As they age, many of our clients will need assistance in caring for themselves. Long-term care (LTC) insurance provides funds for such assistance when it’s needed most for items not covered by Medicare or health insurance. In today’s marketplace, there are many options for providing LTC coverage that will meet a client’s needs. Let’s review some of the guidelines for identifying and selecting the proper type of coverage for an individual’s given circumstances and discuss some of the considerations regarding COVID-19.
The Basics
LTC policies are medically underwritten and should be purchased when an individual is healthy. If an individual qualifies, premiums will be based on factors including the individual’s age, gender, current health, build, smoker status, marital status and resident state. LTC policies provide benefit payments when an individual can no longer perform routine daily activities without assistance, referred to as “activities of daily living” or “ADLs,” which include bathing, eating, dressing, toileting, transferring/mobility and continence. An insured typically qualifies for benefit payments when they can no longer independently perform two of six ADLs or they’re diagnosed with a severe cognitive impairment.
Once an insured qualifies for benefit payments, a policy may pay monthly or daily benefits either in cash or as a reimbursement. A cash or indemnity policy pays a monthly benefit regardless of actual LTC expenses incurred. With a reimbursement policy, the carrier will make payments based on submitted expenses for LTC services up to the limit provided by the policy. Each policy has a benefit period equal to the length of time, typically two to six years, that the policy will pay benefits to the insured. It’s important to note that LTC coverage includes home health care as well as care provided in an assisted living or nursing facility.
Tax Deductibility of LTC Premiums
For stand-alone policies and certain linked benefit plans in which the premium has a portion allocated to the LTC benefits, all or a portion of the premium may be tax deductible by an individual. As with accident and health insurance, individuals who itemize deductions may deduct the lesser of: (1) the actual premium paid; or (2) the eligible LTC premium. The eligible LTC premium for 2021 is:1
Age 40 or less $450
Age 41 – 50 $850
Age 51 – 60 $1,690
Age 61 – 70 $4,520
Age 71 and older $5,640
The medical expense deduction is allowable to the extent that such expenses (including payment of eligible LTC premium) exceed 10% of adjusted gross income.2 The per diem limit for 2021 is $400.
Types of LTC Coverage
A number of LTC coverage options are available—the challenge is finding the best solution that meets a client’s particular needs. The four primary options are:
1. Self-funding. With self-funding, also known as self-insuring, the cost of care is provided from an individual’s own funds.3 Often, the key question centers on the individual’s ability and comfort in self-funding. Is there a level of income/net worth that makes this option a safe bet? Generally, a single client with $3 million to $5 million of investable assets (roughly 50% to 75% more for a married couple) can self-fund. However, factors to consider to determine whether self-funding is a viable option include the client’s age, the type of assets (whether liquid or not), sources of income, expected living expenses (including a substantial cushion for unexpected expenses), the estimated cost of coverage and how a significant LTC expense will affect their spouse and/or dependents’ financial security. Surprisingly, many high-net-worth and even ultra-high-net-worth individuals who can clearly afford self-funding nevertheless elect to purchase LTC coverage due to the peace of mind and comfort the coverage provides.
2. Stand-alone LTC. The sole purpose of a stand-alone LTC plan is to provide for the payment of LTC expenses. Most of today’s stand-alone policies are reimbursement plans with a few offering a partial cash/indemnity payout option. Stand-alone plans can include inflation riders, and most have benefit periods that are limited to a term of years (as opposed to unlimited plans that pay as long as care is needed). Care coordination benefits are available to help a policyholder identify home health care providers as well as nursing home and assisted living options.
Benefit payments are income tax free, and a portion of premiums may be deductible (see below). Plan design should be based on several factors such as age of client, marital status, the local cost of care (sometimes clients price care at a specific care facility), personal and family health history, income and net worth. Clients without children may prefer this type of plan as they don’t have a need to leave a death benefit to anyone. Generally, there’s no death benefit or return of premium associated with these plans, so it could prove to be an expensive option should the client never incur LTC expenses or incur limited LTC expenses. In that case, the coverage simply provided peace of mind. Of note, the pricing of stand-alone products has continued to rise as carriers experience higher claims and react to the prolonged low interest rate environment.
3. Hybrid plans. Hybrid plans combine a permanent life insurance policy with an LTC or chronic illness rider.4 The rider allows the death benefit to be “accelerated” (paid during the lifetime of the insured) at a specified rate (typically 2% or 4% of the death benefit can be accelerated each month for LTC needs). In essence, these plans allow the insured to draw down the death benefit during lifetime to pay for LTC expenses while leaving any unused death benefit for heirs. There’s a limited benefit period with these plans; for example, a 2% annual payout provides 50 months of benefits, a 4% annual payout provides 25 months of coverage. Although hybrid products don’t include inflation riders, a few carriers allow increasing LTC benefits if the death benefit increases over time, and a few companies include care coordination benefits. These plans can be funded by cash or by an Internal Revenue Code Section 1035 exchange from an existing life insurance policy, and premiums can be designed to be paid over any number of years. Finally, the life insurance chassis can be any permanent plan—whole life as well as current assumption, guaranteed, equity-indexed or variable universal life.
4. Linked benefit plans. Linked benefit plans also combine a life insurance policy (or annuity) with an LTC rider in a combined plan design. These life and LTC insurance products are weighted for LTC benefits more heavily than a life with rider hybrid plan, but do include a tax-free death benefit that’s payable if LTC is limited or not needed at all.
There are a number of important differences between linked benefit plans and hybrid plans. The hybrid plan is primarily a life insurance policy with a low cost LTC rider, and benefit payments are a pre-payment of policy death benefits. The linked benefit plan has a greater emphasis on the LTC coverage. LTC benefits are first paid from the policy death benefit and, once exhausted, will be paid from the LTC portion of the contract. Third, with linked benefit plans, some carriers unbundle the life and LTC premiums. As a result, the LTC portion of the premium is deductible to the extent discussed below.
Linked benefit plans may have reimbursement or cash/indemnity payouts and can include inflation factors just like stand-alone LTC. While originally these were asset-based plans that required a single premium dump-in for funding, all carriers now offer a variety of premium payment options allowing more clients the ability to afford and pay for these plans. Linked benefit plans can be funded with an IRC Section 1035 exchange from an existing life insurance policy. In addition, linked benefit plans frequently provide a return-of-premium feature should the client wish to cancel their policy and get their money back.
With linked benefit plans, all benefits are guaranteed so there’s no concern of increasing premiums or the cash value performance of the contract. The care coordination benefit is also a feature of these linked benefit plans. All benefits are income tax free, either as a death benefit or LTC benefit.
Linked benefit plans are also available in an annuity/LTC version. Annuities qualifying under the Pension Protection Act provide meaningful tax-favored treatment not available to traditional annuities.5 Withdrawals that are used to pay qualified LTC premiums (for example, on a stand-alone policy), qualified LTC rider costs or qualified LTC expenses are received tax free as a return of basis. These withdrawals reduce basis, but not below zero. Once basis is reduced to zero, benefit payments from the LTC rider for qualified LTC expenses are tax free and eliminate gain in the annuity dollar-for-dollar. These annuities must be funded from after-tax sources, that is, they can’t be purchased in a qualified pension or profit sharing plan or in an individual retirement account. These linked benefit annuity plans may be funded by a Section 1035 exchange from an existing annuity or life insurance policy.
It should be noted that, because hybrid and linked benefit life insurance plans provide a policy death benefit, they’re more expensive than stand-alone LTC policies.
Selecting Appropriate LTC Product
What’s the best LTC product? The answer: It depends on the facts, circumstances and needs of each individual client. Advisors and their clients should always consider the financial ratings of the carriers and evidence of how well they’ve treated their policyholders and carefully review product features and limitations to ensure that they’re purchasing a secure product that reflects the client’s needs for future care. Here are a few rules of thumb:
- For a client with limited funds, a stand-alone LTC policy frequently provides the best LTC coverage for the cost.
- If a client has available funds and wants strong guaranteed LTC coverage, a linked benefit policy is a good choice. Linked benefit plans can be a great option for clients who are older or clients with health issues (that is, the other types of
- coverage would be cost-prohibitive or unavailable) because there’s less underwriting required.
- For clients who no longer need in-force insurance coverage or who aren’t relying on an existing annuity for income, a Section 1035 exchange from a permanent life insurance policy or a traditional annuity to a tax-favored linked benefit annuity plan can be a great option that efficiently redirects those funds to provide LTC coverage.
- If a client has a life insurance need and some concern about the potential for a care need in the future or wants to make an existing life insurance policy “dual purpose,” then a hybrid life and LTC product makes sense. Again, a Section 1035 exchange of an existing life policy into a hybrid plan can be attractive.
- Finally, there’s a difference in underwriting requirements depending on the type of plan selected:
- Stand-alone LTC policies will require a full review of doctors’ records, phone interview and, for some clients (generally age 65+), a face-to-face interview.
- Linked benefit plans generally only require a phone interview. However, if the interview uncovers health risks, some carriers will require a review of doctors’ records.
- Life with LTC rider hybrid plans require medical and financial underwriting including exams and review of doctors’ records.
Effect of COVID-19
Given the world’s current and recent experience with COVID-19, most people today understand that their health can change in an instant and are sensitive to how that can affect them as well as their families. LTC needs can follow a similar path. Most clients understand that an extended health care need is likely to occur during their lifetime and may warrant planning ahead with LTC coverage. The question for many clients is whether to self-fund or purchase protection from an insurance company.
Although nursing facilities provide a very necessary and important care function for those who don’t have a plan that will pay for home care services or who’ve spent down all their money on care, that isn’t most clients’ preference. Regarding the COVID-19 pandemic, AARP noted in December 2020 that although fewer than 1% of Americans live in LTC facilities, 40% of the deaths from COVID-19 were nursing home residents.6 As a result, the pandemic has dramatically accelerated the trend among individuals who have the option of choosing home care over care in a nursing facility. While some individuals currently residing in nursing facilities have the option to move out and live instead at a family member’s home, many don’t.
All LTC products available today cover home care services so no change in available products is needed. However, older clients who are considering purchasing some type of coverage currently have fewer options. Due to the pandemic, carriers have limited their maximum issue ages and may be tightening underwriting.7 This is due to the higher risk of COVID-19 in older individuals and the fact that social distancing has limited face-to-face interviews required at older ages. It remains to be seen if the pandemic results in increased claims that could negatively affect pricing of LTC products going forward.
Purchase While Young
LTC insurance provides individuals and their families with greater financial security. It’s important for individuals to consider and purchase coverage while they’re still relatively young and healthy. Individuals should carefully consider many factors to identify the product that best meets their needs for coverage.
Endnotes
1. Internal Revenue Code Sections 7702B(a)(1), 213(d)(1)(D) and 213(d)(10).
2. IRC Sections 213(a) and 213(f).
3. The industry is getting away from calling this “self-insuring,” as that’s really a misnomer because there’s no insurance factor included.
4. Based on medical underwriting, it’s possible that the rider isn’t approved while the base life insurance plan may still be available.
5. Public Law 109-280 effective Aug. 17, 2006. IRC Section 7702B.
6. David Hochman, “Four Months That Left 54,000 Dead From COVID In Long-Term Care,” AARP Bulletin (December 2020, Special Edition), www.aarp.org/caregiving/health/info-2020/covid-19-nursing-homes-an-american-tragedy.html.
7. There’s been a call for greater transparency in carriers’ underwriting processes.