It's debatable if the fiduciary standard is 'higher' than suitability. But the better question might be, who's holding the bar?
By Linda Koco
Annuities that offer long-term care riders don’t get a lot of attention in industry news. But brokerage general agent Michael Smith said clients definitely are interested, and the product does sell when the fit is right.
For example, one client had more than $200,000 sitting in a money market account “doing nothing.” This was not money the client needed for income purposes, Smith said, so the recommendation was to leverage a portion of the funds by putting them into an annuity with a long-term care rider.
This way, if the policyowner ever needs long-term care, the policy will pay out the annuity benefits for care-related services free of federal taxes, he said. Once that money is exhausted, the rider’s pool of LTC benefits will start making the long-term care payments, also tax-free.
The pool of long-term care benefits in these policies can be substantial. “Depending on the contract selected, it can be double or triple the account value,” said Smith, who is president of Milwaukee-based CPS Horizon Financial Group.
The payout period for the care benefits can vary. Depending on what the client wants, a policy can be set up to pay long-term care benefits over several years or even for the client’s lifetime.
However, he said, the pool value is available only for care-related payouts. “If the policyholder never uses the annuity’s long-term care benefits, the annuity functions like, and is taxed like, a traditional fixed annuity.”
Smith credits the Pension Protection Act (PPA) of 2006 with breathing life into these products. In 2010, a provision of the act took effect that makes the LTC benefits in what are now called PPA-friendly annuities payable on a federal tax-free basis. PPA-friendly annuities are ones that are specifically designed to meet the requirements of the law.
Smith’s brokerage represents three or four fixed annuity carriers that currently offer PPA-friendly fixed annuities. (He does not work with variable annuities.) Now, owners of older annuities can, and do, make 1035 exchanges into these products in order to get the tax-free long-term care benefits.
Customers should know that these contracts don’t provide much growth, Smith emphasized. For example, at one company, a contract opened with an initial account value of $100,000 may grow only to an accumulation value of $106,000 at the end of policy year five on a non-guaranteed basis (nearly $102,000 on a guaranteed basis).
The modest growth reflects the fact that the cost of the rider’s coverage is factored right into the annuity’s pricing. That is a function of the product being designed for long-term care, Smith said.
So, if a client is looking primarily for growth, this is not the right product.
It’s also not the right product if the person cannot qualify for the long-term care underwriting. “Applicants can, and have been, denied,” Smith said. For instance, for one product, reasons for declination include confinement to a bed, diagnosis with a disease like dementia or Parkinson’s disease, or use of certain medications such as Aricept or Exelon.
Annuity producers who typically work with traditional fixed annuities, which are not underwritten, will therefore need to recalibrate their presentations when selling the PPA-friendly annuities. However, the process may be simplified if the carrier uses tele-underwriters to ask the underwriting questions.
Another consideration is the money the client has available. First, the available funds should not be money the person needs for everyday living, Smith said. Even then, he recommends putting only a portion of the funds into the annuity.
“It is my opinion that clients are best off if they have $70,000 or more to deposit,” he added. It’s not required, he said, but a larger initial deposit creates a much larger long-term care benefit down the road when it’s needed.
For example, he pointed to an illustration for a 60-year-old woman who deposits $100,000 into a PPA-friendly annuity. “By age 70, her total amount of tax-free long-term care benefit will be $310,000 — not bad for a $100,000 deposit,” he said. Her monthly long-term care benefit at that age would be nearly $5,200. Upon claim, the minimum length of time the claim would be paid is 60 months.
By comparison, if the same woman deposits only $43,000 at age 60, her long-term care balance would come only to about $134,000 at age 70, and her monthly benefit at that age would be about $2,200.
The above values are rounded and shown on a non-guaranteed basis.The guaranteed values in both instances would be lower, but the same pattern would occur.
Another consideration: Determine what types of claims will qualify for benefits. In general, a person must be cognitively impaired or be unable to perform two or more activities of daily living (ADLs)—bathing, dressing, etc.— to qualify, Smith said. “But under the definition of a chronic care rider, it is possible to be unable to perform two ADLs and still not qualify for benefits.”
For example, assume that a man falls from a ladder while hanging holiday lights. He breaks some bones and that puts him into casts. “He is laid up and unable to perform two or more ADLs, but under a chronic care rider, the man would not qualify for benefits since he is expected to recover when the bones heal,” Smith said. “The man’s expected recovery will prevent the condition from being classified as chronic.
“By contrast, under a true long-term care rider, the claim would likely qualify, due to the definitions in the rider, assuming any elimination period is met.”
Both types of riders are good, he added, but the producer needs to know the difference, and how it fits with the client’s needs.
PPA-friendly annuities are still relatively new, but Smith considers them to be a very good choice for the right customer. “Some policyowners have already gone on claim, and one is doing so right now,” he said.
Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda may be reached at [email protected].
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