Several DC Diehards have requested a summary of Mark Warshawsky’s talk on the life care annuity. Here’s my takeaway. – Guest author Bobcat2
As late as the late 1990’s no one had apparently ever considered such a product. At that time Mark Warshawsky (MW) was the head of retirement research at the TIAA-CREF Institute. During that time the Paul Samuelson award was established by the institute for the best applied paper on personal finance submitted to the institute.
In an early year of the award over 60 papers were submitted. One of the papers that didn’t win caught the eye of MW. That paper was a careful study of long term care insurance (LTCi). That paper calculated that at age 65, 25% of Americans could not meet underwriting standards for LTCi and by age 75 that percentage had climbed to nearly 33%.
It seemed wrong to MW that so many senior citizens that need LTCi were and are ineligible for it. Mark contacted the two authors of the paper and the three of them analyzed possible solutions to this problem. What they came up with in 2001 is a product that combines a life annuity with a unique type of LTCi.¹
The basic idea is that the adverse selection property of each of the individual products is opposite the adverse selection property of the other individual product. Life annuities are more sought out by relatively healthy seniors, while LTCi is more sought out by those of less than average health. Blending the two products together should, at least theoretically, result in a lower cost than buying each separately. Such a product, named the life care annuity by Warshawsky, is often described as a bundled product, which to my mind turns out to be a slightly misleading characterization. I would describe the product as a life annuity with amplified payouts in months when long term care is needed. Consider the following example to clear things up.
You retire at age 65 and purchase an inflation-indexed life annuity that pays a real $1,000/month for life. If you need long term care assistance at home (by being unable to perform two normal daily tasks such as bathing and eating unaided) then the annuity payout doubles to $2,000/month real for each month the assistance is needed. If you require long term institutional care, the monthly payout quadruples to $4,000/month real, as long as you are in the long term care facility.
The beauty of such a product is that it does not require underwriting and the researchers estimated that it would be about 5% cheaper than buying these products individually. Even better, only about 2% of 65 year olds would be ineligible for the product. (Essentially those that are institutionalized at the time they try to purchase the product.)
To make the the blended product more tax efficient the tax laws had to be adjusted and while Mark was an Assistant Secretary of the Treasury from 2004-2006 he was instrumental in getting key members of Congress to make the necessary changes. These tax changes go into effect on January 1, 2010, but while insurance companies will be combining deferred annuities with LTCi then, as of today no insurance company has announced the introduction of a life care annuity product.
Mark’s presentation was excellent and while there were only about twelve people in the room Sunday, the audience was sharp and engaged and the exchanges between Mark and the audience members were thoughtful, polite, and funny. All and all it was a thought provoking and entertaining meeting.
I thought one of the highlights of the meeting was Mark’s pointing out that Jane Austen recognized the adverse selection property of life annuities over 200 years ago in chapter two of Sense and Sensibility. Jane Austen was one sharp cookie.²
¹ Christopher Murtaugh and Mark Warshawsky, In Sickness and in Health: An Annuity Approach to Financing Long-Term Care and Retirement Income, The Journal of Risk and Insurance, 2001, Vol. 68, No. 2, 225-254.
² Jane Austen, Sense and Sensibility, Chapter Two