Qualified Long-Term Care Insurance Contracts

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8792]

RIN 1545-AV56

Qualified Long-Term Care Insurance Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final Income Tax Regulations relating

to consumer protection with respect to qualified long-term care

insurance contracts and relating to events that will result in the loss

of grandfathered status for long-term care insurance contracts issued

prior to January 1, 1997. Changes to the applicable law were made by

the Health Insurance Portability and Accountability Act of 1996. The

regulations affect issuers of long-term care insurance contracts and

individuals entitled to receive payments under these contracts. The

regulations are necessary to provide these taxpayers with guidance

needed to comply with these changes.

DATES: Effective date. These regulations are effective December 10,

1998.

Applicability date. Section 1.7702B-1 (concerning consumer

protection provisions) of the regulations applies with respect to

contracts issued after December 10, 1999. Section 1.7702B-2 (concerning

special rules for pre-1997 contracts) of the regulations is applicable

January 1, 1999.

FOR FURTHER INFORMATION CONTACT: Katherine A. Hossofsky, (202) 622-3477

(not a toll free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26

CFR part 1) to provide rules relating to consumer protection with

respect to qualified long-term care insurance contracts and relating to

events that will result in the loss of grandfathered status for long-

term care insurance contracts issued prior to January 1, 1997.

A notice of proposed rulemaking (REG-109333-97) under section 7702B

of the Code was published in the Federal Register on January 2, 1998

(63 FR 35). Written comments were received from the public, and a

public hearing was held on May 13, 1998. After consideration of all the

comments, the regulations proposed by REG-109333-97 are adopted as

revised by this Treasury decision.

Explanation of Statutory Provisions

The Health Insurance Portability and Accountability Act of 1996

(Public Law 104-191, 110 Stat. 1936, 2054 and 2063) (HIPAA) added

section 7702B to the Internal Revenue Code of 1986 (the Code). Section

7702B establishes the tax treatment for qualified long-term care

insurance contracts. Section 7702B(a)(1) and (3) of the Code provide

that a qualified long-term care insurance contract is treated as an

accident and health insurance contract and that any employer plan

providing coverage under a qualified long-term care insurance contract

is treated as an accident or health plan with respect to that coverage.

Section 7702B(a)(2) of the Code provides that amounts (other than

policyholder dividends and premium refunds) received under a qualified

long-term care insurance contract are generally excludable from gross

income as amounts received for personal injuries and sickness.

Section 213(d)(1)(D) of the Code was amended by section 322 of

HIPAA to provide that eligible long-term care insurance premiums, as

defined in section 213(d)(10) of the Code, are medical care expenses.

Under section 7702B(b)(1)(F) of the Code, a qualified long-term

care insurance contract must meet the consumer protection provisions of

section 7702B(g) of the Code. In addition, section 4980C of the Code

imposes an excise tax on issuers of qualified long-term care insurance

contracts that do not provide further consumer protections.

Section 7702B of the Code applies to contracts issued after

December 31, 1996. Section 321(f)(2) of HIPAA treats a contract issued

before January 1, 1997, as a qualified long-term care insurance

contract under section 7702B(b) of the Code, and services provided or

reimbursed under such a contract as qualified long-term care services

under section 7702B(c) of the Code, provided the contract met the long-

term care insurance requirements of the State in which the contract was

sitused at the time the contract was issued. Section 321(f)(2) of HIPAA

also provides that in the case of an individual covered on December 31,

1996, by a State long-term care plan under section 7702B(f) of the

Code, the terms of the plan on that date are treated as a contract

meeting the long-term care insurance requirements of that State.

Section 321(f)(4) of HIPAA provides that for purposes of applying

sections 101(f), 7702, and 7702A of the Code, neither the issuance of a

rider that is treated as a qualified long-term care insurance contract

nor the addition of any provision required to conform any other long-

term care rider to the requirements applicable to a qualified long-term

care insurance contract is treated as a modification or material change

of the contract.

Explanation of Provisions

The final regulations provide guidance concerning

The consumer protection requirements that apply to

qualified long-term care insurance contracts under sections 7702B(g),

7702B(b)(1)(F), and 4980C of the Code; and

The grandfather provisions of section 321(f)(2) of HIPAA

under which pre-1997 contracts are treated as qualified long-term care

insurance contracts if certain conditions are met.

The standards in the final regulations are based on safe harbors

that were originally set forth in Notice 97-31 (1997-1 C.B. 417), and

in the regulations proposed in REG-109333-97.

Notice 97-31

Notice 97-31 was issued to provide interim standards for taxpayers

to use in interpreting the new long-term care provisions and to

facilitate operation of the insurance market by avoiding the

[[Page 68185]]

need to amend contracts. For example, Notice 97-31 includes interim

guidance on the determination of whether an individual is a chronically

ill individual, including safe harbor definitions of the terms

substantial assistance, hands-on assistance, standby assistance, severe

cognitive impairment, and substantial supervision. The standards

contained in Notice 97-31 include interim guidance on both the consumer

protection provisions and the scope of the statutory grandfather

provisions that apply to long-term care insurance contracts issued

before 1997.

Consumer Protection Requirements

Under sections 7702B(b)(1)(F), 7702B(g), and 4980C of the Code,

qualified long-term care insurance contracts and issuers of those

contracts are required to satisfy certain provisions of the Long-Term

Care Insurance Model Act (Model Act) and Long-Term Care Insurance Model

Regulation (Model Regulation) promulgated by the National Association

of Insurance Commissioners (NAIC) for long-term care insurance as of

January 1993. The requirements relate to guaranteed renewability,

unintentional lapse, disclosure, prohibitions against post-claims

underwriting, inflation protection, and prohibitions against pre-

existing conditions exclusions and probationary periods. Section 4980C

imposes an excise tax on an issuer of a qualified long-term care

insurance contract if, after 1996, the issuer fails to satisfy certain

requirements, including requirements relating to application forms,

reporting, marketing, appropriateness of recommended purchase, standard

format outline of coverage, delivery of a shopper's guide, right to

return, outline of coverage, and incontestability. Most of these

requirements are based on the NAIC Model Act and Regulation.

The final regulations reflect the standards that were set forth in

Notice 97-31 and in the regulations proposed in REG-109333-97. For

example, the consumer protection requirements will be considered

satisfied if a contract complies with State law in a State that has

adopted the related NAIC model or a more stringent version of the

model.

Commentators generally approved of the consumer protection

provisions of the proposed regulations. Some commentators suggested

that the provisions should be applied on a prospective basis, such as

for long-term care insurance contracts issued more than one year after

publication of the final regulations. Consistent with this suggestion,

the final regulations apply to contracts issued after December 10,

1999.

Commentators suggested that if any State has adopted a Model Act or

Model Regulation requirement, such State's interpretation of that

requirement should be considered probative but not controlling of the

meaning of the analogous requirements for purposes of applying sections

7702B(g) and 4980C of the Code to a contract sitused in another State.

This suggestion was not adopted. If a particular State has adopted a

Model Act or Model Regulation requirement, that State's interpretation

should apply to determine whether the contract meets that State's

requirement. If a State has not adopted a particular requirement, the

determination of what interpretation should apply for purposes of

section 7702B(g) and 4980C of the Code is more appropriately made on a

case-by-case basis.

Pre-1997 Long-Term Care Insurance Contracts

Section 321(f)(2) of HIPAA provides that a contract issued before

January 1, 1997, is treated as a qualified long-term care insurance

contract if the contract met the ``long-term care insurance

requirements of the State'' in which the contract was sitused at the

time it was issued. Under the final regulations, the date on which a

long-term care insurance contract other than a group long-term care

insurance contract is issued is generally the date assigned to the

contract by the insurance company. In no event is the issue date

earlier than the date on which the policyholder submitted a signed

application for coverage to the insurance company. In addition, if the

period between the date of application and the date on which the long-

term care insurance contract actually becomes effective is

substantially longer than under the insurance company's usual business

practice, then the issue date is generally the date the contract

becomes effective. For purposes of applying the grandfather rule of

section 321(f)(2) of HIPAA to a group long-term care insurance

contract, the issue date of the contract is the date the group contract

was issued. As a result, coverage for an individual who joins a

grandfathered group long-term care insurance contract on or after

January 1, 1997, is accorded the same treatment under section 321(f)(2)

as is accorded coverage for those who joined the group before that

date.

Notice 97-31 and the proposed regulations use the term material

change to identify those changes to pre-1997 long-term care insurance

contracts that are treated as the issuance of a new contract and,

therefore, result in the loss of grandfathered status under section

7702B. The use of the term material may have caused some confusion in

light of the bright line standards that the regulations are generally

intended to provide. For this reason, the final regulations do not use

the term material in this context. No substantive change is intended by

this modification.

The final regulations generally adopt the standards set forth in

the proposed regulations for purposes of determining whether a change

to a pre-1997 long-term care insurance contract is considered the

issuance of a new contract.\1\ For example, the final regulations

provide that the exercise of any right provided to a policyholder or

the addition of any right that is required by State law to be provided

to the policyholder will not be treated as the issuance of a new

contract. Thus, as illustrated in an example in the regulations, the

exercise of a right set forth in a pre-1997 contract, without

underwriting, does not result in the loss of grandfathered status.

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\1\ These standards are different from those that apply for

purposes of determining the grandfathered status of other types of

insurance contracts under the Code (including sections 7702, 7702A,

101(f), and 264). Those other provisions limit the tax benefits

associated with the purchase of insurance products that, unlike pre-

1997 long-term care insurance contracts, have a substantial

investment orientation.

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The final regulations also provide that the following practices

will not be treated as the issuance of a new contract for purposes of

the grandfathering provision of section 321(f)(2) of HIPAA: (1) A

change in the mode of premium payment, such as a change from paying

premiums monthly to quarterly; (2) a classwide increase or decrease in

premiums for contracts that have been issued on a guaranteed renewable

basis; (3) a reduction in premiums due to the purchase of a long-term

care insurance policy by a member of the policyholder's family; (4) a

reduction in coverage (with correspondingly lower premiums) made at the

request of a policyholder; (5) a reduction in premiums that occurs

because the policyholder becomes entitled to a discount under the

issuer's pre-1997 premium rate structure (such as when a policyholder

becomes a member of a group entitled to a group discount, or changes

from smoker to nonsmoker status); (6) the addition, without an increase

in premiums, of alternative forms of benefits that may be selected by

the policyholder; (7) the addition of a rider to increase benefits

under a pre-1997 contract if the rider would

[[Page 68186]]

constitute a qualified long-term care insurance contract if it were a

separate contract; (8) the deletion of a rider or provision of a

contract (called an HHS (Health and Human Services) rider) that

prohibited coordination of benefits with Medicare; (9) the effectuation

of a continuation or conversion of coverage right under a group

contract following an individual's ineligibility for continued coverage

under the group contract; and (10) the substitution of one insurer for

another in an assumption reinsurance transaction. These exceptions are

generally similar to those listed in the proposed regulations. In

response to comments, however, the exceptions have been broadened to

permit certain premium reductions and to clarify that a change in

insurer pursuant to an assumption reinsurance transaction is not

treated as the issuance of a new contract (assuming that the contract

would not otherwise be treated as newly issued, such as by reason of a

change in the amount or timing of benefits or premiums).

Some commentators suggested that the regulations include a

parenthetical to the effect that some changes in the amount or timing

of items (such as de minimis changes in premiums) are not treated as

the issuance of a new contract, even if no specific exception applies

under the regulation. An important purpose of these regulations is to

provide certainty as to the qualification of pre-1997 long-term care

insurance contracts, and the exceptions enumerated in the proposed

regulations provide broad relief from treatment as the issuance of a

new contract resulting in the loss of grandfathered status.

Accordingly, the final regulations do not contain this additional

parenthetical.

Some commentators identified additional circumstances under which

expansion of coverage under a group long-term care insurance contract

should not be treated as the issuance of a new contract. For example,

some requested that the addition of a spouse, dependent children, or

others should not be treated as the issuance of a new contract. Other

commentators suggested that no loss of grandfathering should result

from the expansion of coverage under a group contract by reason of a

corporate merger or acquisition, or the extension of coverage to

collectively bargained employees, or the addition of former employees.

The final regulations clarify that such expansion is not treated as the

issuance of a new contract, provided that the addition is without

underwriting and is pursuant to the terms of the contract and the plan

under which the contract was issued as in effect on December 31, 1996.

Thus, the addition of a business's assets and related employees by a

company with a pre-1997 group contract is not treated as the issuance

of a new contract if, as of December 31, 1996, the contract and the

plan under which it was issued provided that new employees

automatically are eligible to participate in the group contract. If,

however, a new subsidiary is acquired by the company and the company's

pre-1997 group contract or plan requires that a subsidiary be

designated by the company in order for its employees to be eligible to

participate, then the designation of the new subsidiary would be a

change in the terms of the contract or in the plan relating to

eligibility. Although the final regulations were not modified to

accommodate further expansion, a new qualified long-term care insurance

contract could be entered into to expand coverage under these

circumstances. Alternatively, the final regulations permit coverage

under the pre-1997 contract to be expanded by a rider to the pre-1997

contract if the rider would constitute a qualified long-term care

insurance contract if it were issued as a separate contract.\2\

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\2\ As was indicated in the preamble to the proposed

regulations, certain of the consumer protection requirements would

not apply to such a rider. Specifically, sections

7702B(g)(2)(A)(i)(III), 7702B(g)(2)(A)(i)(V), 7702B(g)(2)(A)(i)(VII)

(other than section 9B of the NAIC Model regulation),

7702B(g)(2)(A)(i)(X), 7702B(g)(3), 7702B(g)(4), 4980C(c)(1)(A)(I),

and 4980C(c)(2) of the Internal Revenue Code would apply only the

first time a contract is purchased, and would not apply to the

purchase of a rider.

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Finally, it was suggested that the grandfather provisions of the

final regulations should be effective immediately. The final

regulations with respect to contracts issued before 1997 are effective

January 1, 1999.

Standards Before the Effective Date of the Final Regulations

The consumer protection provisions in the final regulations apply

with respect to contracts issued after December 10, 1999. Taxpayers may

continue to rely on Notice 97-31 with respect to contracts issued on or

before that date. In addition, a contract issued on or before December

10, 1999 will not be treated as failing to satisfy the consumer

protection requirements of section 7702B(g) or 4980C of the Code if the

contract satisfies the requirements of the final regulations. Taxpayers

may not rely on Notice 97-31 with respect to contracts issued after

December 10, 1999.

The final regulations are effective January 1, 1999, with respect

to pre-1997 long-term care insurance contracts. Taxpayers may continue

to rely on Notice 97-31 for the purpose of determining whether a change

made before January 1, 1999, to a pre-1997 contract is treated as the

issuance of a new contract. In addition, a change made before that date

to a pre-1997 contract will not be treated as the issuance of a new

contract if the change is not treated as the issuance of a new contract

under the final regulations. Taxpayers may not rely on Notice 97-31

with respect to changes made on or after January 1, 1999.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

does not apply to these regulations, and because the regulations do not

impose a collection of information on small entities, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue Code, the notice of proposed

rulemaking preceding these regulations was submitted to the Chief

Counsel for Advocacy of the Small Business Administration for comment

on its impact on small business.

Drafting information. The principal author of these regulations is

Katherine A. Hossofsky, Office of Assistant Chief Counsel (Financial

Institutions & Products). However, other personnel from the IRS and

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Sections 1.7702B-1 and 1.7702B-2 are added to read as

follows:

Sec. 1.7702B-1 Consumer protection provisions.

(a) In general. Under sections 7702B(b)(1)(F), 7702B(g), and 4980C,

qualified long-term care insurance contracts and issuers of those

contracts are required to satisfy certain provisions

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of the Long-Term Care Insurance Model Act (Model Act) and Long-Term

Care Insurance Model Regulation (Model Regulation) promulgated by the

National Association of Insurance Commissioners (NAIC), as adopted as

of January 1993. The requirements for qualified long-term care

insurance contracts under section 7702B(b)(1)(F) and (g) relate to

guaranteed renewal or noncancellability, prohibitions on limitations

and exclusions, extension of benefits, continuation or conversion of

coverage, discontinuance and replacement of policies, unintentional

lapse, disclosure, prohibitions against post-claims underwriting,

minimum standards, inflation protection, prohibitions against pre-

existing conditions exclusions and probationary periods, and prior

hospitalization. The requirements for qualified long-term care

insurance contracts under section 4980C relate to application forms and

replacement coverage, reporting requirements, filing requirements for

marketing, standards for marketing, appropriateness of recommended

purchase, standard format outline of coverage, delivery of a shopper's

guide, right to return, outline of coverage, certificates under group

plans, policy summary, monthly reports on accelerated death benefits,

and incontestability period.

(b) Coordination with State requirements--(1) Contracts issued in a

State that imposes more stringent requirements. If a State imposes a

requirement that is more stringent than the analogous requirement

imposed by section 7702B(g) or 4980C, then, under section 4980C(f),

compliance with the more stringent requirement of State law is

considered compliance with the parallel requirement of section 7702B(g)

or 4980C. The principles of paragraph (b)(3) of this section apply to

any case in which a State imposes a requirement that is more stringent

than the analogous requirement imposed by section 7702B(g) or 4980C (as

described in this paragraph (b)(1)), but in which there has been a

failure to comply with that State requirement.

(2) Contracts issued in a State that has adopted the model

provisions. If a State imposes a requirement that is the same as the

parallel requirement imposed by section 7702B(g) or 4980C, compliance

with that requirement of State law is considered compliance with the

parallel requirement of section 7702B(g) or 4980C, and failure to

comply with that requirement of State law is considered failure to

comply with the parallel requirement of section 7702B(g) or 4980C.

(3) Contracts issued in a State that has not adopted the model

provisions or more stringent requirements. If a State has not adopted

the Model Act, the Model Regulation, or a requirement that is the same

as or more stringent than the analogous requirement imposed by section

7702B(g) or 4980C, then the language, caption, format, and content

requirements imposed by sections 7702B(g) and 4980C with respect to

contracts, applications, outlines of coverage, policy summaries, and

notices will be considered satisfied for a contract subject to the law

of that State if the language, caption, format, and content are

substantially similar to those required under the parallel provision of

the Model Act or Model Regulation. Only nonsubstantive deviations are

permitted in order for language, caption, format, and content to be

considered substantially similar to the requirements of the Model Act

or Model Regulation.

(c) Effective date. This section applies with respect to contracts

issued after December 10, 1999.

Sec. 1.7702B-2 Special rules for pre-1997 long-term care insurance

contracts.

(a) Scope. The definitions and special provisions of this section

apply solely for purposes of determining whether an insurance contract

(other than a qualified long-term care insurance contract described in

section 7702B(b) and any regulations issued thereunder) is treated as a

qualified long-term care insurance contract for purposes of the

Internal Revenue Code under section 321(f)(2) of the Health Insurance

Portability and Accountability Act of 1996 (Public Law 104-191).

(b) Pre-1997 long-term care insurance contracts--(1) In general. A

pre-1997 long-term care insurance contract is treated as a qualified

long-term care insurance contract, regardless of whether the contract

satisfies section 7702B(b) and any regulations issued thereunder.

(2) Pre-1997 long-term care insurance contract defined. A pre-1997

long-term care insurance contract is any insurance contract with an

issue date before January 1, 1997, that met the long-term care

insurance requirements of the State in which the contract was sitused

on the issue date. For this purpose, the long-term care insurance

requirements of the State are the State laws (including statutory and

administrative law) that are intended to regulate insurance coverage

that constitutes ``long-term care insurance'' (as defined in section 4

of the National Association of Insurance Commissioners (NAIC) Long-Term

Care Insurance Model Act, as in effect on August 21, 1996), regardless

of the terminology used by the State in describing the insurance

coverage.

(3) Issue date of a contract--(i) In general. Except as otherwise

provided in this paragraph (b)(3), the issue date of a contract is the

issue date assigned to the contract by the insurance company. In no

event is the issue date earlier than the date the policyholder

submitted a signed application for coverage to the insurance company.

If the period between the date the signed application is submitted to

the insurance company and the date coverage under which the contract

actually becomes effective is substantially longer than under the

insurance company's usual business practice, then the issue date is the

later of the date coverage under which the contract becomes effective

or the issue date assigned to the contract by the insurance company. A

policyholder's right to return a contract within a free-look period

following delivery for a full refund of any premiums paid is not taken

into account in determining the contract's issue date.

(ii) Special rule for group contracts. The issue date of a group

contract (including any certificate issued thereunder) is the date on

which coverage under the group contract becomes effective.

(iii) Exchange of contract or certain changes in a contract treated

as a new issuance. For purposes of this paragraph (b)(3)--

(A) A contract issued in exchange for an existing contract after

December 31, 1996, is considered a contract issued after that date;

(B) Any change described in paragraph (b)(4) of this section is

treated as the issuance of a new contract with an issue date no earlier

than the date the change goes into effect; and

(C) If a change described in paragraph (b)(4) of this section

occurs with regard to one or more, but fewer than all, of the

certificates evidencing coverage under a group contract, then the

insurance coverage under the changed certificates is treated as

coverage under a newly issued group contract (and the insurance

coverage provided by any unchanged certificate continues to be treated

as coverage under the original group contract).

(4) Changes treated as the issuance of a new contract--(i) In

general. For purposes of paragraph (b)(3) of this section, except as

provided in paragraph (b)(4)(ii) of this section, the following changes

are treated as the issuance of a new contract--

(A) A change in the terms of a contract that alters the amount or

timing of an item payable by either the

[[Page 68188]]

policyholder (or certificate holder), the insured, or the insurance

company;

(B) A substitution of the insured under an individual contract; or

(C) A change (other than an immaterial change) in the 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.

(ii) Exceptions. For purposes of this paragraph (b)(4), the

following changes are not treated as the issuance of a new contract--

(A) A policyholder's exercise of any right provided under the terms

of the contract as in effect on December 31, 1996, or a right required

by applicable State law to be provided to the policyholder;

(B) A change in the mode of premium payment (for example, a change

from monthly to quarterly premiums);

(C) In the case of a policy that is guaranteed renewable or

noncancellable, a classwide increase or decrease in premiums;

(D) A reduction in premiums due to the purchase of a long-term care

insurance contract by a family member of the policyholder;

(E) A reduction in coverage (with a corresponding reduction in

premiums) made at the request of a policyholder;

(F) A reduction in premiums as a result of extending to an

individual policyholder a discount applicable to similar categories of

individuals pursuant to a premium rate structure that was in effect on

December 31, 1996, for the issuer's pre-1997 long-term care insurance

contracts of the same type;

(G) The addition, without an increase in premiums, of alternative

forms of benefits that may be selected by the policyholder;

(H) The addition of a rider (including any similarly identifiable

amendment) to a pre-1997 long-term care insurance contract in any case

in which the rider, if issued as a separate contract of insurance,

would itself be a qualified long-term care insurance contract under

section 7702B and any regulations issued thereunder (including the

consumer protection provisions in section 7702B(g) to the extent

applicable to the addition of a rider);

(I) The deletion of a rider or provision of a contract that

prohibited coordination of benefits with Medicare (often referred to as

an HHS (Health and Human Services) rider);

(J) The effectuation of a continuation or conversion of coverage

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

(K) The substitution of one insurer for another insurer in an

assumption reinsurance transaction.

(5) Examples. The following examples illustrate the principles of

this paragraph (b):

Example 1. (i) On December 3, 1996, A, an individual, submits a

signed application to an insurance company to purchase a nursing

home contract that meets the long-term care insurance requirements

of the State in which the contract is sitused. The insurance company

decides on December 20, 1996, that it will issue the contract, and

assigns December 20, 1996, as the issue date for the contract. Under

the terms of the contract, A's insurance coverage becomes effective

on January 1, 1997. The company delivers the contract to A on

January 3, 1997. A has the right to return the contract within 15

days following delivery for a refund of all premiums paid.

(ii) Under paragraph (b)(3)(i) of this section, the issue date

of the contract is December 20, 1996. Thus, the contract is a pre-

1997 long-term care insurance contract that is treated as a

qualified long-term care insurance contract.

Example 2. (i) The facts are the same as in Example 1, except

that the insurance coverage under the contract does not become

effective until March 1, 1997. Under the insurance company's usual

business practice, the period between the date of the application

and the date the contract becomes effective is 30 days or less.

(ii) Under paragraph (b)(3)(i) of this section, the issue date

of the contract is March 1, 1997. Thus, the contract is not a pre-

1997 long-term care insurance contract, and, accordingly, the

contract must meet the requirements of section 7702B(b) and any

regulations issued thereunder to be a qualified long-term care

insurance contract.

Example 3. (i) B, an individual, is the policyholder under a

long-term care insurance contract purchased in 1995. On June 15,

2000, the insurance coverage and premiums under the contract are

increased by agreement between B and the insurance company.

(ii) Under paragraph (b)(4)(i)(A) of this section, a change in

the terms of a contract that alters the amount or timing of an item

payable by the policyholder or the insurance company is treated as

the issuance of a new contract. Thus, B's coverage is treated as

coverage under a contract issued on June 15, 2000, and, accordingly,

the contract must meet the requirements of section 7702B(b) and any

regulations issued thereunder in order to be a qualified long-term

care insurance contract.

Example 4. (i) C, an individual, is the policyholder under a

long-term care insurance contract purchased in 1994. At that time

and through December 31, 1996, the contract met the long-term care

insurance requirements of the State in which the contract was

sitused. In 1996, the policy was amended to add a provision

requiring the policyholder to be offered the right to increase

dollar limits for inflation every three years (without the

policyholder being required to pass a physical or satisfy any other

underwriting requirements). During 2002, C elects to increase the

amount of insurance coverage (with a resulting premium increase)

pursuant to the inflation provision.

(ii) Under paragraph (b)(4)(ii)(A) of this section, an increase

in the amount of insurance coverage at the election of the

policyholder (without the insurance company's consent and without

underwriting or other limitations on the policyholder's rights)

pursuant to a pre-1997 inflation provision is not treated as the

issuance of a new contract. Thus, C's contract continues to be a

pre-1997 long-term care insurance contract that is treated as a

qualified long-term care insurance contract.

(c) Effective date. This section is applicable January 1, 1999.

David A. Mader,

Acting Deputy Commissioner of Internal Revenue.

Approved: November 24, 1998.

Donald C. Lubick,

Assistant Secretary of the Treasury.

[FR Doc. 98-32759 Filed 12-9-98; 8:45 am]

BILLING CODE 4830-01-U