Convertibility, extendibility and renewability options, in their various forms, are an established part of the financial planning scene. They enable clients to extend the period or alter the nature – with traditional convertible term plans the change was from temporary insurance to endowment or whole-life – of the cover provided at a predetermined age or date.
As the provider asks no underwriting questions at the time of the change, it is exposed to what is known as an anti-selection risk. Clients who are in good health may be advised to replace their cover with another insurer where protection is cheaper or more appropriate.
The option is more likely to be used by those whose health has deteriorated over the years. This is why insurers charge more for plans which include guaranteed insurability options than for those that do not.
A recent development has seen the introduction of protection products where the nature of the cover provided changes automatically at a specified date or age. As clients have no option, there is no anti-selection risk and no need to charge extra for it.
This innovation, I think, is one way of increasing sales of pre-funded long-term care insurance.
There is certainly a demand for such protection. According to Bupa research, as many as one in three of those questioned expressed concern about what would happen to them when they were too old and infirm to cope on their own. They had good cause to worry, with more and more of us living to a not necessarily healthy old age. Already, senile dementia affects around 700,000 people while 100,000 people suffer a stroke each year.
The challenge lies in converting the demand and the statistics into sales. With pre-funded LTC products, we have to find ways of motivating people to consider starting their plans earlier in their lives, when premium costs are more affordable. One avenue open to us is to offer a product which offers a different form of healthcare protection at the outset but then metamorphoses into LTC at expected retirement age.
What form should that start-up cover take? Criticalillness cover is one possibility. On the attainment of a designated threshold age, the eventuality covered may be altered from the diagnosis of any one of a long list of named medical conditions or the performance of certain surgical procedures to the inability to carry out two or three activities of daily living. One problem is that the benefit will normally take the form of a lump sum rather than a regular income. Although it is possible to arrange CIC which pays out a series of tax-free payments on similar lines to family income benefit life insurance, there are practical problems with this approach too. Family income benefit is a form of decreasing temporary cover, with the benefit being paid from the date of the insured event until the end of the policy term.
The need for a financial contribution towards care costs, on the other hand, is likely to continue for what remains of the client's life, which may be anything between a month or two and several years.
Another difficulty with the use of CIC as the starter cover is that the level of sum assured is likely to have little or no relationship with the actual costs of care.
Income protection, I think, provides a much sounder pre-retirement base for LTC later on. It can, for example, work along the following lines. Unusually, it is arranged on a whole-of-life basis, which means that the cover will continue for as long as the client continues to pay the premiums. There is no fixed term.
The plan starts off offering fairly conventional IP cover. There are three definitions of incapacity, which depend mainly on the nature of the client's work. The first two are the inability to carry out one's own occupation and the failure to perform one's own occupation and any other occupation for which you are suited by way of education, training experience and status. The third – based on the inability to carry out three out of six ADLs (shopping, cooking, housework, handling money, taking medicine and child minding) without the continual assistance of another person – is used for those who do not work and earn.
Maximum benefit levels are expressed as a percentage of current earnings and set to provide a financial incentive to recover and start working and earning again. Claim payments can be arranged to escalate in line with price inflation, and an additional special event option enables benefits to rise following salary increases such as those resulting from a job change or promotion. Naturally, premium costs will go up too.
Clients can choose between three different premium bases. Of these, the full-term guarantee is the most expensive. The second enables the insurer to review the rates once every five years, with any change depending on factors such as claims experience and the returns achievable on policy reserves but not on increasing age. Option number three is renewable cover, where the premium costs are recalculated – based on the client's then current age and the rates prevailing at the time – every five years.
The nature of the cover changes to LTC once the policyholder reaches the age at which they expected to retire. The definition of incapacity then alters to the inability to perform unaided three out of six ADLs (washing, dressing, moving, transferring, feeding and continence) that are appropriate in determining whether or not an individual is in need of continuing care.
Under current fiscal legislation, claim payments should be payable as a tax-free income, whether paid to a care provider or policyholders themselves or people with the power to act for them. Payments should continue for the rest of a claimant's life, no matter how long this should turn out to be. They may also – depending on the pre-retirement level of IP cover – come very close to matching the actual costs of care.
Income protection that metamorphoses into long-term care insurance is an innovation that could help to give sales of pre-funded LTC a much-needed boost.