by Steve Goodman
CPA, MBA – President & Chief Executive Officer
Contact Steve today for more info.
Many people are hesitant to spend their limited retirement savings on long-term care (LTC) insurance policy. LTC policies are ‘use it or lose it’ insurance. Unlike a life insurance policy, LTC insurance premiums are not guaranteed to remain the same over the life of the policy. They can be expensive with premiums showing large increases in the last several years.
While industry experts widely believe that the majority of the price increases are now in the past, the LTC insurance product has been tainted. The need for LTC coverage remains, but the attractiveness of an LTC insurance policy has been greatly diminished. Increasingly, people are turning to alternatives to straight LTC insurance.
One alternative showing tremendous growth in the last decade is a life insurance policy with an LTC or chronic illness rider. At first blush, the LTC and chronic illness riders appear similar. The details of how they work show that they are very different when utilized.
Some Life Insurance Basics
Life insurance policies offer three ways to provide long term care benefits;
- a hybrid life insurance-long-term care insurance policy,
- a long-term care rider,
- or a chronic illness rider.
Per government regulations, chronic illness rider “life insurance” is not considered long term care insurance due to their significant limitations. The government prohibits the industry from advertising it as such due to its coverage limitations.
Hybrid life insurance – long term care policies are specifically designed for a dual-use purpose. These products exhibit many similarities with life insurance with an LTC rider option, though there are some differences. This product is not the focus of this paper.
That leaves us with life insurance with an LTC rider and a life insurance policy with a chronic illness rider. Both the LTC rider and the chronic illness riders are classified under IRS regulation 101(g). This allows the benefits to be paid out as a tax-free benefit.
The similarities end here.
LTC riders offer more comprehensive coverage. They also fall under IRS code 7702B. This code requires that claims include a physician’s certification that the condition requiring payment will prohibit the insured from performing at least two Activities of Daily Living for at least 90 days. 90 days is the common elimination period, though policies are available with other elimination periods. Elimination periods are the LTC insurance equivalent of a deductible on an auto or homeowner policy.
Activities of Daily Living, or ADL’s include:
- walking, and
- exhibiting cognitive capabilities.
Even if the condition is temporary, such as a mild stroke, a broken hip, or recovery from certain cancers, a more than 90-day disability is sufficient to begin receiving LTC payments.
When they pay
LTC pays when a doctor certifies the condition will last at least 90 days, but may not be permanent.
Chronic illness only pays when the condition is permanent and highly likely to last for the balance of the insured’s life.
Who can sell them
In most but not all states, the insurance agent must be long term care certified. The government does not consider chronic illness riders to be long term care insurance. Therefore, no additional agent certification is necessary.
LTC riders almost always increase the insurance premium. A prospective buyer will know exactly what the rider costs as an add-on to the policy. The policy specifies the maximum LTC benefit. It does not change over the life of the policy nor do the premiums associated with the LTC rider.
This is not always the case with the chronic illness rider. Some insurance companies will charge an explicit rider fee. Others will attach the rider at ‘no charge’, but it is far from free. If and when the rider requires payment, it decreases the death benefit. A dollar paid out will result in more than a dollar in decreased death benefit. As the policy pays chronic illness benefits, it removes capital from the insurer’s calculation of compounded interest until death.
An insurer estimating 15 years of life expectancy before paying a death benefit must adjust their calculations for the chronic illness withdrawal. In these cases, the price paid for the chronic illness rider remains uncertain until death. (See Payout section below)
There are two ways that an LTC or chronic illness rider can pay. They are indemnity and reimbursement. Almost all chronic illness riders pay via indemnity. Indemnity is a simple per diem payment as specified in the rider. Once initiated, the chronic illness rider pays a set amount per day. The IRS establishes the tax-free allowable maximum each year. If purchased via an add-on payment, the rider will specify the maximum benefit pool and monthly payout as part of the rider’s terms and conditions. If included at ‘no charge’ with the policy, then each payment results in a reduction of the death benefit per the loss of compounding as previously explained.
There are no limitations on the use of indemnity payments. They can pay for medical treatments, compensation for a relative taking time off to provide care, or saved for future needs. The policy continues to pay until either the benefit pool is depleted, the insurance death benefit reaches a policy specified minimum or the insured dies.
LTC riders can pay on an indemnity or reimbursement basis. In the case of indemnity payouts, an LTC rider will pay the contracted amount regardless of actual LTC expenses. Reimbursement payouts only cover qualifying LTC services. Policyholders must document their expenses. Per IRS regulations, services qualified for payment include only those provided by licensed professionals and institutions.LTC payouts can exceed IRS maximums tax-free provided the insured has itemized proof of qualifying treatment. Years ago, reimbursement payouts required the patient to pay the LTC provider first and then the insurance company paid the patient. This is not the case anymore as most insurers pay the provider directly.
While indemnity might appear to be the preferred option, this is often not the case. Indemnity payments shift the burden of paying for extended treatments back to the insured once the maximum benefit is paid out. Reimbursement payments extend the time of coverage by paying only for LTC qualifying services.
Some life insurance policies with LTC riders offer the possibility of a death benefit in excess of the policy stated amount based on LTC payouts. No chronic illness rider offers the option. Some will withhold part of the death benefit even if the chronic illness rider is not utilized.
A policy advertised as ‘long term care’ coverage must be an IRS Section 7702B qualified LTC plan. Companies may not market chronic illness plans as offering long term care coverage in any manner.
Lapses and Termination
LTC policies in most states offer easy reinstatement for unintentionally missed payments. People suffering from cognitive issues may miss payments. This consumer protection feature allows the patient to reinstate the policy without the need for another underwriting. Some chronic illness riders and policies offer this feature, but there is no requirement to do so under most state’s laws. The laws typically cover only LTC policies and riders.
Many states also require the insurance company to extend benefits for intentionally lapsed LTC policies. The benefits paid may be degraded due to the curtailment of premiums paid. Policyholders will receive some benefit for the payments made.
All LTC riders require underwriting of the insured.
LTC rider underwriting is often less stringent than that required for straight LTC insurance.
Only chronic illness riders that are paid via an upfront (add-on) fee require underwriting. The balance issue payments in lieu of death benefits and therefore do not require underwriting.
Reviewing Your Alternative Options: More than Just Buying Insurance
Making an educated decision when it comes to chronic illness, long term care and life insurance is more difficult than it may seem.
If you want to speak with an expert who can help with you this major life decision, please don’t hesitate to contact me.
CPA, MBA – President & Chief Executive Officer
About Steve Goodman
For more than 30 years, Steven has provided insightful solutions to the challenges of business succession, wealth preservation and charitable planning, focusing on the needs of owners of closely held businesses and high net worth individuals.
He's been featured in the New York Times and is an accomplished speaker and has presented over the years to many organizations and professional groups on efficient business succession, estate planning issues and tax strategies. Steven is a CPA who was vice president of the Trust and Investment Division of JP Morgan Chase and a supervisor for KPMG Peat Marwick, and holds an MBA from Fordham University.