A critical aspect of the financial planning process for long term care is determining how to allocate resources for what may be a significant future cost. According to the 2019 U.S Department of Health and Human Services (05/08/2019), nearly 70% of individuals over the age of 65 will require some type of long-term care during their lifetime. The average duration of care is 3 years, with 18% of all seniors require more than one year in a nursing home*.
The Pennsylvania Health Care Association estimates that annual spending on long term care in the United States (excluding unpaid family care) has reached nearly $275 billion. Generally, health insurance does not cover these expenses, nor does Medicare (unless certainly requirements are met through Medicare Part A for hospital service); Medicaid may provide some coverage, but only for individuals with very small countable assets. Roughly 23% of that $275 billion - $63 billion – is paid out-of-pocket.
For insurance purposes, Long Term Care (LTC)is defined as the loss of 2 of the 6 of the Activities of Daily Living (ADL) or cognitive impairment that requires substantial supervision. The ADL’s are defined as:
“Bathing” – washing oneself in either a tub or shower, including getting into and out of the tub or shower, or by sponge bath.
“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.
“Dressing” – putting on and taking off all items of clothing, and attaching any necessary braces, fasteners, or prosthesis.
“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.
“Toileting” – getting to and from the toilet, getting on and off the toilet, and performing associated personal hygiene.
“Transferring” – means moving in and out of a bed, chair, or wheelchair.
The original form of protecting against long term care needs was self-insuring, either through portfolio assets or from the family structure. Over time, increased cost of care and the separation of generations within families put increased pressure on liquid assets to cover the cost of care until governmental programs become available. In addition, as we have seen with recent market events surrounding COVID-19, market fluctuations can force liquidation of assets at depressed valuations.
The individual LTC insurance marketplace started in the late 1970’s and ramped up significantly in the late 1980’s and early 1990’s. The timing in the spike of traditional LTC policies coincided with a widening spread in the difference between the Medical Care CPI and Core CPI annual increase. Combined with the improvement in life expectancy – particularly in the mass affluent and affluent segment of the population, those who bought the insurance product – put pressure on these contracts. The impact of the early stage mispricing began to filter through to consumers in the late 1990’s and early 2000’s, as these policies were structured with non-guaranteed annual premiums. It was common to see annual price increases in excess of 30% in order to maintain coverage to support the liabilities of issuing companies.
In 1987, Lincoln Financial Group launches the first “hybrid” product, MoneyGuard. MoneyGuard is designed as a Modified Endowment Contract (MEC) universal life insurance policy with an LTC rider component build in. Though it is a life insurance policy, the policy is structured to provide long term care benefits, through a 2-year benefit period that can be increased through additional riders, much greater than the stated death benefit.
Unlike the previous traditional “stand alone” LTC insurance policies, the hybrid product provides a death benefit – the minimum amount allowable, but still something should the insured have the good fortune of living a long and healthy life and not needed. In addition, there is an equity component which, depending upon the desired tradeoff of lessening the potential LTC benefit, can be a full return of premium after the 10th policy year.
Since the innovation by Lincoln, several insurance carriers have replicated the hybrid product, including but not limited to Nationwide, Pacific Life, and Securian. OneAmerica adapted the universal life design to a Whole Life chassis. Each carrier added their own product differentiation, whether it be the difference between reimbursement or indemnity, the ability to extend a benefit period for lifetime and adding additional premium duration options (though the most common funding scenarios are single or 10-pays). The policies are guaranteed and fully paid once the original premium design is satisfied.
Underwriting is generally “pass / fail” based upon a personal health history interview and prescription check – some providers will offer various underwriting classes and may collect medical records for approval. For these policies, the focus is on morbidity than mortality.
The next phase of evolution in the LTC marketplace has been the proliferation of either Long Term Care or Chronic Illness Accelerated Benefit (CIAB) riders onto permanent insurance policies. Whereas the hybrid product is LTC first, the life insurance strategy is primarily death benefit focused with the ability to accelerate the death benefit for long term care needs. In our firm, we’ve begun to refer to this the “Bucket of Money” strategy … the death and potential long term care benefit come from the same source, either dollar-for-dollar or pro-rata depending upon the carrier and type of rider.
In general, the significant difference between the LTC and CIAB rider – from a product and positioning standpoint, not in terms of licensing or under which section of the Code allows for the benefits to received income-tax free – is the type of underwriting at application and cost. True LTC riders are built into the scheduled premium and include morbidity underwriting along with traditional mortality underwriting. It is possible to have separate underwriting classes for the base life insurance policy and the rider – in our practice, we had an individual qualify for the best available life insurance rating but be denied the LTC rider due to a history of arthritis and orthopedic surgery.
In most cases, CIAB rider is not underwritten at the time of application and is not incorporated into the premium schedule. (As you can see, this is a good way to get some form of coverage for that individual with physical injury history which does not impact life expectancy.) In the event the rider is activated, there is a reduction of death benefit in the amount of claim, interest and mortality factors. Based on non-empirical observation, that total amount of death benefit that can be accelerated is 70-80% when the rider is used for insureds between Age 80-90.
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, in this case the Trust, based upon the condition of the insured, the challenge is to determine how the benefit goes from the Trust to 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. In addition, there is a lack of guidance as to whether having a rider (elective or not) on a life insurance policy owned by an ILIT insuring the life of the Grantor could be deemed an implied agreement between the trust and the Grantor that he or she has retained a beneficial interest under Internal Revenue Code § 2036(a), regardless of whether the rider benefits are activated prior to death. As a matter of current best practice, we advise holding policies with LTC riders outside of the Trust.
*Pennsylvania Health Care Association https://www.phca.org/for-consumers/research-data/long-term-and-post-acute-care-trends-and-statistics