Fencing in the risk: medically underwritten immediate annuities are not yet a well-known product, but they may become an important tool as retiring baby boomers seek to create income or protect assets.

Buyers of immediate annuities typically expect to live longer than average, and the product writers price accordingly. Now the life industry also is catering to prospects with health impairments by medically underwriting them and offering higher income payments.

According to spiaquote.com, which specializes in marketing medically underwritten immediate annuities, at least 13 insurers offer the single-premium products that provide income for life. Among these companies are such large writers as MG American General, Lincoln National, Hartford Life, ING, Principal Financial and Prudential Financial. Each insured is underwritten separately, and the payments can be much greater for those with significant impairments. But even buyers with relatively modest impairments can expect to receive greater incomes than they would from conservative fixed-income investments or from standard income annuities.

State Life Insurance Co., a member of the OneAmerica group, has built up its business by seeking buyers who already are receiving long-term care at home or in a facility. It provides a good example of how a medically underwritten immediate annuity can play a unique role in financial planning. "Not a whole lot of Americans have bought LTC insurance policies," said Bruce Moon, vice president of marketing for State Life. "We were looking for an opportunity to provide some type of coverage for folks who have not bought LTC policies, but then find themselves in a situation in which they are paying for ongoing costs of care." Moon said an immediate annuity provides the best leverage for the assets of someone in that situation. "That is the best way to provide some type of protection for somebody who obviously can't qualify for any pure insurance instrument."

State Life's product, ImmediateCare, was introduced in 2000, and Moon said sales have grown by about 20% a year.

The idea, he said, is "to put a fence around LTC expenses" by having the immediate annuity generate the money needed for the long-term care. That protects other assets in the estate from potential erosion or dissipation by LTC costs.

An Alternative to CDs

The logic of moving a safe but low-yielding asset like a certificate of deposit into an immediate annuity is that the annuity locks in a much greater cash flow than the 5% or so that a CD might pay in today's environment. The reason is that an insurer pools the single premium an annuitant pays with those of others. As some annuitants die, their premiums can be used to pay those still living. The older and more impaired the applicant, the greater the payment an insurer can offer. For example, as of mid-December 2006, a Lincoln National immediate annuity issued by the company's Jefferson Pilot Financial business to a 75-year-old male would have paid $863.99 a month on a $100,000 single premium. That's an annual rate of more than 10.3%, not counting compounding. Depending on a prospect's condition, medical underwriting could add 6.6% to 19.4% to each payment, taking the monthly payout to as much as $1,031.60, or the noncompounded equivalent of 12.4% a year.

Since the payments are fixed for life, an annuitant need not worry about the effects of declining interest rates. And the exclusion ratio of a payout annuity provides a tax advantage if the premium came from a taxable account. While the Internal Revenue Code requires the taxable earnings from other products to be distributed first, it allows payout annuities to return some of the principal in each payment. Only after all of the principal is returned do the payments become fully taxable. Unfortunately, the code does not allow insurers to use the shorter life expectancies in medically underwritten products to determine the exclusion ratio, Moon said. If it were allowed, more principal could be returned in each payment, and the tax due would be lower.

A downside, of course, is that annuitants no longer have access to the premium paid unless they have chosen a special provision. That means if an annuitant dies soon after buying the annuity, the insurer keeps the money to pay annuitants who live. In effect, annuitants accept a short-term risk to cover a greater long-term risk.

For illustration, Moon offered a fictitious case of an ImmediateCare client with $800,000 in assets. "If she is in a care situation, especially involving Alzheimer's or Parkinson's diseases, which could involve a significant number of years in a facility or at home, there could be a serious depletion of that estate to pay those costs," he said. "What ImmediateCare allows is an option. What if we could section off $200,000, for example, to provide $5,000 a month of immediate-annuity income for the rest of her life? What that does is put a fence around that $600,000 in the estate because you know that guaranteed, no matter what happens to interest rates or to the economy, the insurance company is going to pay $5,000 a month."

Family Decisions

The purchase of such a product is in many cases a family decision enacted through the power of attorney, said Moon. Prospective annuitants may have gotten to a physical stage, or a combination physical/mental stage, where they now have family members looking over their assets and minding their financial business, he said. The family may have analyzed what the long-term-care exposure could mean to an estate and concluded that a medically underwritten annuity makes sense to protect it "from that unknown or possibly unlimited LTC situation," Moon said. "What we've done with this product is focused on people with ADL [activities of daily living] deficiencies. That is where we can sharpen our pencils the best."

Face-to-Face Physicals

Most insurers use medical records forwarded to them by agents for the medical underwriting, but State Life sends professionals to conduct on-site assessments of applicants' physical conditions, said Moon. ImmediateCare was actually created by the Golden Rule Insurance Co. OneAmerica in late 2005 bought Golden Rule's life, annuity and LTC businesses after Golden Rule decided to concentrate on its health insurance line.

Family members can't predict how fast long-term care's costs will rise or how long their loved one will live, so insurers typically offer options for an extra charge. Moon said State Life's inflation option will increase the payments annually, while its refund option returns all or part of the premium paid. About a third of buyers adopt one or the other, but most choose the straight immediate annuity at a higher amount than the current cost of care, Moon said. "So if the cost of care today is $4,000 a month, families assume it will go up over time and buy $5,000 of income a month," he said. If more income is needed, the insured could buy an additional immediate-income annuity, according to a State Life brochure.

State Life sells the product mostly through independent financial planners and advisers who have "built trust with clients and families over the years" and who offer it as an option to liquidating assets, said Moon. "You do that, and sometimes you liquidate the wrong assets, or you liquidate in a stressful situation, and then you regret doing that. So the product has resonated well in the financial planning and advising world." Annuitizing conservative assets allows them to work harder, "and then you've allowed those other less-conservative investments to grow and to build, hopefully," he said.

No Strings Attached

Buyers can use the income from an immediate annuity for various purposes. Phil Elam, senior vice president of fixed annuity product management for Lincoln National, which markets as Lincoln Financial Group, said he suspects many buyers use the income to pay recurring premiums on other life or long-term care insurance policies. "The client may have already obtained certain medical information to qualify for products that are underwritten, so it's readily available to share with an annuity company to get the quote," he said. "We don't require exams and we don't pay for exams, as we do for life insurance. We consider the information applicants provide to us, so if they've already gone through the testing process and have medical information, that can make it easier for us to give them quotes and facilitate an underwritten SPIA [single premium immediate annuity] ."

Buyers with medical conditions typically pay higher premiums for life and LTC insurance policies. These higher costs can be partially offset by the higher income payments provided by an underwritten SPIA, Elam noted.

Lincoln National's product, the Jefferson Pilot Insured Income SPIA, was introduced about two years ago, before the companies merged. Lincoln distributes them primarily through its channel of independent insurance agents. To date, there has not been much interest from bank distributors, broker/dealers or wire-house producers, said Elam.

Insured Income is available as either a standard or an impaired-risk SPIA, and Elam said the company doesn't report sales of those versions separately. But income-annuity sales are "up noticeably this year and last year," he said, and they constitute about 10% of the company's fixed-annuity sales overall.

Elam observed that people are increasingly turning to annuities for income, and much of that is going on without having to annuitize. But the traditional fixed income annuity "will probably continue to provide the highest guaranteed income," Elam said. "And then, where there are health impairments, the ability to get the benefit of underwriting credits is both valuable to the client and equitable from the standpoint of the insurer and the client."

Elam said the major part of the business is not in severe impairments. "It's more a matter of somebody getting credit for an impairment that can shorten life expectancy on average but does not reduce life expectancy to such a degree that longevity is no longer a concern," he said. "I would think advisers and insurance agents are often involved in identifying when an income annuity can fit and serve the needs of a client. It's part of an overall set of solutions."

American General Life Insurance Co.'s immediate annuity is the Platinum Income Annuity. It has been on the market for about five years, said Thomas Booker, president of AIG American General's Annuity Profit Center. Sales have been growing each year, but faster growth is dependent on more education for distributors, Booker said. "Brokers that use it understand it, but there's still a large contingent out there that doesn't understand it," he said.

American General, a member of American International Group, sells medically underwritten annuities primarily through its independent brokerage general agents, personal producing general agents and independent marketing organizations. Fewer are sold through wirehouse broker/dealers.

Product Awareness to Grow

Booker said medically underwritten immediate annuities have been on the market for about 12 years and may be about a third of the way through the product-development phase. Compared to other industry products, however, they remain obscure, and Booker said he's not aware of any industrywide statistics about them. According to the National Association for Variable Annuities, Morningstar and Limra International, insurers sold $11.8 billion of immediate annuities of all kinds in 2005.

Booker, however, sees better sales ahead as major companies, including American General, spend more time on educating producers and as baby boomers mature. Buyers of medically underwritten immediate annuities are typically 60 to 65 years old on the low end and 80 to 85 years old on the high end, Booker said. "As the baby boomers move into retirement, there will be more focus on both standard and medically underwritten immediate annuities," he said. "The more carriers, marketing initiatives and awareness you see out there will help the market overall."

State Life's Moon said he expects medically underwritten annuities to become commonplace over the next decade. "As more planners, independent agents and companies find that there is always a segment of the population that will not or cannot buy LTC insurance, there is still something our business has to do for those folks that do not have that coverage and enter a facility or have home care," he said. "We're just at the beginning of people noticing these products are out there."

Elam of Lincoln National said there is a growing need for income solutions, and he expects to see a lot of innovation in this area. However, there will continue to be a need for the traditional income annuity, with appropriate underwriting, "because what it does, it does very well, namely to provide the maximum guaranteed lifetime income."

Medically underwritten annuities may currently be niche products, but they bring in hefty premiums per sale. State Life sets its minimum premium at $25,000 or the amount necessary to produce $1,000 in monthly income payments. Lincoln National sets its minimum at $100,000. "From the standpoint of purchasing a lifetime income, $100,000 is not too onerous a requirement," said Elam. "It's something we have to use to protect the pricing, and there's a certain amount of expense in generating the quotes." Elam added that the single premiums of income annuities average more than $200,000.

Key Points

* Medically underwritten immediate annuities pay more than standard immediate annuities by factoring in health impairments.

* As baby boomers age, these annuities are likely to become tools in retirement planning and even estate preservation.

* Though currently a niche in the small immediate-annuity product line, medically underwritten annuities are usually bought with extremely large premiums.

What Constitutes a Serious Medical Condition?

The following are some, but not all, of the diseases that could qualify a prospect for a medically underwritten immediate annuity.

Alzheimer's Alcoholism ALS (Lou Gehrig's Disease) Angioplasty or Heart Surgery Cancer (except basal cell) Chronic Hepatitis/Hepatitis C Congestive Heart Failure Cirrhosis of the Liver Diabetes with Complications Emphysema/Chronic Obstructive Pulmonary Disease Heart Attack, Angina, Heart Disease High Blood Pressure Hodgkin's Disease Injury Due to Fails or Imbalance Leukemia Liver Disease Lymphoma Melanoma or Metastatic Cancer Mental Illness Multiple Sclerosis Muscular Dystrophy Obesity with Complications Organ Transplant Organic Brain Syndrome Paraplegia or Quadriplegia Parkinson's Disease Renal Failure Stroke Transient Ischemic Attack Vascular Disease

Source: ImmediateAnnuities.com

Learn More

American General Life Insurance Co. A.M. Best Company # 06058 Distribution: Personal producing general agents, brokers, independent marketing organizations, agency system

Jefferson Pilot/ Lincoln National A.M. Best Company # 06928 (Jefferson Pilot Life Insurance Co.) Distribution: Independent general agents, national marketing firms, career agents, broker/dealers, banks

State Life Insurance Co. A.M. Best Company # 07082 Distribution" Independent financial planners, company general agencies, brokers, registered representatives

For ratings and other financial strength information about these companies, visit www.ambest.com.

[GRAPHIC OMITTED]

Annuity Industry Total Sales-Deferred
vs. Immediate ($ Billions)

Year     Deferred    Immediate      Total

1996       $107.0         $5.3     $112.3
1997        120.8          5.6      126.4
1998        126.2          5.6      131.8
1999        158.0          6.7      164.7
2000        181.4          8.6      190.0
2001        177.4         10.2      187.6
2002        207.1         11.2      218.3
2003        204.5         11.3      215.8
2004        205.9         11.7      217.6
2005        200.5         11.8      212.3

Source: NAVA, Morningstar, Inc., and LIMRA International