A Report on the Actuarial, Marketing, and Legal Analyses of the CLASS Program. VI. Entry Opportunities for CLASS ACT Insurance

10/14/2011

The CLASS Act authorizes the government to sell a traditional LTCI product with a set of rules governing product design, notably a $50 per day minimum average benefit. Our strategic analysis suggests that entry by almost any newcomer would be difficult. The government has some advantages over other entrants, in particular it need not establish a reputation for long-term solvency and it can establish distribution channels through employers by fiat, rather than incurring the selling costs of commercial insurers. Even with access to employers, the government is unlikely to successfully compete without incurring substantial costs educating consumers about LTCI, the same kinds of costs currently incurred by commercial firms.

Rules in the CLASS Act governing enrollment put the government product at a competitive disadvantage. An actuarial forecast made on behalf of HHS suggests that the government would have to charge a premium for its $50/day plan that is commensurate with that charged by commercial insurers for their plans offering $150/day benefits.38 (This comparison does not appear to account for the fact that CLASS benefits do not terminate while private plans typically pay benefits only for 3-5 years.39) Offering only this product puts CLTCI at a high risk for failure.

An important option for the government is to offer additional products that might prove to be profitable. We now consider several such products. When evaluating these alternatives, it is important to remember that CLASS has two related advantages over commercial carriers. It has the ability to introduce its products through the workplace and it does not have to pay substantial selling expenses to agents and brokers. But the value of these advantages would be greatly diminished if CLASS products were complex.

The first two options are motivated by the basic economics of insurance risk pools. In a nutshell, insurance works because low risk enrollees cross-subsidize high risk enrollees. This model is viable only if low risk enrollees are willing to participate; if the cross-subsidy is too large, low risks drop out and the pool falls apart. Commercial insurers are able to sign up low risk enrollees through medical underwriting (offering lower prices to low risk individuals), selling to employer groups where all or most employees are expected to agree to purchase coverage (more important for traditional health insurance), imposing waiting periods (so that individuals are less sure of their risks at the time they enroll) and other benefit restrictions that limit the cross-subsidy. The options we offer provide alternatives for CLASS to limit (but not eliminate) the extent of cross-subsidization, thereby encouraging low risk individuals to sign up for CLASS.

Both of the core options take advantage of CLASS’ access to sales through employers. A key issue is whether CLASS should implement the “opt out” feature of selling through employers (if an employer chooses to offer the product, employees receive the product by default unless they opt out), use an “opt in” approach (employers make the product available but employees must opt in to receive it), or use an “active choice” model (employees must complete a form indicating whether they want to participate in the plan). Given that the individual market will be somewhat foreclosed to CLASS, it is essential that CLASS gets this decision right.

a. Core options to address adverse selection

1. Extended Vesting Period Long Term Care Insurance

Through plan design, CLTCI can reduce the effects of adverse selection. For example, CLTCI could offer a plan design that features a lower premium and an extended vesting period of more than five years. Individuals are less likely to have private information regarding their expected LTC needs in, say, 10 years. Nevertheless, the lower premium and the ability to lock in a premium schedule would provide an incentive for the young and healthy to purchase.

However, if “traditional CLTCI”, with a five-year vesting period and no underwriting, is also available then individuals would have little incentive to purchase the extended vesting period product. They can simply wait until the need is less distant and then purchase the traditional product. Therefore, for the “long vesting period” product to be successful, the age-premium curve must be steeper than actuarial tables so that those who enroll later in life would subsidize those who buy earlier, creating an incentive to join early. For example, the premium at age 50 for a person who enrolled in an extended vesting period plan at age 40 should be below the premium for a person at age 50 who enrolled in the standard 5-year vesting period plan at age 40. Alternatively, “traditional CLTCI” can be limited to a minimum benefits package of $50 daily, while the “vested CLTCI” can be a more generous plan. Alternatively, CLASS could combat adverse selection by limiting enrollment in all CLASS products to individuals under age 50 (in year 1).

Advantages

  • Minimizes adverse selection, thereby offsetting a major advantage of commercial LTCI firms.

  • Commercial LTCI firms are unlikely to offer a similar product and will instead rely on their strengths in medical underwriting and sales to minimize selection.

  • Simple benefit design keeps education costs low

  • Large potential market.

Disadvantages

  • Product offers greatest benefit to those individuals who also benefit from commercial LTCI. Commercial insurers have made significant inroads in selling LTCI through relationships in the individual life insurance market. Some commercial insurers can also be expected to encourage selling agents in the individual market to disparage the CLASS product. CLASS will therefore be heavily dependent on reaching new customers through employers.

  • Even with a simple plan design, CLASS would need to educate consumers about future long term care needs. This may require considerable sales and marketing effort.

  • Because the product will necessarily have a simple design and sales process, success by CLASS has the potential to commodify LTCI. We discuss the implications of commidification in section VI.b.4.

Among the options discussed in this section, we are very optimistic about the potential success of this product. It has broad appeal, is well-protected against adverse selection, and can exploit CLASS’ access to employers.

2. A “Tontine” Plan for Long Term Care Insurance

Two centuries ago, many individuals invested in Tontines. The money was pooled and invested in various assets, where the money remained until all but one investor had passed away. The last surviving investor received the entire investment. This idea of rewarding individuals for remaining healthy can be used to limit adverse selection against CLTCI. Consider a “Tontine” LTCI plan that gives “rebates” each year (possibly after a fixed or age-based number of years of payment of premiums) to individuals who do not use LTC services. The rebates are paid for through increased premiums. In this way, the Tontine reverses some of the cross-subsidy inherent in insurance and encourages low risks to participate in the plan.

The Tontine plan can succeed against commercial insurers if it threads the needle in terms of pricing. Remember that CLTCI has a substantial cost advantage due to minimal selling expenses. If these savings (which are realized for all enrollees) exceed the cross-subsidy on high risk enrollees (which has been reduced by virtue of the higher premium), then CLTCI can offer low risk individuals a net price (premium less rebate) that beats anything offered in the private sector.40

While this structure may at first glance appear to be a variant on medical underwriting, there is an important distinction. With underwriting, net premiums vary only on initial health conditions. A Tontine structure, however, varies net premiums over the life of coverage in accordance with realized health conditions. Among other distinctions, this creates an incentive at the margin--an incentive not present with underwriting--for enrollees to take measures to reduce the likelihood that they will require LTC.

Advantages

  • Tontine feature serves a similar role as medical underwriting: the effective premium decreases for low risks and increases for high risks.

  • Tontine feature immediately communicates value to low risk enrollees.

  • Commercial LTCI firms are unlikely to offer a similar product.

  • Large potential market.

  • Encourages positive health behaviors.

Disadvantages

  • Commercial insurers can still rely on relationships between selling agents and consumers to enhance medical underwriting. Thus, CLASS can never fully equal underwriting capabilities of commercial plans.

  • Commercial sellers may price plans to low risks more aggressively.

  • CLASS will need considerable underwriting skills and demand modeling to determine the size of rebates and implications for profitability.

  • Product is more complicated than the “extended vesting period” product.

  • Success by CLASS has the potential to commodify LTCI.

The Tontine product shares many of the advantages and disadvantages of the “vesting period” product. It is also likely to rely on access to enrollees through employers. We believe the rebate has strong marketing potential and will draw in low risk individuals. However, this product seems more complex than the “vesting period” product. CLASS would need to limit plan features so as to minimize the sales effort and CLASS will require more sophisticated demand modeling. To the extent that the “vesting period” product is a “belt” and the Tontine is “suspenders”, we lean toward the belt or some combination of the two.

b. Additional Options

1. “Short-term” Long Term Care Insurance

There is currently a gap in the insurance market to provide insurance for short-term assisted living at old age. Currently, Medicare does not cover non-hospital institutional care or home nursing care unless it immediately follows hospitalization. Such care can last days or weeks, at a cost of tens of thousands of dollars. Individuals with substantial assets, who are purchasing both life insurance and LTCI, may not be interested in purchasing protection against such expenses. But consumers with modest retirement savings who are not eligible for Medicaid may also be fearful of becoming impoverished by long term care spending. (The average American retires with less than $100,000 of non-housing wealth.) There are two reasons why traditional LTCI sellers may not be serving this market. First, LTCI sellers come from the life insurance market and they are skilled at identifying individuals who wish to protect estates worth hundreds of thousands of dollars. Second, a product that offers modest, short-term protection might be seen as a cheap substitute for other LTCI products that would cannibalize more profitable lines.

Such a product could cover assisted care of all forms for a short period (30-90 days). Premiums paid by someone who enrolls early in life would be very low. The product is a hedge against needing assistance for a short period of time, not insurance for someone who will live out their days in a nursing home. This product would be require some modest vesting period so that individuals do not purchase insurance immediately upon finding out that they require care

This product has several advantages and disadvantages.

Advantages

  • Does not compete directly against existing LTCI products.

  • Current LTCI sellers are unlikely to offer their own versions of this product inasmuch as it targets a different audience.

Disadvantages

  • Limited market size. Medicare covers “short term” long term care needs if there is a hospitalization, so this product is restricted to patients who are not hospitalized.

  • Amount of coverage is much smaller than for traditional LTCI, so that the risk premium and profits are commensurately smaller as well.

  • Requires educating consumers about Medicare coverage limitations.

Overall, we believe that this product is promising but unlikely to generate significant financial returns to the CLASS program.

2. Linkages to the Private LTCI plans

HHS could seek to encourage the development of private sector plans that would supplement the CLASS program in a fashion similar to the way in which Medicare Supplemental plans fill in the gaps of Medicare Part A and Part B coverage. The availability of supplemental plans could increase the attractiveness of the CLASS plan. At the same time, encouraging the emergence of private supplemental products could lessen private insurers’ resistance to the CLASS plan. This could also open a channel to consumers that would impose minimal administrative costs on the CLASS plan.

However, the structure of such plans would need to be carefully considered in terms of both selection effects and marginal incentives. For example, supplemental coverage could increase the appeal of the CLASS plan to individuals with private information that their LTC needs are eventually likely to be substantial. At the margin, private supplemental coverage could make nursing homes a more attractive option relative to formal or informal home health care, with potential budgetary implications for programs such as Medicaid.

Advantages

  • Could increase appeal of basic CLASS coverage.

  • Could induce private plans to market CLASS coverage.

Disadvantages

  • Adds further complexity to the market, working against strengths of the CLASS product.

  • Not a short term solution to CLASS’ budget problems.

3. A Note on Commoditization of LTCI

Because CLTCI will be offered through the workplace with a minimum of selling effort, it will necessarily have to have a simplified plan design. This stands in contrast with existing LTCI products that have many dimensions that a consumer only comes to understand through lengthy consultation with an agent. If CLTCI becomes successful, then the simplified design could become a template for standardized product offerings. In other words, we may see the commoditization of LTCI.

Ironically, the success of CLTCI could sow the seeds of its destruction. If LTCI is commoditized, selling agents will no longer be required and if they disappear, their commissions will disappear with them. LTCI could then be sold by companies like Progressive and Geico, which have miniscule selling expenses (other than advertising to establish brand credibility.) Such companies can continue to medically underwrite, giving them the best of both worlds so to speak: protection against selection and low costs. While this could greatly expand LTCI coverage, it might come at the expense of the viability of CLTCI.

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