States have the responsibility and the right to regulate insurance, however in recent years the federal government has inserted its tentacles into the insurance industry, in particular health insurance of various types. OBRA, COBRA, ERISA, Medicare and HIPAA come immediately to mind. The most recent federal intrusion is with HIPAA, Health Insurance Portability and Accountability Act, which had a major impact in Long Term Care Insurance, primarily in determining that LTCI is health insurance (for years it was hanging in limbo, neither fish nor fowl…) and as such, enjoys certain tax breaks. In response, the California legislature passed several laws that have had an impact on this product.
NAIC MODEL LAWS
The National Association of Insurance Commissioners (NAIC) is an association comprised of the Insurance Commissioners from the various states. They meet regularly, formally and informally, to discuss insurance matters of common interest and to propose legislation and regulations that would create more uniform laws and regulation throughout the country. The NAIC also develops minimum standards for insurance policies, and in particular Long Term Care Insurance policies that can be both successfully marketed and are designed to meet the best interests of the consumers. As changes in the industry occur, the NAIC updates its model acts to reflect these changes.
The NAIC model bills are “suggestions” as the organization as such has no authority to dictate policy forms and provisions without the explicit approval of the state and this allows the states to put more emphasis on certain provisions that may be peculiar to that state or area. The NAIC regularly updates its models to reflect changes in the products and consumer interest. The NAIC’s recommendations assist states in regulating insurance products and in particular the language used in the policies. In actual practice, nearly all of the states have implemented the NAIC model laws in respect to LTCI.
Qualified LTCI policies must satisfy the NAIC’s model requirements and California meets or exceeds the NAIC requirements.
Some of the Model regulations include the following provisions:
Another place where the federal government stepped in was in respect to individuals transferring property so that they would qualify for Medicaid (which is regulated by the federal and state government). The OBRA ‘93 (Omnibus Budget Reconciliation Act Of 1993) legislation applies very stringent requirements for transfer of assets to others (usually a family member) so as to meet the qualifications for Medicaid. The Act requires that regular transfers of assets must occur 36 months prior to applying for Medicaid and transfers out of a trust must occur 60 months prior to applying for Medicaid. The law required that each state enact legislation regarding estate recovery, and all states have complied.
If these time requirements are not met, Medicaid benefits will be reduced by the amount of the transfer. These circumstances include:
The federal law under HIPAA requires that all LTCI policies issued on or after 1/1/97 must conform to standards outlined in the Act to qualify for federal tax-preferred status. California’s regulations in respect to LTCI are contained in the California Insurance Code and have been amended so as to company with HIPAA.
“The Health Insurance Portability and Accountability Act of 1996,” (Public Law. 104-191), (HIPAA) a.k.a. as the Kennedy-Kassebaum Act, was signed into law on August 21, 1996, by President Clinton. One of the stated purposes of this Act was to provide tax incentives to help alleviate the growth of long-term care, where the principal source of financing such care has been Medicaid (Medi-Cal). In order to realize the tax incentives, the law requires that LTCI policies meet certain stated requirements and consumer protection standards.
Effective January 1, 1997, HIPAA provided policyholders and other consumers, the option to purchase tax-qualified LTCI policies. It is interesting that in addition to other provisions (listed below), LTCI was declared a “health” insurance policy for tax purposes, therefore benefits will not be taxed. Since this applies to only tax-qualified policies, some earlier policies were “grandfathered” so as to receive the tax benefits, however the law did not “outlaw” other LTCI policies which differed from the tax-qualified plans—some were/are more liberal in benefits and triggers—and that could mean that benefits received from a non-tax qualified plan could be taxable to the recipient as ordinary income. As far as can be determined, no beneficiary has ever been taxed on the benefits—think of the outcry if the government tried to tax benefits from an elderly citizen in a nursing home. There is, therefore, still some confusion, but all-in-all, HIPAA and corresponding California legislation had made it easier for insurers and marketers to meet their clients needs, but most importantly, it does encourage consumers to decide to protect themselves from the ravages of long-term care, rather than expecting the government to cover these expenses.
HIPAA’s principal purpose was to provide health insurance protection for the estimated 25 million Americans who move from one job to another, who are self employed or who have uninsurable health conditions. Principally, it addressed the “portability” of health insurance that allows a worker who changes jobs to still qualify for health insurance under the new employer’s health plan. It was resoundingly approved by Congress and signed into law in April 1996. Some of the provisions are:
Guaranteed Access for Small Business. Small businesses (50 or fewer employees) are guaranteed access to health insurance. No insurer can exclude an employee or a family member from coverage based on health status.
Guaranteed Renewal of Insurance. No insurer can refuse to renew coverage of an insured individual or group certificate holder because of the health status of the individual or any member of the group.
Guaranteed Access for Individuals. Employees who lose group health coverage —such as loss of job or change of employment to an employer who does not offer insurance—are guaranteed access to individual health insurance. States may develop alternate programs to ensure that comparable coverage is provided. Such coverage will be available regardless of health condition.
Pre-existing Conditions. Employees by group insurance policies cannot be excluded from coverage for more than 12 months because of a pre-existing medical condition. The pre-existing limitations must apply only to conditions treated or diagnosed within the six months period prior to their enrollment in an insurance plan. Insurers cannot impose new pre-existing condition exclusions for workers with previous coverage.
Enforcement. States have primary responsibility to enforce these protections, but if a state fails to act, the Secretary of Health and Human Services can impose civil monetary penalties on insurers. The Secretary of Labor will enforce these rules for self-insured (ERISA) plans. The tax code is modified to allow the Secretary of Treasury to impose tax penalties on employers or insurance plans that are out of compliance.
Self-employed Individuals. The current tax deduction for insurance costs of self-employed individuals is gradually increased from 30 percent in 1996 to 80 percent in 2002.
Medical Savings Accounts. From Jan. 1, 1997, to Jan. 1, 2000, firms with 50 or fewer employees and self-employed individuals enrolled in a qualified high deductible health plan can establish tax-favored medical savings accounts, or MSAs. Annual deductibles are $1,500 to $2,250 for individuals and $3,000 to $4,500 for families . Maximum out- of-pocket expenses are $3,000 for individuals and $5,500 for families. The maximum number of MSAs is limited to 750,000 for the 4-year demonstration period.
Fraud and Abuse Control. A new health care fraud and abuse control program is created, to be coordinated by the HHS Office of the Inspector General and the Department of Justice.
Funds for this program are appropriated from the Medicare Hospital Insurance (HI) trust fund;
Long-Term Care Insurance. (See more complete details below) Minimum federal consumer protection and marketing requirements are established for tax-qualified long-term care insurance policies, including a requirement that insurers start benefit payments when a policy-holder cannot perform at least two “activities of daily living,” defined as bathing, eating, toileting, transferring, dressing, and incontinence. Subject to certain limitations, clarifies that long-term care insurance premium payments and un-reimbursed long-term care services costs are tax deductible as a medical expense, and benefits received under a long-term care insurance contract are excludable from taxable income. Employer sponsored long- term care insurance is to receive the same tax treatment as health insurance.
Medigap Insurance. Revises the notices requirement for health insurance policies that pay benefits without regard to Medicare coverage or other insurance coverage. Long-term care policies are permitted to coordinate with Medicare and other coverage and must disclose any duplication of benefits.
Administrative Simplification. All health care providers and health plans that engage in electronic administrative and financial transactions must use a single set of national standards and identifiers. Electronic health information systems must meet security standards. This should result in more cost-effective electronic claims processing and coordination of benefits.
Health Information Privacy. If Congress does not enact privacy legislation within three years, health care providers, health plans, and health care clearinghouses will be required to follow privacy regulations promulgated by HHS for individually identifiable electronic health information.
Viatical Insurance Settlements. A person who is within 24 months of death can have a portion of their death benefit of a life insurance policy prepaid by the issuing insurance company with no taxation. Such person may sell his or her life insurance to a viatical settlement company with no tax payable. A chronically-ill individual can sell their life insurance and any long-term care insurance rider with no tax payable but the proceeds of such a sale must be spent on long-term care.
Effective Dates. The Long Term Care Insurance provisions are effective Jan. 1, 1997. The MSA provisions are effective Dec. 31, 1996. The insurance reform provisions are effective July 1, 1997.
LTCI contracts are generally treated as accident and health insurance contracts and amounts that insured receives from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness. For an individual taxpayer who claims exclusion for payments made on a per diem or other periodic basis under LTCI policy, they must file Form 8853 with the tax return.
A Long Term Insurance Contract is defined as an insurance contract that only provides coverage for qualified long-term care services.
The contract must:
Qualified long-term care services:
Chronically Ill Individual
Limit on Exclusion
An individual can generally exclude from gross income up to $220 a day for 2003.177
In addition,
Grandfathering
Premium tax-deductibility was effective beginning in January of 1997. Any LTCI contract purchased and in force prior to January 1 of 1997 was considered qualified, regardless of whether or not it meets the provisions outlined above, however any material changes effectively remove the grandfathering status. Material changes include any change in the alternation of timing or amount of any item payable by the policyholder, the insured, or the insurance company.
Exceptions are premium mode changes; class-wide premium increases or decreases; after-issue of a spousal discount or the policyholder’s exercise of any other right provided in the contract; benefit reductions if requested by the insured; continuation or conversion of coverage under a group contract; the addition, without an increase in premium, of alternate forms of benefits that may be selected by the insured; and purchase of a rider increasing benefits of a grandfathered policy if the rider alone would be considered a qualified long term care insurance contract.
Immediately after HIPAA went into effect, the problem for regulators, insurers and agents was the elimination of the “medically necessity” trigger contained in nearly all LTCI policies. Also, few, if any, LTCI policies prior to HIPAA had a 90-day requirement, effectively eliminating long-term care coverage for short-term claims. The major discrepancy, however, is the fact that HIPAA is silent on the tax status of non-qualified plans, and the Treasury has refused to act, taking the position that Congress is the only one that can address the situation. But the approach the Treasury Department did take, is rather interesting—they introduced Form 1099 which must be issued by insurers for any long-term care benefits paid, and which stated in effect that amounts paid under qualified LTCI plans are excludable from income, but with no reference to non-qualified long-term care coverage.
The federal government is aware that HIPAA was a step in the right direction, but the problem of long-term care for the rapidly growing elderly population still exists. Some of these proposals, which may or may not see the light of day, are:
Federal law defines the eligibility requirements for benefits under long-term care policies that are intended to be federally “qualified” for tax purposes and such requirements are generally more restrictive than the eligibility requirements for benefits under policies issued in California prior to January 1, 1997. Contracts sold in California before January 1, 1997 were “grandfathered,” i.e., automatically granted the status of “qualified” contracts, regardless of the nature of the benefits or eligibility requirements in those contracts. However, an insured that requests material changes in such contracts may lose their tax “qualified” status.
HIPAA mandated that certain consumer protections be included in all policies that are intended to be federally tax qualified, but these standards do not apply to policies that are not federally tax qualified.
There are several limitations in determining the deductibility of premiums for tax purposes. First, the deduction is available only to individuals who itemize deductions on their tax returns (most senior citizens do not itemize). If they do itemize, the combined health insurance premiums and un-reimbursed medical expenses must exceed the 7.5% threshold of adjusted gross income in order to qualify for a premium deduction. In this case, as well, this will not apply to most senior citizens, as many have few un-reimbursed medical expenses (except for prescription drugs usually) because of Medicare and Medicare Supplemental policies. In addition, there are certain age limitations that reduce the amount of premium to maximums that may be contained in the 7.5% threshold even though the LTCI premiums may be greater.
Along with several other states, California has passed a number of laws modifying the Insurance Code, and SB 38, modifying Revenue and Taxation Code.
The California Legislature decided that their constituents should be given an opportunity to purchase either those meeting the eligibility requirements of the California Insurance Code but that are not intended to be federally qualified, and those meeting the requirements to be federally tax qualified.178
“Every insurer that offers policies or certificates that are intended to be federally qualified long-term care insurance contracts, including riders to life insurance policies providing long-term care coverage, shall fairly and affirmatively concurrently file, offer, and market long-term care insurance policies or certificates not intended to be federally qualified…"
These laws authorize the sale in California of a new category of LTCI policies that are intended to qualify for favorable tax treatment under federal law, but they also require insurers offering such policies to offer “non-qualified” policies to consumers.
F Actually, this Code Section has expired (sunset provision) and is not in effect, and most insurers have removed their NTQ policies and are selling only TQ policies.
FPlease note Attachment I - in Appendix: Tax Treatment of Long-Term Care Expenses & Long-Term Care Insurance -Also note: IRS Notice 97-31 - in Appendix
SEC.17.25 Section 17213 is added to the Revenue and Taxation Code, to read:
17213. Section 213(d) of the Internal Revenue Code; relating to definitions, is modified to provide all of the following:
The term “medical care” includes amounts paid for qualified long-term care services (as defined in Section 7702B(c) of the Internal Revenue Code as added by the Health Insurance Portability and Accountability Act of 1996).
The term “insurance covering medical care” is modified to include any qualified long-term care insurance contract (as defined in Section 7702B(b) of the Internal Revenue Code as added by the Health Insurance Portability and Accountability Act of 1996).
In the case of a qualified long-term care insurance contract (as defined in Section 7702B(b) of the Internal Revenue Code as added by the Health Insurance Portability and Accountability Act of 1996), only eligible long-term care premiums (as defined in subdivision (d)) shall be taken into account in determining the amount paid for medical care.
(1) For purposes of this section and Section 213 of the Internal Revenue Code, the term “eligible long-term care premiums” means the amount paid during a taxable year for any qualified long-term care insurance contract services (as defined in Section 7702B(b) of the Internal Revenue Code as added by the Health Insurance Portability and Accountability Act of 1996) covering an individual, to the extent that amount does not exceed the limitation determined under the following table:
(2) (A) In the case of any taxable year beginning in a calendar year after 1997,
each dollar amount contained in paragraph (1) shall be increased by the medical care cost adjustment of that amount for that calendar year. If any increase determined under the preceding sentence is not a multiple of ten dollars ($10), that increase shall be rounded to the nearest multiple of ten dollars ($10).
(B) (i) For purposes of subparagraph (A), the medical care cost adjustment for any calendar year is the percentage (if any) by which the medical care component of the Consumer Price Index for August of the Preceding calendar year exceeds that component for August of 1996.)
(ii) Notwithstanding clause (1), the Franchise Tax Board shall utilize the same medical care cost adjustment utilized by the Secretary of the Treasury under Section 213 of the Internal Revenue Code (as modified by Section 322 of the Health Insurance Portability and Accountability Act of 1996).
(e) (1) For purposes of this section and Section 213 of the Internal Revenue Code, an
amount paid for a qualified long-term care service (as defined in Section 220 of the Internal Revenue Code as added by the Health Insurance Portability and Accountability Act of 1996) provided to an individual shall be treated as not paid for medical care if that service is provided by either of the following: .
(A) The spouse of the individual or a relative (directly or through a partnership, corporation, or other entity) unless the service is provided by a licensed professional with respect to that service.
(B) A corporation or partnership that is related (within the meaning of Sections 267(b) or 707(b) of the Internal Revenue Code) to the individual.
(2) For purposes of paragraph (1), the term “relative” means an individual bearing a relationship to the individual that is described in any paragraphs (1) to (8), inclusive, of Section 152(a) of the Internal Revenue Code. This paragraph shall not apply for purposes of Section 105(b) of the Internal Revenue Code with respect to reimbursements through insurance.
(f) This section shall apply to taxable years beginning on or after January 1, 1997.
Federal Law gives preferential tax treatment to TQ policies
• Some persons will receive a tax deduction for all or part of the premium paid.
• All persons will be relieved from the burden of possible income taxes on the benefits.
Taxpayers can include premiums paid on a qualified long-term care insurance contract for themselves, their spouse, or their dependents when figuring their deduction. But, for each person covered, they can include only the smaller of the following amounts.
The amount paid for that person.
The amount shown below - 2004 rates. (Use the person’s age at the end of the year.)
Age 40 or younger $260
Age 41 to 50 $490
Age 51 to 60 $980
Age 61 to 70 $2,600
Age 71 or older $3,250
Per Diem Limitation $230
Age group |
1999 |
2000 |
2001 |
2002 |
2003 |
2004 |
Age 40 or less |
$210 |
$220 |
$230 |
$240 |
$250 |
$260’ |
Ages 41 to 50 |
$400 |
$410 |
$430 |
$450 |
$470 |
$490 |
Ages 51 to 60 |
$800 |
$820 |
$860 |
$900 |
$940 |
$980 |
Ages 61 to 70 |
$2,120 |
$2,200 |
$2.290 |
$2,390 |
$2,510 |
$2,600 |
Ages 71 and older |
$2,660 |
$2,750 |
$2,860 |
$2,990 |
$3,130 |
$3,250 |
(Per Diem Limitation) |
$190 |
$190 |
$200 |
$210 |
$220 |
$230 |
Source: IRS Rev. Proc. |
98-61 |
99-42 |
2001-13 |
2001-59 |
2002-70 |
2003-85 |
Agents need to do a thorough comparison of a grandfathered contract (one sold before 1/1/97) in the event that it is being replaced with another contract. There may be more favorable benefits, benefit triggers or other features that are not in a proposed contract. The replacement notice regarding material improvement should be remembered.179
If a premium increase could result in the loss of the tax-qualified status for a grandfathered contract it should best be referred to the IRS or a tax advisor, even if it is just being contemplated. Our friends at IRS have recently ruled that a premium increase does result in a material change to the contract and the loss of favorable tax treatment. There has been opposition to that stand, but until there is a formal revision, the ruling stands.
When a policy or certificate holder of an insurance contract issued prior to December 31, 1996, requests a material modification to the contract as defined by federal law or regulations, the insurer, prior to approving such a request, shall provide written notice to the policy or certificate holder that the contract change requested may constitute a material modification that jeopardizes the federal tax status of the contract and appropriate tax advice should therefore be sought.180.
The 1099 form must be filed by all insurers who pay benefits from an LTCI policy, whether tax -qualified or not. This form asks the insurer to indicate if the policy was tax-qualified (yes or no) and whether benefits were paid on a per-diem or reimbursement basis.
If the policy is qualified, and has reimbursement (rather than per-diem) style benefits, nothing further is required of the insured. However, if the policy is either TQ and per-diem, or NTQ, they must refer to Form 8853 for instructions. (Note: 1099 LTC form in Appendix)
Tax Form 8853 is used to report the amount of taxable LTC benefits and is submitted with the individual tax return (before April 15, remember). The form is self-explanatory and contains instructions on the reporting benefits from TQ policies that are per diem benefits above the amount allowed by law and reporting benefits from policies that are not tax-qualified.
The top half of form 8853 refers to per-diem benefits received from TQ policies that are over the allowed cap for that particular year, and does not apply to insureds with reimbursement benefits. The caution statement tells taxpayers what to do with the benefits received from NTQ policies.
Please note: All of the forms and publications supplied in this course are for instructional purposes only.
Agents must be cautious in advising applicants and insureds on the tax ramifications of Long Term Care Insurance Policies and if any questions arise in respect to tax-qualified or non-tax qualified policies, it would be wise to recommend that they obtain the advice of a professional tax advisor, accountant or lawyer so that they can determine how different situations could affect that tax consequences from the purchase of LTCI, or the consequences of making policy changes. The IRS can be contacted by telephone at (800) TAX-FORM (1-800-829-3676) or on the World Wide Web at www.irs.gov. See Form 8853 in Appendix.
Part of California’s SB 38 (1996) changed the tax and revenue codes to conform to recently enacted federal law allowing a deduction for medical expenses for the un-reimbursed expenses for long-term care services covered under a tax-qualified LTCI policy and provided to the taxpayer, the taxpayer’s spouse or the taxpayer’s dependents (provided it exceeds 7.5% of adjusted gross income). Premiums are treated as medical expenses, as explained earlier.
STUDY QUESTIONS
1. The National Association of Insurance Commissioners (NAIC) creates “Model” bills, which are
A. mandates that each state must comply with within 12 months.
B. then adopted by the federal government.
C. “suggestions” to other states, allowing states to put more emphasis on certain sections if they desire.
D. automatically accepted “as is” by all states.
2. Some of the Model Regulations of the NAIC pertaining to LTCI include
A. limits for commission.
B. pre-existing condition coverage may be excluded for maximum of six months.
C. inflation protection should not be automatically offered because of the cost.
D. allowing only companies with an A++ Best’s rating to write LTCI.
3. The federal law under HIPAA requires that all LTCI policies issued on or after 1/1/97 must conform to standards outlined in the Act
A. so that the insurer can take tax breaks for their unearned premium reserve.
B. or, otherwise, agents may not accept commissions.
C. and no other LTCI policies will be allowed to be marketed.
D. to qualify for federal tax-preferred status.
4. The principal purpose of HIPAA was to
A. provide health insurance for those who move from one job to another, who are self-employed or have uninsurable health conditions.
B. make it difficult to market Long Term Care Insurance.
C. make certain LTCI products more consumer-friendly.
D. allow tax breaks for insureds of certain types of LTCI products.
5. Because of HIPAA, Long Term Care Insurance
A. is treated as health insurance for tax purposes.
B. benefits paid to an insured is taxable as capital gains.
C. may be marketed only by specific and approved insurers.
D. is not longer under the jurisdiction of the state insurance departments.
6. After HIPAA was enacted, the problem for regulators, insurers and agents primarily was
A. the elimination of the “medically necessity” trigger contained in most LTCI policies.
B. the addition of the “medically necessity” trigger found in most LTCI policies.
C. whether commissions could be paid on the policies.
D. since the federal government is involved, must agents take SEC examinations.
7. If an individual has a LTCI policy prior to the enactment of HIPAA prior to 1/1/97,
A. they are out-of-luck for tax breaks under HIPAA, unless they cancel the old policy.
B. they are automatically grandfathered into the status of a tax-qualified policy.
C. for an additional premium, they could also become tax-qualified.
D. they must ask the insurer for increase in benefits in order to be tax qualified.
8. If an insured has an LTCI policy dated 1/1/96, and meets the requirements of having the policy grandfathered for tax purposes, and he wants to increase the daily benefits substantially to reflect the increased nursing home costs in his community,
A. he may do so with no penalty.
B. he should have the policy framed, as no policies issued prior to 1/1/97 are grandfathered.
C. he may lose his tax-qualified status on that policy as the change would be substantial.
D. he will be required to pay a substantial surcharge.
9. The tax-deduction on a tax-qualified LTCI policy premiums is available
A. to every person who files a personal Form 1040, 100% of premium is deducted.
B. only to those who have adjusted gross incomes of less than 150% of poverty level.
C. only to individuals who itemize deductions on their tax returns.
D. only to individuals who do not itemize deductions on their tax returns.
10. To summarize, the impact on HIPAA on Long Term Care Insurance is in two areas, (1) some persons will receive a tax deduction for all or part of the premiums paid, and (2)
A. all persons will be relieved from the burden of possible income taxes on the benefits.
B. the amount of commissions agents are allowed to earn on LTCI sales.
C. the necessity of LTCI policyholders of filing a Form 1099 each year.
D. LTCI is a separate type of Casualty insurance for tax purposes.
ANSWERS TO STUDY QUESTIONS
1C 2B 3D 4A 5A 6A 7B 8C 9C 10A