# A Report on the Actuarial, Marketing, and Legal Analyses of the CLASS Program. Adverse Selection

A precept of the statute is that no underwriting, other than age, can be used to set premiums or prevent enrollment into the Program. Because the CLASS Program is voluntary, there is a strong potential for the Program to attract a disproportionate number of high risk workers who are likely to need long-term care services. This adverse selection violates the principle for a sound insurance program. Private long-term care insurance generally requires underwriting and therefore can expect to have lower claim costs than that for the CLASS Program. Other things being equal, CLASS premiums may have to be considerably higher than the premiums for private insurance.

If CLASS premiums are uncompetitive against private insurance’s premiums, healthy workers who can meet underwriting requirements would likely pick private insurance over the CLASS Program. As well, employers have a fiduciary responsibility to look out for the best interest of their employees. They would also decline to offer CLASS if the premiums are too high. This exacerbates the problem of a higher than expected concentration of unhealthy enrollees. There may also be organized efforts to encourage workers with functional limitations to enroll. All these factors make it very difficult to determine the correct premiums.

The following simple example illustrates the challenge in such a situation. Suppose there is a 10% chance for a normal worker to have a toothache during a single year. An insurance plan will pay \$1,000 if the participants have a toothache. This plan is offered on a voluntary basis to a group of workers in which 5 of them already had a toothache. Suppose there are only 6 workers enrolled. Ignoring expenses, the range of possible premiums that are expected to be sufficient to meet the benefit obligation is as follow:

Number of Workers
with Toothache Enrolled
0 (5 x .10% x \$1,000) ÷ 6 = \$83
1 (1 + 5 x 10%) x \$1,000 ÷ 6 = \$250
2 (2 + 4 x 10%) x \$1,000 ÷ 6 = \$400
3 (3 + 3 x 10%) x \$1,000 ÷ 6 = \$550
4 (4 + 2 x 10%) x \$1,000 ÷ 6 = \$700
5 (5 + 1 x 10%) x \$1,000 ÷ 6 = \$850

Estimating premiums with this high level of variability is akin to gambling with the enrollees’ funds; gambling is clearly not the role of the insuring entity.

Initial premiums with likely be inadequate if the enrollment of healthy workers turns out to be lower than was assumed in the pricing. Subsequent premiums would need to increase. This action would tend to drive out the healthy enrollees who can get lower premiums through private insurance. With fewer healthy enrollees, there may be more premium increases. This rate spiral can lead to program insolvency. Because of the potential for adverse selection, a number of experts have opined that the CLASS Program is unworkable.

In order to compete with private group long-term care insurance for enrollment, CLASS premiums need to be on par with the premiums for private insurance. Group long-term care insurance generally has a 65% loss ratio. That is, the present value of future benefits is projected to be 65% of the present value of future premiums18. The balance of 35% is essentially earmarked for profits and expenses. A realistic and reasonable projected loss ratio for the CLASS Benefit Plan is 80%19. If the CLASS premiums for the CLASS plan exactly matched private group long term care insurance’s premiums for identical features and benefits, the CLASS Program will have an approximately 23% (80% ÷ 65% - 1) claim allowance over private insurance that can be used to account for the adverse selection effect. The challenge is to control the impact of adverse selection within this allowance20.

Without any mitigation for adverse selection, premiums for an actuarially sound CLASS plan will need to anticipate that virtually every enrollee will qualify for benefits shortly after the 5 year vesting period. Thus the premiums will be set to pre-pay the benefits21. This scenario produces an estimated \$3,000 monthly premium22. The Program will be sustainable even with a very small number of enrollees. Of course, there is virtually no market for it.

Thus, without control for adverse selection, there is little chance for success.

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