Insurance hybrids are attractive but are they the best long-term care solution? Sometimes yes. Sometimes no. They potentially satisfy a number of needs – death benefit, long-term care benefit and investment earnings.
Today, there are a number of long-term care insurance solutions in the market. Traditional pool-of-funds products account about half of policies sold. Also available are hybrids or asset-based products like permanent life insurance with an acceleration or extension rider, or both, and annuities with similar features. The death benefit of the life insurance or the cash value of the annuity can be used to pay for qualifying long-term care expenses. Most hybrids require a substantial single premium to create a desirable long-term care benefit.
Hybrids are attractive to many because they eliminate the “use it or lose it” proposition that comes with a traditional pool-of-funds product. We like to say about hybrids, “Live, die or quit, there is a benefit.” Basically, the policyholder will receive a death benefit, long-term care benefit or a refund of the original premium plus interest should he/she quit the policy.
With all these options, how do you know what’s the right solution for you? We evaluate four factors when recommending a long-term care insurance solution: health, wealth, asset location and financial goals. Each factor contributes to the product decision.
Health – Long-term care insurance products are medically underwritten. Qualifying under a carrier’s medical guidelines is basic to carrier and product selection. Underwriters evaluate the probability that an applicant will develop a disabling condition and need assistance. Traditional products have the strictest guidelines.
Life insurance based products tend to be a bit more lenient. It’s quite common for a carrier to issue a policy to an applicant with some health conditions but charge a higher premium to do so. Annuity products are the most lenient as applicants are paying higher premiums for these products which offset the carrier’s risk.
Traditional products are available to those ages 18 to 85. Life insurance based long-term care solutions are available to those between the ages of 18 and 80 but more appropriate to those 65 and older. Annuity based solutions target an older audience ages 40 through 85 but again are more appropriate to those 65 and older.
Wealth – People purchase long-term care insurance for a variety of reasons: access to care, asset and income protection, quality of care and wealth transfer. Motivations change with wealth levels. For example, access to care is closely aligned with lower levels of wealth. Affordability is key. This may eliminate a more expensive hybrid product from consideration, but it also depends on asset type and location.
Asset Location – We like to help clients with funding options so that whenever possible and prudent, the premium is not coming out of the household budget. For example, if clients have cash value in an existing life insurance policy without long-term care benefits, we would consider repositioning the cash value through a tax-free 1035 exchange to a life insurance product with long-term care coverage. Many issues such as insurability and surrender periods need to be reviewed, but this can be a very efficient and cost-effective funding strategy.
Asset type and annual income are important in determining affordability. As a starting point, the National Association of Insurance Commissioners recommends that a long-term care insurance premium should not exceed 7% of annual income. Further, insurance carriers stipulate suitability requirements related to assets and income and ask if the premium would be affordable if it increased 20%. What we want to understand is the affordability over 10 to 20 years and with the potential of rate increases.
Financial Goals – What you want to achieve with your wealth also plays into the decision-making. If preserving assets for wealth transfer is a key objective, the amount of coverage needs to be appropriate to protect assets. If not outliving income is the objective, that goal also sets guidelines for prudent coverage.
Once we have all the key components identified, we can begin to rule out options. One of the measures that we employ is cost efficiency. Which product will produce the greatest benefit for the least amount of premium?
Because the risk of needing long-term care is so great – 70% by the time we are 65 – it’s pretty likely that most of us will need care at some point. Let’s compare the cost of a traditional product paid over 20 years and the cost of permanent life insurance or an annuity to create the same coverage.
Coverage at $6000 per month for five years creates a pool of funds of $360,000. A single 65 year old male would pay $2781 annually for a traditional policy. Over 20 years the total would be $55,620. The same long-term care coverage using a life insurance based product would cost $141,000. Of course a handsome death benefit accompanies this premium if care is never needed. But if you need care, the death benefit is the first resource used to pay for long-term care expenses. The cost of the same coverage would be $144,000 with an annuity product.
We’re not discouraging the use of hybrids. On the contrary, we think they are very attractive and appropriate solutions for some clients. We just want our clients to understand that the hybrid products may not be the most cost effective solutions in the long run.