LTC insurance: clarifying the tax clarifications.

What Kennedy/Kassebaum did (and didn't) do, from the insurers' standpoint

Frankly, it is difficult for sellers of private long-term care insurance to downplay their enthusiasm for the long-term care insurance tax clarification provisions contained in the Health Insurance Portability and Accessibility Act (HIPAA). These provisions, which went into effect on January 1, 1997, represent the culmination of years of effort by legislators, insurers, healthcare providers and numerous others to encourage the sale of private long-term care insurance.

In essence, the tax clarifications give private long-term care insurance the same tax treatment as accident and health insurance. What this means is that, in most cases, benefits from a qualified long-term care insurance policy are not taxable, just as are most benefits from accident and health coverage are not. Also, premiums paid for a qualified longterm care insurance policy can be deducted from taxes as a medical expense, so long as medical expenses exceed 7.5% of adjusted gross income.

Although several months have passed since HIPAA's tax clarifications went into effect, it is too early to predict the extent to which these will spur demand for private long-term care coverage. Survey data on this will not be available for a couple of years. Initial reports from long-term care insurers indicate, though, that individuals and employers are showing increased interest in purchasing private long-term care coverage. Employers already have accounted for a significant number of sales, and the incentives contained in tax clarification provisions are likely to create even more growth in the employer market.

For employers, the long-term care tax clarifications mean that any employer contributions toward an employee's longterm care insurance policy can now be deducted as a business expense. Meanwhile, any benefits that employees get from their employer-sponsored policies will not be part of their taxable income, and any premiums paid out-of-pocket can be added on to employees' medical expense deductions. Employers, however, remain unable under this legislation to offer qualified long-term care insurance plans as part of a "cafeteria" package of employee benefits.

Despite these clarifications, sales for private long-term care insurance will not come close to reaching their potential until the Treasury Department puts into place final regulations for implementing them. For the time-being, interim guidance from the Treasury Department - known as Notice 97-31 - provides a bit of assistance.

For example, Notice 97-31 provides interim guidance to help determine whether an individual is "chronically ill." It contains terminology to define what constitutes "substantial" assistance in activities of daily living, as well as how "cognitive impairment" is to be determined. However, questions persist. Notice 97-31 contains language, for instance, that might cause private long-term care insurance policies - sold before HIPAA's implementation date and "grandfathered" under HIPAA as tax-qualified - to lose their tax-qualified status.

Under the interim guidance, any change in a private long- term care contract that alters premiums or benefits payable by the insured - or the timetable under which they are to be paid - would be considered a material change and would therefore disqualify that plan from "tax-qualified" status. Would changing an annual premium payment schedule to a quarterly payment schedule be a material change? Would a decision by a carrier to lower or raise premiums based upon claims experience also be considered a material change?

Insurers are concerned that the answers to both questions might be "yes." If so, many, if not most, pre-HIPAA tax- qualified long-term care insurance contracts could eventually lose their grandfathered status. The unintended consequence of this would be to create "churning" in the market by encouraging consumers to drop their pre-HIPAA coverage and buy post-HIPAA tax qualified plans, at their current age, which would likely cost more.

Since such a broad interpretation would be detrimental to consumers, insurers are asking Treasury Department officials not to consider as material changes the exercise of contractual options in the original grandfathered policies.

There are further provisions of interest. Under HIPAA, qualified long-term care insurance policies, in exchange for tax advantages, must contain certain consumer protection provisions. Examples include dropping prior hospitalization requirements, requiring guaranteed renewability, observing a six-month limit on pre-existing condition requirements, and making mandatory the offer of inflation protection and nonforfeiture benefits.

Tax-qualified plans have to meet benefit eligibility triggers as prescribed in HIPAA, such as the policyholder's being cognitively impaired or being functionally impaired in at least two activities of daily living. HIPAA also requires that the insured have a certification of impairment or disability from a physician for at least 90 days.

A long-term care insurance plan that does not meet the HIPAA requirements is considered a non-tax-qualified plan (a plan, for example, not requiring 90-day certification of impairment.) Such non-tax-qualified plans are currently in limbo from a tax standpoint - it is uncertain as to how the Treasury Department will treat nonqualified long-term care insurance plans. People who own nonqualified long-term care insurance plans cannot be certain that they will be able to deduct their premiums, and the benefits they get from their nonqualified plans could be taxable.

For example, let's say you purchase a $100-a-day nursing home benefit from a nonqualified long-term care insurance plan with five years of benefits. If you are taxed on your benefits, after a year you could be subject to paying taxes on $36,500 worth of long-term care benefits. Such a situation could cause greater confusion in the market; consequently, the Treasury Department also should issue guidance on this matter.

Clearly, legislators have a decided interest in seeing more people purchasing private long-term care coverage. Medicaid pays about 50% of the nation's nursing home costs, and in most states, spending on long-term care accounts for about two-thirds of the Medicaid budget. It is estimated that anywhere from 29% to 38% of people with private long-term care insurance policies would be on the Medicaid rolls without it, and that Medicaid would have to spend an additional $7,945 to $15,519 (in 1990 dollars) per person, according to a 1994 study published in the journal Health Affairs.

From the perspective of the health insurance industry, the significance of HIPAA's tax clarification provisions cannot be overstated. With its passage, Uncle Sam is acknowledging that public programs, such as Medicaid and Medicare, are hard-pressed to finance long-term care and that there exist in the private sector many excellent plans that provide much- needed long-term care financing. Unfortunately, consumers are all-too-often unaware of this. Survey data show routinely that a majority of consumers believe that Medicare will step in and pay for long-term care costs.

HIPAA is the latest in a series of occurrences that are sending "good vibrations" about private long-term care insurance to consumers. The very fact that these policies have been on the market for more than a decade is dissipating any doubt about the financial viability of private long-term care coverage. Long-term care policies available in the market today have evolved from earlier policies with limited benefits to policies that provide numerous benefits and meet a wide array of long-term care needs. Premiums also appear to be going down in price. A 1995 Health Insurance Association of America (HIAA) survey shows that premiums from the top sellers that year dropped an average of 5% when compared to premiums from the top sellers of 1994.

In short, there has never been a better time for people and employers to check out private long-term care insurance as a viable, effective method to finance future nursing home or home health care needs.

Susan Coronel is Long-Term Care Director for the Health Insurance Association of America.