What is the Best Way to Buy Long-Term Care Coverage?

Congress made a change in 2006 that makes a long-term care insurance option more attractive. The Pension Protection Act of 2006 enhanced combining annuities or life insurance with long-term care coverage. Insurers are cranking out more of these policies to meet anticipated demand.

The change was a simple one. The combo policies have been around since at least 1998 but were slow sellers. There was doubt about the tax treatment of payments from the policies for long-term care expenses. A few years ago, distributions from qualified long-term care policies were made tax-free. The LTC portion of combo policies did not fit the definition of qualified policies, and benefits might have been considered taxable by the IRS. The 2006 law stated that funds withdrawn from these annuities or life insurance policies to pay for LTC would not be taxable. It also made clear that annuities and life insurance would retain their tax advantages even when packaged with LTC.

Withdrawals from the policies for long-term care are tax free beginning in 2010. But policies purchased now can qualify if the distributions aren’t taken until 2010.

How do you evaluate these combination policies and who should consider buying them?

In a life insurance policy with LTC coverage, accelerated benefits are available when LTC is needed. A portion of the death benefit is paid to cover LTC, and the death benefit is reduced accordingly. There is a ceiling to the total that can be withdrawn for LTC.

An annuity with LTC coverage usually must be purchased with a large single premium. The details of the annuities are different and can be complicated. One common version of a life care annuity pays a fixed monthly payment for life, but that payment increases if LTC is needed. Others don’t make payments during your life unless LTC is needed. The annuities often have options regarding the amount of LTC coverage, inflation protec-tion, and length of time LTC payments will be made.

One advantage the insurers are touting is that people who ordinarily would be denied coverage for one type of policy can obtain it through a combination policy. Life insurance and LTC underwriting have different standards. Someone who has a short life expectancy because of a heart condition might not qualify for life insurance but would qualify for LTC or an annuity. Other people qualify for life insurance but are disqualified or pay a high cost for LTC. Insurers say that such people are able to get coverage when combining LTC with either life insurance or an annuity. They also say that by purchasing the policies together you will pay less for, say, the LTC rider to a life policy than you would for a separate LTC policy.

Here are factors to consider when evaluating these policies.

Do you need both coverages? One example I have seen is that someone who would pay about $1,300 annually for a separate LTC policy would pay a little over $300 annually for an LTC rider on a life policy. A rule of thumb is that the LTC rider costs about 20% of a stand alone LTC policy. That seems like a good deal, but it is only if you need the life policy.

LTC coverage is combined only with permanent life insurance such as whole life, not cheaper term life insurance. If you do not have a permanent life insurance need, it is not economical to buy both policies to get the lower cost LTC rider. You will pay less overall by buying a straight LTC policy. But if you are not able to qualify for a separate LTC policy or have a permanent life insurance need, consider a combo policy. Permanent life insurance needs include paying estate taxes, providing estate liquidity, equalizing inheritances when one child will inherit the family business, or increasing your legacy.

Will you have enough coverage? All LTC coverage has limits, whether it is a stand alone policy or a combo with life insurance or an annuity. The LTC portion of a combo policy is likely to have a lower coverage limit for the premium dollar than a separate policy.

To answer the question, first determine how much LTC coverage you want and when you are likely to need it. Determine the average cost in the area you plan to be living when LTC might be needed. Estimate what that cost will be after inflation when you are likely to need the benefits. It might be 10 or 20 years from now. Then, determine how much of the care you plan to self-insure or pay from other sources and how much should come from the policy. Finally, ask the amount you would have to put in the life insurance or annuity to obtain that amount of coverage.

If you won’t receive enough LTC coverage from a combo policy you can afford, consider the stand alone LTC policies.

Check inflation protection. The combo policies often do not provide the inflation protection that is available from a separate policy. You want compound inflation protection, not simple inflation protection. Inflation protection is a key to LTC coverage. The cost of care rises faster than consumer price inflation and adds up after a decade or more. Inflation provisions of combo policies can be complicated. Make sure you understand them.

Evaluate the pieces separately. Some insurers offer good life insurance but bad LTC coverage or vice versa. You also give up some flexibility and features in a combo policy. Determine if each piece of the combo policy meets your needs. Compare them to separate policies of the same type to see what you might be giving up with the combo.

Do you have underwriting problems? Life insurers look for risks of premature death. LTC insurers look for risks of chronic care, such as dementia or arthritis. Annuity issuers do not consider health issues. An annuity-LTC  combo policy is likely to adjust your premium only if you already need LTC. A life care policy will focus on the risk of premature death when determining the premium. Your health strengths and weaknesses will determine which is the route to the better premium.

How often are premiums paid? If you buy a life care policy with a single premium your cost is locked in, but you lose the time value of the money. If you pay annual premiums, however, the cost of the LTC rider can change each year. You are at risk of substantial premium increases for the LTC rider. I suspect premium increases are likely, because a life insurer might not have experience pricing LTC coverage.