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Warning lights flash for LTC bond funds

Policyholders of two long-term care product providers will shortly be getting letters telling them the bonds used to fund for potential LTC coverage are underperforming and they may need to increase their premiums.

Poor performing markets over the last couple of years, mean that Axa-owned PPP Lifetime Care and Scottish Amicable will be contacting policyholders about the shortfalls in the original projection levels.

Both providers insist the reviews are not out of the ordinary as the products are reaching their five-year anniversaries and were scheduled to be checked at this point in case of this type of scenario.

These types of LTC bonds are funded by a single premium into an equity-linked fund and an actuarial assumption is used to calculate the amount of cover.

Axa admits that, given the steep decline in the markets over the last two years, it should not come as a surprise that the bonds have taken a hit.

Marketing manager Steve Muir says: “Increasing premiums is an option that clients will have. I do not suppose that the last two years of negative investment growth have helped at all.”

He says the PPP product was withdrawn from the marketplace in the last two months, not because of the current situation but in an effort to avoid duplication in its product line. He says there is another product which has a protected bond.

Scottish Amicable intermediary business spokes-man Darragh Leeson confirms there will be a review but it would be inappropriate to prejudge its outcome.

He says: “We will be carrying out a regular review of the product. It would be totally prescriptive at this stage to prejudge the outcome of that review.”

In a conversation with a leading LTC IFA recently, ScotAm client services team leader Patrick O&#39Connor confirmed there will be a review in Q3 which will be likely to lead to letters going out to consumers telling them of the negative outlook.

Once the policyholders get their letters they will have two choices.

They can accept that their investments will not fully meet future LTC needs, cash in their bond and reconsider their future planning – or they can pay higher premiums to overcome the shortfall.

But how much will it cost? There are no firm estimates available for the Scot Am product. For PPP, actuarial estimates are running at 20 per cent increases in premiums for policyholders aged 90 or over and 30 to 40 per cent for younger clients.

Given that the average single-premium size of the original bond has been £14,000 to £20,000, that means the minimum additional sums would be around £2,800.

Howard Horne Associates principal Howard Horne says: “It would appear they are reneging on the deal. It is a difficult one, because the benefits are based on the investment growth of the bond. When the markets are performing well, I cannot imagine you would get providers coming around saying that you can have twice the amount of coverage.”

IFAs have questioned why these products were sold in the first place if they are so dependent on the performance of the markets. When they reached the market five years ago, the industry was enjoying unparalleled growth in the markets and there was unbridled enthusiasm for the prospects.

Direct Financial Services director Derek Will-iams says: “The idea is that there is a fund there as well. If the person were to die, there is an investment which could be passed on to the family. But in most cases the advantages were not there for this type of product.”

Williams estimates that this type of product is only appropriate for 5 per cent of his clients while favouring conventional LTC products for the majority.

The design of the Axa and ScotAm products, where the investment bond pays for any cover is not the only type of bond-based LTC product.

Norwich Union has a bond product which operates slightly differently. The fund is kept intact and not used to pay for care costs but to pay for the risk premiums for the care cover.

NU LTC strategy manager Sandy Johnstone says: “The risks are considerably less than a unit-linked alternative. Even if we were to zero the bonus rates, capital would be guaranteed for the purposes of taking withdrawals.”

Before handing over the extra cash that may be required, policyholders should seek advice.

Both PPP and Scot Am have said they plan to send the letters to IFAs, who in most cases sold the products originally, The firms rely on them to inform their clients.

Care Funding Bureau head Owain Wright says: “I would hope that the consumers would be aware of the risks inherent to an LTC bond but my fear is this will come as a shock to many policyholders when they are asked for more money.I would urge them to take advice before they hand over more money.”

An alternative funding arrangement which Wright believes is often more suitable for many is the DIY version of an LTC bond. By setting up their own commercial property or with-profits bond to fund any potential future care needs, consumers can bypass the often murky actuarial assumptions involved in the PPP or Scot Am bonds.

Wright says with the average returns on a commercial property bond at 9 to 10 per cent, the growth assumptions are more attractive to policyholders and are less likely to produce shortfall in the future.

Horne wonders whether the product providers in question are jumping the gun. Given the point of LTC cover is long term, he says over the next 10 years or so the projections might even out.

But he points out that without knowing exactly what they have on their books, it is difficult to know what position they are in.

When this type of situation arises, there are usually reverberations for the market as a whole. Williams believes consumers will look at LTC with a more jaded view.

He says: “Anything like this is bad news for the market. The general public will think carte blanche they are not a good thing. It will have negative effects for the market as a whole.”

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