As the long-term care insurance industry continues to suffer - a challenge that won't likely end soon, given ongoing increases in health care costs and continued low interest rates that may it difficult for the insurer to generate a return on premium investments - planners and clients have both become increasingly skeptical about long-term care insurance. At best, prospective policyowners feel compelled to buy far less coverage than they can afford, just to leave room in case premiums rise in the future, given the quantity of ugly premium increases on existing policies that have occurred in recent years. Yet the reality is that while many industry trends, from low lapse rates to low interest rates to claims patterns were a surprise relative to what insurance companies expected 10-15 years ago, they are known facts today. Accordingly, even the base cost for a new long-term care insurance policy has risen dramatically over the past decade. However, higher pricing - adjusted for the realities of today's marketplace - actually means that while the pace and severity of premium increases on old policies has risen, the risk of premium increases on new policies purchased today may actually be declining! Are planners and their clients becoming most concerned about long-term care insurance premiums at the time they are actually least likely to occur!?
The inspiration for today's blog post is a series of ongoing conversations I've been having recently with some fellow financial planners regarding the viability of long-term care insurance, and in particular about how to craft appropriate long-term care insurance recommendations in light of the industry's current track record for raising premiums. "I'm not even certain what's safe to recommend anymore," one colleague noted, "when companies can come back and raise premiums by 90% after the fact. How can you be certain the policy you recommend today will even be affordable in the future?"
"But is it really appropriate to assume 90% increases on new long-term care insurance policies from here?" I replied, "Or is the reality actually the opposite - that today's premiums are actually less likely to rise in the future?"
Rising Premiums On Existing Policies
In recent years, nearly every long-term care insurance company has had to raise premiums on at least some prior block of their insurance policies, especially those issued 10-15 years ago, when policies were priced for the far more favorable interest rates available at the time, and before the industry discovered how low lapse rates would be. Although most premium increases are "just" 10%-25%, some have been much more dramatic, most notably a 90% increase in premiums on some John Hancock policies in Illinois earlier this year.
Ultimately, insurers can only raise premiums with permission from the state insurance department, and each premium increase is approved based upon a specific group of policies - for instance, all policies issued in 2004 on those age 65-75 years old. The increase is generally only approved if it is deemed necessary and in the interests of policyholders - essentially, if the premium increase is necessary to ensure that the insurance company will remain viable and capable of paying out claims (after all, while a premium increase is undesirable, an insurance company being unable to pay claims at all is even more undesirable!). Unfortunately, though, because state insurance departments often want clear evidence of an extreme mismatch between premiums and claims before approving a premium increase, and may further delay premium increases in the hopes that current trends will reverse, when the increases do happen, they are often quite severe, as the earlier example noted.
The Real Reasons LTC Premiums Are Rising
Although the popular press has widely blamed rising long-term care insurance premiums on "unexpected" claims from long-term care insurance companies, the reality is that rising costs of long-term care itself has played only a limited role in premium increases.
The true drivers of premium increases - or more accurately, why older blocks of long-term care insurance policies are generating such losses as cumulative premiums exceed cumulative claims - is that long-term care insurance has had "surprisingly" low lapse rates, and it has been difficult for insurance companies to generate much investment return on their premiums collected in the current interest rate environment.
As discussed previously on this blog, early on insurance companies anticipated that long-term care insurance would be like most other types of insurance, where 5%+ of policyowners end out allowing their policies to voluntarily lapse (due to change of mind, change of circumstances, change of financial situation, etc.). However, in practice, the lapse rate has been more like 1% - 2%, which means insurers remain on the hook for far more of their late 1990s and early 2000s policies than they ever expected. As claims come in, they payouts are higher than expected, not simply because costs are higher, but because more people actually held their policies to claim than expected.
Similarly, as insurers expected 5%+ lapse rates and only got 1% - 2%, so too have insurers suffered as interest rates have dropped from 5%+ down to the 1% - 2% range. This has been a significant problem, given that the fundamental business model of insurance is to collect premiums, invest them, and use the aggregate premiums plus growth to pay out future claims. When growth is much lower than expected as interest rates fall (since most long-term care insurers invest in bonds), there simply isn't as much money available to cover claims down the road. Or viewed another way, when interest rates are low, insurers need to charge more up front, to make up for the reduced growth; except 10-15 years ago, insurers didn't know rates would be this low, so they failed to charge enough up front, and are now suffering because of it. Estimates from the American Association for Long Term Care Insurance (AALTCI) are that every 1% decrease in interest rates leads to a 10%-15% increase in required premiums!
Thus, as lapse rates continue to be low, and interest rates continue to be low, insurers find the pricing on their old policies to have an increasingly severe shortfall, leading the companies to go back to the state insurance departments to request a premium increase to ensure the financial strength and viability of the insurer.
Planning For Premium Increases Going Forward
As a result of all the premium increases, many planners and long-term care specialists caution clients not to purchase the maximum amount of coverage they can afford, leaving room for future premium increases that may occur in 10 years for today's newly issued policies, as it has occurred recently for those policies issue 10 years ago.
Yet the reality is that long-term care insurance is not intended to be priced for future premium increases; after all, insurance companies are generally only allowed by state insurance commissioners to raise premiums if they can demonstrate that they are losing significant money on the policies under their current pricing, such that it's in favor of consumers to increase premiums and price the policies appropriately (to ensure the company will be able to pay all promised benefits in the future). As a result, companies that raise premiums will almost certainly have been making little or no profit, or outright losing money on the policies, for many years before even being allowed to raise premiums (as John Hancock surely was on their policies that had a 90% premium increase!). To say the least, this is a rather poor pricing strategy for an ongoing business!
Accordingly, given all the difficulties that have been experienced, some suggest that in reality, the likelihood of future premium increases on today's policies is actually lower than at any point in history! After all, today's policies can be priced far more accurately, as the low interest rate environment is now known, and actuaries have far more information about lapse rates on long-term care insurance, not to mention the improved underwriting and better knowledge about claims patterns. In point of fact, that's why new policies today are far more expensive than comparable policies were 10 years ago - the increases have already been priced into new policies.
Of course, it's hard to say this provides any true surety against the risk of any premium increases in the future. Moody's was out just last month noting a continued difficult environment for long-term care insurers, especially as the extension of the Fed's quantitative easing program means return on investments isn't likely to be higher in the foreseeable future. At best, insurers can price the coverage appropriately but at rates that are so high, far fewer can afford the coverage in the first place.
Nonetheless, it does at least imply that any future pain for new policies issued today is likely to be far less severe than premium increases were for policies issued in the past. The time for premium increases was when prices were low, not after they've risen, not unlike how even though people were more excited about future price increases on tech stocks in 1999 than 1995, their odds of future price increases were actually declining rapidly by 1999 as the upfront price had risen so much!
So what do you think? Are you telling clients buying new long-term care insurance policies today to expect premium increases? Do you think the odds of premium increases are rising or falling? How do you plan for the potential for higher premiums in the future?