PPA's Impact On Combination Products

(While the reference here is to riders, the law grants the same treatment to LTC contract provisions, if they meet the requirements of a qualified LTC policy.)

The law specifically states that annuities contained in qualified plans are not covered by the aforementioned changes.

Given the significant dollars that are resident in in-force annuities as well as the opportunities for new sales, these PPA provisions open up all sorts of opportunities, as discussed later.

Furthermore, after 2009, distributions, from either an annuity or life contract account value, if used to pay for charges for coverage under qualified LTC insurance, will not result in taxable income to the policyholder.

Such distributions first reduce the investment (basis) in the contract to zero. Even when that happens, additional charges are treated specially by not being taxed, even though they reduce contract gain.

This provision is rather unusual. For starters, in annuities and modified endowments, the usual “exit strategy” for distributions is that they come out of gain first. Here, the effective order is reversed. Further, should the basis reduce to zero, the law consequently allows gain to escape taxation in this special circumstance.

Clearly, someone wanted to encourage the sale of such contracts.

There are several other important PPA provisions worthy of note.

The first has to do with the treatment of exchanges. Effective after 2009, the law specifically includes qualified LTC contracts or life or annuity contracts containing qualified LTC insurance riders (or provisions) as being contracts to which, or from which, (income tax free) Section 1035 exchanges can be made.

The PPA specifically impacts annuity and LTC sales by requiring that the policy acquisition expense percentage for such business be 7.7% instead of 1.75% for other annuities, effective after 2009. That is the cost Congress felt the industry had to bear to receive these favorable provisions. The cost is not inconsequential.

Intensive study suggests it may be possible to write annuity and LTC combinations within the next 3 years and do so with a 1.75% policy acquisition expense. Consequently, the next 3 years may present a major opportunity rather than the conventional view of a long holding pattern.

Finally, although PPA’s impact on annuities seems to focus on deferred vehicles, a review of the law and intensive analyses by other knowledgeable parties suggest its favorable provisions may well apply to immediate annuities containing qualified LTC components. Specifically, the favorable tax treatment of benefits may apply to payments under properly structured immediate annuities. Hence, the law ought to be a major impetus to the immediate annuity business, as it enables significant flexibility in the amount of payment as circumstances may warrant or demand.

Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies, Inc., Bloomfield, Conn. His e-mail address is [email protected].