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.
Frame 1: Optimistic Actuary
Thousands of dollars
125%
100%
75%
50%
25%
0%
55 65 75 85 95
Adj Factor 100%
Frame 2: Correct Prediction
Thousands of dollars
125%
100%
75%
50%
25%
0%
55 65 75 85 95
Adj Factor 100%
Frame 3: Pessimistic Actuary
Thousands of dollars
125%
100%
75%
50%
25%
0%
55 65 75 85 95
Adj Factor 100%
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