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Annuity-LTC Combos Would Get Legs From House Legislation

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The House of Representatives passed pension reform legislation on Dec. 15, 2005, that contains clarifications and enhancements for combination insurance products providing long term care insurance coverage, including LTC insurance provided as part of an annuity contract.

The Senate already has passed pension legislation, albeit without any annuity-LTC tax provisions. Now, in early 2006, negotiators in a House-Senate conference are expected to seek to reconcile differences between the bills.

The House legislation is H.B. 2830. If it is enacted, annuity-LTC products would provide consumers with a valuable additional tool to use in planning for retirement and possible LTC needs. This tool would offer an efficient means of delivering LTC benefits as well as some attractive tax advantages. In addition, insurers would gain considerable flexibility in designing new products to meet customer needs.

Much attention has been given to annuity-LTC combinations in recent years, in part because such products may be a more attractive option than stand-alone long term care insurance for many prospective purchasers.

Under combination designs, LTC insurance benefits after the onset of chronic illness often come partially from the annuity’s cash value. This is similar to the partial self-funding of benefits present under cash value life insurance and health savings account/high-deductible health insurance arrangements.

This use of the annuity’s cash value, together with other factors, often allows an insurer to provide a pure LTC insurance element–i.e., the insurer’s net amount at risk–at a substantially reduced cost relative to stand-alone designs.

In addition, the annuity’s cash value allows the product to be used for retirement income and emergency cash needs. It also ameliorates the “use it or lose it” concern that some people have with respect to stand-alone LTC insurance.

One of the most important aspects of the House’s annuity-LTC legislation is that it clarifies that an annuity contract–deferred or immediate–can be offered in conjunction with “qualified” long term care insurance.

Under current law, arguably this already can be done, especially where, for example, a long term care rider to an annuity is separately regulated as LTC insurance under state law. However, current tax law is unclear in this regard because, for example, the cash value under the annuity portion may violate the limitations on cash values that apply to qualified long term care insurance.

H.B. 2830 eliminates the tax uncertainty with respect to the annuity-LTC product. Thus, it removes this artificial barrier that currently inhibits insurers from exploring opportunities with this design.

The House’s annuity-LTC legislation also includes important tax enhancements for annuity-LTC products.

Probably most important: The entire LTC insurance benefit paid from the contract’s qualified LTC insurance portion is treated, under the legislation, as an accident and health insurance benefit that is excludable from income to the same extent as under any other qualified LTC insurance contract. This exclusion is regardless of whether the benefit payment results in a reduction in the annuity contract’s cash value.

This treatment is the same as that applicable under current law to life-LTC insurance combination products. (For example, say there is an acceleration of a life insurance contract’s death benefit and cash value to pay an LTC insurance benefit. In this case, the entire amount of such benefit generally is treated as an excludable accident and health insurance benefit under current law.)

The House bill also includes other tax law changes that will help facilitate the annuity-LTC product.

For instance, if charges are assessed against the annuity’s cash value to fund the LTC insurance, the bill provides that such charges will not be considered as a taxable distribution from the annuity. (Absent this, the charges seemingly would be treated as distributions from the annuity due to the legislation’s treatment of the annuity and LTC insurance as separate contracts for tax purposes.) The bill treats any such charges, however, as reducing the annuity’s “investment in the contract,” so that the income that is tax-deferred under the contract generally will not be treated as reduced by the LTC charges.

This tax enhancement is also provided for life-LTC insurance combination products.

Also in the life insurance context, the bill provides that qualified LTC insurance will be treated as a qualified additional benefit for purposes of applying the tax definition of life insurance, which will allow LTC insurance charges to be prefunded in the life insurance contract’s cash value.

Finally, the bill includes a tax-free exchange rule for qualified LTC insurance and clarifies the tax treatment of exchanges of life-LTC and annuity-LTC combination products.

As health care and LTC costs continue to rise, more and more people will be exploring cost-efficient means to cover the risks they face.

Combination insurance products provide consumers with the ability to leverage an asset, such as an annuity or life insurance contract, to provide more modestly priced coverage as part of a flexible benefits package. The House annuity-LTC insurance legislation is a very important step toward making these alternatives a reality.


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