As the wave of baby boomers continues to reach age 60, ensuring their retirement security will be the driving focus of leading companies serving this market. The insurance industry recognizes the need to create new products now to help boomers face their unique retirement challenges.
Longevity has become a real concern, and guaranteeing lifetime income will be critical for preserving quality of life. Access to affordable long term care becomes increasingly important as longer lifetimes bring increased risk of declining health. Boomers’ misjudgments about what is required to enjoy retirement are also a concern, as results from the 2006 3rd Annual Lincoln Long Life Survey found.
Underestimating the effects of inflation, the amount they will spend in retirement and the significant costs of LTC are areas where boomers may be miscalculating how much they will need in retirement.
The survey found 32% of respondents expect inflation to be the same or lower over the next 20 years than over the previous 20. And 65% are underestimating their projected spending levels in retirement, predicting they will spend less money per year while retired than while working.
The survey also found an alarming 66% of respondents said they do not have any LTC insurance, and only 26% have even considered purchasing a policy.
This is clearly an indication of weakness in boomers’ planning. The costs for LTC services are rising at a rate that consistently outpaces general inflation in the economy. In 2004, according to the Congressional Budget Office, the average annual cost of nursing home care was $70,000. In some areas, the costs are much higher. By 2025, when today’s 67-year-old turns 86, these costs will average $140,000 a year, according to a report by the U.S. Senate Special Committee on Aging. For an average 2-year stay, this would result in an approximate cost of $280,000.
The opportunity for insurance products that combine longevity and LTC protection for consumers is clear. Carriers are looking for ways to address these multiple needs in the most efficient way.
The recently enacted Pension Protection Act of 2006 will help spur further combination product development. It opened the door for product innovation and design creativity by allowing the introduction of tax-advantaged combination annuity-LTC insurance products, starting in 2010. Under the PPA, the annuity distribution payments in a combination annuity-LTC insurance product will not be taxable if used to fund qualified LTC expenses.
Such hybrid products offer clients the ability to use personal assets to meet more than one need. By combining these 2 elements on one chassis, insurance companies are seeking to offer the right mix of longevity protection and LTC insurance. The annuity component focuses on addressing income and longevity needs by providing a lifetime income stream. The LTC insurance portion focuses on providing access to affordable care should the need arise.
There are, however, developmental hurdles to overcome in combining these 2 types of coverage: finding a balance between the needs and addressing state insurance requirements.
What would an annuity-LTC insurance product look like? It could be a single- premium fixed annuity, which would accumulate assets from the general account to fund LTC insurance premiums and claims. Or it could have a variable annuity chassis, which potentially would generate cash values through the subaccounts to fund LTC insurance.
If a VA chassis is used, the account value would fluctuate. Companies will need to understand the unique risk elements introduced by the LTC insurance benefit in order to manage the risk appropriately and keep the product affordable for the client.
On one hand, using a fixed annuity offers a more stable account value and therefore could create a simpler exercise in pricing and risk management.
A VA component, on the other hand, offers a trade-off: a less predictable account value vs. a chance to earn a higher return. To provide effective longevity insurance, many clients and advisors will desire the exposure to equity markets. This can be done in a VA, or clients can position their total portfolio to strike the right balance.
Three potential approaches companies might take in designing a combination annuity-LTC insurance product are shown in the box.
As would be expected, combinations of such approaches could work, and the need to limit the aggregate claim exposure will play a part in finding the right balance between benefits and cost.
Other points to consider when designing a combination annuity-LTC insurance product will be the impact on the sales process and the ease of doing business annuity producers have come to expect. Companies need to ensure that the sales and underwriting process are as efficient and effective as possible. Insurers that find ways to streamline the process will have an advantage by incorporating LTC insurance into an annuity without sacrificing speed or efficiency. Selling the combined product needs to be easy for the advisor and more affordable for the client, and also needs to offer greater leverage of assets than purchasing 2 separate policies.
Protecting boomers in their retirement years demands that insurance companies bring solutions that allow boomers to continue to take advantage of the growth in equity markets and address LTC needs. New product designs will meet multiple needs: protection of assets to offset market fluctuations; lifetime income to offset the risks of longevity; and access to affordable LTC protection. Companies that lead the retirement income market will actively develop products that provide these solutions while simplifying or streamlining the process for advisors. Linking an annuity with LTC insurance could emerge as the perfect choice for many clients.