The Pension Protection Act of 2006, signed into law in August, has important if not profound implications for insurers, insureds, and annuitants, including the sale of so-called combination or integrated products.
Combination products are either life insurance with a long term care feature, or annuities with a LTC feature.
To understand the PPA provisions, it helps to review existing law.
Life/LTC combinations have been available for some 20 years, even predating the Heath Insurance Portability and Accountability Act of 1996.
HIPAA gave official Internal Revenue Code recognition to life/LTC combinations by establishing a new code section, Section 7702B. This section defines conditions under which an LTC policy or LTC provisions of a contract could be considered “qualified long term care.”
Specifically, if an LTC contract meets the requirements to be qualified, it is considered accident and health insurance and its benefit payments are received income tax free under HIPAA. [There are many places in the IRC where the term "qualified" occurs. The discussion here refers to qualified LTC insurance as defined in Section 7702B(b)(1).] Note: The law does not give a blanket income tax free ride to any and all payments.
Life/LTC combinations generally accelerate a portion (typically 2% or 4%) of a life contract death benefit each month, or period, while the insured is chronically ill. The remaining death benefit is typically reduced dollar-for-dollar.
In properly structured contracts, such payments escape tax. The law also allows per diem contracts to be received income tax free, as long as the payments do not exceed specified thresholds, which change yearly depending upon cost-of-living. Per diem contracts make payments independent of the amount of qualified LTC services provided. For 2006, the limit is $250 a day. (An aggregation rule applies to those owning both per diem and reimbursement contracts, the net effect of which may be to curtail the per diem limitation amount.)
HIPAA also imposes harsh limits on the tax treatment of charges made against the life policy’s cash value to pay for LTC charges. This often dampens the appeal of using the cash value to fund the LTC provisions.
Finally, HIPAA is completely silent about annuity/LTC combinations.
However, effective after 2009, the newly enacted PPA will expand the definition of qualified LTC contracts to include those attached to annuities.
This new provision effectively means that annuity assets can be used to fund the LTC features of a contract on a basis consistent with those of other assets. Previously, typical annuity/LTC combinations resulted in enhancements to annuity cash value, which when distributed were taxed no differently than any other annuity account value.
Under PPA then, appropriately structured qualified LTC insurance contracts that are riders to an annuity can have their payments to annuitants be on an income tax free basis.