LTC Riders In VL Policies:
The Design Works For Retirement Planning
Long term care acceleration riders for life insurance contracts have been prominent features in the insurance landscape for several years now.
Their incorporation into variable life insurance contracts, particularly those originally purchased to provide supplemental life insurance coverage, offers such policies enhanced flexibility to meet lifetime needs.
This is especially attractive to financial distribution channels such as banks, wire houses and investment-oriented financial planners, given these channels focus on investments.
Further, incorporating LTC acceleration riders into life policies that are sold as alternatives to certificates of deposit has special value for bank channel distribution. It provides these channels with new opportunities to offer distinctive and needed coverages to their customers.
The riders offer buyers the ability to access potentially the entire death benefit value of their life insurance contract in case they become chronically ill.
Contrast that to the usual situation in supplemental retirement life insurance coverages, in which withdrawals or loans are limited to available cash values, not death benefits. However, if the insured suffers a chronic illness, the presence of the rider means the insured can receive the life policys entire death benefit, not just an amount equal to the cash value. Thus, the LTC rider provides a real expansion of the supplemental retirement benefit.
Now, lets assume that the insured becomes chronically ill. Recall that Section 7702B of the Internal Revenue Code defines the term “qualified long term contracts” and the requirements that must be met by such contracts.
Our interest here is the outcome. If the LTC rider meets the requirements, then payments made under it are also income tax-free. The benefit payment structure sets the monthly payment basis as a percentage (typically 2% or 4%) of the death benefit.
The actual payment can be the payment basis if the so-called per diem approach is used, or up to the payment basis if the reimbursement method is used. But if the per-diem method is used, care must be taken not to exceed the maximum allowable payment under Section 7702B that can be received income tax-free.
For a small extra charge, one can extend (typically doubling) the period of LTC coverage by using an extended benefit rider.
The supplemental retirement benefit payment, if structured properly, will not result in taxable income to the policy owner. This is, of course, true only in non-modified endowment contracts (non-MECs), which are contracts that pass the 7-pay test of Section 7702A of the Internal Revenue Code.
The sale is usually structured so that, when first taking distributions from the contract, the owner takes the money as withdrawals. Once the basis has been withdrawn, further distributions are taken as loans. In Internal Revenue Code parlance, such loans are not actually considered distributions in non-MECs; therefore, they will not result in taxable income.
The CD alternative has more typically than not been an MEC, not a non-MEC. In recent years, dual-product structures have been built that use a single purchase payment to fund a non-MEC life insurance contract. This feature is significant because lifetime distributions from the non-MEC are treated more favorably, as noted earlier.
Recent innovations in life insurance underwriting may have real applicability when LTC riders are also available. Streamlined underwriting techniques are enabling life insurance contracts to be issued quickly while maintaining strong performance characteristics. While the characteristics of LTC underwriting are certainly different from life insurance underwriting, the safeguards built into the streamlined underwriting for life insurance can be utilized for the LTC situation.
The significance of this package of design and underwriting considerations is this: Investment-oriented financial account reps and financial planners now have at their disposal a powerful retirement income package that expands in benefits when an insured becomes chronically ill. And, because the underwriting is streamlined for the entire package, they should be willing and eager to sell it.
Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies Inc., Bloomfield, Conn. E-mail him at [email protected].
Reproduced from National Underwriter Edition, April 16, 2004. Copyright 2004 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.