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Exciting New Opportunities In Hybrid LTC Policies

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We see exciting new opportunities for the life insurance and annuity industry as a result of federal legislation with the enactment of the pension reform bill (HR4).

Now known as the Pension Protection Act of 2006, the legislation includes provisions that clarify and enhance the tax treatment of hybrid long term care insurance plans in which LTC benefits are coupled with either life insurance or annuities.

Several factors led to support from Capital Hill for these enhancements. First, there is increasing concern regarding the need for financial solutions to the growing costs of LTC.

There is growing pressure on Medicaid and states to meet these needs, with little indication of movement toward federal solutions.

At same time, industry figures show the private LTC insurance market dropped by almost 10% from 2004 to 2005, despite the fact that fewer than 10% of 80 million people in the U.S. target market have such coverage.

The decline in stand-alone LTC insurance sales relates to higher premiums being offered for new LTC insurance business, contrasted with premium levels on sales made 2 years ago. This has been triggered by low interest rates, high persistency, and LTC insurance rate stabilization regulations that require conservatism in pricing in order to reduce risk of future rate increases.

Elasticity in the LTC insurance market and general concerns about affordability have resulted in these reductions in sales.

These factors are in turn triggering an opportunity to bring new forms of more affordable LTC insurance coverage to the market. This includes hybrid LTC insurance plans. These have been emerging in various forms and flavors, but all involve some form of self-insurance that reduces the cost of LTC insurance.

One example is life policies that accelerate the payment of benefits when LTC care is triggered. Those LTC benefits, as paid, reduce future life insurance face amounts, with a proportionate reduction in cash values.

After the life face amounts have been paid out in full via accelerated benefits, there may be an optional, independent LTC insurance benefit that continues monthly payouts for a specified period. Some insurance companies will pay a small additional benefit at time of death, if all of the original death benefit has been paid out as LTC benefits.

Another example is a deferred annuity where account values are distributed, without surrender charges, in monthly payouts when the LTC trigger is met. Here as well, additional LTC benefits may be payable after account values are depleted.

PPA includes several clarifications and enhancements to the tax treatment of these plans.

First, charges taken out of account values are deemed distributions from a tax perspective. However, those distributions are not taxable; rather, they reduce the basis in the contract if the LTC insurance rider is tax qualified (TQ).

Second, TQ LTC insurance benefits are paid out tax-free, either from life or annuity platforms.

Third, the definition of 1035 exchanges is being expanded to include these combination plans.

However, there are still questions and challenges regarding certain details of the legislation. Some of these are shown in the chart.

Despite these issues, it is apparent that many in the insurance industry view the tax law changes incorporated in PPA and the stagnant stand-alone LTC insurance market as reasons to pursue new products supported by these provisions.

Some companies also see this as an opportunity to eventually enhance existing life or annuity coverages.

In fact, a number of industry leaders are now turning their attention to the development and filing of such plans. This leads to questions about the status of relevant state insurance regulations and the state insurance department filing process.

The applicability of the state LTC insurance laws and regulations presented early challenges to the filing and marketing of these products. Most states require that the LTC components in combination products meet many requirements for stand-alone LTC insurance.

However, for accelerated benefit provisions in hybrid products, there are several exceptions to these requirements that are reflected in the LTC Model Regulation of National Association of Insurance Commissioners and also in most states. Nonetheless, most states impose requirements for advertising, LTC reporting, producer licensing, and replacement issues.

There were a few states that did not have regulatory requirements to address the hybrid product fully. Some of these states have recently effected, or are considering, regulations that provide specific requirements for the product.

Further, the adoption of the pending revision of the NAIC LTC Model Act 640 may require hybrid product insurers to comply in those states that adopt the model law. (Note: This model mandates producer training requirements consisting of an initial 8 hours of training and 4 hours of ongoing training for producers who sell, solicit or negotiate LTC insurance.)

The filing process itself has evolved with respect to combination plans. It has taken time for some insurance departments to determine which regulations govern these products, and how best to review these submissions. A number of states require separate submissions of the underlying base plan and LTC insurance rider.

Fortunately, a well-defined process has emerged in most states with respect to life/LTC insurance plans, and this appears to establish a precedent for annuity/LTC insurance combinations.

Many companies have devoted significant resources to the development of new hybrid life/LTC insurance products in the last 2 years, with several in the market and many more coming.

With the enactment of HR4, the level of discussion that both life and annuity-based hybrid products are triggering is rapidly escalating, and the pace of product development activity is accelerating. Even for companies that do not have an active interest in, or value proposition for, this market, there may be reasons to study these plans well in advance of Jan. 1, 2010 in order to address the needs of future and existing policyholders.