How Hybrid Annuities Might Fit Into LTC Reform

By Linda Koco

Hybrid insurance products, such as deferred annuities with long-term care (LTC) riders, would be eligible for a LTC subsidy program proposed in a paper released this week by The Hamilton Project at Brookings, Washington, D.C.

The paper also proposes modifications to the Employee Retirement Income Security Act (ERISA). These modifications would allow for penalty-free withdrawals from 401(k) and 403(b) retirement accounts as well as from individual retirement accounts (IRAs) to pay for LTC coverage purchased through the subsidy program.

The two proposals appear in a package of reform measures being floated by the author of the paper, Wesley Yin, an economist and professor with UCLA’s School of Luskin Public Policy.

These two proposals may be of especial interest to annuity and retirement professionals who are looking for innovative ideas involving hybrid annuities and long-term care insurance (LTCi). Yin offered up the proposals as a way to spur more widespread purchase of private LTCi.

The need

The potential need for LTC exposes Americans to catastrophic financial risks, Yin wrote. “While the wealthiest individuals can pay for these expenses through savings, most Americans do not earn and save enough to comfortably pay for LTSS, if needed.”

LTSS stands for long-term services and supports, and is a term Yin used in the paper to refer to institutional care, community-based assistance and home-based assistance with daily living activities.

In theory, private LTC insurance could fill some of this gap in coverage, he allowed. But as things now stand, few buy private LTC policies, he said, and “most” middle-income households risk having to spend down assets to qualify for Medicaid coverage.

For a remedy, he proposed creation of what he called a “voluntary LTC Advantage program.” This program would pay a cost-sharing subsidy to insurers (in lieu of claiming future Medicaid benefits for an individual’s LTSS). The insurers would use the subsidy to offset future LTSS claims, thus lowering an individual’s effective LTCi premium, the professor wrote.

All individuals aged 55 or younger would be guaranteed coverage in the voluntary program, except those with current or immediate LTSS needs, he said. Those aged 56-65 would receive a slightly reduced cost-sharing and subsidy, and would be subject to underwriting approval.

That design would provide an incentive to enroll at younger ages in addition to helping insurers protect against age-specific risks, Yin maintained.

Role of the hybrids

Hybrid annuities are among the products that Yin said would qualify for this subsidy. It is doubtful that originators of hybrid annuities ever envisioned the products’ being used in this way, but Yin makes a case for exactly that.

The LTC Advantage program would include a wide variety of plans, the professor wrote. These include not only the lower-cost home- and community-based service plans and the traditional LTC plans, he said, but also “hybrid insurance products that combine LTC insurance with longevity annuities.” The longevity annuities generally do not start payments until an advanced age such as 80 or 85, he pointed out.

The hybrids in this plan would provide insurance “against two of the primary risks faced in retirement,” he said.

They would provide retirement security at a “reasonable” cost, too, he maintained. Beneficiaries needing LTC are typically less likely to receive longevity payments, he explained, so “the offsetting nature of these risks allows insurers to offer the combination product more cheaply than they could if selling the products separately.”

The ERISA modification

Yin’s proposal to eliminate the ERISA restriction that bars penalty-free distributions from retirement accounts for LTCi premiums also aims to spur purchase of “subsidy-eligible LTC plans” from private sector insurers.

This too is probably not what the developers of ERISA had in mind, but Yin makes the case for it on the grounds of available assets, pressing need and tax recovery.

Between 2000 and 2014, savings in defined contribution plans and IRAs more than doubled from $5.5 trillion to $12.6 trillion, he said, citing 2014 figures from the Investment Company Institute. That’s a 38 percent real increase, he said. It is also money “that can be used to self-insure against LTSS risks in retirement (and should be protected against LTSS risks).”

If the restriction were modified, people still would have to pay taxes on the amount withdrawn before age 59½ , he pointed out, but they would not be subject to the 10 percent penalty for early withdrawals.

As for early distributions from Roth 401(k) and Roth IRA accounts for LTCi premiums, these would not be taxed and they also would be penalty-free, he said.

To accomplish this, Congress would need to modify ERISA, Yin said. But he maintained that this would be “particularly beneficial, given the importance of encouraging earlier financial planning and enrollment into LTC coverage.”

In addition, he said, such modification “would likely have minimal budget consequences as the policy would simply allow taxable withdrawals at an earlier date.”

A subsidy plan? Really?

The concept of “subsidy” may send chills up and down the spines of those who prefer private-sector solutions without government subsidies.

However, Yin contended the proposals “do not necessarily require more overall financing.”

“Rather, they require a financing system that redirects much of what is currently spent in aggregate out-of-pocket expenditures, informal care and public programs toward the cost of more-complete insurance protection.”

Details of how he sees this working are available in the paper, Strengthening Risk Protection through Private Long-Term Care Insurance.

InsuranceNewsNet Editor-at-Large Linda Koco, MBA, specializes in life insurance, annuities and income planning. Linda can be reached at [email protected].

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].