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Life/QLTC Combinations Pique Surprising Interest

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As the January 1, 2010 effective date of the Pension Protection Act approaches, the growing interest in combination annuity/long term care policies comes as no surprise. For the first time, federal tax law enables such vehicles to be sold with the favorable tax treatment that the Health Insurance Portability and Accountability Act has accorded to stand-alone LTC and combination life/LTC products since 1996.

Such products have appeal because they overcome significant negatives associated with stand-alone LTC offerings, including their high cost and the potential complete loss of investment should the insured die without having incurred a LTC claim.

What is somewhat surprising, however, is the interest being shown in the earlier combination product–the life/LTC. This article looks at the tax law highlights related to these products and then the market applications and designs.

Current tax law provides that qualified LTC (QLTC) insurance riders to life contracts will receive favorable tax treatment in several ways.

First, charges made against the cash value will never result in taxable income. This is a liberalization from HIPAA, which had provided that under certain circumstances, when the contract was a modified endowment contract and there was gain in the contract, such charges might result in income.

Second, QLTC benefit payments will be exempt from income tax (except for certain indemnity design contracts where the per diem payment exceeds the daily maximum, which in 2009 is $280 per day and then only the excess of per diem payment over the maximum is taxable). Note: This rule applies to stand-alone and combination annuity contracts as well.

As a consequence of these provisions, life insurance contracts can be attractively designed to pay for LTC needs. QLTC riders can be added to single premium contracts, and it doesn’t matter what kind of underlying life insurance chassis (variable, indexed, fixed) is used.

From a business perspective, such policies are often used to improve upon solutions provided by vehicles such as certificates of deposit, money market instruments or other safe investments that retirees often use as rainy day funds for unexpected or expected costs including LTC.

A combination life/QLTC product leverages those rainy day funds, so that the consumer will have available considerably more than the cash amount previously invested in a CD to cover LTC needs.

Combination life/QLTC contracts generally provide that a given percentage of the face amount or death benefit will be available on a monthly basis to cover QLTC expenses. For example, 2% of a $200,000 face amount, or $4,000, is available each month for 50 months.

Should the insured incur less than $4,000 (in an expense reimbursement contract), the payments will last longer than 50 months. Of course, if the insured should die before the death benefit is fully paid out to cover QLTC costs, the remaining death benefit is payable to heirs.

The cost of this protection is exceedingly modest; it can be as low as 2% of the underlying life cost in such designs.

Many combination life/QLTC contracts contain a provision that promises a minimum death benefit will be paid, say 10% of the purchased face amount, regardless of whether the face amount has been completely paid out. Such amounts are therefore always available to pay for final expenses.

Chronic illness stays in care facilities typically average 30 months to 3 years, but what happens if a chronic illness results in a more extended stay? Many insurers address this by providing QLTC coverage that commences when the base policy has been fully paid out.

A good many insurers offer QLTC riders on multi-pay or flex-pay life contracts, too, whether whole, variable or universal life, and the payout designs are similar to those for the single-premium contracts.

Frequently such contracts are used to pay for estate tax obligations or to provide for liquidity at death. Adding QLTC riders to such contracts must be done with care when the contracts reside within trusts, because trusts have limitations on the use of values to pay for the insured-owner. Solutions exist for this seeming dilemma, so that QLTC riders on such contracts are fully feasible and can provide QLTC coverage at very low cost.

QLTC riders in life contracts provide inexpensive, top quality, broad coverage alternatives to stand-alone offerings. The interest in such offerings is therefore not surprising at all.

Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies, Inc., Bloomfield, Conn. E-mail him at [email protected]

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