As baby boomers begin reaching the retirement years, they are becoming increasingly concerned with long term care issues.
Many are facing needs of aging parents at the same time as they are paying college tuition for children and trying to save for their own impending retirement. Their greatest financial fears, according to the 2005 Financial Retirement Fears survey by the National Association for Variable Annuities, Reston, Va., concern retirement income, the impact a health care event could have on financial security, and their growing need to be self-sufficient as governmental sources become increasingly uncertain (see Figure 1.)
These factors are combining to create a pronounced need for, and awareness of, LTC insurance. However, traditional LTC insurance sales have been declining year over year. LIMRA data through the 2nd quarter 2006 shows LTC insurance sales trailing 2005, which in turn trailed 2004.
One has to ask, in the face of unprecedented demand, “Why isn’t the apparent solution selling?”
Clients share 2 primary reasons for not purchasing LTC insurance: cost and uncertainty of need.
LTC insurance is often viewed as too expensive – something that would be a “sunk cost” if never needed. This has led many clients to “self-insure.” They simply save money in a liquid account where it would be quickly available in case of a major health event. However, growth on these assets is minimal; due to their liquid nature, the assets often are not sufficient to cover the extraordinary costs of long term care; and, over time, inflation further erodes the strength of their savings.
Recognizing the need for LTC coverage and the challenges that traditional solutions have presented, life and annuity insurers have been looking creatively at product development. The goal is to address the feedback clients have provided.
As a result, discussions surrounding hybrid products, such as life insurance combined with a LTC rider or an annuity/LTC combo, have increased.
The appeal of combination products is that they offer a cost efficient way to provide multiple benefits and ultimately flexibility for the consumer. This makes them attractive for 2 reasons: greater flexibility to address multiple needs, and potentially lower cost than single solution products, stacked separately, can provide.
By combining 2 products, the asset is always working for the client in some fashion, whether through LTC insurance benefits, death benefits or annuity values, depending on combinations selected.
The recently enacted Pension Protection Act of 2006 is helping to bring added life to this new generation of products.
The combination product provision of the legislation will afford tax-free distribution status to both the annuity assets and the LTC rider benefits of these combination products, if used for qualified LTC purposes. It will also allow the annuity’s cash value to be used to fund the LTC rider’s premium on a tax-free basis.
The legislation is careful to point out this tax treatment is intended only for non-qualified annuity assets at this time.
Companies are now exploring a variety of opportunities this legislation presents for annuity/LTC combination products. There is much creative thinking going on. One issue, which emerged late in the legislative process, is facing product developers right now. This is how to address the gap between today (2006) and 2010 when the combination product provision of the pension legislation takes effect.
Let’s look at how it works: An annuity combined with a LTC rider would provide leverage and flexibility for clients who are “self-insuring” with liquid assets, which are sitting in a vehicle such as a money market account or even a straight annuity. These funds would be set aside in case of a catastrophic health event, or would be used to supplement retirement income, if needed.
If a qualifying LTC need arises, an annuity/LTC combo product provides leverage and flexibility by allowing tax-free utilization of both the assets in the annuity (let’s say $100,000) and the pure LTC rider (let’s say an additional $200,000). If an LTC need does not arise, the full annuity value (the $100,000 in this example) would be available for income purposes. (See Figure 2.)
The U.S. Department of Health and Human Services states the average length of a nursing home stay is 2.5 years. This means that many claimants purchasing combination products ultimately will cover a significant portion of their LTC need with their own (annuity) assets.
Companies can more easily spread risk by offering “pure LTC” insurance in a very price-efficient manner through the rider portion of the contract. This added leverage provides clients with a more cost-efficient way to cover extraordinary needs that might arise than if clients had only self-funded a portion of their own care.
Essentially, the combo product can offer the equivalent of a higher deductible option than traditional LTC coverage.
In closing, the top 5 things to remember about the potential of annuity-LTC combination products are:
1) “Leveragability:” There is greater leverage of retirement savings assets, helping clients’ money to do more.
2) Affordability: The “higher deductible” option makes for a more price-efficient way to protect against extraordinary expenses.
3) Flexibility: The product can provide solutions to address multiple needs.
4) Availability: There are no “sunk” costs, since the annuity assets remain available if never needed for LTC costs.
5) No taxability: After 2010, the tax benefits kick in and the LTC premiums and benefits will no longer be taxable as annuity distributions.