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Annuities With Qualified LTC Benefits Start To Debut

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At least six annuity companies are now offering deferred annuities that include qualified long term care benefits.

More such combination products are likely to debut, predicted Cary Lakenbach during a presentation here at a combination products panel discussion.

Why? This transforms a tax-deferred vehicle (the annuity) into a tax-free vehicle (when the annuity pays out LTC benefits), said Lakenbach, president of Actuarial Strategies, Inc., Bloomfield, Conn.

This is a “very powerful device,” he continued. “It is not available with other investments other than life insurance with long term care.”

The same demographic that buys annuities alone will be interested in combination products like this, Lakenbach said, especially since the combined annuity and LTC features addresses both longevity and catastrophe risk.

The Pension Protection Act of 2006 is what enabled the tax-free aspect, indicated John T. Adney, of Davis & Harman, LLP, Washington, D.C.

Under PPA, the combination annuity/Q-LTC products must offer qualified LTC benefits, said Adney, noting that “qualified LTC benefits are excludable from income tax as are accident and health benefits.”

Adney stressed that for the LTC benefit payments to qualify as tax-free, the benefits must be paid as insurance. This treatment applies even when the annuity’s cash value is reduced, he added.

He noted that the tax treatment of the Q-LTC benefit is much like that of life insurance policies that offer qualified LTC benefits. The Health Insurance Portability and Accountability Act of 1996 permitted such life/Q-LTC combination products to pay their qualified LTC benefits on a tax-free basis.

The effect of the PPA rules regarding combination annuity/Q-LTC products is to clarify that inside buildup of deferred annuities may be paid tax-free as qualified LTC insurance, Adney said.

These combinations are treated as distributions, but are not includable in income, he added. Such charges will reduce the basis or investment in the contract, but not below zero, he continued, noting these charges are not deductible.

The new rules apply to contracts issued after 1996, said Adney, but only in taxable years beginning after 2009.

That raises a question about treatment of combination products issued today, he allowed. He suggested the annuity with Q-LTC contracts could have a provision inserted in them stating how Q-LTC benefits will be treated starting in 2010.

These new products are subject to a higher deferred acquisition cost tax than are traditional annuities, Adney noted. This is because PPA added Internal Revenue Code Section 848(e)(6) to the code, imposing a 7.70% DAC tax on annuities with Q-LTC benefits, after 2009. By comparison, standard annuities are subject to a 1.75% DAC tax.

This raises questions for insurers about what the DAC on combination products issued before 2010 will be, he allowed.

Another issue for insurers is how to mitigate the tension created by underwriting considerations, said Peggy Hauser, senior vice president-actuarial services, Long Term Care Group, in the Milwaukee, Wisc. office.

Underwriting for individual LTC insurance is moving away from simplified issue, she explained. “The underwriters are becoming more restrictive.”

Meanwhile, in the annuity business, there is reluctance to doing things that slow down the sale, she continued, and some people want no underwriting at all in the annuity with Q-LTC contracts.

That tension can produce sales problems, according to Hauser. Her recommendation is to look for ways to address both of the concerns.

“Maybe use longer elimination periods,” she suggested. Or lessen the underwriting requirements imposed on agents by having telephone interviewers obtain the client’s history. Or, cut down on the number or records obtained and decide to issue if no uninsurable conditions exist.

But don’t eliminate underwriting altogether, Hauser cautioned, explaining that it’s important for combination insurers to be consistent with what the industry is doing.

“For example, don’t issue without doing cognitive testing,” she advised.

The panel was held during the annual retirement industry conference co-sponsored by LIMRA International, LOMA, Society of Actuaries and National Association of Fixed Annuities.