If H.R. 2830 is enacted, it could further the development of combination annuity/long term care insurance products in several ways. This article reviews the current status of such combo products and also how they might evolve post-H.R. 2830.
Currently, annuity products provide LTC benefits in three ways. The first is a relatively common waiver of surrender charges, triggered if the annuitant or owner, depending on the contract, cannot perform at least two of six activities of daily living (as in many stand-alone LTC policies).
The second enhances an annuity benefit if an LTC requirement is met. This enhancement often involves increasing the payment received from a single premium immediate annuity or the annuitization of a deferred contract. Examples: a 50% increase in payments received from an SPIA or a 10% bonus applied to annuitized value.
The third structure strongly resembles stand-alone LTC policies. It uses the annuity cash value to pay LTC benefits for a specific period of time (typically two years). An additional rider will continue the LTC payments (often at the same level) for, say, two to four years or for a lifetime. Often, the products have a 90-day elimination period before benefits start and a daily benefit defined as a percentage of account value, starting at the end of the 90-day elimination period. The benefit payments are considered partial withdrawals from the annuity and are so treated for tax purposes.
Charges for the additional rider are typically defined as a level percent of annuity account value and may vary by issue age. For example, at issue age 55, the charge might be 0.50% to 0.75% a year, while at issue age 65, the charge might increase to 0.80% to 1.20% a year for an additional four years of benefits. These charges typically would be waived after benefits had been paid for a specific period.
Variations on the third combo structure will benefit the most from passage of H.R. 2830. So, expect the most product development activity to occur here.
What’s in it for the consumer? Stand-alone LTC policies have been around for many years but have not reached the market penetration levels many insurers would like. There are ample reasons for this, including the common client objection about “paying considerable premium for something I may never use.” Annuity/LTC combos address part of this by providing surrender and annuitization benefits regardless of whether the LTC is ever used.
Another consumer benefit of combo products relates to risks consumers face. To a large extent, annuities are intended to address the risk of outliving one’s assets. LTC policies are intended to address the risk of personal asset depletion in event of extended and costly long term care.
Since qualifying for LTC benefits often means that a person now has a reduced life expectancy, is it unlikely that the person will now outlive or deplete his or her assets due to LTC costs. One event will occur but generally not both. A consumer could “buy” coverage for each of these risks separately, but an annuity/LTC combo can cover both risks without overkill. Hence, the “total is greater than the sum of the parts.”
What’s in it for life insurance companies? An interesting synergy exists between annuities and LTC coverage. An annuity typically is more profitable for insurers if lapses are low, which is why annuities are said to be persistency-supported. An LTC policy typically is more profitable if lapses are higher–due to the policy’s level charge/increasing risk structure–which is why LTC policies are said to be lapse-supported. Combining the products into one results in less sensitivity to lapse patterns, thereby allowing insurers to reduce overall cost. Once again, the “total is greater than the sum of the parts.”
Annuity/LTC combos do face challenges. For example, if they provide a significant extension of benefits past the period of partial withdrawals, they likely will require underwriting. The drawback is, some primary annuity distribution channels (e.g., banks and broker-dealers) are not familiar or comfortable with underwriting, which they consider to be too time consuming and potentially damaging to customer relationships. Companies wanting to sell through these channels will have to weigh the cost and loss of sales from underwriting vs. more favorable claims experience very carefully.
The second challenge is that although significant historic experience exists for stand-alone LTC insurance, combo products, specifically annuity/LTCs, have little such experience data. Judgment will have to be used to estimate expected claims relative to stand-alone LTC insurance.
A third challenge relates to the need for reinsurance. Although combos can be a good fit for insurers operating in both annuity and LTC insurance markets, other insurers may like the product concept but not be comfortable with or knowledgeable about LTC product risks. These companies potentially would be interested in transferring the LTC risk if an attractive reinsurance solution were available.
Although these challenges are material, the potential market is huge. In fact, due to the anticipated enactment of H.R. 2830, expect to see a number of new annuity/LTC combos in development. Changes in the annuity market are almost certain.