With the Government's stance on long term care stopping well short of Royal Commission recommendatio...
With the Government's stance on long term care stopping well short of Royal Commission recommendations for full coverage, insurers which have hitherto ignored the potential for rapid growth in the impaired life annuities market would do well to return to the drawing board.
The fact is you cannot keep a good product down even when markets and demographics change beyond recognition. Purchased life annuities (PLAs) are living proof of this adage.
Once considered a very safe but equally dull income producer for the over-70s, pessimists argued the PLA market was in terminal decline when mortality improvements and reducing gilt yields pushed the target market into the over-75s bracket.
They were wrong. Over the past few years specialist PLA providers have developed a robust, leading edge product designed to address one of the UK's most serious welfare issues - the open ended cost of nursing home fees.
Unlike the massive income-producing investments market, where PLAs have had to compete with an increasingly sophisticated range of investment options, the impaired life annuity has little competition where the client's sole requirement is to avoid outliving his or her savings while still in need of nursing home care.
Admittedly, clients who plan ahead can take out an insurance policy to cover the potential long term care (LTC) costs. In this way they can avoid having to spend a large chunk of capital later in retirement which might otherwise have been passed on to their children when they die.
Assurance
But for those who have not made any provision and do not want to risk running out of capital, an annuity provides the assurance that the bills will be paid for as long as necessary.
As an insurance, rather than an investment product, is where the annuity comes into its own. Individual underwriting can secure very high rates of guaranteed income. Moreover, while part of the PLA income is usually taxable, if it is paid direct to a care home then the entire amount is tax free.
The pioneer in this market was the Pension Annuity Friendly Society (PAFS) which launched the first impaired life compulsory purchase annuities available on an individual basis in 1995, and extended its product range to include a PLA version the following year.
PAFS only offers impaired life annuities and stresses it does not sell 'lifestyle' annuities, such as those offered by GE Life (previously Stalwart) and Evergreen to those with minor impairments.
Chris Rostron, chief executive of PAFS, says: "The society only considers persons retiring with a health problem under the guidance of a medical consultant where our underwriters consider that the impairment is life threatening which will allow us to enhance terms."
The terms are based on the Anderton Mortality Tables, devised by the late Nick Anderton of Impaired Life Services (the management company for PAFS). The tables enable PAFS' underwriters to assess life expectancy accurately.
These tables were also the basis for the Anderton Diagnosis Index, which enables underwriters to assess activities of daily living (ADLs) as well as life expectancy for people entering nursing homes.
Rostron says: "Most entrants to nursing homes have problems with activities of daily living largely due to strokes and dementia. However, it is still important to check on the diagnosis of further impairments to assess the correct life expectancy."
At present the index is used to arrange annuities on an individual basis, often by the children or grandchildren of the elderly person, in conjunction with a solicitor, accountant or IFA.
However, the society believes the index could easily be developed for group assessments and could be of significant use in the public sector by local authorities, among others.
Advisers find that clients who have considered long term care are past the point of squeamishness and are comfortable discussing life threatening conditions and reduced life expectancy.
Above all, they do not want to live to see their children paying the nursing home fees when their own capital dries up. Qualifying impairments include AIDS, Alzheimer's disease, cancer, cirrhosis, coronary disease, diabetes and stroke.
Enhanced income
Depending on the client's medical condition they could qualify for an income worth 30% more than the rate paid to someone of the same age in good health. PAFS reckons that in very serious cases the income could be as much as 70% of the capital.
Rostron highlights the need for this type of service with a quote from a letter to the Financial Times published on 11 February 1995, the year PAFS was launched. The FT reader's complaint was as follows:
"I will be 70 next birthday, am 6ft 6in, weigh 18.5 stone and have had high blood pressure for 15 years. I'm on the maximum daily dose of my drug. I have had malaria three times, cancer of the larynx five years ago and now have apnoea which surgery in 1993 has relieved but not cured. So, I am a low health prospect according to the life offices. I agree. But let me seek an annuity - and hey presto! I am a normal life with an expectation in line with standard tables."
Care home fees
When a client buys an impaired life annuity to cover the cost of care home fees it is important to arrange it in conjunction with the home itself. Under a special tax dispensation the Inland Revenue does not tax payments from the insurance company made direct to the care home.
Peter Quinton, managing director of The Annuity Bureau, says: "It is essential the payments are made direct to the home. If they are paid to the client first and then passed on to the home they would be taxed in part like a conventional annuity."
It is also essential to ensure the annuity payments keep up with rises in nursing home fees.
To meet this requirement the impaired life annuity must be linked to a rate of inflation proofing agreed in advance with the home so there are no nasty surprises later on, Quinton says.
Impaired life annuities aside, what remains of the simple voluntary annuity market? The reduced rates generally available on annuities at present - and this includes compulsory purchase annuities - have not eliminated this product as an option for the income seeker in retirement. According to Quinton the rates still look attractive for clients in their late 70s and beyond.
Then there is the growing market for 'lifestyle' annuities which are not individually underwritten.
William Sallit, head of retirement at Carrington Investment Consultants, says: "It is important to note that each impaired life case will be judged on its own merits according to the likely reduction in life expectancy, rather than the impact on quality of life. However, in addition to the more serious impairments, it is possible to obtain increased rates for those with less serious health conditions." Smokers, those with high cholesterol, diabetes and a weight problem might qualify, he adds.
The tax treatment of voluntary annuities also benefits the older client. With a compulsory purchase annuity the income is fully taxable, whereas only part of the income from a voluntary annuity is taxable. This is because the Inland Revenue regards part of the payments as a return of the original capital and part as interest and only taxes the latter. The older clients are when they purchase the annuity, the greater the proportion of the income represented by the capital element, so the tax liability decreases accordingly. As a rough guide, a 65-year-old man would be taxed on 50% of the income but this figure drops to under 40% for an 80-year-old.
A non-tax payer can receive the whole of the annuity income tax-free. Higher rate tax payers should declare the interest element of the payments on the annual tax return. In most cases the capital cost is non-refundable, even if the client dies shortly after the transaction. Capital guarantees are available in some cases, depending on the client's condition but these cost more or, for a given lump sum, reduce the income.
In conclusion, the combination of increasing mortality and reducing gilt yields seem likely to encourage the greater use of lifestyle and impaired life annuities. The demand for impaired life annuities will also increase following the growth of the income drawdown market which is taking many healthy lives out of the insurance pool in the under-75 annuities market.
Whether these factors will force up standard annuity costs remains to be seen but it must be a serious concern to providers in this very competitive market.
Debbie Harrison is a freelance journalist
