Updated December 18, 2007

If you're shopping for long-term-care insurance, recent legislation in Washington is giving rise to more products and more options -- if not more simplicity.

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The Pension Protection Act of 2006, among other provisions, changed the tax rules involving the way two types of products -- life insurance and annuities -- intersect with long-term-care insurance. In short, sellers of annuities for the first time are allowed to package long-term-care contracts with their products that pay tax-free benefits.

Additionally, under the legislation, funds that are withdrawn either from an annuity or from the cash-value portion of a life-insurance policy to pay for long-term-care coverage will no longer be taxable as income.

The changes, which take effect Jan. 1, 2010, already are prompting insurers to design and sell more hybrid products -- policies that offer the benefits normally associated with an annuity or life insurance, as well as protection against long-term-care expenses. About 20 insurers have started selling life insurance with long-term-care benefits, and six companies are offering annuities with a long-term-care component, according to insurance research firm Limra International Inc. of Windsor, Conn.

Pleasant Surprise

At first glance, the products appear to be the insurance equivalent of having your cake and eating it too. Tom Lockwood, a 63-year-old construction-company owner in Vero Beach, Fla., recently bought a combination policy from New York Life Insurance Co. After paying his mother's assisted-living-facility bills for nine years, Mr. Lockwood was familiar with the high cost of long-term care and had looked at a wide range of insurance options.

But when he spoke with his accountant about estate-planning options, Mr. Lockwood found out he could invest his savings in a life-insurance policy with a long-term-care rider, rather than buying life insurance and long-term-care coverage separately. "I was unaware that this product even existed," Mr. Lockwood says. "For someone looking for security and concerned about long-term care, it's a great combination."

That said, the policies aren't without their drawbacks. Products that combine life insurance or annuities with long-term-care coverage typically involve a single -- and very steep -- premium. Mr. Lockwood, for example, paid $100,000 for his policy.

Additionally, such products can be numbingly complex. Buying a hybrid, in some cases, means combining an already complicated investment (an annuity) with an already complicated insurance policy (a long-term-care contract) to create a product that only an insurance actuary could love.

How They Work

A life-insurance policy combined with long-term-care coverage typically involves accelerated benefits, meaning that if you need long-term care, a portion of the policy's death benefit is paid out to cover expenses, and the death benefit is reduced accordingly. With an annuity, you generally make a one-time payment ($100,000 is the example most often used by insurers) to buy a deferred, fixed annuity with a long-term-care rider.

Some products let you take regular monthly payments that increase by a certain percentage if you need long-term care. Others function as a souped-up savings account for long-term-care needs and don't allow you to tap the benefits until you specifically need them.

Some annuities give you various options involving the time period for long-term-care payments, the amount of coverage, or the type and amount of inflation protection. For example, Genworth Financial Inc.'s Total Living Coverage annuity lets you choose long-term-care benefits worth either two or three times your initial premium, benefits lasting either four or six years, and inflation protection compounding either 3% or 5% a year.

Insurers, of course, see the changes in the Pension Protection Act as opening a door to new business. "There's a whole reservoir of annuities out there set up for emergency purposes that could be moved into an annuity product with a long-term-care rider," says Mark Doherty, second vice president for product manufacturing at insurer Lincoln National Corp. of Philadelphia.

Mark Warshawsky, director of retirement research at consulting firm Watson Wyatt Worldwide, says hybrid products help bring together two different risk pools. "The people who have below-average life expectancies are getting long-term-care insurance they couldn't get otherwise," he says, "and the hale and healthy are getting a reduced-cost annuity."

What to Consider

If you're interested in a policy that combines an annuity or life insurance with long-term-care protection, here are some factors to consider:

Do you really need life insurance -- or are you at a point in life where you would go without it if you weren't enticed by one of these products?

Maureen Mohyde, director of gerontology for Hartford Financial Services Group Inc. in Simsbury, Conn., says hybrid policies aren't for everyone because the combination of life insurance and a long-term-care rider typically costs more than a stand-alone long-term-care policy. However, if you are leaving a family business to one child and want an inheritance for others, have a younger spouse or otherwise need "estate liquidity, permanent life insurance may be the product that fits the bill," she says.

And, in that case, a long-term-care rider could be the cost-effective choice. Hartford's rider costs about 20% of what it would cost to buy a comparable long-term-care policy, she says. A 55-year-old man, for example, would pay $3,818 a year for the life premium and $319 for the long-term-care rider, compared with $1,296 for a stand-alone long-term-care policy.

If you currently have life insurance that you'd simply like to replace with long-term-care insurance, consider this: When the Pension Protection Act provisions take effect in 2010, you could exchange the cash value of a life-insurance policy or annuity contract for a tax-qualified long-term-care policy -- and the exchange would be tax-free. Currently, you would owe income tax on the policy's value.

Prudential Financial Inc. is trying to develop life-insurance and annuity products that you could buy at a younger age, say 55, and then have the right to exchange all or part of the policy at age 65 for long-term-care insurance, says Malcolm Cheung, Prudential's vice president of long-term care in Roseland, N.J.

How much long-term-care insurance do you actually need -- and will a combination policy provide it?

Consider where you would like to live in retirement, the average cost of long-term care in that location, and the portion of that amount that you want to cover with insurance, says Phyllis Shelton, president of LTC Consultants, a Hendersonville, Tenn., consultancy on long-term-care insurance. (For online charts on the cost of care in various metropolitan areas, go to longtermcare.genworth.com; click on "What is the cost of long-term care?" Or you can go to maturemarketinstitute.com and click on "Studies.")

Next, Ms. Shelton suggests calculating a 5.8% increase in costs each year until you turn 80. So, if you're 60 and nursing-home care costs $5,400 a month where you live and you want your benefit to cover 60% of the cost, you would need $3,240 a month today, or about $10,000 a month in 20 years based on compound inflation. Using that number, you can ask insurance agents how much money you would need to invest in the policies or annuities they're selling to achieve that goal in 20 years.

Is inflation protection an option?

Some combination life-insurance policies and annuities offer inflation-protection riders, which help the value of your long-term-care benefits keep up with fast-rising health-care costs. But few make clear the distinction between simple inflation protection, which increases your benefit by a certain percentage of the original benefit level every year, and compound inflation protection, which increases your benefit by a certain percentage of your new benefit level each year.

"A lot of times consumers don't think about it, and they aren't being advised about it -- because it's just a rider," says Julie McPeak, executive director of the Kentucky Office of Insurance in Frankfort. "People generally don't realize that inflation protection is important until it's too late."

Something else to watch for: Sometimes inflation coverage applies only to a policy extension you purchase, Ms. Shelton says. In that case, she recommends withdrawing the policy's or annuity's main benefit as quickly as possible so the additional benefits -- which have inflation protection -- kick in faster.

How would you fare in underwriting?

The screening for life insurance typically involves a complete physical exam looking for heart problems and other potential killers, while long-term-care insurance screening is more likely to focus on the likelihood of dementia, arthritis and other chronic conditions. So, depending on your health strengths, you might qualify for a better rate for one or the other, but not both.

In contrast, the life-care annuity products could be open to just about anyone not currently receiving long-term care.

For example, State Life Insurance Co., a unit of OneAmerica Financial Partners Inc. of Indianapolis, has been selling a life-care annuity even without the tax advantages for a decade as an alternative that doesn't require much underwriting, says Bruce Moon, State Life's vice president of marketing. It provides access to the annuity's cash value for long-term-care expenses and has an optional rider providing lifetime coverage. With the pension law's passage, the company is updating the product to meet the requirements for policyholders to get tax-free benefits.

Are you handing over a lump sum or paying a yearly premium?

Some people prefer to pay a large chunk one time to buy a combination life/long-term-care policy. This approach, of course, means you give up the time value of your money. But benefits through life-insurance riders you pay for each year could change, or premiums could increase, depending on the language of your policy.

Can you get the benefits you want in each piece of a combined policy?

"You're giving up a lot of flexibility to pick the best life product and the best long-term-care product," says Byron Udell, chief executive of AccuQuote, an insurance-sales Web site based in Wheeling, Ill. "Some carriers are great on long-term care but just do a decent job on life."