With few exceptions, most companies that stopped selling LTC policies did so over the past decade. Table 6 shows the distribution of companies by market exit year. It shows that more than half of companies in the sample have exited the market (or specific market segments) in the past eight years. The largest number of companies exited the market in 2003 and 2010.
There does not seem to be any discernible difference between those companies that chose to exit the market earlier rather than more recently. Most companies made the decision to exit the market within a year of considering such a strategy and roughly a quarter within six months. Thus, once these companies seriously began re-evaluating the desirability of remaining active in the market, it did not take long for them to make a final decision to leave the market.
We asked executives to highlight all of the reasons why the company left the market (Table 7) and the single most important reason for doing so (Figure 8). In broad terms the reasons can be related to profit, risk, internal management, sales and distribution, public and regulatory policy, or other issues posing challenges to companies.
As shown, product performance, that is, not hitting profit objectives was the most cited reason for leaving the market. Incorrect assumptions about two underlying pricing assumptions -- voluntary lapses and interest rates -- have had a lot to do with this and have been key drivers behind the need of many companies to increase rates on products. The concern about the ability to obtain needed rate increases from state insurance departments was the second most cited reason for market exit. Slightly more than half of respondents also cited high capital requirements as a reason for exiting the market. It is noteworthy that only a single company cited an unfavorable public policy environment specifically as a reason for exiting the market.
Figure 8 highlights the point that a high capital requirement to support the product was cited most frequently as the most important reason for market exit. Product performance is the second most cited reason. Some of the other reasons cited include a concern that a continued focus on LTC insurance detracted from other core products, that tax qualification guidelines inhibited certain innovative product designs, and others. In terms of classifying these reasons into major categories, slightly less than half are related to profitability, about a quarter to risk issues and a quarter split out across the other reasons.
It is important to note that some of the reasons -- particularly those related to changes in the outlook of upper management -- are likely "intermediate" factors. That is, if senior management wanted to exit the market, it was likely related to the fact that business objectives were not being met, or they had a different evaluation of the risk, etc. In some cases, it likely required a new CEO to take a fresh look at the business which led to a market exit.
FIGURE 8. Single Most Important Reason that the Company Left the Market
SOURCE: Survey of executives from 26 LTC carriers who exited the market or exited segment of the market.
Concerns related to capital requirements and rate increases may represent something unique about the structure and regulatory requirements relating to LTC insurance that have a major impact on profitability. LTC insurance is a guaranteed renewable product which means that as long as an individual pays premiums, the insurance company must continue to honor the coverage. Premiums are not guaranteed, although they are designed to be level-funded over the life of the policy. This means that if the actual experience of any of a number of underlying pricing assumptions (claims, interest rate, mortality, voluntary lapse rates, etc.) varies from what was anticipated, the financial viability of the product can be threatened, unless there is an adjustment to rates.
Rate adjustments can only occur with the permission of individual state insurance departments. Rate increases would typically be sought for policies that have been in the market for enough time to gain credible experience. This means that policyholders would typically be older and more likely to be on fixed incomes at the time that a company might be seeking a rate adjustment. Given the sensitivity around increasing rates for older policyholders, it is not surprising that companies are concerned about their ability to raise rates; in fact, many companies have experienced significant challenges obtaining the level of rate increases that they request, even when such increases may be actuarially justified. For example, a company may request (and require) a 35% rate increase, yet be allowed to adjust premiums by only 15%. This does not mean that regulators have ignored requests for rate adjustments. With few exceptions, most companies have increased rates on some if not all of their policy series, and clearly the increases have been significant.45
The failure to hit profitability targets as a reason to leave the market was pervasive in the interviews with executives. Therefore it is important to understand what is meant by profitability and how it is measured in evaluating the success of a product. Profit can be defined differently by companies and the application of various standards affects premium levels. Some of the more common profit standards include: (1) a pre-tax measure (e.g., 10% of gross premium); (2) a post-tax measure (e.g., 5% of some level of the RBC allocated to support the product); (3) pricing to a specific lifetime loss-ratio standard (e.g., 60% at a conservative earnings or interest assumption); or (4) an IRR (e.g., 15%). Even when all other assumptions are held constant, use of an alternative profit standard can yield significant differences in premiums. For example, for a 62 year old, everything else held constant, using a 10% pre-tax standard compared to a 15% IRR calculation leads to a premium that is roughly 10% lower.46 The post-tax profit measure focuses on a target rate of return on RBC -- which is the level of capital that a company is required to allocate to support the product.
The calculation behind the level of capital required to support insurance products was set by the Risk-Based Capital for Insurers Model Act which went into effect in 1992/1993 for life and health companies. A company's RBC is monitored by both state regulators and A.M. Best or other rating agencies. State regulators use an RBC model that is developed and maintained by the NAIC. The purpose is to require companies to measure their capital allocation compared to a standard risk-based calculation of needed capital.47 In essence, the idea is to determine the minimum capitalization that is appropriate to a company's risks. While the exact formula will depend on the specific type of insurance, in general there are four risk areas that are typically considered: C1 is credit risk; C2 is pricing risk; C3 is interest rate risk, and; C4 is other business risks. The key risks that are the focus of LTC insurance include C2 and C3.
At the core of the NAIC model is a formulaic approach to developing a "Company Action Level (CAL)" of capital and then generally relating actual capital to this CAL. For example, if a company's CAL is $100M and its actual capital is $400M it would have a 400% RBC ratio. Regulators monitor this ratio and various actions generally result if this ratio falls below certain target levels.48 For many years, the RBC level on the C2 (i.e., pricing risk) had been to establish a level equal to 5% of claim reserves, plus $25 million of the first $50 million in premiums and 15% on all additional premium beyond that. The formula now reflects a lower percentage (10% instead of 25%) applied to premiums and an additional component related to claims. The intent was to hold higher levels of RBC as claims increased and to match the level of required capital to the actual pattern of risk in the product.
Again, the capital requirements for LTC insurance are high relative to other products such as health and life insurance. High capital requirements are due to the long-term nature of the coverage and other "unknowns" which make the product inherently more risky. Thus, the actual required capital is very high per dollar of earned premium or reserves because of the perceived product risk, the long-term nature of the guaranteed renewable coverage, and the fact that rating action impacts are muted as policyholders continue to age.49 Also, and in particular, with respect to policies with inflation protection, the capital strain is often large in the early years of a policy because sales commissions, underwriting and issue, taxes, and administrative expenses are large relative to earned premium. For that reason, it is not uncommon for companies to show financial losses in the first 2-3 years after a policy is sold and then show ever increasing reserves for many years and continued losses. While claims may be low during these initial years, expenses are high and for inflation policies, reserves high. Thus, at the very least, for the product to be profitable over its lifetime, it must generate returns that take account of the initial 1-3 years of expense-associated losses.
FIGURE 9. Moody's Yield on Seasoned Corporate Bonds--All Industries, AAA and Ten Year U.S. Treasury Note Yield Rate
This would not be a major issue if the actual or expected returns on capital were strong. However, that has rarely been the case. In addition to voluntary lapses being lower than anticipated (resulting in premiums being lower than necessary), interest rates have also been lower than anticipated, resulting in earnings on invested reserves that are lower than anticipated. More specifically, an analysis of rates of return on Triple A (AAA) corporate bonds and U.S. Treasure Notes over the last two decades highlights why so many companies exited the market in the last 7-10 years -- yields on both types of investments have experienced very major declines.50 Between 1992 and 2002, yields on Corporate Bonds were typically above 6.5% whereas in 2003, they began a precipitous decline such that by 2010, they had fallen to below 5%. For Treasuries, yields dropped to below 4%. The vast majority (85%) of companies that exited the market did so from 2003 through 2010, which correlates closely to this decline in yields.
In addition to absolute declines in returns on invested capital, when carriers point to required capital as a reason for exiting the market, they are also viewing constrained capital in light of expected returns from other lines of business. If profits do not emerge at either the rate or levels expected, then economic pressures will lead companies to allocate such capital to products offering higher returns. The high "hurdle rate" needed to justify the allocation of capital to the LTC insurance product line is particularly sensitive to the interest rate environment, given the level-funded nature of the product.
While for most companies the primary motivations for leaving the market were related to high capital requirements and the seeming inability to meet profit objectives, many factors converged and played a role in the decision. Some of these were related to challenges around marketing and sales, risk management strategies, regulatory policy, the lack of reinsurance coverage and others. Executives were asked to indicate whether a specific factor "Strongly influenced the decision to leave the market", "Somewhat influenced the decision to leave the market" or "Did not influence the decision to leave the market at all". Table 8 on the following page summarizes results.
There are a number of important points to be made about the data presented in Table 8. First, consistent with prior results, the factors cited most often as having the strongest influence on the decision to exit the market included high capital requirements and pressure to reallocate capital to other more profitable business lines due to profitability challenges. As well, roughly one-in-three respondents indicated that the level-funded nature of the product made it particularly susceptible to investment risk (i.e., interest earnings), and there were few ways to successfully mitigate this risk.
Second, issues relating to marketing and sales were not cited frequently as having a major or even moderate influence on the decision. Third, finding skilled staff for underwriting, claims and actuarial analysis has not played much of a role in the decision nor have issues related to enforcing policy provisions in the context of a changing provider landscape. In contrast, half of respondents indicated morbidity experience was worse than they had anticipated and this influenced their decision to exit the market. On a cumulative basis, most of these companies actual claims experience was better than what was anticipated; that is, the actual-to-expected loss-ratio was less than 100%. However, more recent claims experience suggested that claims costs were increasing at a rate higher than expected, and that this did not bode well for projected future profitability. (See Figure 11.)
Clearly, all of the activity related to risk management has costs which must be absorbed or built into the underlying pricing of the product. As morbidity experience has deteriorated for a growing number of companies, it is not surprising that companies are investing significant resources in risk management -- not sales -- activities. Roughly two-in-five respondents indicated that the costs associated with managing the product have become too high and this has been one of the factors that hasled them to exit the market.
Regarding regulatory policy, the most cited factors having a moderate influence on a company's decision to exit the market have to do with the ability to obtain rate increases in a timely manner or at all, as well as having the necessary flexibility to engage in appropriate risk management activities; roughly one-in-three companies indicated that this had a moderate impact on their decision. The costs of regulatory compliance and the possibility that such compliance encumbers product innovation were not seen as factors in the market exit decision.
A number of companies have reinsurance partners that enable them to share or spread the underlying risks in the product. For some companies, the ability to obtain reinsurance coverage is a pre-requisite to either entering or staying in the market. For two of the companies, the difficulty of obtaining such coverage or of meeting the requirements of the reinsurer proved to be very important to their decision to leave the market. For roughly one-in-three carriers, the difficulty of obtaining such coverage had some level of influence on their decision, but it was clearly not a dominant factor. It is noteworthy that over the last five years the number of reinsurance companies providing coverage for stand-alone LTC insurance policies has declined and that today, only 1-2 companies provide such coverage. Surveys of executives in these reinsurance companies suggest that capital requirements and inadequate returns were primary drivers of their exit from the market as well. The fact that these companies have also exited the market reinforces findings about the inherent level of risk in the product (as it is currently configured).
Finally, more than half of companies were concerned that a negative rating on their LTC insurance business would adversely affect other business lines, and this played some role in their decision to leave the market. This is because most writers of LTC insurance are multi-line companies and for the most part this insurance represents a small component of their overall portfolio. Again, it is worth mentioning that very few companies felt that an unsupportive public policy played a role in their decision to exit the market.
In addition to "missing" the interest and voluntary lapse assumptions, another reason for falling short on profitability assumptions relates to morbidity. Companies typically focus on two performance measures related to this parameter: the annual and cumulative loss-ratio and the actual-to-expected loss-ratio. The loss-ratio focuses on the relationship between claims and premiums and can be viewed on the basis of a single year (e.g., claims incurred during the year compared to premiums earned during the year) or on a cumulative basis (e.g., total claims incurred to date compared to total premiums earned to date). The higher the loss-ratio, the greater are claims in relation to earned premiums. Over the life of a group of policies, claims payments will ultimately exceed the amount of annual premium payments; the difference is expected to be paid for by the reserve that the company sets up. The reserve is funded in large part during the years where annual premium exceeds the level of annual claims incurred. It is the excess premium plus the interest earned on that excess premium that funds the future gap between premiums and claims.
Figure 10 highlights the annual industry-wide loss-ratio as well as the cumulative loss-ratio.
As expected, claims represent a growing percentage of premium payments over time. This reflects both the aging of the in-force policyholder base as well as the wearing off of the underwriting effect on morbidity. The slow-down in sales of new policies -- with lower initial annual loss-ratios -- also contributes to the rate at which such ratios are increasing for the industry. The growth in the loss-ratio does not represent a problem for the industry so long as the premiums collected are sufficient to fund the expected liabilities priced into the policy. What it does show is how claims are growing and this is typically compared to what the ratio was expected to be. Thus, the most important performance measure is whether or not the actual incurred claims by a company are in line with expected claims paid.
FIGURE 10. Annual and Cumulative Loss-Ratio
SOURCE: NAIC Experience Reports, 2011.
If a company anticipated that during a specific year its incurred claims compared to its earned premiums would be 50%, and in fact the ratio of incurred claims to premiums was actually 55%, this would indicate worse than anticipated experience. The converse is also true: if a company expected to pay out in claims the equivalent of 50% of its earned premium, and instead paid out 45%, this would suggest better than anticipated experience. An actual-to-expected ratio of 100% suggests experience is exactly in line with what was anticipated.
The expected claims underlying the pricing in a policy represent the best estimate for the amount of money that the insurer is going to need to pay out on an annual basis, given the age, gender, marital status, and health status of policyholders. Typically companies develop this "morbidity" or "claims cost" curve based on a set of assumptions related to: (1) the probability of someone becoming disabled in a certain year (incidence rate); (2) the probability that once disabled, an individual will require paid care for a certain amount of time (continuance risk); (3) the intensity of care required while the individual is disabled (intensity risk), and; (4) the level of service cost in relation to the daily benefit chosen by the individual to pay for care. The claims cost assumptions are a key input to the overall pricing of the policy -- see Table 4 -- and once filed with the state, these assumptions become the basis on which reporting and performance is monitored. If the actual experience does not conform to the initially priced assumptions, companies can request rate relief from state insurance departments and they would be required to file a new set of claims assumptions, which would result in changes to premiums.
Figure 11 shows industry-wide average cumulative actual-to-expected losses between 1992 and 2009.
FIGURE 11. Industry-Wide Actual Losses to Expected Losses
SOURCE: LifePlans Analysis of NAIC Experience Reports, 2010.
As shown, there has been variability in cumulative industry performance over the last decade. If we focus exclusively on the last six years, in four of six of these years the actual-to-expected loss experience has been over 100%; the average ratio over the past six years has been 102%; this compares to a ratio of 95% in the preceding eight years. Moreover, given this represents cumulative experience, for the ratio to increase by three percentage points between 2008 and 2009 suggests that the annual performance for that year must have been much worse than this.
As mentioned, in 2009 the NAIC changed its reporting format for companies and experience tracking for the new format. Data in these reports is not directly comparable to data from earlier reports because certain methodologies had changed regarding calculation of the actual-to-expected loss percentages. In the context of the new reporting, and as shown in Figure 12, based on recent data on the annual actual-to-expected incurred claims, experience over the last three years has been worse than what was priced for.
FIGURE 12. Industry Actual to Expected Annual Incurred Claims: 2009-2011
SOURCE: NAIC Experience Reports, 2012.
To obtain a summary view of industry change on key market indicators, we present data from the beginning and end of the decade, including information on market concentration. As shown in Table 9, market concentration has increased over the decade, with the top ten companies now accounting for slightly more than two-thirds of covered lives and the top five accounting for more than half of all policyholders. Given the recent exodus of additional companies from the market, such concentration is likely to grow.
In addition to identifying the motivations for leaving the market, we also asked if there were specific actions that were taken in support of staying in the market. Figure 13 shows that most companies changed product design and also changed rates on existing products. As well, more than two-in-five and one-third respectively changed their risk management techniques and tried new approaches to marketing and sales. Not shown in the figure is the fact only three of these companies (12%) have not raised rates on existing policies. For the remainder of companies, roughly two-thirds raised rates before they left the market. Only three companies left the market because of a sense that they needed to raise rates and this would make ongoing sales extremely difficult.
FIGURE 13. Actions taken Prior to Leaving the Market
SOURCE: Survey of executives from 26 LTC carriers who exited the market or exited segment of the market.
Clearly, these actions represent most of the "levers" that a company can pull to influence underlying product profitability. We know for example that companies changed product designs, tightened up their approaches to underwriting and claims management, and increased premiums. Some of these actions can only influence performance on new policies issued (e.g., underwriting approach, marketing approaches, and policy design changes) whereas others can also affect the performance of older policies (e.g., rate increases and claims management strategies).
Although not explicitly addressed in this study, we also know that the specific investment strategy vis-à-vis RBC and premium reserves has a major effect on profitability. While companies have little control over general interest or inflation rates, there are hedging strategies that can be undertaken to improve product performance. Such strategies are important because insurers are paying fixed rates on forward contracts; that is, premiums are received on an ongoing basis and they have to be invested in assets that mature around the expected payout dates.51 This can cause a mismatch between future cash inflows and outflows because payouts can be influenced by macro-economic trends that are outside of the control of the carrier.
Although few companies indicated that the need for rate increase activity is what drove them to leave the market, there was general concern across companies about the impact that this would have on sales. We asked respondents how concerned they were with being able to continue selling the product if rates on the product had to be raised. Figure 14 shows that roughly two-in-five respondents were somewhat or very concerned, and this had more to do with reputation risk and the impact on consumer confidence than it did with losing business to a competitor.
FIGURE 14. Level of Concern about Selling the Product if In-force Rates had to be Raised
SOURCE: Survey of executives from 26 LTC carriers who exited the market or exited segment of the market.