A client recently asked Edward Kohlhepp, president of Kohlhepp Investment Advisors in Doylestown, Pa., about acquiring long-term-care insurance. “I thought it was a no-brainer she would qualify,” he recalls. But he was wrong.

The ostensible reason for the denial: The client, a retiree and widow in her mid-60s, was in good health—she simply wanted to protect her assets for her kids, in case she ever became nursing-home dependent—but a previously broken wrist hadn’t healed properly.

“The carrier said she could reapply in another year,” Kohlhepp says. “Now she has to decide whether to wait or go with another option.”

For those turned down for LTC insurance, the alternatives are asset-based, hybrid or linked-benefit plans—i.e., LTC riders on either life insurance or an annuity. But life insurance still requires health-based underwriting, Kohlhepp observes, whereas annuities with LTC riders are the easiest to qualify for. “They can be a good fit for someone who doesn’t qualify medically for traditional LTC insurance,” he says, “because the underwriting is much less stringent.”

Whether or not you like annuities as a savings and investment option, they do offer clients several distinct advantages, supporters say. Simplified underwriting for LTC coverage is just one.

LTC Riders Vs. LTC Insurance
To be sure, an annuity with LTC coverage will usually cost more up front than a traditional LTC policy. And even so, there is inevitably a degree of applicant screening. “Most carriers will run your application against your MIB report to make sure it all lines up,” says Carol Jochem, a vice president at BMO Harris Financial Advisors, based in Milwaukee, referring to the Medical Information Bureau, an industry data-exchange group. “Then there’s a phone interview to test your cognitive abilities. No blood, urine or doctors’ statements, typically. Approval decisions usually come quickly.”

Annuities with an LTC component may be of the fixed, indexed or variable variety. Payments can be made once, annually, or over a 10-pay schedule. “The rider charge is so small,” says John Riley, president of Cornerstone Investment Services in Providence, R.I., and Terrell, Texas, outside Dallas. “Though it’s a cost, clients find it pretty painless because they’re not making that payment every year, not receiving bills as they would with a traditional LTC policy. So they are less likely to want to cancel it later.”

That’s especially important considering the way stand-alone LTC policies’ premiums have been rising in recent years. “They’re increasingly crazy,” says Kohlhepp. “If you have the costs built in, so to speak, as you do with the hybrid policy, you don’t have to worry about that.”

Multipurpose Coverage
Perhaps the most appealing advantage of an annuity with an LTC rider, for some, is that the investment is never wasted. “Many clients say LTC insurance isn’t worth the expense because they may never need it,” says Riley. “The truth is, as they get older they’re more likely to need it, but they have a hard time seeing it that way.”

With an LTC annuity, any residual value can be used later or passed on to heirs. “If you don’t have an LTC event, you still have the value of the annuity,” stresses Patrick Bradley, principal with LTCI Partners, an LTC brokerage headquartered in Lake Forest, Ill. “You can buy a stand-alone LTC policy for, let’s say, $3,000 a year. But if you don’t use it, that money is gone. With the annuity, if you don’t use the LTC protection, you still have that investment when you die.”

At the same time, though, if you do use the LTC benefit, you will spend down the original investment first. Only when that’s depleted does the carrier foot the bill (for however long it is obligated under the terms of your individual plan). “That’s the trade-off,” says Bradley.

Qualified LTC benefits come tax-free. That’s true of traditional LTC insurance policies, too, but not true of other annuity withdrawals. So an LTC rider can be a more tax-effective way of deriving value from an annuity. “You’re flipping taxable to tax-free, if you will,” says Kohlhepp.

Additional Rider Strategies
For clients who already have an annuity, it may not be possible to add an LTC rider. “This is often at the carrier’s discretion,” says Judson Forner, a director at ValMark Securities in Akron, Ohio. “Some carriers allow riders to be added or removed, although I would not assume this flexibility is a given and would always inquire before purchasing a product.”

So some advisors recommend converting an existing, underperforming annuity to a new one with LTC coverage. Conversions can be done tax-free via a 1035 exchange, though early surrender charges may apply if the original annuity hasn’t been owned very long.

“If clients have a non-IRA annuity that they are not going to use for retirement income, we’ll show them the pros and cons of a 1035 conversion to a PPA annuity,” says BMO Harris’s Jochem, referring to a qualified annuity under the Pension Protection Act of 2006 (which actually took effect in January 2010). “Withdrawals from the PPA annuity come out tax-free if they are used for either qualified LTC services or to buy a qualified LTC insurance plan.”

She says buying an LTC plan this way is 80% cheaper than buying one on the open market “because the annuity essentially becomes the deductible, and the higher the deductible, the lower the cost.”

Growth And Safety Considerations
Jochem prefers to use fixed annuities, not variables, for LTC protection since most of her clients are in their 70s or older. “I try to keep expenses low and guarantees high,” she says.

Yet there are options for variable annuities with built-in LTC coverage. For instance, Lincoln Financial Group offers one that “allows you to actually use the growth of the annuity to provide additional tax-free LTC benefits,” says Dan Herr, Hartford, Conn.-based senior vice president for annuity product development at Lincoln. This, he explains, would allow a younger person to buy in and hold the annuity long enough to experience significant growth. “By the time he or she needs it, the LTC benefit would actually be much greater,” he says.

Chronic Care
The definition of a qualified LTC event is that individuals become unable to perform two or more “activities of daily living,” such as bathing, dressing or feeding themselves. “It can be more than once, or even intermittent,” says Jochem.

But if the condition is permanent, it’s considered a chronic-care need. Some annuities (and life insurance plans) offer separate riders for chronic care. “Chronic- or confinement-care riders are often enhancements to other riders, like an income rider, for example,” says Forner. “These may not require any underwriting but may only pay out when someone is confined to a comprehensive nursing-care facility, not in the cases of home health care or assisted living.”

This is generally considered an “accelerated benefit”; it is tapped in reaction to an emergency. Annuities vary in how it’s carried out. The most restrictive ones might require a physician’s diagnosis of a chronic condition before paying out.

If an annuitant receives an extra payout for qualified chronic-care expenses, it would likely be taxed as a regular annuity withdrawal, says Forner.

Not Your Father’s Annuities
In some cases, death benefits can also be “accelerated,” allowing annuitants to draw down cash during their lifetime if they become terminally ill. This, of course, depletes the legacy they leave beneficiaries. What’s more, such accelerated benefits can take as much as 1.25 percentage points from an annuity’s returns, according to the American Association for Long-Term Care Insurance.

Another similar option is to add a “continuation of benefits.” “With this rider, you have an additional three, six or nine years of coverage once your account has nothing left,” says Michael Levine, president of Levine Advisors in Newport Beach, Calif. “The cost for those riders comes out of the interest earned by the annuity, so there’s no additional money out of pocket. The interest earned by the annuity is tax-deferred, of course, and if it’s used for qualifying LTC expenses it comes out tax-free. So what we’ve done in this example is taken a finite pool of money and leveraged it multiple times.”

Other popular riders known as “living benefits” provide guarantees in case of a market downturn. For example, the Guaranteed Minimum Withdrawal Benefit guarantees a stream of income payments—generally a percentage of the annuity’s original value—for a specified period of time. The lifetime version is known as the Guaranteed Lifetime Withdrawal Benefit. Payments are maintained till death, even if a market downturn brings the account value to zero. A variant is the Guaranteed Minimum Income Benefit, which sets the annual income withdrawals at a predetermined level after a minimum waiting period, and the Guaranteed Minimum Accumulation Benefit, which ensures the annuity will be worth a certain minimum after a period of years. These forms of investment insurance require annuity holders to pay extra to protect against price declines.

“It’s like buying a portfolio of mutual funds with an insurance wrapper—that’s how I like to explain it,” says Adam D. MacDonald, first vice president and investment officer at Wells Fargo Advisors’ Adams Financial Group in Irvine, Calif. “The wrapper typically costs you some extra money, but what it does is guarantee you a withdrawal rate at some point—when you turn on the spigot—that can last until you die if you choose that particular feature.”

The spigot may turn on an LTC or chronic-care event, a predetermined period of years, retirement or death. Whatever the terms, it’s a guaranteed cash flow. “Now that the market is up 150% since 2009, doesn’t it make sense to siphon off 15% or 20% from your portfolio and put it into an annuity instead of exposing it to additional risk?” asks MacDonald.

Especially since, as Herr at Lincoln Financial puts it, “annuities can multitask.”