How LTCI is Priced Dynamics of LTCI Pricing Long-Term Care Insurance (LTCI) is priced and regulated as a level-premium contract. The insurer can, however, raise premiums on policies with similar coverage if the carrier can demonstrate that their initial pricing was inadequate to support their claims. These petitions are granted at the discretion of Authored by: David Wolf, Wolf & Associates
the state regulatory agencies based on sufficient actuarial proof of pricing inadequacy. Knowing that premiums have the potential to increase helps the consumer understand the contributing Dynamics of LTCI Pricing: Lapse Rates, Interest Rate Assumptions, and Claims Expectancies.
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Lapse Rates: Early Pricing Inaccuracies When carriers price LTCI products they assume that a number of purchasers will not persist in paying their premiums and their policies will lapse due to non-payment. An insurer’s assumption of the number of lapses per year is referred to as the “lapse rate.” If a large number of these policies are not renewed and lapse prior to a claim, the LTCI carrier will collect premiums for a certain number of years without needing to pay a claim. Conversely, if most consumers hold on to these policies until old age, the number of claims that carriers need to pay will be much higher. If, for example, 4% of policyholders dropped their policies per year, and the average age of applicant were 57, by the time this group of policy holders reached an average age of 80, less than 40% of them would still own the product. If, on the other hand, only .05% of policyholders dropped their policies per year, almost 90% of them would still have policies at age 80. Early in the development of LTCI products (1965 to the late 1980s), it was assumed that these ratios would be much higher than they actually have proven to be. Early carriers assumed that a significant number of policy purchasers (7-10%) would drop their policies every year. In actuality, early lapses were higher because these policies were nursing home policies. It wasn’t until policies started covering home and community-based care that consumers began to hold on tightly to their purchases. These estimates have continually been revised over the years with lower and lower estimates of policy lapses (3-4% by the 1990s and 2-3% by the early 2000s). At any point in this historical development, different carriers could have estimated dramatically different lapse rates from each other. However, virtually all current products are now filed with the assumption that nearly all policy holders will persist in holding tightly to their products (only 0.5-1% lapses), paying premiums until the time of claim. This has proven to be the actual historical reality. »
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Lapse Rates: Early Pricing Inaccuracies
Interest Rate Assumptions
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Interest rates also affect how initial LTCI premiums are priced. As we all know from experience with borrowing and saving, the interest rate environment in the last decade has been challenging (dropping from 5% to 1%). Insurers must price products according to their ability to invest premiums for future claims. Premiums are based on current interest rates and estimated future rates. The good news is that interest rates are likely the lowest they will ever be; certainly the lowest they have been in U.S. history. The bad news is that the initial costs of LTCI products were understandably less expensive a decade ago. However, if interest rates trend back in the direction of historical norms, it will increase the industry’s ability to reserve for future claims, making it less likely that carriers will need to raise premiums. In the event that interest rates increase significantly, there is inherent value in owning an LTCI product issued by a Mutual Company (owned by policyholders) that can pay dividends to policyholders. Publicallytraded stock companies do not have this advantage as they distribute profits to stockholders.
The responsibility for early pricing inaccuracies lies both with the LTCI industry pricing the product too aggressively AND with the dynamics of a changing industry. The LTCI industry was essentially reinvented in the early 1990s when carriers tried to respond to consumer demand that these products cover more than simply nursing home care. Consumers expected that LTC insurance instead cover all forms of professional care (Assisted Living, Memory Care, Home Care, Respite Care, etc.). As these products advanced in their comprehensive nature, consumers increasingly held on to their policies. The significance of this dynamic might not be fully understood by the consumer. However, lapse rates have been by far the MOST SIGNIFICANT issue in LTCI pricing accuracy. Fortunately, this issue has been largely solved and will no longer present the challenge to pricing that it has in the past.
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Claims Expectancies The challenge for the insurer in precisely estimating the cost of LTCI claims is that this product is most o en purchased 20 to 40 years prior to a potential claim. However, over the last several decades, insurers have gained more accurate information due to the significant volume of claims data. This information is the basis from which they currently set rates. In addition, we must recognize the impact of a changing care delivery system. The way we care for frail and aging loved ones has changed dramatically in the last two decades. This evolution has altered LTCI utilization. The Long-Term Care delivery system used to be dominated by nursing home care. Today nursing homes meet the minority of LTC needs. Since the early 90s we have continually pushed back the threshold to the nursing home in exchange for home care, assisted living, memory care and other community-based care se ings. This means we are entering the nursing home at much later stages of frailty and accessing lower levels of care at earlier stages. In the last decade, we have seen the impact of this shi and its relevance to LTCI pricing. The result is an overall increase in claims, as we are utilizing these policies at earlier stages in more desirable community-based se ings. Fortunately, this information has led to a basis for more accurate pricing for current and future policies. Medical advancements also continue to affect the expected cost of LTCI claims. Generally, the longer we live, the higher the odds of either physical or cognitive frailty and, in turn, the frequency of LTCI claims. However, one of the most significant potential impacts on LTCI claims would be a treatment for Alzheimer’s disease. Either a mitigating treatment or a cure would drastically reduce claims. Nearly 50% of the dollars LTCI insurers pay in claims are for cognitive frailty.1 Although physical frailty is more common, it is the cognitive frailty claims that are generally the longest in duration. 1
Genworth internal data (LTC fact sheet), as of December 31, 2014.
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A Practical Lesson for Astute Consumers Comprehending the assumptions behind LTCI pricing provides a rationale for why these products, though designed to have level premiums, do not have guaranteed premiums. Some carriers have been more successful than others in their efforts for stable pricing. A solid understanding of the carrier from which you choose to purchase is valuable. The lesson here is to not budget too tightly. If there are no changes to underlying rates, then you came out ahead. However, if rates change you also have margin in your budget to accommodate. In the end, you can take comfort knowing that the products today have been priced based on far more reliable data than policies of the past.
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