Sales of long-term care annuities, a kind of insurance against long-term care, have been declining this year. But industry watchers expect that trend to reverse in 2010, when new federal rules kick in. Starting next January, no federal income tax will be due on the proceeds of up to two to three times an annuity’s account value if used to pay for long-term care, thanks to the Pension Protection Act of 2006.
“The message in favor of combination plans is simple, and to many buyers more compelling,” says Carl Friedrich, Milliman consulting actuary and principal. “There are potentially significant tax advantages to the pay out of annuity values, including gains in those contracts, as tax-free long-term care benefits, as allowed under the Pension Protection Act of 2006. In addition, people don’t like the idea of paying level premiums into a standalone long-term care insurance policy and never getting money out of the contract if they don’t need long-term care.”
Estimated sales of combination life and single premium annuity combination plan long-term care products tallied $660 million at year-end 2008 for first-year premiums, according to Milliman, Seattle. This compares with $600 million in new first-year premiums of mostly annual premium standalone long-term care insurance. Overall, long-term care sales dropped 32 percent in the first quarter of 2009 and 24 percent in the fourth quarter of 2008, according to LIMRA, Windsor, Conn. Karen Fisherkeller, LIMRA associate analyst, cites the recession, rate increases, insurance company rating downgrades and consumer resistance to long-term care planning, in general.
Long-term care, largely uncovered by Medicare, refers to medical and non-medical care for those with a chronic illness or disability. It covers support services for things like dressing, bathing, and using the bathroom at home, in the community, in assisted living or in nursing homes. But a single-premium fixed annuity with a long-term care rider may cost less than a standalone long-term care policy. Plus, if policyholders don’t ever need to tap their policy, at least they still can tap the annuity’s cash.
Major insurers issuing combination annuity-long-term care products include Genworth, John Hancock, United of Omaha, Conseco, StateLife/One America and Guarantee Income Life. Allianz Life also may launch a combination product, a company spokesperson says.
Long-term care insurance in general is not an easy sale. But the risks it protects against are rising. Today, the average cost of a nursing home is almost $80,000 annually. And inflation was expected to drive it into the six figures in years to come. The number of older people is expected to increase dramatically from 2010 to 2030. Meanwhile, the lifetime probability of becoming disabled in at least two activities of daily living or being cognitively impaired is 68 percent for people age 65 and older, according to a report by the American Association of Long-Term Care Insurance.
“There are roughly 140 million people over the age of 40 and less than 10 million have long-term care,” says Terence Holahan, assistant director of long-term care at Northwestern Long Term Care Insurance Co, Milwaukee. “It is a large unfunded open liability.”
Milliman’s Friedrich says there are several policy designs used to pay benefits. Typically it works this way: The policyholder invests a lump sum in an annuity with a long-term care insurance rider. The annuity pays a rate of interest set by the company, reduced by charges related to the cost of the long-term care rider. Maximum monthly long-term care benefits are equal to the account value at the start of the claim, times a percentage. If long-term care is needed, benefits are paid out first as accelerated benefits, ranging from 1 percent to 6 percent per month, until the money in the annuity is exhausted. Then, the long-term care benefit extension kicks in, continuing the long-term care insurance payments at the same monthly level for a specified period, often ranging from 25 to 50 months.
Policies issued, for example, by Genworth, John Hancock and United Omaha Life Insurance Company pay out two-to-three times the account value for long-term care for up to six years. So, for example, a client who invested $100,000 in a fixed annuity that grew to $150,000 by the time a LTC claim occurred could get $300,000 to $450,000 of long-term care coverage, .
There is typically a two-year waiting period from the time the annuity is purchased before benefits can be activated and a 90-day “elimination period” once a claim is filed. The policies also come with optional inflation protection riders.
If long-term care is ultimately not necessary, the client often has three choices: He or she can continue earning tax-deferred interest on the annuity; withdraw the cash and pay income tax on the proceeds; or annuitize the contract for guaranteed lifetime income.
On average, policyholders pay between 40 and 125 basis points annually for a long-term care rider. In addition, underwriting generally is simpler than with a standalone long-term care policy. The hybrid annuity-long-term care product may appeal to those ranging in age from 55 to 75 with at least $300,000 in investable assets.
“Premiums on standalone products have increased,” says Milliman’s Friedrich. “As a result, the standalone product is unaffordable for many who would benefit from long-term care insurance. Combination plans offer the possibility of accessing base plan values on a tax-preferred basis to cover the first layer of long-term care costs on a low cost basis, coupled with the continuation of coverage to address the comprehensive long-term care need efficiently.”
The Pension Protection Act, Friedrich notes, also permits policyholders of existing annuities to do 1035 exchanges into combination policies. There is a market of $750 billion in nonqualified annuity contracts, much of which could potentially be 1035-exchanged into annuity-long-term care products, the Milliman report says.
Not all combination products are alike. Annuity interest rates, the cost of the riders and the methods used to determine long-term care claims payouts vary. Those in poor health who may not qualify for standalone long-term care coverage may be able to get coverage through a hybrid annuity-long-term care product, says Holahan of Northwestern Mutual. That’s due to less stringent underwriting on the hybrid products.
However, he adds that the hybrid product, with benefits continuing only for a specified number of years, generally does not protect against a long-term catastrophe. “We feel long-term care insurance is more flexible and a pure play against risk,” he says.
Lydia Young, director of insurance services with the Barry Financial Group, Boca Raton, Fla., says she doesn’t recommend the annuity-long-term care product to affluent clients because the amount of coverage is insufficient.
The cost of the long-term care rider also reduces the annuity’s tax-deferred income stream.
“We use long-term care insurance as part of an estate plan or business plan,” she says. Long-term care annuities “may be a good approach for some people who can’t afford long-term care insurance. But we want comprehensive lifetime long-term care coverage that increases with the cost of living.”
Regardless of whether your client buys a hybrid annuity-long-term care policy or a standalone long-term care policy, the coverage is only as good as the financial strength of the insurance company. The strongest are rate A to A++ by A.M. Best.