By almost all measures, the private market for LTC insurance is not meeting the initial expectations of companies that entered the market as well as current expectations of those that continue to sell policies. Yet no one disputes the need for a product that insures against the financial risk associated with LTC services nor is there an argument about the fact that this need will increase over time. Even so, as companies have entered the market to fill this need, most have fallen short on meeting sales and profitability objectives and it is this latter failure that has driven most of them from the market.
Clearly companies can do little to influence macro-economic trends affecting interest rates and in fact, many companies have exited the market over the past seven years because of the extremely low interest rate environment. Simply put, they could not generate sufficient income on reserves and RBC to fund future liabilities. Yet there are a number of actions that carriers can take to improve the overall profitability of products. The results presented in this study suggest that the ability to generate a reasonable level of profit is critical to assuring that companies remain in the market and that new companies will find the market attractive.
First, change to the underlying funding structure of products should be considered. Currently, products are level-funded, but they could be priced on a "term-basis", much like life insurance. This may be particularly relevant for individuals purchasing policies at younger ages. For example, the premium could be set to cover the risk (expected claim costs) over the term (e.g., one year) and there would be an understanding that every year the premium would increase to cover the increase in expected claims. At a certain point the premium would be fixed and level-funded, say at age 70 or 75. The schedule may also include a small amount of pre-funding.60 Because the annual increase in premiums could approach 10%, in addition to limiting the age at which premiums can be increased, it may also make sense to limit annual increases to smaller amounts.61
Such an approach minimizes the importance of interest earnings, makes the product more affordable and attractive at younger ages and makes awareness of future LTC risk more pervasive. This in turn, should help to reduce selling costs and "mainstream" the product as part and parcel of a standard retirement plan. Results presented here suggest that it may also draw companies back into the market.
A second approach involves indexing both premiums and benefits to account for increases in the cost of services. Such an approach should be tied to actual changes in the cost of LTC services which many companies track on an annual basis.62 This method has the virtue of reducing the uncertainty around the inflation risk, as well as lowering initial premiums, since a fixed inflation adjustment (e.g., 5%) is not built into the initial premium. It makes the product more affordable for consumers but even more importantly, reduces the level of initial reserves that must be set up by the company, which in turn eases the amount of capital required to support the product.
Clearly, a focus on restructuring the product is an important direction to consider for the industry as well as for regulators, who have a great deal to say about what is and is not acceptable in terms of product design. The industry will need to work with the NAIC as well as consumer groups to assure acceptance of such designs. Even though current regulations do not prohibit such approaches, insurers have not offered them in part because of a concern about introducing additional complexity into the product. Moreover, there is a legitimate concern that increasing premiums for people who are on fixed incomes will cause them to drop their policies. Designs that begin with term or indexed pricing, and then adjust the indexing rate downward at a certain point can reduce these concerns. As well, new combination-product approaches are also designed (in part) to lower the inherent risk in the product or even provide for off-setting risks (mortality and morbidity) within a single product (e.g., annuity-LTC products).
Another strategy involves deploying more sophisticated investment strategies. Even with major changes in product design, there will always be some need for an investment strategy that maximizes returns on invested premiums and capital. While companies have little control over general interest rates, there are mechanisms that can minimize some of the risk associated with the mismatch between future cash inflows and outflows. Helwig et al. (2007), identify a number of financial market innovations that can mitigate interest and inflation risk in products. For example, a carrier can use what is called a "Forward Interest Rate Swap" to lock in future interest rates; it then replaces these contracts with assets funded by future premiums which can help to match the asset/liability of their profile.63 The same principle holds for Inflation Swaps; the carrier pays a fixed inflation rate in exchange for the realized inflation rate for a period of time, thus eliminating any uncertainty about future inflation. These strategies are designed to hedge against the inflation and interest rate risks and they do require a level of sophistication in managing investment portfolios.
Providing companies with more certainty regarding the anticipated actions of state insurance departments vis-à-vis requested rate adjustments is also very important. Many companies were uncertain how they would be treated by regulators when making rate increase requests. While it is true that the vast majority of companies have increased rates on exiting policyholders, in many cases the approved rate change is less than what carriers demonstrated they required to cover anticipated losses, let alone earn a minimum return on their investment. Insurance regulators must of course balance insurer solvency and consumer protection, and it is not the role of insurance regulators to guarantee a certain level of profit to companies. Nevertheless, the concern about being able to obtain rate changes, when state-approved actuarial assumptions have not been met, is real: the product is priced to be guaranteed renewable but not non-cancellable.64 This means that companies have approached this market with the knowledge that if experience is not consistent with underlying pricing assumptions -- all of which are reviewed and approved by state insurance departments -- they have the ability to make adjustments prospectively. One approach to dealing with this issue and viewed positively by many companies is the ability to file multiple business rates that could be pre-approved and triggered when events occur outside of the control of the individual company such as precipitous declines in interest rates. This has the virtue of reducing the inherent risk in the product and thus may attract more capital and firms into the marketplace.
By taking some of the most risky elements out of the product, one could argue that relatively high capital requirements would no longer be justified. High capital requirement have been both a major barrier to entry as well as a major reason why companies have not been able to justify staying in the market. New arrangements with reinsurers may also reduce some of the need for capital, but this would also require changes in product to make the business opportunity attractive to reinsurers.
Finally, actions designed to reduce the costs of producing the product will enhance profitability. The most important non-claims related cost is sales commissions. Many view them as high today, in large part because of challenges in selling the product and the need to attract more agents to sell LTC insurance. As noted, however, given the challenges involved in selling the product, commissions are not out of line with what is paid for other voluntary insurance products in the individual market. There are a variety of reasons why it is difficult to sell the product and these have been outlined -- along with potential solutions -- in Frank et al. (2013).65 Some of the reasons relate to household behaviors associated with savings, purchase of insurance, and health-related behaviors (i.e., demand) and others with the efficiency of the private insurance market (i.e., supply). Solutions include strategies linking LTC insurance to health insurance, simplifying the product, providing more support for employer-sponsorship of insurance, educating the public about the risk and costs of LTC, forcing active choice, providing state-based organized reinsurance pools to provide a "back-stop" for industry experience, implementing targeted subsidies, and others. All of these strategies are designed to increase demand -- both through lowering selling costs and through changing peoples' attitudes about the value of LTC insurance -- and help address risk challenges facing the industry.
While not directly related to the central issue of product profitability, it is worth noting again that a majority of policyholders are in closed-blocks of business. These tend to perform less favorably than open blocks and in fact, a small number of large companies are responsible for this experience among both closed and open blocks. Thus, negative performance is to some degree skewed by a few companies and may not represent the overall experience of the industry as a whole. Unless there is a dramatic increase in new sales, the experience of these blocks will increasingly characterize overall industry performance. Because such blocks may not represent significant profit or growth opportunities for companies, it may become increasingly difficult to attract necessary levels of investment to service the policyholders in these blocks. As well, it may become increasingly difficult to attract and retain top risk management talent to work with a segment of the business that has been deemed unprofitable.
This poses potential risks to policyholders and challenges to regulators who may face unique issues associated with closed-blocks of business. A certain level of regulatory flexibility may be required to work through new and unknown issues. There may be circumstances where carriers desire to take actions that will benefit consumers as well as reduce costs or mitigate risks to the carrier, and it may not be clear whether such actions are allowable under existing regulations. For example, adding no-cost riders to policies that enable a more proactive approach to managing care, offering policyholders the ability to change the underlying structure of benefits to keep premiums more stable, supporting flexible approaches to applying alternate benefit provisions that take account of changes in the service delivery environment and so on.