LTC Insurance for Owners and Executives

EXECUTIVE SUMMARY

COMPANIES INCREASINGLY OFFER LONG-TERM-CARE insurance as a benefit to owners and key employees. Company-sponsored LTC insurance is an economical way to prefund long-term care and protect executive retirement income from the cost of nursing home care. ACCORDING TO GOVERNMENT STATISTICS, individuals age 65 or older have a 40% chance of entering a nursing home sometime in their life. The annual cost of a nursing home stay is $50,000—even higher in certain metropolitan areas. Specialized care can be as much as $200,000. PREMIUMS A C CORPORATION PAYS ON LTC POLICIES are fully deductible. Pass-through entities and sole proprietorships enjoy a full deduction for nonowners and up to 100% for owners depending on their age and the premium amount. Company-paid premiums are not taxable income to the executive. CPAs SHOULD PAY CAREFUL ATTENTION TO the fine print in an LTC policy. The lowest premium does not necessarily mean the lowest cost over the life of the policy if premiums increase or coverage is not adequate to meet long-term health care costs. WHEN EVALUATING LTC COVERAGE companies should consider the variety of optional riders available. They cover things such as automatic cost-of-living increases and the availability of home health care benefits.

PAUL S. DEVORE, CLU, CFP, is chief executive officer of Financial Management Services Inc. in Encino, California. His e-mail address is pdevore@fms3.com .

PAs are generally familiar with the many nonqualified benefits available today for business owners and key corporate executives. Many companies offer programs designed to provide these individuals with financial security in the event of death, disability or retirement. But they just now are beginning to see long-term medical care insurance as a valuable benefit for a broader range of key employees. More and more, CPAs are being asked to help companies determine the viability of establishing insured long-term-care (LTC) plans and to analyze available policies.

Business owners are realizing that company-sponsored LTC insurance is an economical way to prefund long-term care and protect retirement income from the enormous cost of nursing home and related medical expenses. This article describes the nuances of LTC policies CPAs will need to understand when recommending this insurance to employers or clients.

THE GROWING NEED
The issue of providing employees with long-term-care coverage comes to the forefront at a time when medical care costs are skyrocketing and people require more assistance as they live into their 80s and beyond. A 2001 report by the U.S. Department of Health and Human Services said individuals age 65 or older have a 40% chance of entering a nursing home some time in their lives. And the need for long-term care isn’t limited to the elderly; fully 40% of people receiving these services are between the ages of 18 and 64.

Individuals need long-term care when they no longer can perform daily activities including bathing, dressing, eating and toileting or suffer from cognitive impairment. Care can be provided in a variety of settings, including nursing homes and assisted living facilities, or through in-home patient care. Many people assume Medicare will foot the bill for long-term-care services. Not so. Medicare was designed to cover acute medical care, not chronic care or disabilities due to old age. The Insurance Association of America says the average annual cost for home care is $20,000. Other studies put the annual cost of a nursing home stay at $50,000 or more in certain metropolitan areas. Specialized care can cost $200,000 or more.

HIPAA
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) defines LTC plans as accident and health insurance. Thus they are not subject to ERISA guidelines (IRC section 7702B(a)(2)). This means companies can decide who is to participate in the plan and limit it to certain highly compensated employees and their dependents if they so desire.

Some of the important tax characteristics of an insured LTC plan are

Premiums paid on policies are fully tax-deductible to C corporations for all employees, including stockholders (IRC section 162(a); Treasury regulations sections 1.162-10(a) and 1.106-1).

Pass-through entities and sole proprietorships enjoy a full tax deduction for nonowners and 100% or partial deductions for owners depending upon their age and the premium amount (sections 162(a) and 162(1); regulations sections 1.162-10(a) and 1.106-1; IRC sections 213(d)(1)(D) and 213(d)(10)).

Premiums paid by the company are not taxable income to the executive (IRC section 106(a)).

Benefits are tax-free (up to $240 a day in 2005) (IRC section 7702B(d)(4)).

When the policy contains a “refund of premium” feature, the insured’s beneficiary can receive all premiums paid into the policy as a tax-free benefit at the death of the insured (IRC section 7702B(b)(2)(c)). This can be especially attractive for stockholders/employees as the premiums were originally deductible, fully or partially, by the company.

THE BENEFITS
In addition to the obvious advantage of paying for long-term care with tax-deductible corporate dollars, group LTC insurance plans offer other benefits.

Guaranteed acceptance. Most plans will insure all active employees the employer wants to cover. New employees typically are covered as long as they apply within the time frame stated in the policy.

Payroll deductions. Insured employees can make any required premium contributions through regular deductions from their payroll or pension checks.

Technical assistance. Most insurers help companies explain the coverage to their employees with written materials and on-site seminars.

The right long-term-care coverage can provide significant benefits for a company’s executives and their spouses.

Example. International Widget, a C corporation, decided to implement an insured LTC plan to cover the owner, six highly compensated employees and their spouses. The premium for the policies, $87,265 a year, would be fully paid after 10 years. This amount is 100% deductible to the corporation and not taxable as income to any of the insured executives or their spouses. When the insureds ultimately die, their beneficiaries will receive the total amount of premiums paid on their behalf tax-free.

Shortly after the policy is in place, the owner’s wife suffers a stroke and begins to receive insurance benefits of $280 a day to pay for care she receives at home. The first $240 a day is tax-free, while the additional $40 a day is taxable. (Higher limits are likely to apply in 2006 and beyond.) When the owner and his wife die, their children will receive 100% of the premiums the corporation paid into the policy as a tax-free death benefit in addition to any long-term-care benefits the couple may have received.

Given the potentially devastating costs of long-term care, having such insurance is an extremely valuable perk that can act as part of a “golden handcuffs” package to help retain key employees. Under one company’s plan, should an executive leave the company prior to age 65, a vesting schedule determines the portion of the premium refund that would be paid to the employee’s beneficiary at death. The balance would be paid to the company. The vesting schedule can be modified as necessary to accommodate situations such as death, disability or involuntary termination.

Long-term-care coverage isn’t limited to large businesses. In another example, the sole employee of one highly profitable C corporation wants to provide LTC coverage for herself and her family. The company’s CPA helped devise a plan that provided a strong program of benefits using a policy that will be fully paid in 10 years. The owner will pay $19,822 a year. When she and her husband die, their trust will receive the $198,220 of premiums tax-free. (As with any insurance product, insurance companies make their money on LTC coverage through investment earnings.)

THE FINE PRINT
Companies typically have a great deal of flexibility when deciding on plan objectives, eligibility, types of policies to use, optional policy benefits and riders, coverage amounts and durations, guarantees and payment options. CPAs who are helping companies select the right coverage should keep in mind the lowest premium does not necessarily mean the lowest cost. Indeed, initial low-cost policies can end up costing more if the policy does not adequately cover long-term health care costs or allows rates to rise. Here are some other policy features CPAs should understand to recommend the best coverage.

PRACTICAL TIPS TO REMEMBER

Pay careful attention to policy features such as the waiting period before benefits are paid and whether home health care is covered to make sure the LTC coverage the company selects meets the needs of all covered executives. Keep in mind the lowest premium does not necessarily mean the lowest cost. Low-cost policies could end up costing more if they do not adequately cover long-term health care costs or allows premium rates to rise. A good optional rider to have with LTC policies is one that provides cost-of-living adjustment (COLA) increases to keep up with inflation in health care costs. The increase is often a set percentage each year, increasing either on a simple or compound basis up to a multiple of the base policy.

LTC policies are typically “guaranteed renewable.” This means that as long as premiums are paid when due, the insurer cannot refuse to keep the policy in force. It can, however, increase rates—sometimes after a brief guarantee period. The company may be forced to choose between paying the higher premium and losing the policy.

Unlike most LTC policies for the general population, executive benefit policies are customarily paid up within 10 years and sometimes even with one single premium. Besides the larger tax deduction for the shorter premium period, the policy is truly “paid” and the insurer cannot increase premiums. Thus, an extra measure of price safety exists.

Most LTC policies specify how many activities of daily living the insured must lose before triggering benefit payments and classifying the loss as needing “hands on” or “standby” assistance.

Policies are structured as “indemnity” or “reimbursement” models. In its pure form, the indemnity policy pays a specific amount of daily benefit irrespective of costs actually incurred, while the reimbursement model pays actual qualified costs or a percentage.

Elimination (waiting) periods are spelled out in the policy. These are essentially deductible features where the insurer pays no benefits for a specified period of time after the insured begins care. Typical waiting periods are 30 to 90 days; the executive must pay long-term-care costs out of pocket until the benefits kick in. The shorter the waiting period, the higher the policy premium.

Optional riders are available with LTC policies. A common one provides a cost-of-living allowance (COLA) designed to keep up with inflation in health care costs. These come in a variety of formats, often a set percentage each year, increasing on a simple or compound basis up to a multiple of the base policy. For example, if a policy has a $250 benefit today at age 57 and a 5% annual compound benefit including riders with no cap, the daily benefit would increase to $319.07 at age 62, $663.32 at age 77 or $1,379 at age 92.

Home health care, which allows benefits for care provided in the recipient’s home instead of in a nursing home or other facility, is another important policy feature. It might be included as part of the base policy or as a separate rider. Some policies pay benefits to a family member or friend who provides care, while others will pay only licensed caregivers.

LOW-COST FINANCIAL SECURITY
Offering LTC insurance as a perk to owners and high-level executives can be a benefit to the company as well as the insureds. It’s a tax-efficient method to attract, retain and reward key people. Because of the financial security the coverage provides, executives can focus their attention on company business. CPAs should expect such coverage to become a more common benefit in executive compensation packages. With the multitude of coverage variations and distinctions between LTC plans, it is critical that CPAs understand the fine print when evaluating policies for their employers and clients.

The AICPA Life Insurance/Disability Plans Committee has introduced an enhanced long-term care (LTC) plan for members and eligible family members. The plan, with coverage issued by the Prudential Insurance Company of America and developed under the supervision of the AICPA Insurance Trust, offers higher daily benefit amounts, expanded eligibility, additional features and lower rates for most ages than the prior plan.

Expanded eligibility. The LTC plan covers AICPA members and their families, including spouses, adult children and their spouses, parents, parents-in-law, grandparents, grandparents-in law and domestic partners.

Choice of coverage amounts and benefit periods. A selection of nursing home care daily benefit amounts (up to $300) is available, as well as home care options (60% or 100% of the daily benefit) and a choice of benefit payment periods of 3, 5 or 10 years.

“Locked-in” rates. Base rates are determined by the age at enrollment and rates do not increase with age. By enrolling at younger ages, CPAs can lock in the lowest rates and secure important protection that can help safeguard their financial assets.

New Benefits
The LTC plan now includes some additional features.

Informal care coverage allows an unpaid person, typically a family member or friend, to receive benefits for assisting with the activities of daily living.

Caregiver training benefit provides up to $500 for training an informal caregiver.

Private care management services reimburses policy holders for up to 12 times the nursing home care daily benefit per calendar year.

Restoration of benefits returns the lifetime maximum benefit amount to the original level if an insured resumes his or her normal activities for at least six months.

Contingent nonforfeiture benefit option provides a shortened benefit period if the policy lapses after three years due to nonpayment of contributions.

Get the Details
More information on LTC offerings is available on the AICPA Insurance Trust Web site at www.cpai.com/ltc or by calling the plan agent, Aon Insurance Services, at 1-800-AICPAIT.