Chelsea K. Bachrach
The marketplace is showing increasing interest in a hybrid product that consists of long term care insurance and an annuity (LTC-Annuity products).
Although this idea has been around for a while, insurers are beginning to take more notice of the efficiencies such products provide–both to policyholders and insurers–in comparison to their separately purchased stand-alone counterparts.
One indication of the level of interest in the products is the fact that, in June, the U.S. Treasury Department and the Department of Health and Human Services sponsored a forum in Washington, D.C., on LTC-Annuities. This meeting drew representatives of not only Treasury and HHS but also other federal agencies, the National Association of Insurance Commissioners, other state officials, governmental policy organizations (The Urban Institute, AARP, etc.), and insurance companies.
So, just what are these products all about? Their advantages are reminiscent of those in life insurance contracts that are combined with “acceleration” LTC riders.
In the life policies, economies are generated because the insurer can support two risks–premature death and LTC need–with one pot of money. Since insurance benefits are paid when the first risk is realized, the cost to the insurer of providing the LTC coverage is simply the time value money cost of paying all or part of the death benefit prior to the insureds death.
Similarly, with a LTC-Annuity, the structure is a combination of LTC insurance and a single premium immediate annuity. The advantages of this design stem primarily from the fact that the two risks being covered–longevity and the need for LTC services–are inversely related. Individuals needing LTC services generally will have shorter life expectancies than similarly aged people who do not require such services.
Because of the complementary nature of the risks associated with life-dependent immediate annuities and LTC insurance, a single insured is unlikely to require the full insurance “value” associated with both products–i.e., he or she is unlikely to experience an extended period of LTC need and then live to a very old age.
In effect, an insurer can “hedge” one type of risk with the other, and therefore the cost to provide the hybrid product is less than if the two products were purchased separately.
A related factor can significantly reduce the cost of LTC-Annuities over their separately purchased stand-alone counterparts. The fact is that such products are inherently less susceptible to adverse selection. An individual expecting to need LTC services (but who nonetheless may pass underwriting) soon is unlikely to purchase a combination product, since the part of the premium that purchases a life-dependent immediate annuity would not provide the expected return that it would for a healthy individual.
The practical consequence is that insurers may need less underwriting for LTC-Annuities than would otherwise be the case. Also, and perhaps more important from a policy perspective, if a person would be uninsurable for a LTC-only product, the insurer might be willing to issue a LTC-Annuity since the consequence of adverse selection is also less to the insurer.
Thus, a higher percentage of the elderly population may be insurable under LTC-Annuity products than under stand-alone products.
A LTC-Annuity product may also be structured as a combination of LTC insurance and a deferred annuity. Here, the payment of LTC benefits may reduce the annuity account value by part of the benefit payment, with the remainder of the payment coming from net amount at risk.
Given this relationship, similar efficiencies with respect to adverse selection and underwriting may apply to these LTC-Deferred Annuity products. If a person expected to enter a nursing home soon, he or she would prefer a stand-alone LTC policy (assuming underwriting could be met), since all benefit payments would come from net amount at risk.
Some questions exist regarding the proper tax treatment of LTC-Annuity products. (See chart.)
To address these and other concerns, Treasury representatives at the June forum had a suggestion for the industry: Become the impetus to spur any requisite legislative or regulatory action.
In fact, they said they would welcome views from the industry on what could be done under current law, under any of the Administrations proposals in this area, or changes to existing tax laws that would aid in making LTC-Annuity products more attractive. Information on the target market for these products would also be helpful.
Craig Springfield is a partner, and Chelsea Bachrach is an associate, with Davis & Harman llp, Washington, D.C. Their e-mails are email@example.com and firstname.lastname@example.org.
Reproduced from National Underwriter Life & Health/Financial Services Edition, September 2, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.