What’s Keeping LTCi from Achieving its Full Potential?

If you ask most people heading out the door if they would grab an umbrella with a 40% chance of rain, the answer would probably be yes. So when it comes to Long-Term Care insurance (LTCi), why might many independent insurance agents tell you that getting their customers to purchase it is a difficult sale? Statistics indicate that 40% of Americans will require some form of long-term care in their lives, either as “assisted living” at home or at a nursing facility. Even in this year’s difficult economy, LIMRA has indicated that permanent life insurance sales are up 6% over 2010. Yet, sales of LTCi remain fairly tepid.

One of the primary reasons for the purchase of life insurance is to financially protect a family against a premature death. On the other end of the spectrum is the concern of “longevity risk,” or outliving one’s financial resources. According to National Center for Health statistics, the life expectancy of a newborn American male in 1900 was 46.3 years, while the life expectancy of a newborn American male today is 75.3 years. With American longevity increasing annually, long-term care insurance continues to grow in importance.

But carriers underpricing LTCi and general misconceptions about what Medicare covers (see sidebar) contribute to the negative press the product receives; the reality, though, is that exposure to catastrophic LTCi costs in retirement represent one of the biggest risks to retirees. And, one out of four LTCi claims is filed for people under the age of 65.

In addition, in October 2011, Health and Human Services Secretary Kathleen Sebelius announced an end to efforts to implement the CLASS Act, a recent government-run voluntary long-term care insurance program authorized as part of the health care overhaul law.

The CLASS Act was deemed unworkable under the parameters spelled out in the law, mostly due to an amendment added by former Sen. Judd Gregg (R-N.H.) stipulating that the new entitlement program must be actuarially sound over the course of 75 years.

The program was designed to pay out a minimum benefit of $50 per day and be paid for only by premiums, with no taxpayer funding. However, its design made that impossible because actuarial studies indicated an overwhelming majority of Americans would opt out of the program, resulting in an adverse selection of program participants. Simply put, the less-healthy population would participate, and the healthier population would opt out.

Meanwhile, an increasing number of states are reducing coverage for Medicaid recipients. The cost of Social Security, Medicare and Medicaid are estimated to represent more than 50% of the federal budget by 2020 and are straining state and federal coffers.

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Accordingly, the need for private LTCi will continue to increase, as it can be expected that eligibility criteria and funding will be negatively impacted along with the aging of the Baby Boomers. Currently, a majority of people will pay for LTCi costs either through self-insurance or Medicaid. In order to be eligible to have Medicaid pay for LTCi expenses, an applicant must meet the program’s financial guidelines, which means people who have meaningful assets will have to first pay substantially for their own LTCi expenses until they qualify for Medicaid.

But the question then becomes: Do most people have the assets to pay for LTCi? According to a 2011 John Hancock Financial Cost of Care Survey conducted by LifePlans, the national average annual cost of care in the U.S. is $85,775 for a private room in a nursing home, $75,555 for a semi-private room in a nursing home and $39,240 for an assisted-living facility. At-home care costs average about $20 per hour.

Since studies indicate that two out of five Americans will at some point incur significant LTCi expenses for a period of six months or longer, coupled with the government safety net continuing to fray and the collapse of CLASS, agents need to reengage their clients in a dialogue about LTCi—but keep in mind some of the current carrier trends. Due to fast-rising LTCi costs and weak returns on their investments, insurers have been raising long-term care premiums by double-digit percentages. And, a number of national carriers have exited the market. A decade ago, 130 companies offered LTCi, and today that number has dwindled to about 20.

A November 2011 study sponsored by Genworth found that most adults believe that long-term care insurance should be purchased between the ages of 45–64, yet 82% of this age group has not purchased a policy. The study also found that since the 2008 financial crisis, only 20% of adults have taken any action on their financial strategy.

This means that there is a large swatch of consumers who realize they should be taking action but need to talk to someone to learn about their options. Agents should first remind their clients that LTCi benefits are received income tax free—a great incentive from the get-go. Even if the expense is catastrophic, under current tax laws, only medical expenses in excess of 7.5% of adjusted gross income (AGI) can be deducted if the taxpayer itemizes their return.

For clients with adequate savings or an existing life insurance policy or annuity, there are other avenues provided through “hybrid” LTCi policies. While there are variations among carriers, hybrid policies link long-term care to a life insurance policy or annuity contract. Using a life insurance policy with an LTCi rider, the insured deposits a set premium into a policy. Depending on the age, gender and health of the client, an immediate pool of money is created for long-term care. At the same time, an immediate death benefit is created in life insurance. Both are received income tax free.

A hybrid approach links long-term care benefits to a single premium deferred annuity. The contract begins as an annuity with either a lump sum deposit or structured deposits made over time. If no care is needed, the annuity gains interest functioning like any other fixed annuity. But if the owner or annuitant needs care in a nursing home or elsewhere, a formula will be used to determine the amount of the monthly benefit available to the client.

The newest generation of hybrid policies is the long-term care annuity. This product also functions similar to a fixed annuity, but has a long-term care multiplier built into the policy. There is no premium rider attached to the annuity policy, which is medically underwritten. Instead, a portion of the internal return in the contract is used to pay for the long-term care benefit. Long-term care is calculated based on the amount of coverage selected when the policy is purchased. The policies typically provide a payout of 200% or 300% of the aggregate policy value over two or three years after the annuity account value is depleted.

With these new tax-efficient policies—and with the collapse of the CLASS program—agents should be reaching out to their clients to explain the advantages and disadvantages of these new policies, while pointing out that it is more important than ever to have a strategy in place for the risk of catastrophic LTCi expenses.

Evans (dave.evans@iiaba.net) is a certified financial planner and an IA contributing editor.

For people who cannot afford to pay for a policy that offers lifetime LTCi benefit payments, one approach would be the purchase a “partnership” LTCi policy. The partnership program couples the purchase of long-term care insurance with eligibility for Medicaid coverage for LTC services. With the purchase of a partnership policy, a consumer can become eligible for Medicaid coverage after using the insurance benefits without having to exhaust his or her own assets to qualify for such coverage. Assets equal to the amount expended by the insurance policy are not considered countable assets for purposes of Medicaid eligibility and are exempt from the Medicaid estate recovery provisions. (One significant caveat: Those with home equity exceeding $500,000 are not eligible for Medicaid even with a partnership policy, although states may increase that ceiling to $750,000.) Most states participate in the partnership program, although there are nuances among states, so agents need to consult their specific states to understand specific provisions. For more information, visit http://w2.dehpg.net/LTCPartnership.

—D.E.

Some of the reasons that LTCi has been kept from broader acceptance include: Misunderstanding of Medicare’s coverage for long-term care. Many people incorrectly believe that Medicare covers long-term care, which has limited benefits following a hospitalization.

Agents have often taken a “Cadillac” approach to providing coverage, such as including inflation riders, $200 per day perdiems, five-year or longer benefit periods and short elimination periods, all of which can result in sticker shock. While those are desirable features, the overall cost creates purchase paralysis.

Carriers that have underpriced the product have raised rates significantly, creating negative press and leaving some retirees wondering why they purchased the coverage in the first place.

—D.E.