Federal Employees Should Explore Alternatives for Paying Future Long-Term Care Expenses (Part I)

With millions of baby boomers – this includes federal employees already in retirement or nearing retirement – the need for long-term care (LTC) insurance appears obvious. Today’s and future retirees face extended life expectancies as well as rising costs for nursing home stays, assisted living facilities and home health care. In the 1990s and early 2000s there was a tremendous push for individuals to purchase long term care (LTC) insurance policies in order to pay for the strong likelihood of incurring future LTC expenses.

But stand-alone individual LTC insurance policy sales declined nearly 70 percent from 2012 to 2017 according to the LTC Insurance Sales Survey conducted by LIMRA, a research learning and development organization. At one time in the 1980‘s and early 1990’s, 80 to 100 insurance companies offered individual LTC insurance. Today in 2018, perhaps there are 8 to 10 companies offering individual LTC insurance policies.

One reason for the significant drop in individual LTC policy insurance sales is increasing premium costs. This includes the Federal Long-Term Care Insurance Program or FLTCIP available to Federal employees and annuitants. According to the National Long-Term Care Insurance Price Index published by the American Association for Long-Term Insurance, a married couple in which both spouses are both age 55 had an average annual premium of $2,466 in the 2012 survey. By 2018, that number had increased to $3,000.

This is the first of two columns discussing alternatives for stand-alone LTC insurance policies. This column discusses a combination fixed annuity with payouts for LTC expenses. If LTC is in fact needed, such an annuity will provide either increased liquidity or additional cash flow to pay LTC expenses.

Annuities with Long-Term Care Benefits

With a fixed annuity that can be used to pay for LTC expenses, an individual who purchases the annuity (the annuity “owner”) pays an insurance company a lump sum amount of money upfront. For many individuals, this upfront lump sum payment is more attractive than the future premium cost uncertainty associated with paying an annual premium to the insurance company for a stand-alone LTC insurance policy.

Many individuals do not like the high premiums associated with LTC insurance and the possibility that the insurance company will likely raise premiums in future years. This is exactly what has happened to Federal employees and annuitants who have enrolled in the FLTCIP and will likely occur again in 2023 when OPM renews its contract with the Long-Term Care Partners LLC, currently run by John Hancock Life and Health Insurance Company. Beyond the current and potential future premium expenses, prospective LTC insurance policy buyers may object to the idea of never receiving a benefit if LTC is never needed. This would occur for example if the LTC insurance policy holder died before every needing LTC.

Accessing Benefits with a LTC Annuity

Although the exact guidelines may vary by contract annuity, annuity owners with access to pay LTC expenses can only do so if they qualify for care that is needed because of a diagnosis of some type of dementia or the inability to perform two of six activities of daily living (ADL’s): The ADL’s are bathing, eating, dressing, toileting, transferring from place to place, and refraining from incontinence.

It is important to note that combined LTC insurance–annuity policies can deliver some investment returns to the policyholder even if LTC is never actually needed. Many annuities have “lifetime income riders” in which the rider increases the monthly or annual payout to 150 percent or 200 percent of the regular payout once the annuity owner cannot perform two for six ADL’s. The increased payout may be limited by time or account value. For example, if the lifetime payout is $20,000, then the insurance company may increase the payout to $30,000 or $40,000 per year for up to five years, or until the policy value reaches zero. At that point, the annuity payout would return to $20,000 for the remainder of the annuity owner’s life.

Drawbacks Associated with a LTC Annuity

Annuities with LTC benefits do in fact have their drawbacks and flaws. One drawback is that the opportunity cost is high because the investment return on the fixed annuity is usually less than one percent, often zero percent. With some of these annuities, the investment return is actually negative every year; the cash surrender value decreases every year instead of increasing.

Another drawback of LTC annuities is the fact the annuity owner must make a rather large lump sum payment upfront– usually in the order of $100,000. The insurance company will then use the lump sum payment first to pay qualified LTC expenses before the company starts using its money. In reality, the annuity owner is in reality “buying a $100,000 deductible”.

The other major drawback associated with LTC annuities are the high fees. While annuities have higher fees than other investment products, the insurance companies who offer LTC annuities justify these fees on the following grounds: An annuity is transferring investment risk, interest rate risk, and longevity risk to the insurance company. The only reason that the insurance company is willing to absorb these risks is because it is being paid a fee.

Which Individuals Are Ideal Candidates for a LTC Annuity?

The ideal individual for purchasing an LTC annuity is someone who does not want to pay annual premiums for a traditional, “stand-alone” LTC insurance policy and wants his or her money in a safe, yet low-yielding somewhat safe investment. Note that if LTC benefits are not triggered, then the annuity owner can still earn a low yield from the annuity and life-time income from the annuity.

Those individuals who have significant cash value built up in cash value or permanent life insurance policies (these include whole life, universal life, and variable life insurance policies) in which the death benefit is no longer needed are ideal candidates for LTC annuities. These individuals can perform an Internal Revenue Code (IRC) Section 1035 exchange in which the built-up cash value from the life insurance policy is directly transferred tax-free to the LTC annuity. In so doing, the individual is addressing his or her future LTC needs in an ideal way to get LTC insurance with no additional out-of-pocket expenses.