The benefits that can be provided
Pre-funded long-term care insurance policies can be in the form of protection policies or investment policies.
Under each type of policy the differences in the extent of cover provided have a significant influence on the size of premiums. Benefits are paid under this type of insurance when the policyholder becomes unable to look after himself. Different policies will measure this inability in a more or less rigorous way. In general, this means that a more expensive care policy will have more generous rules on when a policyholder can claim and payments be made, and vice versa.
The inability of a person to care for himself or herself is measured by the policyholder’s inability to perform some of the “Activities of Daily Living”. Payments under the policy will usually be made after the policyholder has become unable to perform a set number of
“Activities of Daily Living” for three months or more and the disability is not expected to improve.
The better policies will also make payments where the policyholder has suffered mental cognitive impairment for three months and this condition is expected to continue. For example, this would be determined by testing memory, reasoning and decision making. As a general rule, the more expensive the policy chosen, the fewer “Activities of Daily Living” tests that need to be failed to trigger a claim for benefits.
The best (and most expensive) long-term care plans will normally pay full benefits when the policyholder is unable to perform two or more “Activities of Daily Living” for three months and looks likely to continue to have to cope with that level of disability. However, as with private medical insurance, budget plans offering cheaper premiums are likely to set the test for benefit payments somewhat higher.
Some policies offer a 10 year guarantee not to raise premiums or reduce benefits. At that time a policy review will be carried out. Also some policies may withdraw or reduce benefits once they are being paid unless the policy imposes a “pool of benefit”. A “pool of benefit” policy will restrict benefit to a certain upper maximum limit either by reference to a specific figure or by reference to the cumulative payment of benefits over a period of years. This provision will, of course, reduce the cost of the policy. Other important policy features will include benefits which can be paid to buy disability aids such as wheelchairs. Such equipment is frequently referred to as ‘assistive devices’.
The cost depends on the quality of a policy in terms of benefits it will provide and in what circumstances, as well as the views of each insurance company’s actuaries as to the likely claims experience. The provision of long-term care is not cheap and consequently neither are the insurance policies which provide long-term care cover, but the earlier the provision is set in place the cheaper will it be. Premiums increase with age as older people are more likely to need long-term care. For older people single premium cover may be more appropriate.
Added care services
The onset of the need for long-term care can place people in a difficult position as to their choice of care provision and benefit payments. This will frequently arise at a time when they may not be best suited to making such decisions. One key benefit under a policy therefore can be the help and support that the product company can provide before, during and after making a claim.
Some care insurance providers have help lines and counsellors who help the claimant and his family come to terms with the disability and discuss with him the alternative courses of action. They will help make appropriate care arrangements, liaise with the local authority and stay in touch to ensure the care provided is effective in the future.
Long-term care investment policies
One possible drawback of a long-term care insurance policy arranged on a protection only basis is that if the policyholder never requires care services, the policy may provide no return to the family or dependants on the policyholder’s death. For this reason, certain long-term care policies have been developed that combine long-term care insurance with a lump sum investment. Such policies will provide valuable insurance to meet the costs of long-term care should they be required but, because they also provide an opportunity to secure investment benefits, it means that should the need for long-term care not arise there will still be some benefits available for the policyholder and, after his death, his beneficiaries.
These lump sum investment policies provide two main benefits:-
· Long-term care benefits. These consist of cash payments which will normally be paid direct to the institution providing the care and, in appropriate cases, provide for the purchase of disability aids.
· An investment fund. This can provide benefits for the policyholder’s beneficiaries on his death. It is possible for the policyholder to draw on these benefits during his lifetime should the need arise although this may reduce the size of any long-term care benefits. A number of providers will allow additional life cover to be built into the investment fund. The sum assured is set at the amount of the total premium to the policy (i.e. the combined cost of the long-term care insurance benefits and the investment fund) as a means of ensuring the cost of the long-term care policy is ultimately returned to the policyholder’s beneficiaries. It may also be of some comfort to the policyholder to know that the sum assured will be paid on death regardless of whether he actually claims on the policy or not. Such policies are designed to alleviate concerns that the premium will have been wasted in the event that care is never needed.
These policies are sometimes provided by insurance companies based outside of the UK. In such cases, the following additional benefits will be available: -
· The growth in value of the investment will accrue free of UK tax. There can however be an income tax charge on death, full surrender or part surrender under the chargeable event rules.
· The cost of providing the long-term care benefits is deducted monthly from the investment fund without an income tax charge then arising.
· Should it be necessary to draw cash benefits from the investment fund, under current legislation use can be made of the 5% part surrender withdrawal facility which means that a surrender of benefits of up to 5% of the premium invested can be made each year, for 20 years, without any immediate tax charge.
The estate of some investors may be subject to a potential inheritance tax liability on death. For many married couples a liability to inheritance tax will be deferred until the death of the second of the couple to die. Nevertheless, a liability may still ultimately arise. On the death of the policyholder the investment value of the policy will count as an asset of their estate for inheritance tax purposes. It may be possible to overcome this problem by use of an appropriate trust.
Immediate long-term care policies
Immediate care annuities come into operation when someone is already in care or is in a condition where long-term care can no longer be avoided. It will usually be the case that significant lump sums are required to provide a suitable income to meet care costs and this in most cases will come from the sale of a property or investments.
The insurer may negotiate rates and future rate increases with the care provider prior to establishing the annuity. This ensures that the level of benefit should always be sufficient to meet costs. An immediate care annuity is a purchased life annuity and as such has a tax free capital element and a taxable interest element. For further information on purchased life annuities see ‘Taxation of a purchased life annuity’ .
If annuity payments are increased due to the individual’s poor state of health, the capital element of the annuity will be the same as for a person of the same sex and age who has an annuity issued at normal rates. This means that the enhancement in rate will be fully reflected in the interest element and so be fully subject to tax.
However, payments under a purchased life annuity which qualifies as an immediate needs annuity are exempt from tax, ie. the interest element is not taxable.
Legislation was introduced in section 147 Finance Act 2004 to put the matter beyond doubt and confirm the exemption from tax as some doubts had been expressed as to the correctness of this tax treatment. This legislation has applied since 1 October 2004 to new and existing contracts. Section 147 achieves its objectives by inserting a new section 580C into ICTA 1988 which has now been incorporated into sections 725-726 ITTOIA 2005.
The main requirements for qualification as an immediate needs annuity are that at the time the annuity is taken the person upon whose life the annuity depends is unable to live independently without assistance because of injury, sickness etc and the benefits are paid direct to a registered care provider or a local authority by an insurance company for the provision of care for the person upon whose life the annuity depends.
This treatment contrasts with the situation where a purchased life annuity is purchased and sometime later the annuitant moves into long-term care. When that person goes into long-term care then the annuity payments would continue to that person and the capital element/interest element treatment would continue.
Home equity release
Many elderly retired people have substantial assets tied up in their main residence and yet they are “cash poor”, making the funding of long-term care impractical. In these cases an equity release scheme could be considered.
Those most suited to these schemes are sole occupiers aged 70 and over, who have properties worth £60,000 and over. The advantages of using a home equity release scheme are that, to many, they are financially justifiable and have political acceptability. They also allow their family to inherit the balance of the equity in their home. The downside is primarily that the individual would need to give much thought to the time and expense in effecting a scheme of this type. The alternative for the asset rich, cash poor retired person might well be to sell their home to pay for long-term care.
It has been suggested that since the introduction of the local authority Deferred Payment Scheme (which is, in effect, an interest-free loan granted by the local authority – for more details see Deferred Payment Scheme in ‘How an individual can provide for the costs of care’ – home equity release schemes should not be recommended to fund long-term care costs until this interest-free loan option has been fully explored.
The taxation of benefits under pre-funded policies
Prior to April 1996, benefits payable under a number of long-term care insurance policies were frequently paid directly to a care provider as, under Inland Revenue practice, this meant that the benefits were tax free for the insured (they were taxable if paid to the insured person). However, subject to the satisfaction of certain conditions, benefits can now be paid in cash to the insured without a tax liability. For some people this gives the flexibility of being able to arrange care in the family home.
Section 143 Finance Act 1996 introduced legislation that has the effect of making cash payments made under certain long-term care insurance policies to the insured tax free provided certain conditions are satisfied. These conditions are in sections 735-740 ITTOIA 2005.
Regulation of long-term care insurance
Before 31 October 2004 only long-term care insurance policies with an investment element were subject to regulation by the FSA. From 31 October 2004 long-term care policies without any investment element, ie. pre-funded protection only policies, are also subject to FSA regulation.