Hybrid Policies Allow You to Have Your Long-Term Care Insurance Cake and Eat It, Too

As long-term care insurance premiums rise and fewer companies offer policies, alternatives to traditional long-term care insurance policies are springing up.  Previously, we wrote about annuity “doublers” that help pay for long-term care. Another increasingly popular hybrid product combines life insurance with long-term care coverage and offers buyers solutions to a number of problems that have kept people from buying traditional long-term care policies. 

The life insurance hybrid policies are often available to individuals who would not qualify for conventional long-term care insurance due to preexisting conditions.  In addition, the long-term care benefit is not a “use it or lose it” proposition.  If the benefit is not used, or is only partially used, the unused portion is paid out to an individual’s heirs in a death benefit.  Finally, one reason people are wary of traditional long-term care insurance is fear of hefty premium increases down the road.  Extraordinary premium increases are not a big factor with the life insurance hybrid products.

How They Work

Hybrid life insurance products add a long-term care “rider” to a permanent life insurance policy (whole life or universal life products, not term life).  Policyholders typically pay a lump-sum premium up front or a guaranteed set of premiums for a prescribed period of time.  If the long-term care feature is included, it allows the insured to receive a tax-free advance on her life insurance death benefit to pay for long-term care while she is still alive.  The insurance benefit kicks in when the policyholder can't perform two of the six "activities of daily living." Once a doctor certifies that the person is eligible, the insured can start to accelerate her death benefit to pay a monthly amount that covers her long-term care costs. 

For example, an individual with a life insurance policy with a face amount of $100,000 who wishes to accelerate the death benefit to pay for long-term care might receive either 2 percent or 4 percent of the face amount each month.  If the rider is for 4 percent a month, the policy will accelerate $4,000 a month until the benefit is exhausted, which would be 25 months. 

Importantly, most of these policies also have an “extension-of-benefit” rider, which is an option to continue paying the monthly benefit even after the base amount has been exhausted.  These riders can continue paying for another one or two times whatever the length of time would have been without the extension.  For example, in the example above an extension-of-benefit rider might pay $4,000 a month for an additional 25 months, and some of these riders even have a two-times kicker and would pay for another 50 months. 

All this long-term care coverage comes at a cost, of course: the accelerated death benefit adds between 3 percent and 15 percent to the original standalone life insurance premium, while extending the benefits as in the example above usually at least doubles that.

The long-term care benefit can be used to cover any level of care, including home care, although company policies differ and some may exclude mental conditions, which can be common among senior citizens.  In most cases, the beneficiary gets a monthly check rather than submitting bills for reimbursement.  Any premium increase in the hybrid products would not be on the whole premium but only on the portion for long-term care. 

One very attractive benefit to policyholders is the possibility that heirs will receive the portion of the death benefit that is not consumed by long-term care costs.   For example, if the policyholder uses only $50,000 of a $300,000 long-term care benefit before death that she paid for with a $100,000 premium, her heirs would get $250,000. 

On the other hand, if the same policyholder decides 10 years down the road that she doesn’t want the product anymore, she’d get back the $100,000 premium plus accrued interest. 

Some Hidden Costs

However, it should be noted that insurers are under no obligation to pay prevailing interest rates, so when rates start rising, as they inevitably will, companies could keep returns level and pocket the difference.  Holders of these hybrid products may be avoiding the kind of hefty premium increases that have become common in the conventional long-term care insurance market, but if their insurer pays interest below the prevailing rates, the lost interest could effectively equal a premium increase.  And in today’s low interest rate environment, a 1 percent to 3 percent rate of return would likely be eroded by a policy’s cost-of-insurance charges, according to financial planner Michael Kitces writing on his blog, Nerd’s Eye View. Some policies provide no rate of return, just a death benefit and long-term care benefit, Kitces says.

One of the leading life insurance hybrid products is called MoneyGuard, offered by Lincoln Financial. Nationwide also sells a long-term care rider, and the American Armed Forces Mutual Aid Association reportedly offers this option in all the permanent life insurance policies it sells.

In determining whether to write coverage for a potential client, life insurers offering these hybrid products typically evaluate the risk in the same way they do for a conventional life insurance policy, with some additional questions to review the long-term care risk.  The evaluation is generally more basic than with traditional long-term care insurance and may not even involve a medical exam.

There are downsides, of course.  It’s possible to zero out your funds, leaving nothing to your heirs, although some policies will pay out a small amount to your loved ones when you die.  Also, many of these hybrid plans will charge a surrender fee if the money is accessed before a certain number of years.

A hybrid product can work well as an estate planning tool for people in their 60s, 70s or even 80s who have some cash on hand want to avoid taxes and pass it on to their children but protect themselves in the event they need long-term care.  The person may have money parked in an investment, money market account, or certificate of deposit and not earning much return.  Shifting it to a life insurance benefit can be a smart tax play.  The funds in the life policy are growing with tax-free interest and if the client needs to tap the long-term care benefit, the accelerated payments come out tax-free.

For more on hybrid life insurance/long-term care insurance policies, click here and here.