Contingencies - January/February 2018

The PV factors and COI charges would be “locked in” at issue. Thus, updating the adjustment factor would be a routine and objective calculation based on the actual performance of the plan.

In this concept, the insurer would still take on some morbidity risk because the COI charges collected every year might not be sufficient to pay for that year’s claims. However, even that risk could be shared with policyholders by giving the insurer the right to change the COI schedule if there is poor experience or allowing true-up credits and debits to be made to policyholder accounts so that the adjusted COI charges equal the actual claims paid plus expenses. If the account value were to increase more than what was anticipated in pricing due to a combination of favorable interest returns, lapses, and mortality, the favorable experience would automatically cause the benefits to increase. Likewise, unfavorable experience would cause the benefits to decrease.

To ensure that variable LTCI benefits remain meaningful, a benefit “floor” would be established for the policies, below which the adjustment factor (and the corresponding Maximum Lifetime Benefit [MLB] or target benefit) could not fall. The more margin built into the COI charges, the higher the floor. Higher margins may be necessary if there is concern that the floor not be too far below the target payout. If the policyholder is willing to accept more risk—say a minimum floor of only 25 to 30 percent of the original target benefit—the margin could be lower.

Actuarial effort will be required to determine the appropriate floor; ideally it would be set high enough that benefits remain useful in covering LTC expense risk, but far enough below target to ensure that the plan does not guarantee too high a benefit. This is to avoid a situation similar to that which occurred with variable annuities during and after the investment banking crisis of 2008–2009, when the requirement to make guaranteed minimum payments above the market value of assets resulted in steep losses for insurers. Ideally, the variable LTCI floor will ensure an adequate LTC benefit at a price that is stable without the insurer having to add in high margins. As with universal life, a “no-lapse guarantee” would be in place so that significant decreases in the account value do not trigger a lapse.

This approach provides a transparent and objective mechanism to adjust benefits. Because the premiums, COI rates, and actuarial assumptions are known at policy issue, insurers could provide policyholders with a table illustrating the present value of future premiums and present value of future COI charges. With this information, policyholders could calculate their changing benefit adjustments based on actual account values, and could compare account growth to what was shown in these illustrations.

Such a design does raise questions of equity if systemic changes in assumptions occur. For example, say the policy illustrated in Figure 1 was a variable policy. If all of the various pricing assumptions exactly matched the best estimates and there were no margin, the benefit would be identical to what was illustrated. In contrast, what if best estimates anticipate 5 percent interest yields for all policy years, but immediately after issue the interest return drops to 4 percent and stays there? Because the adjustment factor would gradually and automatically decrease from 100 to 72 percent over the life of the policy (See Figure 2, Frame 1), a problem of intergenerational equity arises, as policyholders who go into claim at younger ages could get higher benefits.

Figure 2: Frame 1 shows how the variable LTC adjustment factor would systematically drop from 100 percent to 73 percent if the plan was priced at 5 percent, only received a 4 percent yield every year, and no actuarial adjustments were made to the PV tables.

Frame 2 shows that if the actuaries adjusted the PV tables there would be an 83 percent adjustment in all policy years. Frame 3 shows that if the actuaries made the adjustment to 4 percent but a

5 percent yield was actually achieved, the 83 percent adjustment would increase to 100 percent by age 85 (when most claims are paid anyway) and would get as high as 116 percent by the end of the projection.