Executive Summary
As traditional long-term care (LTC) insurance becomes more and more expensive, and interest rates remain at ultra-low levels, planners and their clients have become increasingly interested in so-called "Hybrid LTC" policies that match together a life insurance or annuity policy with LTC coverage, especially with a more favorable set of tax rules that took effect in 2010. For many, though, the primary appeal of hybrid policies is the simple fact that, unlike their traditional LTC insurance brethren, the premiums really are guaranteed and cannot be increased in the future. Given some of the extraordinarily large premium increases that traditional LTC coverage has experienced in recent years - especially for some of the early policies issued in the 1990s and early 2000s - a cost guarantee is remarkably reassuring.
Yet the reality is that the guarantee of LTC premiums in a hybrid policy may be entirely offset by the fact that the insurance company controls the cash value, and is under no obligation to pay a going rate of return, especially if interest rates rise. In other words, it doesn't really matter that the insurance company can't increase the premiums on the policy by $4,000/year, when the company can simply under-pay on the interest rate by $4,000/year to accomplish the same result! And while the cash value of a hybrid LTC policy generally does remain liquid, taking a withdrawal to reinvest to get better, higher rates would entail surrendering the policy and forfeiting the LTC coverage! In fact, for some types of hybrid LTC policies, the arrangement contractually provides no rate of return to the client at all, and is essentially the equivalent of the client selling a call option on interest rates to the insurance company, where the more rates rise the greater the company wins at the expense of the client!
Given the unique structure of hybrid LTC policies, though, there are still several circumstances where they may be appropriate, despite the concerns about how they may perform in a rising rate environment. In some cases, simplified underwriting provides a way to get coverage for those who otherwise couldn't get any, and in other scenarios, the favorable tax treatment alone can make a hybrid policy compelling as a place to park an existing appreciated annuity. Nonetheless, the bottom line is that in today's environment, consumers must be careful not to engage into hybrid policies that amount to little more than offering the insurance company the unilateral right to profit if/when interest rates rise, when the reality is that simply following a "buy LTC insurance and invest the rest" philosophy would lead to a far better outcome in the long run.
Understanding Hybrid LTC Policies
The basic concept of hybrid long-term care (LTC) policies is fairly straightforward: to pair together life and long-term care insurance (hybrid life/LTC) into a single policy, or alternatively to pair together an annuity and long-term care insurance (hybrid annuity/LTC) into a single policy. Typically funded with a single lump sum premium, the hybrid policy provides the usual benefits/guaranteed associated with its life or annuity policy base, along with the available benefits of a long-term care insurance policy, with all the associated costs deducted directly from the cash value of the policy without current income tax consequences (this treatment was made more favorable for hybrid policies issued after 2009 under the Pension Protection Act of 2006).
Thus, for instance, an individual might put $200,000 into a hybrid life/LTC policy, that will pay a $400,000 death benefit if the client passes away, provide $400,000 of long-term care insurance benefits if he/she gets sick and needs care, and in the meantime the $200,000 of cash value remains invested in the policy and eligible for a modest rate of return (e.g., 1% to 3%). Notably, most/all of the growth in the policy at those interest rates will likely be eroded by the life and long-term care cost-of-insurance charges, but hybrid life/LTC policies typically provide a guarantee that no matter what, the client's original $200,000 remains assured, liquid and available without surrender charges or penalties (though withdrawals would impact available amounts for claims, and claims may affect the amounts available at surrender or death as well). Thus, in essence, the client gets a long-term care benefit if needed, a death benefit if the long-term care claims never manifest, and a guarantee for liquidity in the meantime. In the case of a hybrid annuity/LTC policy, the approach is similar, although the policies typically have a small surrender charge if liquidated early, and pay a lower rate of interest, but also have lower costs (as there is no life insurance death benefit to pay for, and the policy simply pays out its cash value at the time of death).
Perhaps one of the most popular features of hybrid LTC policies, though, is the fact that their costs are typically guaranteed, including and especially the cost of long-term care insurance charges that come out of the policy. This is a notable distinction from "traditional" long-term care insurance, where premiums are not guaranteed against future increases (and in fact for older LTC policies, significant premium increases have occurred in recent years for older policies that were underpriced when originally issued long ago, in addition to other changes in policy pricing and structuring).
The "Risk" Of Hybrid LTC Policies
The conceptual framing for hybrid policies is fantastic - to aggregate together offsetting risks (dying sooner reduces likelihood of big long-term care claims, living longer pushes out how soon life insurance claims are paid), and perhaps gain a little more scale for policy administration as well. However, it's hard to be excited about the actual product selection that’s out there, and the way they’re typically constructed at this point.
The primary issue, as I've discussed previously on this blog, is that those buying hybrid life/LTC or annuity/LTC policies are at risk to losing out on significant long-term returns, because if/when rates ultimately rise, there's no guarantee that hybrid policies will pay competitive fixed income rates of return. In other words, if a client puts $200,000 into a hybrid LTC policy, and interest rates rise to 5%, the hybrid policy might only pay out 3%, and the client "loses" $4,000/year of return as an indirect "cost" of holding the policy. In fact, the whole reason hybrid LTC policies can guarantee the LTC insurance costs is BECAUSE they are NOT guaranteeing to pay fair market returns when rates rise! Of course the company can guarantee that the LTC costs in your hybrid policy won't be increased by $4,000/year (or at all), when the company can simply under-pay on the return by $4,000/year to get the same result with impunity, because they control the money!
This is not to say that insurance companies are necessarily nefarious or that there's any particular reason to expect them to underpay on policies in the future; the point is simply that they can, that it is a risk, and that this risk entirely offsets the value of having the costs "guaranteed." Sure, if the hybrid LTC company isn't paying a competitive rate, the investor can take the money out and reinvest it - the principal generally does remain liquid - but then the client loses the LTC insurance, and might not be able to buy replacement coverage at that point! In other words, just as with traditional LTC coverage, if the policy "costs" increase (by underpaying on the return with a hybrid policy, or increasing the premium charges on a traditional policy), the policyowner is still faced with the choice to keep the coverage at the higher (direct or indirect) cost, or walk away and forfeit the policy and its benefits.
Even worse, though, the reality in today's marketplace is that some hybrid policies explicitly pay NO rate of return, they just provide a death benefit and a long-term care benefit (and a liquid return-of-premium cash value guarantee). While many clients don't care in an environment where cash pays "hardly nothing" anyway, the insurance companies certainly know that rates will eventually rise... and when it does, the returns from those rising rates is all money the insurance company keeps. The more rates rise, the more the insurance company makes, since it is contractually agreed upon for the company to not pay any interest rate to the investor at all! In other words, with the hybrid policies that pay no rate of return, this is basically the equivalent of selling a call option on interest rates to the insurance company, where the insurance company wins (and the investor loses) when rates rise... and if the investor wants out and chooses to reinvest, he/she has to forfeit the long-term care insurance policy just to reinvest the money elsewhere!
Accordingly, it seems that over the long run, investors in such circumstances (with hybrid policies that pay little or no return in today's environment) would end out with more money simply by investing the money themselves in bonds (or more aggressively if they wish), buying long-term care insurance with the bond interest (or other growth), and keeping the rest invested on their own (where the assets stay liquid simply because the client keeps control of it in the first place!). Of course, the bond interest might not quite be enough to cover the traditional LTC premiums right now (and therefore deplete principal slightly), but it will be more than enough once rates rise, which again seems like a reasonable "bet" for someone who still has a 10-20+ year time horizon for long-term care and retirement needs (and over that time horizon, the client could have generated an amount equal to the hybrid life/LTC death benefit just with normal growth!).
In other words, just as permanent insurance is often not competitive to "buy term and invest the rest", today's hybrid long-term care insurance is often even LESS competitive to "buy LTC and invest the rest" as soon as rates rise. Which means, in essence, many of today's hybrid LTC solution only "win" if rates stay unexpectedly low for an unexpectedly long period of time (and do you and your client really want to make a bet where you only win if rates DO NOT rise from here for the next 10-20+ years the client might be alive?).
When Are Hybrid LTC Policies Worth Considering?
Notwithstanding these concerns about the exposure to foregone income and growth if interest rates rise, there are a few situations where hybrid contracts are appealing right now are:
- Using a hybrid annuity with simplified underwriting (a unique offering from a few of today's annuity/LTC hybrids, that allow for coverage after only a very limited amount of underwriting) for a client who can’t get traditional long-term care coverage in the first place. If the client is in poor health and is high risk, and it's possible to get ANY coverage, such as from a hybrid annuity/LTC policy, that’s often a good deal. And the time horizon is likely short enough that the risk of foregone growth from future rising interest rates is greatly diminished anyway. In practice, we've already seen some very poor health clients get an offer from the insurance company to issue a hybrid LTC/annuity coverage (in part because the insurance company knows the overwhelming likelihood is still that the client will pass away before meeting what is often a 3-year self-insurance deductible period). Notably, it's generally only hybrid LTC/annuity policies that have simplified underwriting options, not hybrid LTC/life policies.
- Parking an existing appreciated annuity in a hybrid product, as a way to liquidate the gains for future LTC needs on a tax-preferenced basis. After all, under the standard treatment for annuities, withdrawals from an appreciated annuity are taxable, and often can only partially be offset by medical expense deductions when spent on long-term care insurance needs. However, claims paid directly from an (appreciated) hybrid LTC/annuity are 100% tax free under the changes that took effect in 2010 from the Pension Protection Act. Thus, if the goal is to earmark the funds from an appreciated annuity for long-term care needs anyway, a hybrid policy may be a more appealing way to execute the strategy (and at worst, the annuity will still pay out its cash value as a death benefit to beneficiaries, as it would have anyway). The caveat to this tactic, though, is that it has to make sense from an investment perspective, too, which isn’t always the case given how low the returns are on many fixed hybrid annuity/LTC policies. The approach must also be weighed against simply doing ongoing partial 1035 exchanges of the appreciated annuity to fund a traditional long-term care insurance policy directly on a tax-preferenced basis.
- Using a hybrid life/LTC policy for a portion of money that was specifically going to be allocated to lower-return bonds anyway AND is not anticipated to ever be needed. While the net return on the cash value of the life/LTC policy (especially after life and LTC insurance costs) may be mediocre, the internal rate of return (IRR) for the policy if held to death is often at least competitive with today’s bond rates (which is also why clients should be cautious about surrendering existing permanent pure life insurance policies in today's environment) and is guaranteed under the terms of the policy. With this strategy, the client gets a reasonably competitive fixed rate of return by holding the hybrid policy until death, and still gets significant potential upside if there’s a long-term care event. Notably, this is specifically for hybrid LTC/life policies, not hybrid LTC/annuity policies, as a key part of the value is the assuredness of the death benefit boost. On the other hand, if rates rise enough, the client might still have had more by simply keeping their investments liquid and buying traditional long-term care insurance separately.
The bottom line is that in today's marketplace, there are some opportunities to effectively use hybrid life/LTC and annuity/LTC policies, but the evaluation is more complex and nuanced than to simply focus on the guaranteed LTC costs, guaranteed liquidity of the policy, and potential to get a death benefit (at least for life/LTC policies). While those features may be appealing, as long as the insurance company gets to control the money, and the rate of return it pays, the guarantee on costs alone is meaningless, and clients must be cognizant than in a rising interest rate environment they may finish with far less money than simply buying traditional LTC insurance and investing the rest. This is especially true since, if interest rates rise, the risk of traditional LTC policies having premium increases is further diminished and it becomes more and more likely that today's LTC policies will experience no future increases; in other words, clients should be cautious not to run away from traditional LTC policies and towards potentially-low-return hybrid policies at the exact moment that traditional LTC premium increases are slowing and interest rates are near the bottom of a long-term cycle! Nonetheless, if a client's needs perfectly match one of the scenarios where a hybrid policy is appropriate, it's difficult to beat the cost/benefit trade-offs in today's environment!
Are there any companies still offering hybrid annuity/LTC?
As far as I know, State Life is still writing their Annuity Care product (http://www.oneamerica.com/wps/wcm/connect/oa/statelife/care+solutions+ltc+insurance).
– Michael
AnnuityCare is available from State Life – OneAmerica in many states.
State Life and Forethought both carry annuity products in most states except NY.
re annuity products: compare ratings.
What do you think about Nationwide’s Indexed Universal Life / LTC Rider?
What do you think about Transamerica’s stand alone LTC?
Michael, thank you for this article. It is very well thought out. After spending many years analyzing these products and presenting multiple solutions to my clients it is very clear that you gain the most LTC leverage with traditional LTC policies. Although, the gap has closed somewhat over the last year for females with the introduction of gender based pricing. While rate increases are certainly an objection for some clients, I find that the much larger objection is that there is no financial benefit in traditional LTC if you never need care. Some clients are just not interested in that type of “use it or lose it” solution. Mathematically you present a very clear case for traditional LTC if the client actually needs care. However, what if the client never needs care? Financially they would certainly be better off selecting a Linked product in this scenario. Unfortunately we can’t see the future and tell our clients whether or not they will need care. This leads me to the conclusion that it is in the best interest of our clients if we present multiple solutions and then help them to tailor a plan that meets all of their needs in terms of their health, finances, and preferences. Thanks again.
Tim Kelly
Tim,
There’s no real difference in the “client doesn’t need care” scenarios. A client can spend $3,000/year of growth from a $100,000 investment, or put $100,000 into an asset-based policy that doesn’t grow (because the growth is being allocated to the costs of the policy). The end result is the same in both scenarios – the $3,000 of growth is gone, and the $100,000 of principal remains. Yes, it’s true that with a standalone policy you WRITE the check for the cost, and with the asset-based policy the company EXTRACTS the cost directly, but the net result is essentially identical. The asset-based policy may appeal to our “if I don’t have to write the check it doesn’t hurt as much” mental biases, but that doesn’t actually change the result.
Regardless of whether you buy traditional LTC or hybrid LTC, the cost of LTC coverage is a real cost – and frankly, I’d HOPE that’s the case, as an insurance company that ISN’T charging a fair cost for its LTC benefits isn’t going to have the money to pay them when the time comes! But getting coverage has a cost, and while a hybrid policy makes the cost less TANGIBLE, it doesn’t necessarily make the cost LESS in the first place. And in fact, by surrendering control of the assets, there’s a risk that the cost will actually be MORE (and to say the least, certainly no guarantee the NET cost is assured).
– Michael
Thanks Mike. I agree 100% concerning the cost. I was referring more to the benefit side of the equation where if you have a traditional LTC plan and never need care you will receive no financial benefit. However, in a linked life plan if you never need care your beneficiaries will receive the death benefit.
Hi Tim,
With traditional LTCi, if you never need care, it’s not equivalent to say “you will receive no financial benefit”. Michael has described a scenario wherein LTCi is equivalent to “buy term and invest the rest”. So, with the money one is NOT tying up in LTCi, those premiums are theoretically being invested aggressively somehwere.
(That argument is not novel: we’ve always maintained that by protecting your assets with LTCi, it frees up money you’d otherwise have to squirrel away for more aggressive growth, since you no longer have to earmark it for future care costs.)
So, even if you never needed care, it’s by virtue of being protected that you received a tangible benefit.
Stephen
That’s exactly the case. It’s simple back of the napkin stuff to show that investing the difference creates a much larger “death benefit” than a typical hybrid death benefit. Plus, I’ve always been put off badly by the “benefit” of “you can have your money back at any time.” What legitimate company continually advocates lapsing a policy, which is how that phrase translates in real terms?
Consider this scenario and as Mike says, I’m not saying they’re being nefarious, but…give me a lump sum that you could, with a wise adviser, invest, pay a traditional premium out of, never put a cent in again and have your traditional premiums paid for life.
But instead, I’ll pocket the investment returns instead of you, penalize you if you want it back and now you have no LTCI. So after making money in every conceivable way, I never have to pay a claim on you, either because I made it acceptable to lapse your policy! No wonder I’m continually touting “you can have your money back at any time” to thousands of agents and advisers.
With traditional, if one needed the money, the smaller premiums mean I could probably get my money back after having made money, no penalties and could probably still make the premium payments.
Not to mention that if you go on claim, you’re paying it yourself to the tune of how much of a lump sum you put down. That’s not shifting the risk…til much later.
Can you tell I’m not a fan of sales jingles? If the DOL pushes forward with the fiduciary standard, tradition can only benefit.
“continually touting “you can have your money back at any time” to thousands of agents and advisers”
As someone who’s been in LTCI virtually since its founding, I can tell you that “use it or lose it” was never a top objection of clients until hybrids began their furious marketing a few years ago. Suddenly, the phrase “use it or lose it” was everywhere you turned.
This product class was developed not to quell any major concerns of LTC applicants, but of agents and advisors.
Hi Michael,
I’ve been thinking of writing the “definitive” article on hybrids for some time, but you’ve done an excellent job with this piece, In particular, you raised an “opportunity cost” issue that I haven’t seen adequately explored elsewhere.
Having said that, I will agree with my colleague Tim Kelly in one regard. In my experience, the greatest objection to traditional LTCi (or put another way, the biggest draw to linked-benefit products) isn’t the “cost guarantee”. Rather, it’s the “what if I never need it?” objection.
In fact, in my “Sales Idea #27: Confessions: What the Policyholders Tell Us”, we learn that only 3% of buyers surveyed actually raise the issue of “rate increases” as a concern. It turns out that this objection is perpetuated by agents, who project their own anxieties where none exist in the marketplace.
On the other hand, I would posit that most linked-benefit sales today are made as a result of overcoming the “What if I never need it?” objection… and not by LTCi Specialists (who know how to overcome that objection), but by FA’s. For them, it’s a “take the money from one pocket and move it to the other pocket” sale.
Stephen D. Forman, CLTC
@ltcassociates
That means most hybrid sales are made by FAs succumbing to the objection, not overcoming the objection! I do agree 100% though.
Michael,
What tax rule changed in 2010 to make a “hybrid LTC” policy more attractive?
Thanks,
Michael,
I disagree with your analysis on the hybrid LTC/Chronic Illness Life Insurance products. You stated how most policies required single premium dump ins had no market exposure, the benefit did not rise if interest rates rose, to name a few and that is just not true at all. There are so many other benefits that clients and advisers reading this article are missing out on learning about based on the information you presented.
To address the single premium idea (Lincoln money guard, genworth total living care) while you can single pay you can also pay over periods of 1-10 years. There are dozens of insurance companies who have life insurance policies that not only allow for a lifetime payment option but also allow the client to decide what age they want to pay premiums and if you do that with a no lapse guarantee policy the client (as long as they paid their premiums on time) will have a locked in death benefit and LTC rider and no future premiums, there are no traditional long term care companies that allow single or short pay periods anymore (to my knowledge).
You referred to the cost of investing on your own in bonds and other vehicles and using those funds to fund traditional LTC on its own but never got into the power of leveraging those same dollars into a life insurance policy with a long term care rider due to the income tax free benefit upon death of the client to the beneficiaries compared to traditional assets possibly being taxed upon the clients death.
To address clients dollars not working for them as the market rises or as interest rates rise. There whole life companies such as MetLife and no there are variable companies that offer chronic illness riders as well. Take the Lincoln VUL1, not only is the client offered the ability to pay a certain amount of years, lump sum, or pay for life, but the death benefit/chronic illness rider is a no lapse guarantee death benefit. Furthermore the client can put his insurance dollars into mutual fund sub accounts that will decrease increase as the market does and if the market grows enough it could push the death benefit up which would also push the chronic illness rider pool up. MetLife’s whole life product works similarly where the dividends grow the cash value and death benefit which in turn increases the chronic illness pool or cash value for distribution.
Lastly, there are two excellent benefits this article overlooked regarding these hybrid policies. The first being how some of these companies chronic illness rider’s pay out upon claim. If the companies rider is set up as an indemnity LTC/Chronic illness rider then upon the client qualifying for LTC/Chronic illness payments, these payments are NOT reimbursement and are the payments are sent directly to the client, what that really means is that a client does not necessarily have to be in a LTC facility or have a professional in home care person take care of them because these type of rider payments are paid to the insured directly regardless of receipts sent in.
The second benefit overlooked which may be the most important for some clients and advisers reading this is there are now a hand full of life insurance companies that have these chronic illness/LTC riders built right in to their policy. Think about that, that means that a client who knows they have a need for LTC but has been denied for traditional LTC coverage the ability to purchase a Life/LTC,Chronic illness without showing insurability for LTC they just need to qualify for the Life Insurance (usually up to a sub standard table 3-6).
Full disclosure I am a general agent who works with agents/advisers and their clients on all individual insurance lines Life, LTC, hybrid, DI and am not beholden to one company rather look at any and every company to make sure the objectives of adviser and client are met. I wrote this long winded response because after reading your article felt it was necessary to give those reading this another view on hybrid life/LTC products that were missed in the article
I cannot agree more with Tim Kelly in that clients should be shown all options and we help guide them to make a decision that best fits their needs and objectives.
Feel free to reach out to me if you’d like to go into more detail on where I came up with all my information, there are so many more options available to clients today than listed in this article.
Best Regards,
Drew Tagliavini
Drew,
I find your comments quite illuminating. What are your thoughts on Lincoln’s Money Guard product?
Best,
Alan
Drew,
I have to take issue with indemnity being an ‘excellent way’ to pay claims. First, they’re bound by tax law to pay that way and despite being advertised nowadays as a benefit: “You control your money, not the insurance company!”, what it really guarantees is straight line reduction of the pool of money in as fast a time frame as possible with no accountability and no real assurance that the money is being devoted for care rather than enhancing someone else’s wardrobe. Stories of fraud are rampant, especially with non-certified caregivers and less than well-intentioned family caregivers. I think the reimbursement model, which documents and accounts for care and can be billed directly by most major companies, is in the client’s best interest. The money certainly lasts longer and that’s why they bought the insurance.
I also believe a lot is lost with hybrids in that they are lacking access to state Long Term Care Insurance Partnership Plans like those in my home state of MN; Mike, have you ever given thought to putting a value on these programs/plans? Both with the premium tax credits and Medicaid planning/assistance. Thank you; great topic, great article.
Outstanding piece that has generated important discussion. One consideration that I find absent from much of the discussion comparing the traditional individual with the asset-based policies is the substance and breadth of the contractual entitlements offered under each contract.
Aside from the financial attributes, which are a function of contract design, I remain curious about other elements of each contract that will have a bearing on the sufficiency and flexibility of coverage that will impact the owner’s and, inevitably, family’s access to and application of the benefits.
Would anyone care to comment on this in any way they deem appropriate?
It is also critical to do any cost-accounting comparison to like benefits. Most linked-benefit policies do not contain an automatic inflation increase on the LTCi benefits, and when comparing to traditional coverage it needs to be compared this way. Most of my clients are couples who buy traditional coverage with “shared” benefits. Designed and presented properly, shared benefits for a couple remove almost all “use-it-or-lose-it” concerns.
– Bill Comfort, CLTC
My agent has informed me that there are now life insurance policies with LTC riders that can be paid for with annual premiums (rather than a one-time upfront premium), much like a traditional LTC policy. What do you think about the relative benefits of policies of this nature?
We have discovered a life insurance death benefit you can use while alive and well. This may be the start of a product revolution. Today we know of only one company and one product that offers an option to use the death benefit while alive and well. We are not talking about accessing cash values nor are we talking about a chronic illness, accelerated benefit or LTC option. Alive AND WELL is the unique access option of this life insurance product.
– You don’t need to be dead
– You don’t need to be sick
– You don’t need to be in a nursing home
– You don’t need to be disabled
Our expert Russ Towers presents some great opportunities for turning “death insurance” into “life insurance”. Read more here: http://blog.bsmg.net/legacy-planning-breakthrough-turn-death-insurance-into-life-insurance
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Insurance is not an investment. Anyone expecting to earn a competitive rate of return on an insurance product is not purchasing the type of product they’re looking for. You invest in things that grow your money. Insurance is a protection tool.
Also — benefits on these policies don’t rise or fall with interest rates anyway. They increase on a set compounding schedule (usually 3% or 5%) just like standalone benefits.
Michael,
Do you know off hand whether if someone has two LTC policies they are both primary (creating a possible legal morass) or if one can be secondary? So if someone has two policies each with three years of coverage, can they be stacked or is there a fight?
It would be nice to see an update to this article. The LTCi landscape has changed quite a bit over the past 8 years.