true—if the reserves plus the present value of future expected
premiums are insufficient to pay the future expected claims and
expenses—the reserves must be increased so that the formula becomes true. Depending upon the company’s assets, an adjustment
may be needed to achieve solvency. And the factor to be adjusted
has always been premium.
Adjusting premium makes sense for many lines of insurance,
especially where the benefit is based on a replacement value, such
as income, as in disability or life insurance, or the market value of a
residence, as in property insurance. But is this the best approach with
LTC insurance, for which no such objective amount can be stated?
In our view, an LTCI policy should be based on the insurable loss,
which is the full cost of care for as long as that care might be needed.
However, most people cannot afford a policy with a high maximum
daily benefit, robust inflation protection, and lifetime benefits, so
they end up buying as much coverage as they can afford and then
fill in any gaps in care however they can. If premium affordability is
what primarily drives the choice of plan, for some consumers it may
make more sense to adjust the benefit level rather than premiums.
But does adjusting benefits rather than premiums make sense
from an actuarial perspective? The key point to keep in mind is
that more than any other insurance product, LTCI is a prefunded
liability. For the first several years of a policy, the vast majority of the
net premiums are intended to be saved to accumulate with interest
and policy survivorship to fund claim costs that will eventually
rise steeply. Consequently, if a projected shortfall emerges after the
policy has been issued, adjusting the benefits provides more leverage
than adjusting the premium: By the time adverse experience has
emerged and the need for a rate increase becomes manifest, most
of the claims are still in the future, but most of the premiums are
already in the past.
Consider the net premium and claim cost[ 6] pattern illustrated in
the first frame of Figure 1. In this example, a 55-year-old purchases
a policy with a $1,200 per year net premium. This premium funds
a claim cost pattern that begins very low but grows exponentially
and approaches $9,000 a year the time she is 90.
The second frame of Figure 1 shows a projection of the present
value of future benefits and the present value of future net premiums.
The orange area between these two lines is the reserve. As the graph
shows, on a present-value basis the premiums are heavily weighted
toward the beginning of the policy and benefits toward the later years.
Is raising premiums the best way to address adverse experience,
or is there an alternative? Let’s suppose that based upon new industry
data that becomes available in policy year 15, we now expect that
for all future years, claims will be 15 percent higher than previously
forecasted. Thus, the present value of future claim costs increases by
15 percent in the year the shift in the projection occurs.
If we could go back to the date of policy issue, a 15 percent
premium increase could fund the difference. But of course the
only premiums that can be increased are those going forward. To
account for the revised forecast in year 15, the premiums need to
be increased by 38 percent (see Figure 1, Frame 3).[ 7]
With Variable LTCI, on the other hand, rather than imposing
a 38 percent premium increase, the nominal benefit level for
future years would simply be reduced by 15 percent to counteract
the underlying 15 percent morbidity increase. For the policyhold-
er who purchased an LTCI policy based on affordability, this may
be a preferable adjustment.
Here is a starting point for how adjustments to a variable LTCI
policy might be handled in a way that is fair and transparent. First,
every variable LTCI policy would have an associated account, similar
to a universal life (UL) policy. Premiums would be paid into the
account, cost of insurance (COI) charges to fund claim payments
and expenses would be assessed against it, and the account would
grow with interest. However, the policy would have no surrender
value. Whenever a policyholder dies or lapses, the money in the
fund would be transferred to the other policyholders in the pool,
and accounts would be credited proportionately. In this way, the
policies still get the insurance leverage provided by lapses and
mortality. The COI portion would then be used by the insurance
company to pay incurred claims, expenses, commissions, and as
a source of profit.
The actual benefit level to which each policy is entitled at the
time of claim is the nominal benefit level of the policy, multiplied
by an adjustment factor. The adjustment factor would be updated
periodically so that the account value plus the present value of
future premiums is sufficient to pay for the present value of the
adjusted COI charges:
Account Value + PV(Future Premium) =
adj Factor × PV(COI Charges)
If claims increased by 15 percent,
would you rather have a 38 percent
premium increase or a 15 percent