Clearly, the insurance carrier actuary would have to adjudicate.
If there is a significant shift in interest rates, lapses, or mortality
that causes a best-estimate forecast of the benefit level steadily to
erode, this would trigger an event where the discount factors are
updated. In this example, once the discount factors are updated,
the adjustment formula would then drop the benefit to 83 percent
immediately, with the projection that all future claims would remain
at that level. (See Figure 2, Frame 2).
The optics here are important. Policyholders will be monitoring
the amount in their accounts and will see it increasing due to premiums, interest, lapses, and mortality. They will understand that their
ultimate benefit level is tied to the performance of this account. If
adjustments to actuarial assumptions result in benefit reductions,
we believe that it will be important for the policy communication
to demonstrate that the change—really a pooling charge—will enhance and protect the value of everyone’s account so that the insurer
will be able to pay more to future claims of older policyholders
by ensuring that too much money is not being spent on younger
claimants. Another point to keep in mind: When the insurer changes
the benefit percentage, the adjustment is only theoretical until the
time of claim, which lies in the future for most policyholders. With
traditional standalone LTCI, rate increases are immediate and not
likely to be reduced.
Variable LTCI dynamics are different. To continue with the prior
example, say that the insurer updates the discounting factors resulting
in an 83 percent benefit adjustment because it now believes interest
rates will only be 4 percent, but the actual yields returned 5 percent.
In this case, as the favorable experience emerged and accumulated
in the account, the 83 percent adjustment factor would gradually
and automatically increase to 100 percent by age 85 (when most
claims are paid anyway) and could get as high as 116 percent by the
end of the projection (See Figure 2, Frame 3).
In the formulas described above, everything was priced on a
best-estimate basis. If this plan were implemented in the real world,
a margin would be added to the premium. This margin would
accrue to the accounts so that in the years it isn’t needed, the value
of the accounts (and thus the benefit level) would increase. This
would result in a pattern seen like in Figure 2, Frame 3, but with
the adjustment increases beginning at 100 percent at issue rather
than 83 percent at issue.
Perhaps the key point is that with variable LTCI, the balance
between the present value of future premiums and the present
value of COI charges can be made without the necessity of recovering the margins that emerging experience reveals should have
been present in the past. Variable LTCI allows for smoother, less
It could be argued that having the option to pay a premium
increase or reduce one’s benefit, which is available in conventional
LTCI, is preferable to the automatic reduction that variable LTCI
imposes because the former allows choice. But such choice comes
with a cost. Conventional fixed-benefit plan rate increases are
driven by actuarial projections of future experience—i.e., what will
happen with morbidity, mortality, lapse, expense, and interest. In
contrast, the variable plan is primarily based on actual experience
as it emerges. Because the insureds are participating in the emerg-
ing experience and the benefit level is adjusted accordingly, high
margins are no longer needed. If the accumulated premium plus
gains from interest, lapses, and mortality are insufficient to pay for
projected claims, the value of claims or benefits is simply lowered
across the board so that they do become sufficient. If experience
later improves, the variable benefit is adjusted upward. Additionally,
policyholders could be allowed to replenish their target benefit after
a benefit reduction by purchasing additional coverage and would
be in a better position to do so thanks to the lower premium cost
enjoyed to date, which reflects lower initial margins.
In the end, variable LTCI gives policyholders confidence that
they are truly pooling their risk with other policyholders and that
any better-than-expected experience will benefit the policyholder
pool. If the pooled risk turns out to be higher or lower than the
actuaries originally thought at issue, the good and bad experience
automatically flows to the policyholders.
While policyholders will not know at the time of issue exactly
or even roughly what the future benefit level will be (apart from the
benefit floor), they will know they are getting a fair value for the
premiums paid and paying less to the insurer in margins. This is
because any increases or decreases in benefit payouts will be visible
via policyholders’ individual variable LTCI accounts. Policyholders
will have the assurance that they are participating in more of the
actual experience of the insurer. This perceived partnership could
even lead to a wiser use of benefits. If enough policyholders see
their nominal value growing above 100 percent of the original
benefit, they might mentally project that good experience into the
future and delay going on claim in order to receive a larger benefit
down the road, as with Social Security, pensions, and other forms of
protection. Additionally, this design lowers the risks of the insurers
and facilitates smoother and more predictable earnings.
It may be objected that variability introduces another kind of
uncertainty on top of the existing uncertainty of whether premiums will increase. This is true, if you assume that the buyer of a
conventional LTCI policy can depend on receiving down the road
what he or she is buying for a benefit upfront. But in reality, that
benefit may be subject to periodic rate increases, which could be
substantial—and benefit reductions are often the de facto result.
The real issue is not whether the total benefit payout is certain,
but whether buyers can predict the amount that the benefit they
bought might change and whether they can easily adjust financially.
In other words, unless conventional LTCI buyers plan on paying
significant increases at time of purchase, or purchase sufficiently
generous protection at issue to weather future benefit reductions,
significant uncertainty already exists. With variable LTCI, uncertainty is a given and the process is transparent. Buyers are educated
upfront that fluctuations in total benefit payment are to be expected
and must be planned for and are invited to monitor the status of
their benefits throughout their policy’s life. Thus, the process mirrors
what is expected in most other areas of long-range finance.