For first generation policies sold in the 1970s and 1980s, insurers were convinced that because nursing homes were viewed as places of last resort to receive care, there would be little moral hazard because it was well known that most people viewed nursing home residency as a "dreaded event". Not surprisingly, little attention was paid to underwriting and claims management for these early policies. So long as an applicant was not already in a nursing home, they could apply for coverage and would likely be issued a policy. Given that the average age of new buyers at the time was 68, most carriers still expected to see significant claims activity only 10-15 years in the future.
As companies began to market and sell comprehensive coverage they well understood that the aversion to using nursing homes was no longer an impediment to moral hazard; hence, companies felt a need to invest in more robust approaches to managing the two primary risks associated with product performance that were completely under their control: underwriting to guard against adverse selection, and claims management, to protect against moral hazard.
In the early 1990s, insurers began to employ more vigorous approaches to the underwriting of policies; these approaches focused on two broad dimensions: (1) medical criteria; and (2) tools and requirements gathering. Regarding medical criteria, the three domains on which companies focused their attention were the medical, functional, and cognitive status of individuals. Risk managers tried to better identify factors that put the individual at immediate or near term need for the services that were being insured for, namely, human assistance required to compensate for an individual's inability to perform ADLs due to functional deficits or to cognitive issues. Diagnoses were viewed as markers for current or future manifestations of functional need. Data mining, as well as more comprehensive reviews of the medical literature resulted in the development of detailed medical underwriting guides by companies. The information in these guides was considered proprietary, since the ability to perform more effective risk selection was seen as a competitive advantage for a company. At the same time, cognitive testing was adopted in the early 1990s and became a standard business practice. The availability of third party assessment companies serving the industry significantly enhanced the ability of insurers to perform their risk management functions both for underwriting and for claims management.
Companies also invested in more robust information gathering. The most common tools included information provided from the application, telephone interviews, medical records or attending physician statements, medical exams, in-person assessments and pharmacy databases. Many of these tools are in use today. An analysis of underwriting practices across the industry suggested that over the last decade, as companies have been able to link their up-front underwriting strategies with back-end claims experience, there has been a marked shift toward more conservative underwriting practices.31 In 2009, underwriting rejection rates across the industry were at 19.4%. For applicants under age 45, declination rates are below 10% whereas for those over age 80, rates increase to more than two-in-five.32
Regarding claims, insurers focused on managing three major types of risks associated with a claim: (1) the incidence risk, which is the risk that someone becomes disabled and requires LTC services covered by the policy; (2) the intensity risk, which focuses on the level of service and associated expenditure required to compensate for the individual's functional or cognitive deficits; and (3) the continuance risk, the amount of time that an individual would require paid services. Companies typically deploy -- through third party vendors -- nurses into the homes of claimants to measure whether the benefit eligibility trigger has been met and these same nurses are also involved in the development of care plans. These benefit assessments are fairly standard across the industry, especially when someone is claiming home care or assisted living benefits.
For nursing home care, many companies rely on nursing notes or the Minimum Dataset Survey to obtain the information necessary to adjudicate a claim. The latter is an assessment that must be completed on all nursing home residents. Companies also conduct regular follow-up with claimants to assure that they remain eligible for benefits under the terms of the insurance contract. Over the last decade insurers have invested significant resources into claims management systems and are far more active in terms of helping claimants navigate the LTC system and get services in place.33
This investment is clearly warranted given the rapid growth in claims payments. Figure 7 shows the growth in new claims over the period. The average growth in annual incurred claims over the period is 13%. Although not shown in the figure, through 2010, companies reported paying out on a cumulative basis over the last two decades slightly less than $50 billion in incurred claims; on an annual basis, the liability covered from private LTC insurance is roughly $6 billion, which is less than 5% of total expenditures on LTC services in the United States.
FIGURE 7. Industry-Wide Actual Annualized Incurred Claims
SOURCE: NAIC Experience Reports, 2011.
NOTE: The growth in incurred claims in and of itself does not translate to underlying profitability or performance for the industry, nor does its relationship to changes in earned premiums (which are not shown in Figure 4) relate directly to profitability. Profitability is related in part to the actual relationship between claims and premiums over the life of a policy.