U.S. Department of Health and Human Services
Premium Pricing of Prototype Private Long-Term Care Insurance Policies
Joshua M. Wiener, Katherine M. Harris and Raymond J. Hanley
The Brookings Institution
This report was prepared under grant #88ASPE205A between the U.S. Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, Office of Social Services Policy (now DALTCP) and the Brookings Institution. For additional information about this subject, you can visit the DALTCP home page at http://aspe.hhs.gov/daltcp/home.shtml or contact the office at HHS/ASPE/DALTCP, Room 424E, H.H. Humphrey Building, 200 Independence Avenue, SW, Washington, DC 20201. The e-mail address is: webmaster.DALTCP@hhs.gov. The DALTCP Project Officer was Paul Gayer.
These opinions are those of the authors and should not be attributed to other staff members, offices or trustees of the Brookings Institution. No endorsement by the Office of the Assistant Secretary for Planning and Evaluation or the U.S. Department of Health and Human Services is intended or implied.
The authors wish to thank David Kennell and Lisa Alecxih of Lewin/ICF and Gordon Trapnell and John Wilkin of the Actuarial Research Corporation for their invaluable assistance and comments. Kennell, Alecxih, Trapnell and Wilkin reviewed the premium pricing methodology. Kennell and Alecxih directed the programming of the Brookings-ICF Long-Term Care Financing Model. Trapnell and Wilkin estimated premiums for prototype policies using the Actuarial Research Corporation pricing model. All errors remain those of the authors. We also wish to thank Paul Gayer, our project officer, for his patience in the completion of this study.
The Problem and Research Objectives
Although American society relies heavily on insurance to protect against catastrophic costs, private insurance to protect against the potentially devastating costs of long-term care is relatively rare. As of June 1990, 1.65 million policies have been sold.
The long-term care insurance market has been slow to develop partly because the risk and expected costs of nursing home and home care have not been adequately estimated. The Task Force on Long-Term Health Care Policies, the U.S. Department of Health and Human Services, and the Health Insurance Association of America have all called for better data that could be used to price insurance premiums.
This research helps fill the data gap identified by insurers and others by using a much revised version of the Brookings-ICF Long-Term Care Financing Model to estimate premiums for a variety of prototype private long-term care insurance plans. These prototype premiums will be of use to insurers, prospective purchasers of insurance and public policymakers. The premiums will offer insurers a simple double-check on the estimates of company actuaries. They will also provide an order of magnitude estimate of the cost impact of changing benefit levels. Public policymakers will find the estimates useful as a way to evaluate the potential of private insurance to finance long-term care. Knowing the price of various prototype policies, government officials will be better able to assess the possibility of widespread purchase of insurance.
Research Design and Methods
In this study, all estimated premiums are priced according to initial age of purchase. Special emphasis is placed on the sensitivity of the results to different assumptions (e.g., amount of increased use of nursing home and home care, rate of return on reserves). In particular, we examined the tradeoff between affordability and coverage by pricing policies that vary by:
- Amount of nursing home and home care covered.
- Amount that indemnity levels are indexed for nursing home and home care inflation.
- Whether insurance policies are sold on an individual or group basis.
- Effect of discount rate assumptions.
- Effect of lapse rate assumptions.
Insurance premiums have a benefit portion (known to economists as the "actuarially fair premium" and to actuaries as the "net premium") and an administrative and profit portion. Using output from the Brookings-ICF Long-Term Care Financing Model, the basic pricing strategy was to make the present value of the benefit stream equal to the present value of the premium stream and then apply a factor to account for administrative and profit costs.
The methodology has four main steps:
First, in order to calculate the present value of benefits, it is assumed that different age cohorts (e.g., 65-69, 70-74) purchase an insurance policy with a specific set of benefits. The stream of benefit payments are simulated in the model for each year between 1986 and 2020. The benefit payment stream is discounted back to find the present value of the payment stream in 1986. The benefit stream implicitly discounts for mortality.
Second, in order to calculate the present value of premiums, it is assumed that the same cohort pays annual premiums of $120 per year. An aggregate stream of premium payments is simulated in the model for each age cohort for each year between 1986 and 2020. Like benefits, the premium stream is discounted back to 1986. The premium stream implicitly discounts for mortality.
Third, in order to establish the actuarially fair premium, the ratio of the present value of aggregate benefit payments to the present value of aggregate premiums is calculated for each cohort. This establishes the ratio of benefits to premiums actually paid. Multiplying the ratio by $120 yields the actuarially fair premium per year.
Fourth, to calculate the final premiums, the actuarially fair premium is divided by the loss ratio. A loss ratio of 70 percent is used for individual policies and 80 percent for group products.
Results and Conclusions
Several important implications for long-term care financing can be drawn from this study of prototype private long-term care insurance policies. First, while there is no technical reason why private long-term care insurance cannot offer coverage with fewer restrictions than what is currently on the market, to do so will substantially increase premiums. At age 65-69, the estimated annual premium for a policy that covers four years of nursing home care and four years of home care, indexes indemnity benefits for inflation on a compound basis, and has a nonforteiture value equal to the full asset share is $2,607 a year. Although indexing benefits for inflation dramatically increases the premium costs, it is essential to maintaining an adequate benefit level. Too often individuals buy a high initial indemnity value, which then erodes in value over time.
Second, the debate over the affordability of private long-term care insurance has been flawed by a failure to specify the adequacy of the policy people are assumed to be "buying." By limiting benefits, private insurance policies can be designed to fit any affordability criteria. The more restricted the benefits, the lower the premiums, the higher the affordability estimates will be. Conversely, the richer the benefits, the higher the premium, the lower the affordability estimates will be. If what people mean by saying that people "can afford" private long-term care insurance is that individuals can buy a high quality policy, then the percentage of the elderly who can afford private insurance is almost certainly less than we and others have previously estimated. Previous analyses were based on premiums that were much less expensive.
Third, these premiums emphasize the desirability of group policies sold to the working age population. Group policies sold to active workers are substantially less expensive than individual policies sold to the elderly population. Changing the age of purchase has a much larger impact on premiums than does changing the number of years of nursing home and home care coverage.
Although much is often made of the lower administrative and marketing costs of group versus individual insurance, dramatic differences have yet to really show up in the marketplace. At this time, current group policies are really more like individual policies sold in a group setting rather than true group policies. Thus, in calculating premiums, most insurers only assume that there is a 10 percentage point difference in the anticipated loss ratio between individual and group plans. While this difference is desirable and serves to lower premiums, it is not a large difference. The real payoff from promoting employer-sponsored plans results from individuals buying policies at younger ages.
Despite the much lower costs of purchase at younger ages, level premiums for quality policies, which index indemnity benefits for inflation, are still fairly expensive, exceeding $800 per year at ages 40-44. To date, insurance companies have tended to minimize premium prices by selling employer-sponsored group policies with unindexed benefits at a fraction of the cost of indexed policies. For example, an unindexed policy costs only about $250 a year at ages 40-44. At the same time, level premiums are less important for the working age population because the incomes of the insured will tend to increase over time. It is also more expensive to pay for the inflation benefit increases totally in current dollars. Indexing premiums can reduce costs at younger ages by more than half, bringing premiums down to a more manageable level.
Fourth, lapse rates can significantly affect premiums. Limited data suggests that long-term care insurance currently has a fairly high lapse rate. Given the newness and rapidly changing nature of the product this is somewhat to be expected, but pricing should not depend on half or more of the insured dropping their policies. Regulations should be considered which require public disclosure of lapse assumptions and experience and which require nonforfeiture values.
Fifth, the expected rate of return on reserves also has a major impact on premium prices. The higher the real interest rate, the lower the premium will be. For policies that index indemnity benefits, the impact of higher real interest rates will be eroded. In other words, the fact that nursing home and home care inflation is likely to be higher than the general consumer price index lessens the premium reducing effect of interest earned on reserves.
Finally, the long time span between initial purchase and use of long-term care services makes the profitability of insurance particularly sensitive to how well the assumptions used to price the policy mirrors future reality. Moreover, unlike acute care insurance where benefits are financed on a pay-as-you-go basis rather than with reserves, insurers cannot as readily increase long-term care premiums when experience does not meet expectations. Thus, setting premiums for private long-term care insurance involves a degree of uncertainty unmatched by any other insurance product currently marketed to consumers.
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