A Report on the Actuarial, Marketing, and Legal Analyses of the CLASS Program. IV. Positioning Analysis

10/14/2011

Beyond certain requirements described at the outset of this analysis, the ultimate form of the CLASS plan will be determined by the Secretary of the Department of Health and Human Services. Success of the CLTCI plan will likely ultimately be judged on two dimensions. First, does the plan meet the statutory requirement that its premiums cover its costs over a 75-year horizon? Second, does the plan meaningfully expand the size of the population with long term care insurance? Success on these two dimensions will require that the government plan capitalize on the unique strengths of a federal LTCI plan while counteracting the statutory and bureaucratic weaknesses of a federal plan. The performance of LTCI will depend both on its relative strength vis-à-vis private-sector competitors, and on its choices regarding product positioning. For example, should the CLTCI plan attempt to compete directly with private LTC insurers by offering either lower costs or lower benefits? Or should the CLTCI plan avoid direct competition and instead offer a set of features that private LTC insurers are unlikely to match?

a. Strengths

The key strengths of the CLTCI plan are in part inherent to the federal government and in part derive from various provisions of the CLASS Act.

  • Long-term solvency. Table 2a and Table 2b show that all of the substantial private sellers of LTCI are more than 70 years old, which indicates that when it comes to purchasing insurance against risks decades hence, consumers place a premium on the perceived stability of the insurer. The federal government should have an advantage over private insurers on this account.

  • Strategic commitment. Once enacted, it would literally require an act of Congress to eliminate the CLTCI plan. Recognizing this, efforts by incumbents to deter entry or engage in practices to drive the government out are fairly unlikely.25 This ability to commit gives the CLTCI plan a strategic advantage over other potential entrants.

  • Automatic enrollment, opt-out, and payroll deductions. For employers that choose to participate in the CLTCI plan, employees will be automatically enrolled and premiums will be deducted from paychecks. Employees who desire to opt-out are allowed to do so. Inertia may result in fewer opt-out decisions and the opt-out structure is certain to result in higher initial enrollment than would an opt-in structure.26 As we discuss in the Industry Mapping section, the group segment, while smaller in magnitude, is growing more rapidly than the individual segment (18% vs. 12%), which will increase the value of the opt-out structure over time if the trend persists.

  • Low overhead and disintermediation. The CLASS Act restricts administrative costs of the plan to 3% of premiums in each year of the program. The interpretation of administrative costs is broad and includes advice and counseling. This will force the CLTCI program to aggressively manage expenses. If the CLASS plan can meet this mandate while still offering a product that consumers are aware of and interested in purchasing, it will have a significant cost advantage over private LTC insurers, which are dependent upon commissioned brokers.

  • Simplicity and standardization. The CLASS plan will have a simple and easily understood design that features a vesting period of at least 5 years, no elimination period, benefits that last for as long as the enrollee requires them, and inflation-adjusted benefits. This should complement the low overhead mandate by lessening the need for intermediaries to explain the various benefit options and configurations.

  • Access to the over-65 population. Medicare is a popular entitlement program with frequent contact with its 45+ million beneficiaries. Were CMS to directly advertise the fact that Medicare does not cover most home health and nursing home costs, and include literature on CLASS in its annual Medicare and You booklet as well as information on Medicare.gov, the CLTCI program could realize a substantial boost in enrollment.27 Of course, only seniors with earned incomes are permitted to purchase the product, so this strategy could generate confusion among retirees; targeting still-working seniors or those who are about to turn 65 could reduce this confusion.

  • State governments would benefit from greater CLASS enrollment. For individuals with both CLTCI and Medicaid coverage, 95% of the CLTCI payments for institutional care and 50% of the CLTCI payments for in-home or community-based care will be directed to the state program, with the remainder retained by the CLTCI/Medicaid enrollee.28 Accordingly, the states will have a direct financial incentive to promote CLTCI enrollment.29

b. Weaknesses

  • The break-even requirement. The CLASS Act requires the CLTCI plan to set premiums to cover costs over a 75-year period and the relevant language in the ACA prohibits the use of “taxpayer funds” for payment of benefits.30 If consumers expect Congress to maintain this commitment and not subsidize CLTCI coverage then the early success of CLTCI is critical to its long-term success. If early failures lead consumers to believe CLTCI will fail, then the opt-out rate is likely to be higher. This reaction will in turn undermine the success of CLTCI. Thus, there is a strong element of path dependence in the success or failure of CLTCI that implies a very large premium on a successful initial launch of the program. If, however, consumers expect Congress to offset any shortfalls, then this factor may not be as important.

  • No medical underwriting. Any CLTCI plan can set premiums that vary according to the age of the enrollee but cannot vary the premium by health status, as is commonly done by private LTC insurers. This creates the clear possibility that the CLTCI plan will become the LTCI plan of last resort, purchased only by those that have private information that they are likely to require LTC services. This would increase premiums further and could in the limit result in the collapse of the program--a result referred to as an “adverse selection death spiral.”

    Adverse selection remains the greatest threat to the long-term viability of CLTCI. CLTCI’s solvency will be highly dependent upon effective use of the tools allowed by statute for combating adverse selection. These include the 5-year vesting period; the requirement of earned income in excess of the Social Security minimum wage during 3 of the 5 years immediately following purchase; and the steepness of the age-premium curve. All else equal, a steeper curve will benefit those who enroll earlier and act as a tax on those who enroll later.

  • Premium subsidies. Premiums will be subsidized for employed full-time students and for those with incomes below the federal poverty level. The initial premium for both groups will be $5, an amount that will grow over time with inflation.31 The subsidy expense must be covered out of the CLTCI’s premiums. This will worsen the actuarial value for higher income potential enrollees and improve the value for lower income potential enrollees. If this induces the former to opt-out and the latter to remain in, the size of the required subsidy will increase and the fracture will grow. In the limit, this could also cause the CLTCI plan to collapse. Several factors may mitigate this concern. A $5.00 premium may be not be far from the actuarially fair premium for students; if this induces continued enrollment following graduation (or drop-out), then this subsidy may function as a loss-leader that brings in attractive customers. Similarly, to the extent that poverty is a transitory status, income-based subsidies may also act as a loss-leader that expands the pool of favorable risk enrollees.32

  • Other features that may draw an adversely selected risk pool. Unlike the typical private plan design, the CLTCI plan is structured to vary the benefit level in proportion to the degree of impairment of the enrollees. Enrollees who expect to have a high degree of impairment will receive a higher level of benefits, though they will not pay more than other enrollees of the same age. Additionally, unlike most private plans, which feature maximum benefit periods, the CLASS program does not limit the duration of the benefit. This will, all else equal, attract enrollment by those who expect to have LTC needs of greater duration and cost. We expect this to expose CLTCI to adverse selection. To the extent that some consumers are attracted by this design feature and willing to pay its actuarially fair cost, private firms will find this aspect easy to replicate and will not work to the advantage of CLTCI.

  • Inability to pair LTCI with life insurance. The need for life insurance as part of wealth protection is readily understood; LTCI covers additional, related risks that whole and term life policies do not. There are likely economies of scope from joint production, particularly with respect to marketing costs.33 It is no surprise that, to date, the largest sellers of LTCI are all significant sellers of life insurance. The CLTCI plan will have no comparable targeted access to the population most interested in LTC.

  • Mistaken perceptions that Medicare covers LTC costs. A 2006 survey by the AARP found that only 25% of respondents over the age of 45 knew that Medicare would not pay for a long-term care stay in a nursing home.34 Thus, 75% of the core target market segment is, apparently, unaware that they may need LTCI. This is a challenge that the CLTCI plan will share with private LTCI companies. Those private companies keep potential customers informed through the relationships they have from life insurance sales and on networks of affiliated and independent brokers. The CLTCI plan, which is restricted to 3% overhead (advocacy and counseling are considered administrative expenses), will not be able to match that network.

  • Minimal allowances for marketing and administrative expenses.Misperceptions about LTCI are common and brokers have historically played a central role in distributing correct information. The administrative expenses restrictions on the CLASS plan leave little room for marketing to increase consumer awareness. While, as described above, CMS and the states may provide some degree of free marketing, this is not guaranteed.

  • Lower investment returns. The CLASS plan is required to invest its premiums in government-issued securities and so will likely earn a lower return on the float between premiums and expenditures than private LTC insurers.

c. Implications

The greatest strengths of the CLTCI plan are the automatic enrollment of employees of firms that choose to participate in the CLASS program and the associated reduction in selling expenses. The greatest threat to the success of the CLASS program is the inability to medically underwrite premiums, which does raise the real possibility of an adverse selection death spiral and insolvency. Simply put, if the CLASS plan primarily attracts those for whom private LTC insurance is a bad value, it is likely to fail. This outcome is most likely if the CLASS plan is structured to simply mimic private plans but without underwriting and to appeal to the same set of consumers (primarily, those who purchase life insurance through a broker, a higher-income group).

The CLASS plan will better leverage its strengths by developing a plan structure that (1) appeals to a different set of consumers (lower and middle income) and (2) encourages enrollment by the relatively young and healthy members of that set of consumers. In section VI, we analyze a set of products that meet these criteria.

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