Annuities and long-term care insurance seem like a natural pairing — the insurance equivalent of chocolate and peanut butter. When the Pension Protection Act’s (PPA) changes for these hybrid (or linked) annuities took effect in 2010, it appeared this market was poised for rapid growth. But while some advisors and insurers have experienced solid sales of these products, others report that the expected sales growth hasn’t materialized for several reasons. Nonetheless, advisors, industry consultants and insurers believe that the product’s potential is undiminished and that sales eventually will increase.
Mixed sales results
OneAmerica has experienced “double-digit growth” with its hybrid annuities since 2009, according to Chris Coudret, executive vice president with OneAmerica Care Solutions in Indianapolis, Indiana. He notes that the company’s internal research and information received from LIMRA indicate the company has sold “just a little over 80 percent of the premium in that marketplace since 2009.”
Debra Newman, CEO of Newman Long Term Care in Richfield, Minnesota, reports that most of her agency’s hybrid annuity sales come from bank affiliates that are primarily moving customers out of certificates of deposit. In contrast, she notes, there is much more interest and activity in the hybrid life products. Scott Boyd, vice president of long term care at National Benefit Group in West Des Moines, Iowa, has seen similar results. He estimates that his agency produces approximately six times as much hybrid life as hybrid annuity business. He cites several reasons for that imbalance, including his view that hybrid life offers qualified applications more value for their premiums. “When I’m in consultation with an agent about their clients, I’m going to steer them toward the life with LTC most often because of the fact that the ultimate objective is to create the most amount of leverage and long-term care benefits I can off the amount of money they’re putting in there,” he says.
Several advisors cite a scarcity of product as a reason for their low hybrid annuity sales. That condition could be partly attributable to the regulatory hurdles insurers must overcome in getting products approved by state regulators. Dan Herr, vice president, annuity product management at Lincoln Financial Group in Hartford, Connecticut, describes that process as “long and arduous.” To date, Lincoln Financial has completed the process in about 30 to 40 states, he estimates.
A lack of clarity on hybrids’ tax treatments can be an issue, as well, says Carl Friedrich, principal and consulting actuary with Milliman in Bannockburn, Illinois. The PPA provided “a lot of clarification,” he says, and it “covered most of the major issues, including the fact that benefit payments from those contracts are generally tax-free long-term care benefits.” But he notes there is still a gray area around the impact on a contract’s basis when long-term care (LTC) benefits are paid out because an IRS private letter ruling said that the LTC benefit payments reduce the basis. That ruling appears to be contrary to the law’s intent and the American Council of Life Insurers has asked for clarification and is currently awaiting an IRS response.
Advisors’ attitudes can be another stumbling block to selling hybrid annuities, says Chris Conklin, senior vice president of product design at Genworth Financial in Richmond, Virginia. States impose additional licensing requirements to sell LTC. Many states also have LTC license continuing education requirements that must be satisfied every few years, which can put off some advisors, he says. Some advisors are uncomfortable dealing with the underwriting process, as well, he believes. Agents who sell annuities want to talk to customers about protecting and growing their money and eventually converting it to income. Consequently, they typically don’t talk about long-term care expenses or insurance with clients. A related problem: The underwriting standards with some hybrid annuities can lead to an applicant’s rejection, a result advisors prefer to avoid. “The fact that these type of features typically have an underwriting process that rejects some applicants is a real challenge when it comes to reaching the annuity customer because annuity agents are simply not comfortable with an underwriting process,” he says.
Insurers can recognize the impact of underwriting and can attempt to facilitate the application. Herr says Lincoln Financial Group uses “self-underwriting” with its fixed and variable hybrid annuities. Instead of having applicants go through a medical exam or have a cognitive screen, the initial inquiry uses a series of medical questions and a prescription drug screen, which is done behind the scenes. “The clients and their advisors can look at the medical questions and the list of prohibitive prescription drugs and understand whether they’re going to qualify or not before they even apply for the benefit,” he explains. “That self-underwriting is really meant to be more transactional so that you’ll know you can’t qualify for the business before you ever apply.”
Waiting for the Fed
One of the most important factors influencing the contracts’ development and availability has been recent years’ persistent low interest rates. Many of the hybrid annuities’ designs feature level charges that are assessed against the interest earnings on the contract, Friedrich explains. When the credited interest rates are as low as they are currently, the LTC charges for older policy owners and for richer benefits “may in fact exceed that crediting rate that otherwise would be credited,” he says. “And that creates an adverse scenario for most people — not all necessarily — where account values would actually decline over time instead of increasing over time.”
Conklin cites Genworth’s decision to pull its Total Living Coverage® Annuity off the market in 2011 as an example of low rates’ impact. Rates had dropped substantially between the time of the product’s design and when it reached the market, making it less viable. “The product was simply not designed for the low interest rate environment in which it found itself, so the company pulled it off the marketplace,” he says.
Despite these less-than-favorable conditions, hybrid annuities work well for clients in the right circumstances. For instance, Boyd believes that applicants in poor health should consider choosing an annuity over hybrid life. He cites an applicant with serious heart problems such as heart attacks and multiple bypass surgeries. That person could not buy a life insurance-backed product because of his or her high mortality risk, but a hybrid annuity remains a viable option. “There’s almost no mortality-based underwriting at all with that product,” he says. “There are other combinations and situations but as the general rule, the annuity-based carriers are very, very liberal in their underwriting. I like to phrase it this way to my agents to tell their clients: If you’ve got one foot in the nursing home door and the other on a banana peel, you ain’t going to get this, either. But it has to be almost that bad to get turned down for an annuity-based.”
Hybrid annuities can benefit clients who already own non-hybrids, says Newman. She gives the example of a client whose non-hybrid has a $50,000 basis and a current value of $150,000. If the client withdrew funds from the non-hybrid annuity to pay for long-term care expenses, the first $100,000 of withdrawals would be taxable. Under the PPA, a Section 1035 exchange to a hybrid annuity can bypass that potential tax bite because amounts coming out of the hybrid annuity for LTC expenses are tax-free.
Several developments are likely to influence the hybrid annuity market for the foreseeable future. While it’s impossible to predict with any precision when interest rates will move appreciably higher, the start of such a move upward is widely expected by mid-2015. Several sources disclosed that multiple insurers have told them that when rates do increase sufficiently, the insurers plan to roll out or reintroduce hybrid annuities and pursue the market aggressively.
In the meantime, the hybrid annuity market continues to evolve, albeit probably more slowly than it would under higher interest rates. For example, Lincoln Financial has a variable annuity policy with a LTC rider which Herr believes is the only variable product available. OneAmerica’s State Life Insurance Company now offers the only indexed annuity with a LTC benefit that qualifies for preferential treatment under the PPA, according to Sheryl J. Moore with Moore Market Intelligence in Pleasant Hill, Iowa. These changes indicate that the hybrid annuity market is starting to mature with broader solutions, Herr maintains. “There isn’t this kind of one-size-fits-all mentality anymore,” he says. “There are different ways to approach this market and there are different needs from every client.”
Advisors are adapting their use of the products, as well. Sharon Luker with LTC Planning Consultants in Plano, Texas has clients consider combining hybrid annuities with smaller amounts of traditional LTC benefits. That approach helps control LTC premium costs and facilitates estate plans because unused hybrid annuity amounts can pass to heirs. Ultimately, the decision of which product to use and how to use it depends on the client’s goals, Boyd observes. Is the client’s priority growth of money or funds to pay for long-term care? That decision requires a trade-off, he says: “It is worth bearing in mind that you have costs involved with creating more long-term care benefits; therefore, the annuity itself cannot grow as much.”