the probability distributions. For example, there may be a 40% chance that there will be no long-term costs, a 50% chance that the present value of costs will be less than $15,000, and so on, up to a 99% chance that the present value of costs will be less than $1,010,000.
PDRP Plus provides streams of costs for both a single life as well as for a couple (a male and a female, or two males or two females). It is important to understand that the streams of costs for a couple are not the same as the sum of the streams of costs for each member of the couple. For example, the 80th percentile of stream of costs for the couple is not equal to the sum of the 80th percentile of the stream of costs for the first member of the couple plus the 80th percentile of the stream of costs for the second member of the couple. It will always be less.
Why are probabilty distributions necessary to properly analyze long-term care costs?
Long-term care costs can range from zero to well over a million dollars over the lifetime of a retiree client. This wide range of possible costs makes the analysis complicated. The only way to properly account for this is to compute the chances of these long-term care costs to be certain levels. So there may be, for a given client, a 45% chance that the client will incur no long term care costs, a 5% chance that the costs will be between $1 and $6,000, and so on, with a small chance that the costs will be between, for example, $1.2 million and $1.3 million. To plan for long-term care costs by assuming a more simplified cost structure (such as always assuming the client will incur a three year nursing home stay at age 85, for example), will lead to wrong conclusions about the chances of not outliving assets and spending strategies. Only PDRP Plus can properly compute long-term care probability distributions customized to client's life expectancy and health!