Monday, February 3, 2014

Insurer Nastygrams: When Long Term Care Insurance Premiums Rise

Why This Has Been Happening And What To Do If You Are Affected

If you are a long term care (LTC) insurance policyholder who has had a policy for five or more years, you are likely to get an unpleasant piece of mail if you have not already: a whopping increase in your LTC insurance premium.  Double digit percentage increases are the norm and 85% and higher increases have been levied on some policyholders.  Worse yet, just because you had your premium increased significantly does not mean that you will not see your policy cost rise even further in future years.  To add insult to injury, several significant players in the LTC insurance market have seen their credit profile degrade resulting in lower claims-paying ratings, raising the chance that they will have difficulty paying claims down the road.  In this post I will discuss the economics of LTC insurance, how insurers got themselves into trouble with this product (necessitating giant rate increases), and what to do if you have an LTC insurance policy and get slapped with one or more premium increases.

First, it is worth taking a peek at the economics of these policies from the insurers' point of view.  The product that has been the mainstay of the industry for years requires an annual premium for the length the insured is covered in return for a specified level of coverage (3 years at $XX per day 5 years, lifetime, etc.).  These policies are generally sold to customers in their 50s and claims are mostly made by insureds in their late 70s into their 80s.  Premiums may be guaranteed for some specified period of time (commonly 5 to 10 years), but after that they can rise if the amount insurers collect on the block of business they have proves to be inadequate.  There were single pay and "short pay" (5 to 10 years) policies sold that involved the insured paying a lump sum or set amount for a set number of years and then not having to pay anything further to be covered for the rest of their lives.  However, single and short pay policies were always less than 10% of the LTC insurance market due to the very large premiums these policies entailed compared to the annual premium variety.

From the insurers' perspective, they accepted a payout obligation on an unknown (but hopefully estimable) percentage of their insureds in 30 years' time in return for a stream of payments.  These premiums would have to be invested to earn enough money to be able to pay out claims down the road, but insurers had no real way to know what interest rates they would earn when the premiums came in 5, 10 or 20 years hence.  They knew that some of the insureds would pay premiums for a while and then stop paying for a variety of reasons (premature death, financial distress, etc.) and no longer be in the pool of eligible insureds when the claims started coming, but there was no way to know for sure how many policyholders would lapse prematurely.  To summarize, insurers accepted three major risks by underwriting this business: claims amount and timing, interest rate uncertainty, and lapse risk.  Sound scary? Well, they thought, no problem.  We have lots of actuaries and they are smart guys; they can figure it out (even though they didn't have a lot of data to work with owing to the relative newness of LTC insurance compared to life insurance).

Unfortunately, two or three (depending on the insurer) of the three major risks did not go in the favor of the insurance companies.  Lapse risk was the first one to give the industry a nasty surprise.  When a lot of companies became active in this market in the 1990s they went to market assuming that LTC insurance policyholders would settle out at a annual lapse rate of about 3% annually.  Too bad for them that lapse rates were closer to 1%.  A 2% difference between expected and actual lapse rates might not seem like that much, but compounded over a few decades it makes a huge difference:

Year 3% Lapse Rate 1% Lapse Rate
0 1000 1000
1 970 990
2 941 980
3 913 970
4 885 961
5 859 951
6 833 941
7 808 932
8 784 923
9 760 914
10 737 904
11 715 895
12 694 886
13 673 878
14 653 869
15 633 860
16 614 851
17 596 843
18 578 835
19 561 826
20 544 818
21 527 810
22 512 802
23 496 794
24 481 786
25 467 778
26 453 770
27 439 762
28 426 755
29 413 747
30 401 740

The above table shows a block of 1000 policyholders showing a 3% and a 1% lapse rate over 30 years.  The block with the 1% lapse rate has 85% more insureds in it at the end of 30 years than the block with a 3% lapse rate!  All those people the actuaries thought would pay out years of premiums and then go away without claiming anything were sticking around in droves.  Once insurers realized their error, a number of companies with a smaller presence in this line of business decided to stop writing policies and many of them hit their insureds with significant premium increases.

Next, insurers assumed that the interest rates at which they would be able to invest the premiums they would receive over the course of a few decades would be relatively stable in future years.  Some attempted to hedge this risk, especially if they had a large book of LTC insurance.  However, hedging is expensive, often causes accounting headaches, and the market for very long duration interest rate hedges is relatively small compared to some of the blocks of business the bigger players had.  Many of the insurers just "went naked" and hoped for the best on interest rates.  None of the actuaries had a financial crisis and several years of quantitative easing featured prominently in their models, unfortunately.  All those premiums they were expecting to invest at 6% and higher rates in high grade corporate bonds and treasuries were now being invested (for years) at 3%.  To make it worse, some insurers chose to deliberately invest in much shorter term bonds gambling that rates would spike back up and that they would not have to lock in low rates for the long term. This has proved to be a poor bet.  Still more insurers left the industry and just about everyone left in the market (plus those that ceased selling new policies) started hammering their blocks with double digit percentage rate increases.

The jury is still out to some extent on the third of the three major risks, namely the timing, duration, and size of claims made by insureds as they entered nursing homes.  Most of the policies in existence are too new for many to have gotten to the point of making a claim.  Of the insurers that have more than a handful of claims, experience compared to pricing is mixed.  The insurers who got into this market as an accommodation to their customers (i.e. reluctantly) seem to be doing OK.  The insurers who spent too much time listening to the marketing department ("Bob, we need to loosen underwriting and offer a generous new benefit to gain market share") have had cause to regret doing so.  We will see whether insurers get the claims they priced for in coming years.

So now you have an inkling as to why this mess has happened, but the LTC insurers' problems are theirs and the resulting premium increase is your problem to deal with.  What do you do when you get the dreaded premium increase?  First, use this as an opportunity to re-evaluate your LTC insurance needs in the context of your overall financial plan.  It has probably been 5 to 10 years (or more) since you bought the policy.  Do you still need this insurance, or has your net worth increased to the point where you could feasibly self-insure?  Are the premiums so low even after the increase that they are easily affordable for the foreseeable future?  Second, you should make sure that this insurer is one you want to continue doing business with.  The LTC insurance business has not been kind to insurers and those with a big presence in this market have generally seen their financial strength degrade and their ratings drop.  LTC insurance is by nature a very long term contract and the risk that an insurer falls down on its end of the deal is a lot higher over the course of a few decades than it is over a year or two.  Third, it would be a good idea to get new quotes on LTC insurance policies from other insurers to compare them with the newly increased premium you are asked to pay.  In most cases even the jacked-up premiums for old policies will be well below what insurers are charging for new policies (which should help illustrate how badly insurers underpriced the old policies).  If you have a lifetime coverage or even a 5 year benefit period on your existing policy and wish to keep it, a new policy will not be an option as insurers have almost entirely ceased selling those types of policies.

If you have determined that you still need a LTC insurance policy, the insurer remains acceptable, and the price is better than what you can get on the open market, clearly you will be keeping the policy and paying up.  Usually when insurers raise LTC insurance premiums they give policyholders the option of keeping their existing benefits at the higher price or reducing benefits in exchange for a smaller or possibly no increase.  Whether or not accepting the reduced benefits is a good idea depends on your budget and how much LTC coverage you feel you need.

Regardless of which choice you make, expect that you will see future premium increases in the future.  Given the degree to which these policies are underpriced, many blocks of business likely need to have their premiums increased 50 to 200% in order to be actuarially sound.  In order to raise premiums on LTC insurance policyholders, insurers have to go through a state regulatory process and usually receive permission (and they have to do so in each and every state where they have policyholders they wish to charge more).  Most state insurance regulators do not want the bad press and complaints they may face by allowing enormous premium increases all at once.  As a result, insurers who may need a 75% average increase will ask for 35%, get permission for a 30% increase, and be told or expect to come back for the rest in a few years.  So its likely that premium increases will be like cockroaches: where you see one, there are probably more lurking.  Make sure you can afford at least one more premium increase if you decide to keep your policy.

Its unfortunate that insurers badly underpriced LTC insurance policies over the past 15-plus years.  That said, the industry has learned some painful lessons and changed the product to one that is hopefully more sustainable in the future.  I believe that anyone buying a new policy should do so with the understanding that premiums could go up and a premium of 50 to 100% above whatever you are quoted should fit in your budget before you sign on the dotted line, just in case.

As always, this is meant for your edification and amusement, not for your financial advice or financial planning.  Consult your advisors, do your own research, take your own risks, make your own insurance decisions.

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