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Long Term Care Long Term Care Insurance: A Lesson For Insurance: A Lesson For

All ActuariesAll Actuaries

Middle Atlantic Actuarial ClubMiddle Atlantic Actuarial Club

2008 Meeting2008 Meeting

September 18, 2008September 18, 2008

John WilkinJohn Wilkin

Actuarial Research CorporationActuarial Research Corporation

(ARC)(ARC)

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What is Long Term Care What is Long Term Care Insurance (LTCI)Insurance (LTCI)

►LTCI pays for nursing home care or LTCI pays for nursing home care or home health care when the home health care when the policyholder becomes frail.policyholder becomes frail.

►LTCI is guaranteed renewable and LTCI is guaranteed renewable and financed with a level premium that financed with a level premium that varies by issue age.varies by issue age.

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LTCI: Elements of Health, LTCI: Elements of Health, Disability, and Life InsuranceDisability, and Life Insurance

► Benefits like health insurance:Benefits like health insurance: Nursing homeNursing home Home health careHome health care

► Benefit Trigger like disability insurance:Benefit Trigger like disability insurance: Unable to perform Activities of Daily Living Unable to perform Activities of Daily Living

(which is similar to unable to work)(which is similar to unable to work) Cognitive impairment (Alzheimer’s)Cognitive impairment (Alzheimer’s)

► Financing like whole life insuranceFinancing like whole life insurance Level premium for benefits paid near the end of Level premium for benefits paid near the end of

lifelife

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How Should LTCI be How Should LTCI be Regulated?Regulated?

► It is a unique product that should have its It is a unique product that should have its own regulationsown regulations

►When policies were first issued in the When policies were first issued in the 1980s, there were no regulations specific 1980s, there were no regulations specific to LTCIto LTCI

►Based on historical development Based on historical development (stemming from policies covering short-(stemming from policies covering short-term nursing home stays after a term nursing home stays after a hospitalization), state insurance hospitalization), state insurance departments applied health insurance departments applied health insurance regulations to LTCIregulations to LTCI

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Focus on Financing and Setting Focus on Financing and Setting PremiumsPremiums

► Health insurance uses the concept of a “loss ratio”Health insurance uses the concept of a “loss ratio” The “loss” is the benefit paymentsThe “loss” is the benefit payments The denominator is the premiumsThe denominator is the premiums The concept is that premiums must not be too HIGH; they must be The concept is that premiums must not be too HIGH; they must be

LOW enough so that benefits are commensurate with premiumsLOW enough so that benefits are commensurate with premiums In health insurance, loss ratios are generally applied to yearly In health insurance, loss ratios are generally applied to yearly

renewable term insurancerenewable term insurance For LTCI, initial yearly loss ratios are low and then become very For LTCI, initial yearly loss ratios are low and then become very

highhigh In order to calculate a loss ratio that would apply over the life of In order to calculate a loss ratio that would apply over the life of

the product, the later high benefit payments are discounted by the product, the later high benefit payments are discounted by mortality, interest, and lapsemortality, interest, and lapse

Thus, a high lapse rate produces a low premiumThus, a high lapse rate produces a low premium► Life insurance uses the concept of adequate reservesLife insurance uses the concept of adequate reserves

In life insurance, the concept is that premiums must not be too In life insurance, the concept is that premiums must not be too LOW; they must be HIGH enough to fund adequate reserves LOW; they must be HIGH enough to fund adequate reserves

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Ramifications of a Level Ramifications of a Level Premium Used to Finance an Premium Used to Finance an

Increasing RiskIncreasing Risk Initially, premiums are greater than Initially, premiums are greater than

needed to finance current risk.needed to finance current risk. Eventually, premiums are not sufficient to Eventually, premiums are not sufficient to

finance current risk.finance current risk. Insurers must create an active life reserve Insurers must create an active life reserve

from excess early premiums that can be from excess early premiums that can be drawn down to finance benefits later drawn down to finance benefits later when premiums are insufficient.when premiums are insufficient.

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Active Life Reserves:Active Life Reserves:So You Thought That It Was So You Thought That It Was

Your MoneyYour Money► By overpaying the initial risk, each By overpaying the initial risk, each

policyholder has a stake in the active life policyholder has a stake in the active life reserves of the insurerreserves of the insurer

►How is this stake protected, if at all?How is this stake protected, if at all? What happens if the policy is terminated? Who What happens if the policy is terminated? Who

gets the active life reserve?gets the active life reserve? What are the conditions under which the policy What are the conditions under which the policy

can be terminated? Can you be forced to can be terminated? Can you be forced to terminate and lose all of your investment?terminate and lose all of your investment?

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What happens to the Active Life What happens to the Active Life Reserve on Policy Termination?Reserve on Policy Termination?► Four Options:Four Options:

ProfitProfit Lower Initial Premium (LTCI)Lower Initial Premium (LTCI) Give to continuing policyholders as dividends (a Give to continuing policyholders as dividends (a

Tontine Scheme popular until the early 1900s)Tontine Scheme popular until the early 1900s) Give back to lapsing policyholder (nonforfeiture Give back to lapsing policyholder (nonforfeiture

benefit)benefit)

► For LTCI with no nonforfeiture benefit, the For LTCI with no nonforfeiture benefit, the only method by which a policyholder can only method by which a policyholder can preserve his stake in the active life reserves is preserve his stake in the active life reserves is to hold on to the policy.to hold on to the policy.

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Release of Reserves Under Release of Reserves Under LTCILTCI

►For the most part, LTC insurers used For the most part, LTC insurers used estimated release of reserves from estimated release of reserves from lapsing policyholders to reduce initial lapsing policyholders to reduce initial premiumspremiums If actual lapses were greater than If actual lapses were greater than

assumed, then there would be more profitassumed, then there would be more profit If actual lapses were less than assumed, If actual lapses were less than assumed,

then premiums may have to be increasedthen premiums may have to be increased

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Renewability OptionsRenewability Options► Five Renewability options:Five Renewability options:

CancelableCancelable► Can be terminated or premiums increased at anytime on selected Can be terminated or premiums increased at anytime on selected

individuals or a class. (Auto insurance)individuals or a class. (Auto insurance) Optionally RenewableOptionally Renewable

► Can be terminated on specified date (usually renewal date) and Can be terminated on specified date (usually renewal date) and premiums may be increased for a class, but not on specific insuredspremiums may be increased for a class, but not on specific insureds

Conditionally RenewableConditionally Renewable► Insurer can terminate only in the event of conditions stated in the Insurer can terminate only in the event of conditions stated in the

contract (usually attaining a specified age or losing employment). contract (usually attaining a specified age or losing employment). Premiums may be increased on a class.Premiums may be increased on a class.

Guaranteed RenewableGuaranteed Renewable► Requires policy renewal as long as premiums are paid, but premiums Requires policy renewal as long as premiums are paid, but premiums

may be increased on a class (LTCI)may be increased on a class (LTCI) NoncancelableNoncancelable

► Policy cannot be terminated as long as premiums are paid and Policy cannot be terminated as long as premiums are paid and premiums cannot be increased (whole life insurance)premiums cannot be increased (whole life insurance)

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LTC Insurers Argued That the LTC Insurers Argued That the Right to Increase Premiums AND Right to Increase Premiums AND

the Lack of Nonforfeiture the Lack of Nonforfeiture Benefits Were EssentialBenefits Were Essential

►The risk of frailty was unknown in an The risk of frailty was unknown in an insured environment.insured environment.

►The cost of adding nonforfeiture The cost of adding nonforfeiture benefits would increase the premium benefits would increase the premium to unaffordable levels.to unaffordable levels.

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Premiums By Assumed Lapse Premiums By Assumed Lapse RateRate

No Nonforfeiture BenefitNo Nonforfeiture Benefit

Lapse RateLapse Rate PremiumPremium Percent Increase If 0% Percent Increase If 0% Lapse AssumedLapse Assumed

0%0% $2,400$2,400 ----

1%1% $2,220$2,220 8%8%

2%2% $2,050$2,050 17%17%

5%5% $1,630$1,630 47%47%

15%15% $920$920 161%161%

Note: Premiums (to the nearest $10) for 65 year old $100/day comprehensive policy.

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Limits On Rate Increases?Limits On Rate Increases?

► State regulators applied the same loss ratio State regulators applied the same loss ratio test to rate increase filings as they did to test to rate increase filings as they did to initial rate filings – a minimum 60% loss initial rate filings – a minimum 60% loss ratio over the life of the policy.ratio over the life of the policy. This meant that the later corrective action was This meant that the later corrective action was

taken, the greater the increase necessary to taken, the greater the increase necessary to reach a 60% loss ratio.reach a 60% loss ratio.

This also meant that if benefits were greater than This also meant that if benefits were greater than expected (i.e., the 60% of the premium), then expected (i.e., the 60% of the premium), then the 40% “load” (for commissions, expenses, and the 40% “load” (for commissions, expenses, and profit) also got the same increase.profit) also got the same increase.

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LTCI Rate Increases:LTCI Rate Increases:Hobson’s Choice or Morton’s Hobson’s Choice or Morton’s

ForkFork► Hobson’s Choice is actually choice regarding one option Hobson’s Choice is actually choice regarding one option

– “take it or leave it”– “take it or leave it”► Morton’s Fork is a choice between two equally Morton’s Fork is a choice between two equally

unpleasant alternatives – “between a rock and a hard unpleasant alternatives – “between a rock and a hard place”place”

► A LTCI rate increase would be a Hobson’s Choice if you A LTCI rate increase would be a Hobson’s Choice if you could drop the policy with no bad consequences.could drop the policy with no bad consequences.

► However, once you terminate, you lose all of the value However, once you terminate, you lose all of the value of your active life reserve and you cannot buy a policy of your active life reserve and you cannot buy a policy from a different company at a comparable rate (if you from a different company at a comparable rate (if you are still insurable) because you have a higher issue age.are still insurable) because you have a higher issue age.

► Therefore, a LTCI rate increase is more like a Morton’s Therefore, a LTCI rate increase is more like a Morton’s Fork.Fork.

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LTCI: Who Bears the Risk?LTCI: Who Bears the Risk?

► If premiums can be increased and, if If premiums can be increased and, if increased premiums induce more lapses, increased premiums induce more lapses, where is the risk? (Note: Much of it is on the where is the risk? (Note: Much of it is on the policyholders.)policyholders.)

► What happens with a rate increase?What happens with a rate increase? If a policyholder continues, the increased If a policyholder continues, the increased

premiums means higher revenue.premiums means higher revenue. If the policyholder lapses, the release of reserves If the policyholder lapses, the release of reserves

means higher revenue.means higher revenue. However, this could lead to a loss of good will and However, this could lead to a loss of good will and

reduced future sales.reduced future sales.

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A Booming MarketA Booming Market

► With little risk, over 100 companies moved With little risk, over 100 companies moved into the LTCI market in the 1990s.into the LTCI market in the 1990s.

► LTCI was not an easy sale.LTCI was not an easy sale.► Competition drove (initial) premiums down Competition drove (initial) premiums down

and commissions up.and commissions up. You are the actuary of company ABC. What would You are the actuary of company ABC. What would

you do? Producing high premiums could lead to a you do? Producing high premiums could lead to a company replacing you with a more cooperative company replacing you with a more cooperative actuary. An even greater consequence is that a actuary. An even greater consequence is that a premium may not sell, and that company may premium may not sell, and that company may have to give up the LTC market completely.have to give up the LTC market completely.

Why low premiums and high commissions Why low premiums and high commissions increase sales.increase sales.

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Guidance to Pricing ActuariesGuidance to Pricing Actuaries

► From the Actuarial Standards of Practice No 18 – 1999: Actuarial assumptions in combination should

reflect the actuary’s professional judgment of future events affecting the incidence and cost of LTC benefits. In setting actuarial assumptions, the actuary should consider available experience data and reasonably foreseeable future changes in experience over the term of the benefit promises. Appropriate provisions for adverse deviation should be considered.

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ASOP LTC #18 ContinuedASOP LTC #18 Continued

► Voluntary Termination (Lapse) Assumptions are critical to the estimation of costs and to the evaluation of liabilities, because for most plans, higher lapse rates will produce lower expected costs. The actuary should select appropriate lapse assumptions, taking into consideration the method of marketing, policyholders expected to be covered, product and premium competitiveness, premium mode, premium payment method, nonforfeiture benefit, and the service of the entity providing the benefits. At the time any rate change is determined, the effect on voluntary lapses should be considered.

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A Period of AdjustmentA Period of Adjustment

►By the late 1990s, rate increases By the late 1990s, rate increases became fairly common.became fairly common.

►Policyholders reacted by bringing class Policyholders reacted by bringing class action law suits against companies action law suits against companies that increased rates excessively.that increased rates excessively.

►Many companies sold their LTC Many companies sold their LTC business and got out of the market.business and got out of the market.

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Class Action Law SuitsClass Action Law Suits

►Companies argue that their right to Companies argue that their right to increase premiums was stated in the increase premiums was stated in the policy.policy.

►Policyholders argue that rate increases Policyholders argue that rate increases were far beyond reasonable, that they were far beyond reasonable, that they would not have bought their policies if would not have bought their policies if they knew the rate increases were coming, they knew the rate increases were coming, and that they cannot go back to the and that they cannot go back to the situation at the time they bought and situation at the time they bought and select another company.select another company.

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Actuaries In Class ActionsActuaries In Class Actions

►Pricing actuaries had to explain how Pricing actuaries had to explain how they arrived at their assumptionsthey arrived at their assumptions Actuaries need to be prepared to explain Actuaries need to be prepared to explain

assumption setting based on actuarial assumption setting based on actuarial principles and ASOPsprinciples and ASOPs

Actuaries do not want to have to say “My Actuaries do not want to have to say “My boss told me to lower the premiums”boss told me to lower the premiums”

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NAIC ReformsNAIC Reforms -- 2000-- 2000

►Loss Ratios no longer required for initial Loss Ratios no longer required for initial premium filingspremium filings Insurance companies had the responsibility Insurance companies had the responsibility

to make initial premiums adequateto make initial premiums adequate Actuary must certify that premiums are Actuary must certify that premiums are

sufficient to cover anticipated costs under sufficient to cover anticipated costs under “moderately adverse” experience“moderately adverse” experience

►Rate increases are still possible based on Rate increases are still possible based on a weighted average loss ratio of 58% of a weighted average loss ratio of 58% of initial premium and 85% of the increaseinitial premium and 85% of the increase

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NAIC Reforms – 2000 NAIC Reforms – 2000 ContinuedContinued

► Increases above a specified amount Increases above a specified amount require the offer of a contingent require the offer of a contingent nonforfeiture benefit or continuation of nonforfeiture benefit or continuation of the same premium with reduced the same premium with reduced benefits.benefits.

►Disclosure of past rate increases to Disclosure of past rate increases to potential buyerspotential buyers

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LTCI After 2000LTCI After 2000

► Fewer companies sellingFewer companies selling► Initial premiums are higher and less likely to Initial premiums are higher and less likely to

be increased. Any increases are likely to be be increased. Any increases are likely to be much smaller.much smaller.

► Lapse rate assumptions typically 2% or Lapse rate assumptions typically 2% or lowerlower

► Still little provision for nonforfeiture benefit, Still little provision for nonforfeiture benefit, even though the additional cost is now smalleven though the additional cost is now small Nonforfeiture benefit can be reduced by offering Nonforfeiture benefit can be reduced by offering

after specified policy duration (3, 4, etc.) and after specified policy duration (3, 4, etc.) and offering less than asset share.offering less than asset share.

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Life Insurance 1759: The Life Insurance 1759: The beginningbeginning

► The first life insurance corporation in the U.S. The first life insurance corporation in the U.S. was created in 1759 by the Presbyterian was created in 1759 by the Presbyterian Synods in Philadelphia and New York as the Synods in Philadelphia and New York as the Corporation for Relief of Poor and Distressed Corporation for Relief of Poor and Distressed Widows and Children of Presbyterian Widows and Children of Presbyterian Ministers.Ministers.

► Between 1787 and 1837 more than two Between 1787 and 1837 more than two dozen life insurance companies were started, dozen life insurance companies were started, but fewer than half a dozen survived.but fewer than half a dozen survived.

► No one worried about the reserve, so it No one worried about the reserve, so it reverted back to the insurance company.reverted back to the insurance company.

► Thus, life insurance become one of the first Thus, life insurance become one of the first “lapse-supported” insurance products.“lapse-supported” insurance products.

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Life Insurance Growth 1840’s Life Insurance Growth 1840’s – 1860’s– 1860’s

► New York Life started in 1845New York Life started in 1845► Equitable Life Insurance Assurance Society started in Equitable Life Insurance Assurance Society started in

1859. Its lavish expenses (including a coming out party 1859. Its lavish expenses (including a coming out party for the niece of company vice president James Hyde) for the niece of company vice president James Hyde) was one of the companies whose actions brought about was one of the companies whose actions brought about the Armstrong Commission of 1905. Later it developed the Armstrong Commission of 1905. Later it developed a social conscience starting a job-training program for a social conscience starting a job-training program for drop outs and investing heavily in Columbia, Maryland.drop outs and investing heavily in Columbia, Maryland.

► Mutual Life Insurance Company of New York started in Mutual Life Insurance Company of New York started in 18431843

► Metropolitan Life started in 1863 (originally chartered Metropolitan Life started in 1863 (originally chartered to insure union soldiers during the Civil War). It took to insure union soldiers during the Civil War). It took the name Metropolitan in 1868.the name Metropolitan in 1868.

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Life Insurance: 1895Life Insurance: 1895

► From “Semi-Centennial History: New York Life From “Semi-Centennial History: New York Life Insurance Company, 1845-1895”,Insurance Company, 1845-1895”, ““The reserve fund, created by contributions from the early The reserve fund, created by contributions from the early

premiums and by interest, was to make up the deficiency of premiums and by interest, was to make up the deficiency of the later years. When a policy was discontinued, its reserve the later years. When a policy was discontinued, its reserve fund was no longer needed for the purpose for which it was fund was no longer needed for the purpose for which it was accumulated; but it was not the practice of the early accumulated; but it was not the practice of the early companies to return this fund to the discontinuing policy-companies to return this fund to the discontinuing policy-holder. The theory required it, but various pretexts were found holder. The theory required it, but various pretexts were found for retaining it: — the company did not agree to do it; the for retaining it: — the company did not agree to do it; the insured had broken his contract; those who discontinued were insured had broken his contract; those who discontinued were the best risks, hence the mortality among those remaining the best risks, hence the mortality among those remaining would be higher than the average; Life Insurance was yet in would be higher than the average; Life Insurance was yet in its infancy, and no one could tell whether the theory was its infancy, and no one could tell whether the theory was entirely safe or not, when applied to the particular class of entirely safe or not, when applied to the particular class of lives insured.” – John A. McCall, President New York Lifelives insured.” – John A. McCall, President New York Life

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Armstrong Commission of Armstrong Commission of 19051905

► Prohibited deferred dividends and tontine Prohibited deferred dividends and tontine policies, requiring annual distribution of policies, requiring annual distribution of dividendsdividends

► Limited the amount of new business in a yearLimited the amount of new business in a year► Limited costs and sales commissions Limited costs and sales commissions

(eliminating rebates)(eliminating rebates)► Increased reporting requirements to state Increased reporting requirements to state

insurance departmentsinsurance departments► Lessened competitive forcesLessened competitive forces

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Industrial InsuranceIndustrial Insurance

►Metropolitan and Prudential (the 4Metropolitan and Prudential (the 4thth and 5 and 5thth largest companies) came out of the Armstrong largest companies) came out of the Armstrong Hearings in better shape than the big three.Hearings in better shape than the big three.

►Mostly because they sold industrial insurance Mostly because they sold industrial insurance and paid some dividends to policyholders and paid some dividends to policyholders even though not required toeven though not required to

► However, the commission did question the However, the commission did question the high expenses and high lapse rates associated high expenses and high lapse rates associated with industrial insurance, issues that also with industrial insurance, issues that also apply to LTCIapply to LTCI

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The First Nonforfeiture LawsThe First Nonforfeiture Laws

►Elizur Wright, Commissioner of Insurance Elizur Wright, Commissioner of Insurance of Massachusetts in the 1850s, required of Massachusetts in the 1850s, required the conversion of the policy to a term the conversion of the policy to a term policy that could be bought with the policy that could be bought with the reserve reduced by 20%.reserve reduced by 20%.

►Standard Nonforfeiture Law became Standard Nonforfeiture Law became effective in 1948 – almost two centuries effective in 1948 – almost two centuries after the first life insurance policy after the first life insurance policy