Chapter 4
The federal government has recognized the
need for insurance. Although funding the cost of institutionalization can be
achieved through other means besides long-term care insurance, for most people
that seems the most sensible avenue. As a result of this recognition, in 1996,
the U.S. Congress enacted the Health Insurance
Portability and Accountability Act, generally referred to as HIPAA. It may also be known as the Kennedy-Kassebaum Bill. This act was signed into
law by President Bill Clinton in August of 1996.
Federal and state tax codes have a purpose
beyond raising revenue through taxation.
Public policy is often served by providing economic relief to some
taxpayers or motivating them for public good.
The 1996 Health Insurance Portability & Accountability Act, called
HIPAA, is one of the most far-reaching laws passed by Congress in the 20th
Century. It may also be referred to as
Public Law 104-191. The entire law is
very complex, and for our purposes only the long-term care portion will be
relevant.
Congress attempted to fulfill a number of
different public policy objectives:
Specifically, the IRS defines qualified
long-term care services as:
Necessary diagnostic, preventative, therapeutic, curing, treating,
mitigating, rehabilitative services and maintenance and personal care services
required by a chronically ill individual pursuant to a plan of care prescribed
by a licensed health care practitioner.
Obviously, this definition is very
broad. It could include any type of
health service. To control when the
cost of long-term care services could receive favorable tax treatment, Congress
established a trigger basis for initiating benefits by tying services to a
state of disability defined as a chronically ill individual.
A chronically
Ill Individual must be certified by a licensed health care
practitioner within the previous 12 months as one of the following:
It is important to note that this
standardized definition of a chronically ill person cannot be altered in any
way by state law, and it is the only definition allowed to receive the
favorable tax treatment for the cost of long-term care services.
Perhaps the most misunderstood aspect of
HIPAA is the 90-day certification for activities of daily living. Its relevance to the deductibility of
long-term care expenses is clear.
Congress intended to limit long-term care costs to those associated with
chronic illness. A clinical definition
of chronic illness is one that is expected to last 90 days or more. Some expenses for acute or short-term illnesses
were already deductible as a medical expense.
If policy makers had ignored the distinction between acute and chronic,
it would have had the unintended consequence of allowing taxpayers to deduct
all their expenses associated with short-term disabilities, due to the vague
nature of the definition of qualified long-term care service.
A taxpayer who wishes to deduct qualified
long-term care expenses using the ADL definition must have a licensed health
care practitioner certify that the insured is likely to need substantial
assistance for at least 90 days. It is
important to note the requirement concerns the likelihood of needing
care, not necessarily the actual receipt of care. In fact, there is no requirement that the person actually
receives the full 90 days of care. The
insured must be re-certified at least annually.
The IRS Publication 502 stipulates that the
90-day certification period is not a deductible period for people who have
long-term care insurance. Long-term
care insurance may still pay benefits following the deductible period of the
policy, if there are any, as long as the certification stipulates that the
person is likely to need qualified long-term care services for at least 90
days. The certification may also be
done retroactively in the event a claim is not filed until after the deductible
period in the policy has been met.
The future is going to see some controversy
regarding taxation of long-term care benefits (the money received when a claim
is filed). An earlier House Resolution 3101 declared long-term care insurance
the same as health and accident insurance with respect to its tax status. Until
then, long-term care insurance was in a sort of tax limbo. No one was quite
sure if the premiums and benefits were tax-favored like those of regular health
and accident policies. Although HIPAA answered that question to some extent,
there are still many disagreements regarding the taxation of premiums and
benefits.
There will be few disagreements on one type
of long-term care policy: tax-qualified long-term care contracts. The HIPAA created
this category under the legislation. If a long-term care insurance contract
meets the Act's requirements it will receive specific tax advantages. All other
policies are considered to be non-tax qualified. There is an exception, which
was made for all long-term care policies issued before HIPAA had been state
approved. These policies were "grandfathered" in. Therefore, they are
considered tax-qualified even though they did not meet the requirements that
were spelled out in the legislation. If, however, these policies are altered,
then the grandfathered tax-qualified status is lost.
It would be easy to assume that all
consumers would want to purchase only tax-qualified policies if they are to
receive favorable tax treatment. In fact, this is not necessarily true. When
the Act was passed, it set specific terms regarding tax-qualified benefits,
benefit triggers, provisions and so forth. Perhaps the most dramatic difference
between the qualified and non-qualified plans are the benefit triggers. A
benefit trigger is the circumstance (typically medical in nature) that
"triggers" the start of insurance benefits. For most types of
insurance, the circumstance that triggers benefit payment from the insurance
company is fairly easy to understand. For example, in life insurance, when the
insured dies benefits are paid. While there may be variations that allow cash
to be withdrawn, as a benefit trigger, this is pretty easy to understand. In
health insurance, if the insured breaks a leg benefits are paid by the
insurance company after a deductible is met. When it comes to nursing home
policies, however, benefit payments are not necessarily so easily understood.
Before the creation of tax-qualified
long-term care insurance plans, benefits were paid when it was determined they
were medically necessary. If the insured's doctor felt that it was
necessary for his patient to be in a nursing home, his written statement was
all that was required to trigger benefit payments. Some policies might also
require an inability to perform some type of activity (called activity of
daily living or ADL) such as bathing oneself without assistance. Another
formal benefit trigger was cognitive impairment, the inability to reason
or a loss of mental capacity due to some organic disorder such as Alzheimer's
disease.
Before anyone had ever heard of
tax-qualified long-term care plans, insurance policies could require the
inability to perform a certain number of activities of daily living (ADLs),
which were spelled out in the policy. The actual number of ADLs sometimes
varied since not all companies included the same amount. Typically, there were
between five and seven listed. The number of ADLs that could no longer be
performed by the insured could vary. Some policies required only one, while
others required more than one. If a policy listed 7 ADLs and only required an
inadequacy in performance of one, benefits were easier to obtain than one which
listed 5 ADLs with an inadequacy in performance of one (1 out of 7 are better
odds than 1 out of 5). Few consumers recognized the importance of this. In
fact, agents often did not recognize it either.
Today, most non-tax qualified plans list
seven activities of daily living, while tax-qualified plans list six. It is
important to note that we said "most". It is possible for some plans
to have a different number, unless the state has regulated them (and many
have). This alone gives benefit triggers a better chance with the non-qualified
plans. The benefit trigger that has been eliminated in the qualified plans is ambulating.
Ambulating is the ability to get around adequately without assistance.
Let's look at the activities of daily
living. First, we'll examine the non-qualified plans, which typically have
seven ADLs.
Eliminating ambulating is a serious change.
For many elderly people, ambulating is the first activity of daily living that
is lost. The inability to move around means the person may not be able to fix
meals, get to the bathroom, or even get up to answer a ringing telephone.
The six ADLs that are included in HIPAA are:
The definitions, you'll notice, are somewhat
different although the meanings remain very close.
Most professionals feel that home care
benefits have especially been limited by the difference in the ADLs since the
loss of ambulation is almost always part of the need for care in the home. Even
so, the qualified plans do also offer consumer protection requirements. As a
result, there is a great deal of disagreement about which plan, qualified or
non-qualified, should be sold.
Perhaps the greatest difference lies in the
benefit triggers. Most people did not purchase their long-term care policy to
receive a tax deduction. They purchased their policy for health care
protection. Therefore, if the ability to use the policy is limited when health
care is needed, was it really worth having a tax benefit? Agents must be very
careful about explaining the benefit trigger difference when presenting
policies. Currently, both types are available in most states. Some of the
states have resisted the approval of tax-qualified plans because they felt the
benefit triggers were more restrictive than the state requirements. Such was
the case in California, for example. By fully explaining the difference at the
point of sale, the agent is allowing the consumer to do several things:
Decide whether the
tax benefit of the premium deduction will benefit them personally;
Decide whether the
loss of the ambulating ADL could affect them personally (especially if home
care benefits are important to them); and
Fully understand the
circumstances that will allow benefits to be paid under their policy. Most
policyholders want to understand this and it is in the agent's best interest to
be sure that they do.
The federally qualified (tax-qualified)
plans do provide worthwhile benefits, even though ambulating is not an ADL. Federally
qualified plans, which provide coverage for long-term care services (nursing
facility, home care, and comprehensive) must base payment benefits on the
following criteria:
Although currently the insured must be
either chronically ill by virtue of the ADLs or due to cognitive impairment, it
is possible that the federal government could expand these requirements at some
point. If that were to happen, each state would have to adopt the new triggers
as well.
As an insurance agent, we know that
definitions are extremely important in policies. This is also true of the
tax-qualified plans. Because certain phrases were used for specific meanings, IRS Notice 97-31 has established guidance for
many of these terms.
Substantial Assistance
in the ADLs means hands on assistance and standby assistance.
Hands-On Assistance
means the physical assistance of another person without which the individual
would be unable to perform the activity of daily living (ADL).
Standby Assistance
means the presence of another person within arms reach of the individual that
is necessary to prevent, by physical intervention, injury to the individual
while the individual is performing the activity of daily living. The IRS Notice
gives the examples of being ready to catch the person if they fall, or seemed
to be ready to fall, while getting into or out of the bathtub or shower or
being ready to remove food from the person's throat if the individual chokes
while eating. Overall, standby assistance is just what it indicates: being near
to help when necessary.
Severe Cognitive Impairment means a loss or deterioration in intellectual capacity that is
comparable to Alzheimer's disease and similar forms of irreversible dementia
and measured by clinical evidence and standardized tests that reliably measure
such impairment. The impairment may be in either their short-term or long-term
memory. It would include the ability to know people, places, or time. It would
include their deductive or abstract reasoning, as well.
Substantial Supervision
is used in reference to cognitive impairment. It means continual supervision,
including verbal cueing, by another person that is necessary to protect the
severely cognitively impaired person from threats to their health or safety.
Such impaired people are prone, for example, to wander away. Substantial supervision
is needed to prevent this.
It is not possible to use the activities of
daily living to measure severe cognitive impairment. Individuals with such
impairment are often able to perform all of the ADLs without difficulty. Even
so, they are unable to care for themselves due to their cognitive impairment.
Therefore, the ADLs are not used when assessing this.
State laws may not be the same as the
federal requirements. In fact, it would be surprising if they were the same.
Non-qualified plans will meet the state's requirements while qualified plans
will meet the federal requirements. Because states do differ, it is not always
easy to state the differences between qualified and non-qualified long-term
care policies. Generally speaking, however, it is usually safe to say that
federally qualified plans are harder to receive benefits under than are the
state's non-tax qualified plans.
Insurance companies who have issued non-tax qualified
plans are offering a change over to qualified, for those written after the
federal act was passed. While there are differing opinions on this, many people
feel that the switch over is a good idea since:
There are two separate tax issues involved
in the tax qualified long-term care policies. The first involves the ability to
deduct part or all of the premiums paid. This is possible only under specific
conditions. The possibility of the deduction began with the 1997 tax year
premiums for tax qualified long-term care plans. The premiums can be itemized
as deductions for medical expenses the same as one does for other health care premiums.
Of course, if the taxpayer does not itemize their returns, this does them
little good. Even so, this is an important change in the tax code because it
gives recognition to the importance of protecting oneself against the
possibility of long-term nursing home confinements.
For those who do itemize, they can deduct
their regular medical expenses (including LTC premiums) if they exceed 7.5
percent of their adjusted gross income (AGI). For long-term care insurance, the
maximum deduction a taxpayer can take for their premiums depends upon their
age. The dollar amounts of the
deductions changes from year to year, so it is best to consult your personal
tax advisor. The deductions are based
on individuals, so if there are two people in the household (husband and wife)
who each have a policy, the deductions will apply to each one of them.
To deduct the premiums, several conditions
must exist. First of all, the taxpayer must itemize their deductions on their
tax returns. Many people in these age groups do not itemize because they do not
have enough deductions to allow it. Nationally, less than 30 percent of all
federal taxpayers itemize according to "Statistics of Income",
Department of Treasury. This 30 percent reflects ALL taxpayers; even less
itemize that are 65 and older.
In addition, in order to deduct the premium
cost, the amount of total medical expenses (counting the premium) must exceed
7.5% of the taxpayer's adjusted gross income
(AGI). Since many of these taxpayers pay very little of their
medical expenses, this is unlikely. Reimbursed expenses will not count towards
this percentage amount.
The second tax issue has to do with benefits
when they are received for a covered confinement or benefit. In the past,
benefits from health care policies have not been reported as income, but it
appears that the Internal Revenue Service would like to change this. If it does
change, those with qualified long-term care policies will not be taxed
on the benefits they receive.
To benefit from the tax-favored status, the
contract must meet certain provisions. It must provide only coverage for
qualified long-term care services and meet the following requirements:
The deduction and benefit exclusions
generally apply to contracts issued after December 31st, 1996. A grandfather
rule provided that contracts issued earlier and that met the long-term care
insurance requirements of the state where issued, would be treated as a
qualified long-term care contract. Non-qualified contracts could be exchanged
tax-free for qualified contracts until December 31st, 1997.
Accelerated death benefits can be available
under certain conditions. A taxpayer who is terminally ill, or in some cases
chronically ill, may elect to receive accelerated life insurance death benefits
tax-free. Accelerated death benefits must be aggregated with long-term care
benefits in determining whether the income exclusion limitations have been
exceeded.
Whether or not to purchase a long-term care
insurance policy should never be made upon the tax implications of the
purchase. Such a policy is intended to protect against the catastrophic losses
of confinement to a nursing home or for losses due to prolonged illness at
home. It would be hard to imagine anyone buying such a policy purely for the
tax favorable status that might be available. Therefore, the primary
considerations are always the benefits offered or the overall protection
available. Even so, tax status issues will be part of the discussion between
the consumer and the agent. At no time should an agent attempt to advice on tax
issues. They are simply too complicated and too many issues have yet to be
resolved.
There are also issues regarding the
long-term care policies issued prior to 1997, which were grandfathered in as
tax-qualified policies. Although these pre-1997 policies were granted
tax-favorable status, any material changes
will revoke this status. It is the definition of "material changes"
that has raised questions. Initially, even a premium change could have
constituted a material change in the policy. If this were the case, insurance
companies could cause a material change simply by raising the premium charged.
When policies issued prior to 1997 were
grandfathered in as tax qualified plans, consumers had the impression that they
were guaranteed this tax-favored status. In fact, this was not necessarily the
case.
The Kansas Insurance Department said in
comments that if it was possible to loose the tax-favored status by virtually
any change implemented, it would have a serious impact on the long-term care
market in that state. The federal law did not in any way indicate that a change
in the contract language would result in a pre-1997 policy becoming
non-qualified, the Kansas department said.
The IRS stance is contrary to the intent of HIPAA they felt.
Actually HIPAA did not specify the
circumstances in which changes to a contract would be so significant that they
would cause a new policy to be issued. Insurance companies have historically
decided which changes indicated a new policy rather than a modification to an
existing policy. State law also provided guidelines. The aim is generally to
preserve the pre-1997 grandfathered policy.
Since consumers are not likely to be aware
of these issues, they may make changes that would allow them to loose their
tax-favored status. The American Council of Life Insurance, which said its
member companies represent 80 percent of the long-term care insurance market,
was extremely troubled by the very narrow interpretation of the grandfather
rule contained in the IRS Notice 97-31.
The group called it inconsistent with statutory changes and will lead to the
inappropriate loss of grandfathering of many policy contracts.
So many groups were concerned about the
material modification issue, that classifications were eventually made. The
Treasury responded to the obvious concerns by clarifying what a material
modification represented. They applied "exceptions." This meant that
specific changes were not considered grand enough to require a new policy;
rather they were considered endorsements to the existing policy. These
exceptions include:
The Final Regulations suggest that the
following practices will be treated as issuance of a new contract (which would
then remove any grandfathered status):
What does a material modification mean to
the selling agent? Any time a consumer
or agent considers replacing a policy issued prior to January 1, 1997 extreme
caution should be exercised. A pre-1997
HIPAA policy may contain provisions that make it easier to qualify for benefits
while still enjoying tax qualified status.
Beginning in the tax year 1997, every
insurance carrier is required to report to the Internal Revenue Service on Form
1099 any benefit paid under any contract that was sold, marketed or issued as a
long-term care insurance contract. The insurer is not required to determine
whether the benefits are taxable or not; they must simply report the benefits
paid.
Ironically, there are no instructions for
the taxpayers themselves about their use of these 1099 forms. No one, not
Certified Public Accountants, not the insurance legal departments, not the
state insurance departments can tell the taxpayers if they need to do something
with these issued forms.