A Needed Boost

• Ronald J Panko
• January 2010
• 

The new year begins what may become a new era in insuring against the financial risk of long-term care.

As of Jan. 1, benefits from annuities that pay for long-term care expenses are tax-free. This provision and others, which are part of the 2006 Pension Protection Act, are likely to boost the development and sales of these hybrid products and of annuities and long-term care insurance in general.

They also may help Americans prepare for the costs of long-term care. According to Carl Friedrich, a consulting actuary and principal at Milliman Inc., less than 10% of the target population that should consider long-term care insurance actually owns the product.

There are many reasons for the unpopularity of traditional, stand-alone long-term care insurance. The top concern is that if buyers don't use it, they have wasted their money. "The annuity combo products really offer the ability to overcome that objection," said Jesse Slome, executive director of the American Association for Long Term Care Insurance. "If you need it, you have access to a LTC benefit; if you don't, you have access to the annuity side."

Long-term care annuities are nonqualified, fixed deferred annuities bought with a single premium. They come with a rider that adds an LTC benefit, after a waiting period of a year or more, that is equal to two or even three times the size of the annuity's account value. The insurer charges an annual fee for the rider equal to a percentage of the account value. The benefits, starting now, are tax-free.

One of the early entrants into the long-term care annuity line was Genworth Financial, which introduced its Total Living Coverage Annuity in 2007 on a pilot basis. It originally came with a two-year deferral period, but the company is planning to reduce that to a one-year deferral, said Beth Ludden, senior vice president in LTC product development. The official launch is planned for the first quarter of this year.

"We recognize the advantages that would come our way under the Pension Protection Act, so we gave ourselves a long runway to experiment and get this product right before we do the official launch," she said. "The game changer is around the ability to put nonqualified money into one of these products and get it out tax-free."

Another important element, Ludden said, is that the law permits tax-free exchanges (under Section 1035 of the tax code) of existing nonqualified annuities into LTC annuities. Ludden said that any carrier that has a lot of annuity assets under management will want to protect those against exchanges and that many large annuity carriers are looking at ways to add a long-term care piece to their annuities in force.

The Genworth product allows a buyer to choose either two or three times the annuity value for the LTC benefit and to select how the benefit will be paid out, either over 24 or 36 months. Interest is credited to the contract value--about 3% as of November--less the cost of the rider. The benefits are the same as in any Genworth stand-alone policy: They pay for home health care or for facility care, including a nursing home or assisted living.

The annual fee for these annuities will vary by age and deferral period. Friedrich said they could range from a low of 45 basis points a year at issue age 45 to a high of 215 basis points at age 75 (see chart on next page). For a typical buyer from 65 to 70 years of age, Ludden said Genworth charges about 130 basis points. The LTC part of the product is treated like a guaranteed renewable product, so the fee will be based on the issue age for the life of the contract, Ludden said.

Friedrich said there are three main designs that writers of these product can use to pay out the benefits: tail, co-insurance and pool. Under the tail design, the insurer pays a certain percentage each month from the account value as an accelerated benefit without a surrender charge. When that is depleted, a benefit-extension provision continues monthly payments for the period chosen at the time of product purchase. Under the coinsurance design, the accelerated and independent benefits are paid concurrently in fixed proportions until the benefit is exhausted. Under the pool design, benefit payments are based on the pool amount defined at issue.

An example provided by Friedrich of the tail design demonstrates the product's potential: A 60-year-old annuity purchaser deposits $100,000. At age 80, she needs long-term care. If the annuity had no LTC rider and grew at 4% annually, she would cash out $219,000 and pay $36,000 in tax, assuming a 30% tax rate, for a net of $183,000. But with a rider that pays 200% of account value with an annual cost of 65 basis points, the annuity would grow to $193,000, so the contract would pay out $386,000 tax-free.

Slome said this type of annuity is "incredibly attractive" and changes the sales conversation with clients that have sizable assets and the inclination to self-insure, but that don't want to risk losing everything. The only downside is that to have a meaningful long-term care benefit, the buyer has to commit significant funds into the annuity and let them grow. Withdrawals would weaken the benefit, and annuitization would eliminate it, Ludden said. Genworth's minimum purchase price is $50,000.

Friedrich said this element of self-insurance is what makes the long-term care coverage embedded in these products typically less than half the cost of a stand-alone policy. "It's not creating money out of thin air," he said. "The insured is obviously sacrificing those account values for LTC benefits. But that's understood as part of the overall mechanism."

However, to cover the costs of a long-term care event of five years or more, or of Alzheimer's disease, a stand-alone product would provide a greater level of benefits, said Ludden.

Genworth's consumer research has shown that many stand-alone buyers have a family member that has needed long-term care, so that they know first-hand what the costs can be, she said.

LTC annuities also will compete with life insurance/long-term care hybrid products, which have been available for more than a decade. Friedrich said these products are more expensive due to the cost of the death benefit. However, the death benefit would be paid tax-free, while the gain in an annuity held until death is taxable, he said.

Seeking a Sales Edge

The jury is out as to what kinds of professionals will sell these products, according to Friedrich. "There will be knowledgeable annuity specialists who see the opportunity," he said. "If they don't have a health license or LTC training, they'll get it." Some will resist, and some will not want to get involved in the underwriting process. But as activity increases, they will realize they are missing an opportunity, losing new business or even losing in-force clients, he said.

A lot of sales will be through financial planners and long-term care specialists, advisers in a position to assess clients' overall financial pictures, Friedrich said. The average annual stand-alone premium has risen 30% to 50% over the last five years to about $2,100, he said. "Instead of tying down that client to that annual commitment, moving funds from a $100,000 certificate of deposit into a hybrid product can be an appealing concept, where the LTC insurance cost, assessed directly against the annuity account value, might be a third of the $2,100 stand-alone premium," he said.

Ludden said that for Genworth's LTC annuities, brokerage general agencies have shown the most interest and that stockbrokers and independent financial planners have also expressed interest. Genworth has relationships with Smith Barney, Merrill Lynch, Edward Jones and Ameriprise, she said, but not all of those firms have approved the products for sale.

While the product's potential is great, annuity writers may have to worry about conserving in-force business as producers may want to use the 1035 exchange to move existing business into the new products. But Friedrich noted that once long-term care annuities are on the books, they will likely stay there.

Cumulative surrender activity for annuities in general in the three or four years following the end of surrender charge periods range from 60% to 70%.

"The presence of a LTC rider will knock down those lapse rates to levels much closer to those on stand-alone LTC insurance, which is 1% to 2% annually," he said. And while stand-alone long-term care insurance is more profitable when lapse rates are higher, annuities are more profitable when the lapse rate is lower, said Friedrich. That means opportunity for annuity writers to solidify relationships with their insureds, lock in that business, and earn their spread on the base plan assets over a much longer period of time.

Said Slome: "Once one or two large annuity companies enter the marketplace, everyone else will have to, if for nothing else than from a conservation standpoint."

Besides Genworth, companies with LTC annuities include Mutual of Omaha, OneAmerica, John Hancock, Midland Life (an indexed LTC), Conseco and Guaranty Income Life, according to Friedrich.

He said the financial crisis of the past year has slowed down some companies, but he expects introductions over the course of this year.

Learn More:

Genworth Life and Annuity Insurance Co.

A.M. Best Company # 06648

Distribution: Long-term care specialists, brokerage general agents, banks, securities brokerage firms, producer groups, mutual fund companies and work-site marketing brokers

For ratings and other financial strength information visit www.ambest.com.

By Ron Panko, senior associate editor, Best's Review: Ronald.Panko@ambest.com