A Report on the Actuarial, Marketing, and Legal Analyses of the CLASS Program. VIII. Premium Formula

10/14/2011

The model calculates long-term care premiums on a closed-group basis until the end of life for each cohort separately beginning in the year 2012. A cohort represents all policies issued in a single year to a single year of age. This is the actuarially accepted practice for individually equitable premiums (as opposed to premiums with built-in cross subsidies) for policies sold on a voluntary basis. Premiums calculated in this manner do not rely on premiums from future purchasers to support the benefit payments to past purchasers, as is the practice for social insurance programs such as Social Security and Medicare. A common practice for judging the financing of social insurance programs is to do a 75-year open group projection.

It is important to realize that a premium cannot be precisely calculated for a LTC policy that increases premiums or benefits by some index (such as the CPI) that cannot be known for all future years at the time of the premium calculation. The premium calculation can use assumptions about these indices for the future. However, if these assumptions turn out not to be realized (which will occur 100 percent of the time) then the premiums will not be accurate. Premiums can be precisely calculated in an actuarial manner if assumptions used to represent these indices are specified (such as 2.8 percent per year), and then in the actual operation of the program, the premiums and benefits are increased at the rate of the stated assumption and not by the actual index.

The premium calculation starts by projecting the cash flow separately for each issue age until the end of life (assumed to be age 100) for the last remaining individual in the cohort. Cash flow includes premium payments, nursing home and home health care benefit payments, and administrative expenses.

Administrative expenses are those costs that are not included in the cost of benefits paid to policyholders: wages for the government workers that administer the program, processing fees, the provision for office space, and computers are examples of administrative costs. The law specifies that premiums cannot be loaded by more than 3% for administrative expenses, although it does not rule out the financing of administrative expenses from other sources. The loading percentage is a user input.

Because the level of the premium payment stream cannot be know before the level of the premiums are calculated, the premium stream is initially calculated using a premium of $1 per month (which is indexed if so specified by the user). The premiums are then calculated by determining the level of premiums such that the present value of premiums is equal to the present value of benefits and expenses for each issue age separately. Administrative expenses are specified by the user as a percent of premiums. The equation for the premium for a given issue age cohort is as follows:

Premium = PVCohortBenefit / [(1 – PPAdmin) * PVCohortIncome]

Where,

PVCohortBenefit = the present value of the estimated stream of future benefit payments

PVCohortIncome = the present value of the estimated stream of future premium payments starting at $1 per month

PPAdmin = the percent of premium load for administrative expenses

Premium Indexing Options

Under the federal long-term care program outlined in the CLASS Act, there are certain triggers that will stop premium increases for inforce policies. An enrollee’s premium will cease to increase after an enrollee has paid premiums in the program for at least 20 years, is aged 65 or over, and is unemployed. It is not clear if these provisions of the law apply only to unexpected increases, as opposed to those that are specified at the time of issue. The model user can specify whether automatic, planned increases stop at a specified age or specified duration. If activated, these premium indexing parameters are taken into account when accumulating the stream of future premium payments. Of course, a level premium can also be modeled by entering 0.0% in the premium indexing input parameter.

Low-Income Premium

The CLASS Act guarantees a low premium to individuals whose income falls below the poverty line, as well as employed students who are less than twenty two years of age. This low-income premium starts at $5 per month and can be indexed upward for each year after 2012. Taking this lower premium into account results in increased premiums for enrollees above the poverty threshold, because their premiums must subsidize the difference between the low-income premium and the actuarially fair premium. The model allows the user to specify an income level different than the poverty line for eligibility for the low-income premium. If this level is set higher than the amount required to be eligible for the CLASS program, then no one would qualify for the low-income premium.

March 2009 CPS data were used to determine the proportion of workers who fall below the poverty line and the model sets the participation percent for the low-income population by age as input parameters. The premium adjustment to account for the low-income subsidy is calculated on an aggregate basis (i.e., across all ages) with all unsubsidized policyholders having their premiums increased by the same percent. The model first calculates the present value of the total shortfall for the low-income policyholders by accumulating the difference between the PVCohortBenefit and the PVCohortIncome (assuming a $5 initial premium) across all years of birth. After also accumulating the present value of the total benefits for the above poverty threshold participants across all years of birth the premium adjustment is calculated as follows:

PremiumAdjustment = (PVShortfallTotal + PVBenefitsTotalAbove) / PVBenefitsTotalAbove

The calculated preliminary premiums for all issue ages are multiplied by this Premium Adjustment Factor to determine the actuarially balanced premiums for the above poverty population including the low-income subsidy.

Premiums with Periodic Cash Benefit and Death Benefit

To calculate premiums when modeling a periodic cash benefit or death benefit that is a function of the premium, the present value of the benefit is calculated as a percentage of the present value of the total cohort premium payments (i.e., cohort income). This factor is then applied in the denominator of the premium calculation in a manner similar to that for the percent of premium administrative expense load as follows:

CashBenefitFactor = pvCashBenefit/pvCohortIncome

DeathBenefitFactor = pvDeathBenefit/pvCohortIncome

Premium = PVCohortBenefit / (0.97 * (1-CashBenefitFactor-DeathBenefitFactor)*PVCohortIncome)

In this way, the premiums are increased to account for the additional benefits being paid for the cash benefit and/or death benefit. These benefits can be modeled independently or concurrently.

Premiums for Initial Issue Year by Issue Age

The premium calculation starts by projecting the cash flow separately for each issue age from the age at issue until the end of life. Cash flow includes premium payments, nursing home and home health care benefit payments, and expenses. Premiums are calculated so that the present value of premiums is equal to the present value of benefits and expenses for each issue age separately. The premium calculation can be characterized as being on a closed-group basis until everyone in the group has died. This is the actuarially accepted practice for individually equitable premiums (as opposed to premiums with built-in cross subsidies) for policies sold on a voluntary basis. Premiums calculated in this manner do not rely on premiums from future purchasers to support the benefit payments to past purchasers, as is done for social insurance programs such as Social Security and Medicare.

Premiums for All Issue Years by Issue Age

The premiums obtained for the initial issue year are projected to all other issue years using the CPI-U. These premiums are used in the simulation of the long-term care program over the specified time period. The premiums are the basis for calculating the fund balance over the length of the simulation.

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