Best of Both Worlds 
Combining Annuity and Long-Term Care Products

With health care costs climbing and baby boomers beginning to reach their retirement years, insurers have understood the need for long-term care insurance for many years.  However, many have been reluctant to enter the market, citing, among other issues, slow sales of long-term care and difficulty pricing the product.  The Pension Protection Act of 2006 (PPA) may offer a means for insurers to address these concerns through combination products that include long-term care benefits with annuity products.

In the past, annuity writers have tried to assist with their customers’ long-term care needs by adding to their annuities a waiver of surrender charges in the case of a long-term care event.  While this was of some benefit, it provided only a minimal assistance in a long-term care event and at least a portion of withdrawn proceeds could be taxable as ordinary income. 

The PPA creates an opportunity to better provide such combination coverage, allowing favorable tax treatment for annuity products combined with long-term care insurance and expanding the availability of Section 1035 exchanges.   Effective January 1, 2010, the PPA will exclude from taxable income any charge against the cash value or an annuity contract made as payment for coverage under a qualified long-term care insurance contract that is either part of the annuity or a rider to the annuity1.   In addition, the PPA authorizes Section 1035 exchanges from life insurance policies, annuity contracts or qualified long-term care insurance contracts to qualified long-term care insurance contracts.  As a result, consumers may exchange their existing annuities, which do not have any long-term care insurance benefits, for annuities that do have such benefits. 

There are a number of ways to design an annuity product with true long-term care insurance benefits, and insurers continue to develop new product designs.  However, the most common combination annuity long-term care product takes a regular deduction from a deferred annuity’s account value to fund long-term care insurance.  If a long-term care insurance event occurs, the annuity will begin paying the account value, sometimes at a higher credited interest rate than that credited otherwise.  Once the account value is depleted, the separate long-term care insurance would be provided.

These combination products address two obstacles that commonly arise in long-term care sales - - consumers’ concerns that they are purchasing coverage they will never need and insurers’ pricing concerns.   If long-term care coverage is never needed, the annuitant still receives the income benefits of the annuity.  Annuity/long-term care combination product can provide long-term care coverage at a reduced cost because they minimize adverse selection by combining annuity consumers, who expect longer than average life spans with those at higher risk of disability, who would be more likely to seek out long-term care insurance.  The typical combination plan will also, in essence, provide an extended waiting period by depleting the annuity’s account value before providing the additional long-term care.

While annuity/long-term care insurance products address some of the obstacles that have kept insurers out of the long-term care market or otherwise minimized their involvement in the market, insurers who wish to sell such products will need to address new issues.   Probably the biggest of these concerns is producer education and licensing.  Long-term care insurance is a specialized product and specialized knowledge is needed to sell it.  Annuities, particularly variable or fixed indexed annuities, can also be complicated products.  Producers selling one product are not typically involved in selling the other and may be reluctant to begin doing so.   Insurers need to make sure that producers selling their combination products are licensed to sell both types of products and have the required education to sell both2.   Both annuities and long-term care insurance have disclosure, reporting and suitability requirements; when selling combination products, all of these requirements will need to be considered.  In addition, the PPA requires reporting of charges made against the cash value of an annuity contract, which are excludable from gross income.  Each individual identified in such report must receive a statement regarding such charges.

The PPA offers insurers great opportunity to enter into or expand their long-term care insurance business.   Careful consideration of the benefits and obstacles must be taken, and a certain financial commitment will need to be made.  This can be difficult in an economic climate where many insurers are cutting costs wherever possible.  However, the need for quality, cost-efficient long-term care insurance coverage is certainly growing and as January 1, 2010 draws nearer, we are likely to see an increase in annuity/long-term care combination products.  Insurers must begin looking at these products now if they are to be a part of this market.  

1The PPA provides for identical treatment for a charge against the cash surrender value of a life insurance contract; however, this treatment was recognized prior to PPA of 2006 and is not specifically addressed in this article.

2This includes the necessary long-term care partnership education requirements, in most of states that have adopted partnership plans.  Such requirements apply even  if the combination product is not a partnership plan.