482 / How does the law treat long-term care contracts issued before 1997?

Any contract issued before January 1, 1997 that met the long-term care insurance requirements of the state in which it was issued is treated for tax purposes as a qualified long-term care insurance contract, and services provided under the contract or reimbursed by the contract will be treated as qualified long-term care services.¹

Planning Point: For many years, this was considered a major deal. Policyholders with “grandfathered” policies had the best of both worlds: the tax favorability of IRC Section 7702B, and the more liberal benefit triggers and policy language that preceded it. No one wanted to give that up, or do anything to forfeit it. Agents were extremely reluctant to replace any grandfathered plans (as they should be), except for the occasional few plans containing egregious policy language.

Planning Point: Although it’s much less of a question today (over 20 years later), there was some angst back in 1997 surrounding a policy’s “issue date”. After all, those issued prior to January 1, 1997 were “grandfathered”. But who chooses the “issue date”? It’s enough to know the IRS clarified it in Notice 97-31 as a date assigned by the company (no earlier than submission date, and sometimes coinciding with effective date).

By definition, certain policy changes are considered “material”, and others immaterial. Material changes require the exchange for, or issuance of, a new contract—one whose issue date cannot precede the date the changes take effect. Therefore, these changes will cause a loss of grandfathered status and are enumerated below:

(1) a change in the terms of a contract that alters the amount or timing of an item payable by a policyholder or certificate holder, an insured, or the insurance company;

(2) a substitution of the insured under an individual contract; or

(3) a material change in contractual terms or in the plan under which the contract was issued relating to eligibility for membership in the group covered under a group contract.²

Not everyone has found this guidance clear, so the carriers have given their own instructions for the kinds of changes that will cause a loss of TQ status, which generally include any increase in benefits (e.g., daily benefit, benefit period, elimination period or inflation protection).

The following items are not treated as the issuance of a new contract:

(1) a policyholder’s exercise of any right provided under the contract in effect on December 31, 1996, or a right required by applicable state law to be provided to the policyholder;

(2) a change in premium payment mode;

(3) a class-wide increase or decrease in premiums for a guaranteed renewable or noncancellable policy;

(4) a premium reduction due to the purchase of a long-term care insurance contract by a family member of the policyholder;

(5) a reduction in coverage requested by the policyholder;

(6) a reduction in premiums as a result of extending to a policyholder a discount applicable to similar categories of individuals pursuant to a premium rate structure that was in effect on December 31, 1996, for an issuer’s pre-1997 long-term care insurance contracts of the same type;

(7) the addition of alternative benefit forms that a policyholder may choose without a premium increase;

(8) the addition of a rider to a pre-1997 long-term care insurance contract if the rider issued separately would be a qualified long-term care insurance contract under IRC Section 7702B and any regulations issued under this section;

(9) the deletion of a rider or contract provision that prohibited coordination of benefits with Medicare;

(10) the exercise of a continuation or a conversion right that is provided under a pre-1997 group contract and that, in accordance with the terms of the contract as in effect on December 31, 1996, provides for coverage under an individual contract following an individual’s ineligibility for continued coverage under the group contract; and

(11) the substitution of one insurer for another insurer in an assumption reinsurance transaction.³