by With the cost of long term care insurance rising, they are gaining attention.
Could these products answer a financial dilemma? Many high net worth households worry about potential long term care expenses, but they are reluctant or unable to buy long term care insurance. According to a 2014 report from the Robert Wood Johnson Foundation, less than 8% of U.S. households have purchased LTCI.1
Costs of traditional LTCI policies are rising, and then you have the “use it or lose it” aspect of the coverage: if the insured party dies abruptly, all those insurance premiums will have been paid for nothing. If the household is wealthy enough, maybe it can forego buying a LTC policy and absorb some or all of possible LTC costs using existing assets.
Are there alternatives allowing some flexibility here? Yes. Recently, more attention has come to hybrid LTC policies and hybrid LTC annuities. These are hybrid insurance products: life insurance policies and annuities with an option to buy a long term care insurance rider for additional cost. They are gaining favor: sales of hybrid LTC policies alone rose by 24% in 2012, according to the American Association for Long-Term Care Insurance’s 2014 LTCi Sourcebook. Typically, the people most interested in these hybrid products are a) wealthy couples concerned about the increasing costs of traditional LTCI coverage, b) annuity holders outside of their surrender period who need long term care coverage. Being able to draw on LTCI if the moment arises can be a relief.2
They can be implemented with a lump sum. Often, assets from a CD or a savings account are used to fund the annuity or life insurance policy (the policy is often single-premium). In the case of a hybrid LTC policy, the bulk of the policy’s death benefit can be tapped and used as LTC benefits if the need arises. LTC benefits generated can end up equaling 400% of the initial deposit (or even more). In the case of a hybrid LTC annuity, the money poured into the annuity is usually directed into a fixed-income investment, with the immediate or deferred annuity payments increasing (possibly even doubling or tripling, in some cases) if the annuity holder requires LTC.2,3
What if the annuity or policy holder passes away suddenly, or dies with LTC benefits left over? If that happens with a hybrid LTC policy, you still have a life insurance policy in place. His or her heirs will receive a tax-free death benefit. It is also possible in many cases to surrender the policy and even get the initial premium back (what is known as a return of premium rider). The annuity holder, of course, names a beneficiary – and if he or she doesn’t need long term care, there is still an immediate or deferred income stream from the annuity contract.3
There are some trade-offs for the LTC coverage. Costs of these products are usually defined by the insurer as “guaranteed” – LTCI premiums are fixed, and the value of the policy or annuity will never be less than the lump sum it was established with (though a small surrender charge might be levied in the first few years of the annuity). In exchange for that, some hybrid LTC policies accumulate no cash value, and some hybrid LTC annuity products offer less than fair market returns.4
Tax-free withdrawals may be used to pay for LTC expenses. Thanks to the Pension Protection Act of 2006, the following privileges were granted regarding hybrid insurance products:
- All claims paid directly from appreciated hybrid LTC annuities and hybrid LTC policies are income tax free so long as they are used to pay qualified long term care expenses. In using the cash value to cover LTC expenses, you are not triggering a taxable event.2,4
- Owners of traditional life insurance policies and annuities are now allowed to make 1035 exchanges into appropriate hybrid LTC products without incurring taxable gains.2
If you shop for a hybrid insurance product, shop carefully. The first hybrid LTC policy or hybrid LTC annuity you lay eyes on may not be the cheapest, so look around before you leap and make sure the product is reasonably tailored to your financial objectives and needs. Remember that annuity contracts are not “guaranteed” by any federal agency; the “guarantee” is a pledge from the insurer. If you decide to back out of these arrangements, you need to know that some insurers will not return your premiums. Also, keep in mind that over the long run, the return on these hybrid products will likely not match the return on a conventional fixed annuity or LTCI policy; actuarially speaking, when interest rates rise there is no incentive for the insurer to adjust the fixed income rate of return in response.2,4
Are hybrid insurance products for you? If you can’t qualify medically for LTCI but still want coverage, they may represent worthy options that you can start with a lump sum. You might want to talk to your insurance or financial consultant about the possibility.
1 – rwjf.org/content/dam/farm/reports/issue_briefs/2014/rwjf410654 [2/14]
2 – forbes.com/sites/jamiehopkins/2014/04/21/new-and-unexpected-ways-to-fund-long-term-care-expenses/ [4/21/14]
3 – fa-mag.com/news/hybrid-ltc-insurance-gains-traction-among-the-affluent-17070.html [2/25/14]
4 – kitces.com/blog/is-the-ltc-cost-guarantee-of-todays-hybrid-lifeltc-or-annuityltc-insurance-policies-just-a-mirage/ [10/16/13]