The sale of traditional long-term care insurance (LTCi) has retreated significantly since 2002. According to the U.S. Department of Health and Human Services, LTCi sales hit a record high of $1.2 billion of new premium in 2002. Also that year, 754,000 lives were written through 104 carriers.
Fast-forward 10 years to 2012 and the total LTCi premium production dropped from $1.2 billion to $580 million. The number of lives written decreased from 754,000 to 233,000, and the number of companies that issued LTCi dropped from 104 to a meager 21. LIMRA pointed out that LTCi sales pulled back an additional 30 percent in 2013 alone.
Despite the fact that the number of maturing Americans needing this valuable coverage is increasing at an unprecedented rate, the number of LTCi sales has steadily declined since the 2002 high-water mark. Iconic insurance companies who offered LTCi in the past — MetLife, Prudential, Allianz and Unum, just to mention a few — began to withdraw their products starting as far back as 2009.
Meanwhile, boomers are reaching retirement age at the rate of 10,000 a day and many will face the high cost of care at some point. The Affordable Care Act, while trying to address some of the problems with our health care system, does not address the growing long-term care crisis in the U.S. The costs of nursing home care, as well as home health care, are soaring. Today, the average cost of a one-year stay in a private nursing home room tops $91,000.
This chart shows the cost of home health care, assisted living care and skilled nursing care at the end of 2013 and projected to the year 2028 using a 4 percent inflation rate. In all three cases, the cost of care would nearly double during that 15-year period.
Genworth pointed out in its Cost of Care Survey: “Research shows that at least 70 percent of people over 65 will need long-term care services and support at some point in their lifetime. Long-term care can impact people and families in many different ways including finances, careers, lifestyles and state of mind.”
Will annuity-based LTC policies save the day? To answer that question we must first examine some of the reasons why traditional LTCi sales have declined:
Pricing issues and premium increases — There were some miscalculations early on in the developmental stages of traditional LTCi. The lapse rate assumptions were higher than the actual lapse experience. The assumption that a large percentage of LTCi policyowners would decide to stop paying their premiums equated to lower claims expectations. This did not turn out to be the case. As unexpected claims grew, the carriers were forced to increase premiums to offset claims. Common rate increases have been in the 50-100 percent range. As a result, many potential LTCi buyers are unable to afford the current cost of the coverage and fear the rates will go even higher.
The use-it-or-lose-it proposition — Many potential buyers have a tough time getting past the mindset that if they don’t use their LTCi benefits, they lose their premium payments. So instead of buying LTCi, they choose to self-insure, putting their retirement savings at risk.
Tight underwriting — When insurers can’t get needed premium rate increases approved to offset their claims liability, they are left with the choices of exiting the LTCi arena or cherry-picking their insureds. Applicants who may have easily qualified for LTCi 10 years ago may find it difficult to pass muster in the underwriting department today.
Low interest rates — With all of these challenges facing LTCi carriers, the current low-interest-rate environment was the final nail in the coffin for some. Low yields on investments equate to lost profit to insurance companies.
In 1999, one insurance company saw the opportunity early on and introduced the first annuity-based qualified long-term care solution available for independent agents to offer their clients. This is a guaranteed tax-deferred annuity that also provides tax-qualified long-term care coverage. The long-term care coverage is equal to three times the annuity value at a fraction of the cost of traditional LTCi. The long-term care premiums are deducted from the annuity’s value, so there are no large out-of-pocket premiums.
Annuity-based LTC products can protect policyholders’ assets from the high cost of care. The owner maintains control of the asset and may receive up to three times the annuity value, tax-free, to cover the cost of care. If the asset is not needed for care, the full value plus net interest can be passed on to the heirs.
Because annuity-based LTC provides all of these benefits with no out-of-pocket premiums, it is an attractive alternative to traditional LTCi.
The concept is simple: If clients deposit $100,000 into this annuity, they will have $300,000 to pay for LTC expenses, tax-free. The annuity-based LTC concept addresses all four of the issues currently facing traditional long-term care insurers.
Annuity-based LTCi requires no out-of-pocket premiums, so those who are on a tight budget can simply reposition an underperforming asset or an asset at risk in order to leverage the protection they need.
The use-it-or-lose-it proposition found in traditional LTCi is changed to benefits if you need them or your annuity value plus net interest back if you don’t. This changes the consumer’s mindset about paying large premiums for benefits they may never use.
Because the annuity value is used to pay benefits first, there is reduced claim exposure so underwriting has not tightened. Annuity-based LTCi providers have taken a simplified underwriting approach — some requiring only an interview by a registered nurse. This approach eliminates physicals, blood draws, attending physician statements, medical records and all of the obstacles that add unwanted time to the underwriting process.
The premium for the long-term care riders for annuity-based LTCi are significantly lower than the cost of traditional LTCi, so even at these current low interest rates the interest credited, at most ages, is greater than the cost of the rider. This creates a scenario in which the annuity value continues to grow due to the additions of net interest that are credited to the annuity value. Best of all, if the long-term care rider is not used, the full annuity value plus net interest is passed on to the heirs.
Annuity-based LTC has some unique tax advantages. As of Jan. 1, 2010, under The Pension Protection Act of 2006, the annuity value used to pay for the long-term care rider no longer is taxed. This piece of legislation created an important change in the hybrid tax landscape. Hybrid products now offer tax-free rider premiums, tax-deferred growth and tax-free long-term care benefits.
Another tax advantage of annuity-based LTC is the potential to eliminate the tax on a tax-deferred annuity. According to LIMRA, about $1.8 trillion of nonqualified annuities were in force at the end of 2013. A significant portion of annuities on the books today is difficult to reposition due to lifetime minimum crediting rates of 3 percent and higher. This is where the suitability question comes into play. Is it a suitable transaction to reposition an annuity with a high guaranteed rate and no surrender period to an annuity with a lower guaranteed rate while the owner will be stuck with a new surrender period? For some annuity owners, the answer may be yes. If the current annuity is transferred via a 1035 exchange to annuity-based LTC that triples in value to cover long-term care expenses, the owner will enjoy the benefits of owning LTCi with no out-of-pocket LTCi premiums.
In addition to solving the annuitants’ long-term care funding problems, annuity- based LTC offers a substantial tax advantage for some policyholders. The chart below uses an example of an annuity with a current value of $100,000 and a cost basis of $50,000. At some point, the tax on the gain ($50,000) will need to be paid. If the owner repositions that annuity to annuity-based LTC and uses the tax-free long-term care benefits, the tax on the gain can be eliminated.
The concept of annuity-based LTC is catching on with traditional long-term care insurers and agents. Some traditional LTCi carriers are developing new products to address the current challenges in that marketplace. Shorter benefit periods, longer waiting periods and fewer “Cadillac” plans are among the changes we have seen recently. Traditional LTCi may still be the best solution for many of your clients, but for those who have reduced retirement incomes and have done a good job building their savings, annuity-based LTC may be a viable alternative.
Premium increases, tight underwriting and lack of consumer interest have led many advisors to throw in the towel rather than offer LTCi to their clients. Offering alternatives to traditional LTCi will change the landscape for both advisors and their clients.