I have written several times in the past – either as a feature topic or a subset of broader planning and product discussions – about the changes in the Long Term Care (LTC) insurance (LTCi) marketplace. Catalyzed by the recent legislative changes in the state of Washington and the continued interest in the general marketplace, I thought a refresher and update on the LTC marketplace would be a timely topic.
What is Long Term Care?
For insurance purposes, Long Term Care (LTC) is defined as the loss of 2 of the 6 Activities of Daily Living (ADL) or cognitive impairment that requires constant supervision (e.g., dementia or Alzheimer’s disease).
The defined ADLs are:
1. “Bathing” – washing oneself in either a tub or shower, including getting into and out of the tub or shower, or by sponge bath.
2. “Continence” – ability to control one’s bowel and/or bladder function, or the ability to perform associated personal hygiene (including caring for a catheter or colostomy bag) when unable to control one’s bowel and/or bladder function.
3. “Dressing” – putting on and taking off all items of clothing, and attaching any necessary braces, fasteners, or prosthesis.
4. “Eating” – feeding oneself by getting food into the body from a receptacle (such as a plate, cup, or table) or by a feeding tube or intravenously.
5. “Toileting” – getting to and from the toilet, getting on and off the toilet, and performing associated personal hygiene.
6. “Transferring” – means moving in and out of a bed, chair, or wheelchair.
According to the U.S. Department of Health Services 2020 study*, someone turning Age 65 – which 10,000 people will do every day until 2030** – has a 70% chance of requiring some form of long-term care during their lifetime.
Genworth’s Cost of Care Survey, which has been done annually since 2004 and is an excellent resource for clients and their advisors to evaluate potential regionally-specific costs, reports that the cost of the facility and in-home care has increased 1.88%-3.80% per year***, outpacing the average increase in inflation. The ongoing impact of COVID is yet to be fully understood, but early follow-up studies indicate that the various direct (equipment costs) and indirect (wage pressure) factors may result in rate increases going forward.
Funding Mechanisms for Long Term Care Expenses (also known as insurance)
The 2020 Cost of Care Survey showed the national median annual cost for a private room in a nursing home to be $105,850. Assuming no insurance is in place – and the individual(s) do not qualify for the needs-based Medicaid based on income and assets (Medicare does not cover the cost of long-term care) – the default funding source for long-term care expenses is the retirement/liquid asset portfolio. Depending upon the client’s overall living expense needs and/or legacy planning strategy, paying out-of-pocket for long-term costs may cause a rapid erosion to their asset base.
Today, there are 4.5 primary products in the LTCi space.
1. Traditional “Stand-Alone Long-Term Care”: The original form of specific long-term care insurance started in the 1970s but has largely been phased out of the sophisticated marketplace. The design of the benefit was rather straightforward: a stated initial monthly benefit amount, a benefit period, elimination period, inflation benefit (if elected), and an elimination period – most did not include any surrender or refund of premium option or a death benefit … this was "use it or lose it".
Many of these policies were structured in a way where the premiums were due every year (limiting the ability to guarantee a finite period, i.e., 10 years) and were non-cancellable (the insured did not need to requalify), however, they were not guaranteed renewable, which means that the annual premium could increase in the future. It did. A lot. Like, a real lot.
A combination of longer life expectancies, increased costs of care, and the spread between the low-interest-rate environment (I held off as long as I could) and the contractual Cost of Living Adjustments (COLA), when added as a rider, put enormous pressure on the profitability of in-force blocks of business. The insurance companies not only increased the rates on newly issued policies but also gave existing policyholders the option to either increase their premium payment or reduce their benefits.
Earlier this year I reviewed a policy that was purchased in 2001 featuring a lifetime benefit period and a 5% compound COLA rider, two features that put extra pressure on the issuing company. The policy owner was notified by the company that they could expect to see a 503.42% rate increase over the next 3-6 years; the other option was to i) reduce their benefits and/or ii) reduce their benefits further and take a cash payment. These policies were not built with a cash accumulation component, so the payment from the insurance company was a buy-out to get the liability off their books.
2. Hybrid / Asset-Based Life Insurance: Starting in the mid-1980s, a specialized life insurance chassis was adapted to be a long-term care-focused insurance product. The policies featured a guaranteed premium – at first either a lump or 10-years, though now multiple options are available depending on the age of the insured – and a death benefit should there not be a need for long-term care.
The death benefit of the policy is generally two years of the initial monthly benefit and a continuation of the benefit of the rider is added to extend the benefit period if desired. Therefore, the total pool of long-term care benefits can be greater than the initial death benefit. These policies also feature a cash surrender value, designed either as a full refund of premium or a slightly lower amount (which increases the LTC benefit amount per premium). An inflation benefit rider could be added to the long-term care benefit, but this does not also increase the death benefit.
3. Hybrid / Asset-Based Annuity: Similar to the asset-based life insurance – annuities are insurance contracts, after all – there is a market, though more limited than their life insurance counterparts, for annuities. These contracts are single premium, fixed deferred interest chassis that combines the ability for long-term asset growth and long-term care benefits.
As we’ll discuss later on in this very informative and well-written document, the annuity option is available for both non-qualified and qualified dollars.
4. Permanent Life Insurance with …
i. A Long Term Care Rider: The latest addition to the LTC solution bin is the ability to add a rider that interacts with the life insurance to which it is attached to accelerate all or a portion of the face amount (note: not the death benefit). These benefits are fully underwritten and the rider is assessed a monthly fee, which is guaranteed not to change.
The LTC rider benefit is defined by Section 7702(B) of the Internal Revenue Code and is classified as long-term care insurance.
ii. An Accelerated Benefit Rider (ABR): Similar to the “true” LTC rider, and ABR or Chronic Illness Accelerated Benefit rider allows the policy to, as the name implies, accelerate all or a portion of the death benefit tax-free for a qualifying event under Section 101(g) of the Internal Revenue Code; is it not long term care insurance.
This version of the rider contains more variability in terms and costs than the LTC rider. The rider may be added without any additional medical underwriting and at no upfront cost – in that version, the acceleration of the death benefit is not dollar-for-dollar but proportionate with the cost of the rider being embedded in the difference between the amount of benefit received and the reduction in the cash value and death benefit. For other insurers and/or products, there is an upfront cost (which allows for a dollar-for-dollar reduction and total acceleration) and may include some underwriting.
4.5 Annuity with a Long Term Care Rider: This rider can be added to annuities designed for lifetime income (generally through a guaranteed withdrawal or income benefit rider) which, assuming the qualifying long term definition is met, will increase by a factor – generally double – the lifetime income amount while maintaining the guaranteed lifetime income stream. Generally, these riders are for a single annuitant and are a single-care option – if there is a long-term care event for a finite period of time and the individual recovers, the benefit will not restart at a second event.
As stated earlier, absent from the use of an insurance product, the primary funding source for long-term care is the liquid asset base; therefore, when our practice evaluates an insurance design, we view the coverage as part of the portfolio. In this way, the LTCi is ‘insurance for the portfolio’, and the premium outflow is considered as a reallocation of dollars within the overall strategy.
The recent changes to the tax treatment of inherited IRAs due to the SECURE Act has created a tax-efficiency opportunity to use qualified dollars (after distribution and taxation) as the premium source, especially for the life insurance with a LTC/ABR rider. Given the added difficulty and cost of applying for coverage after Age 72, we suggest structuring the insurance to be funded initially by existing after-tax dollars and switching over to RMD’s at the mandatory start date.
The asset-based LTC annuity provides a solution for a situation where there is an existing qualified annuity that is not needed or does not provide an advantageous lifetime income option. Through a tax-free 1035 exchange, the qualified dollars are rolled into a qualified fixed deferred annuity where distributions for long-term care qualify as tax-free – this is a unique way to eliminate taxation on qualified distributions.
For individual clients acquiring individual permanent insurance that is personally owned – the rules around LTC distributions from second-to-die policies vary by carrier and may only be available after the death of one insured – it is advisable to evaluate whether the cost of adding a LTC rider for an additional cost makes sense given the relatively inexpensive marginal premium. This approach provides an additional insurance benefit supplemental to the primary concern of legacy planning and can relieve some concern around the premium outflow limiting available funds should expenses for long-term care be needed.
In the application described above, the qualifier of “personally owned” was intentionally included. Whether using the LTC or CIAB rider, we encourage our clients to seek guidance from their tax advisor on the potential income and gift tax consequences of using the rider for a policy owned by an Irrevocable Life Insurance Trust. Since the benefit is paid to the owner (the Trust), the challenge is to determine how the benefit goes from the Trust to the insured, who is generally the Grantor. One solution is to determine whether or not an existing Trust contains language that enables the Grantor/Insured to access trust assets through a series of demand loans that are secured by property pledged by the Grantor/Insured, with interest payable at a fair market rate.
For the life insurance with a rider, it is important to note that for medically underwritten riders, there may be separate ratings for the life insurance risk and for the rider. In other words, the individual is rated both for mortality and morbidity – we have seen situations where a client is rated in a Preferred category for life insurance but declined rider coverage due to medical history that might lead to long-term care issues without impacting life expectancy. In these situations, consider the use of a non-underwritten automatically applied rider as a way to secure some long-term care expense insurance while acquiring death benefit protection.
The Washington State Mandate
Earlier this year, Washington state enacted the nation’s first state-run long-term care insurance program, known as the “WA Cared Fund”. The program provides an LTC benefit of $100/day with a maximum of $36,500 (my calculator says that’s a year’s worth of benefit) and will be funded by a new 0.58% payroll tax deduction on all W-2 wages – there is no cap on income or the tax. The only way for eligible participants to opt out of the program is to request a waiver and attest they own an individual LTCi plan (7702 only) prior to November 1, 2021.
This caused quite a disruption in the marketplace for insurance carriers. If you’re a resident of Washington and haven’t yet taken action, good luck acquiring coverage. The massive influx in applications – and the anticipated adverse persistency risk (individuals acquiring coverage and immediately dropping it after they qualified for the one-time waiver) – caused most providers to either raise minimums on policy face amounts and/or initial premiums and, eventually, to discontinue sales only in the state of WA for asset-based products and riders on permanent policies.
It remains to be seen if the idea of state-run / payroll-funded long-term care will become more popular around the country, but the early results of the Washington test case show that those individuals and advisors that acted quickly were able to make active decisions around their personal LTC planning.
Long Term Care will continue to be an important part of planning for individuals and their advisors. The Baby Boomer generation is at a point where they have or will soon be caretakers (directly or indirectly) for their parents and/or will be entering a stage of life where they will soon need care. From a qualification and pricing standpoint, it is essential to start the conversation around implementing an insurance plan as soon as possible, much sooner than the actual concern.
The LTCi landscape will continue to evolve and change as more insurance carriers are participating in the marketplace. When evaluating LTCi options, it is critical to understand how each of the policies and riders work, what are the underwriting requirements (based on the specific rider available), and how the design fits into the overall objectives of the client’s plan.