Long–Term Care Insurance in the Decade Ahead: Issues and Opportunities
By John L. Timmerberg
New approaches to long–term care insurance products and marketing need to be taken, including products to younger clients..
Competitors in the long–term care insurance market struggle to demonstrate consistent profitability. A number of large competitors left the market in recent years and key pricing components continue to move against us. When will we get a break? When we expand our options to consider some new approaches to products and marketing.
In looking at the risks that face long–term care insurance (LTCI) competitors today, one needs to focus on the risks to the younger issue ages (which I define as 62 and under). Why? Because in 2003, 54 percent of the policies sold were to issue ages 59 and under and 31 percent were to issue ages 54 and under.1
Claim Costs: Still Developing
Claim costs are the average claim payments per unit of coverage for each attained age and are a fundamental input to LTCI pricing. Approximately 75 percent of the claims paid on a policy will be for claims initiated at attained ages 81 through 95. For a group of policies issued at age 65, we need to wait over 30 years before having credible data for these critical attained ages. Although the recent SOA LTCI Experience Study has added much to our understanding, we are still awaiting credible experience from products issued 10 to 15 years ago, which just about covers the lifespan of the LTCI industry. There is very little industry data on assisted living facility claims or benefit utilization, and this benefit has become prevalent in newer policies.
The slope of the claim cost curve increases rapidly between attained ages 75 and 85. The claim cost at 85 may be six to 10 times the level at age 75, indicating that even if credible data is available through the mid 70s, this is not giving us much information about what is going to happen at ages 81 through 95.
Additionally, current pricing is based on the experience from people born in 1910, but is being sold today to people born in 1960. Will these generations have different attitudes towards benefit utilization? More than likely. So, if we don't start focusing on the younger issue ages, we'll end up with unexpected results.
Investment Income: Unpredictable
The table shows sample annual premiums for policies with compound inflation coverage at issue ages 40, 50 and 60; priced assuming investment income returns of 4 percent, 5 percent and 6 percent.
Interest rates are unpredictable, and the pricing structure of LTCI products with inflation coverage are especially vulnerable to relatively small changes in investment return. At issue age 40, the premium when priced at 4 percent is almost double the premium if priced at 6 percent. It is very interesting to view the table's fields diagonally from left to right. Doing so shows that if the interest rate increases by just 100 basis points, then someone who had purchased the product at age 40 could have waited 10 years and still purchased the product at the same premium rate. Or if rates increase from 4 percent to 6 percent, then one could wait 20 years, save $40,000 and still only pay an extra $400 per year at issue age 60. One can see similar results in the other fields by using the same viewing method.
If the actual investment earnings are below the rate assumed in pricing, then profitability will be less than expected. But, if investment earnings are higher than assumed, does the company have gains? Not necessarily. If investment earnings are higher, then companies face disintermediation risk as competitors re–price to lower premiums and policyholders have opportunities to replace their policies for less. Policyholders, whose health has worsened, will not be able to replace their policies and will stay with their current insurer resulting in anti–selection to the company. Possibly, only stable investment income rates, at or near the level assumed in pricing, will produce the actual earnings that were anticipated.
At a premium of $1,500 for an individual who is 40 and will most likely not use the product for another 40 to 50 years, the initial commitment required from the policyholder is high. If an LTCI policyholder lapses, he usually receives nothing. The purchaser is making a 50–year commitment to a single product and a single company. What is this $1,500 providing? A term–to–62 product that covers the LTCI risk from 40 to 62 would cost about $100 per year. This indicates that of the $1,500 annual premium, $1,400 is pre–funding for risks after age 62.
Today's Approach to Marketing and Product
When competing in an industry where profit margins are substantial, there is increased justification for taking on outsized risks. This is not the case in today's LTCI market. More than once, we've experienced the odd phenomenon of seeing a carrier in the top five in new sales exit the market less than 24 months later.
The top 10 carriers have 79 percent of the market2 and competitors are targeting the same market segment: these prospects are healthy, aged 50 to 70, tend to be married, upper middle class and could be termed 'responsible planners.' In 2003, the average issue age was 59.3 In recent years, companies have moved in unison as the average issue age has been trending lower, underwriting has continued to tighten and spouse premium discounts have increased.
Product offerings tend to be very similar across the industry: a 42–year–old has the same product choices as a 72–year–old and the premium rates for males are the same as females, even though experience may justify lower rates for males. Products are guaranteed renewable and priced assuming level premiums for life. Insurers attempt to differentiate their products through minor differences in benefits and rider offerings. I suggest that we are competing in a well–defined market with a commodity–type product, leading to competition primarily on rates.
Rather than competing on rates with a commodity–type product, we can expand the LTCI market through innovative product offerings and new approaches to pricing. Opportunities for market segmentation and niche development exist, where specialization and focus can yield increased profits. In today's market, LTCI is not priced to yield level profit margins across all segments. Pricing subsidies abound with males subsidizing females, spouses subsidizing singles, one issue age group subsidizing another and profitable regions subsidizing unprofitable regions. There is substantial opportunity both to increase the accuracy of the pricing 'pricing segments closer to their true cost' thus expanding the penetration in those markets and to introduce innovative products, while achieving higher margins.
An Example: Product for the Young
To develop an example of new marketing, consider focusing on the niche of the younger (62 and under) issue age market. Buyers in today's market are responsible early planners, who believe in insurance and insurers. As noted above, current product offerings require a policyholder to make a high initial commitment (level premiums with high pre–funding) as well as a 50–year commitment to a single product and a single company. In addition, policyholders are exposed to the risk of product obsolescence. Will the product cover long–term care services to be offered 50 years from now?
To address these risks and substantially expand this market, please consider this new product concept. It provides term LTCI coverage to age 62, combined with an insurability guarantee that allows the policyholder to purchase guaranteed renewable LTCI coverage at age 62, without underwriting. The policyholder pays the issue age premium rate in effect at the time of their purchase of the regular LTCI policy at age 62. For a 40–year–old, the annual premium for this product (term–to–62 coverage with his insurability insured) could be around $300. This is a much lower initial commitment for the buyer, as compared to $1,500 for today's product. The 50–year commitment to a single product and company are lowered, as well as the investment and claim cost risks. The policyholder retains his options and flexibility. The lower cost greatly expands the market with good opportunity to achieve high margins.
For other segments to pursue, think of varying product offerings by geographic region, issue age, buyer commitment level and health status. For example, which regions provide the most opportunity for profit? Should your analysis compare census regions, states, or could you benefit from going finer, comparing metropolitan areas against rural, within the same state? Or a new entrant to the market could consider sex–distinct pricing, producing a males–only product. Would that shake up the market?
Because of a general uneasiness with the LTCI risk, competitors fall into being product and market 'followers,' sticking to the beaten path. Right now, there are substantial profitable opportunities for companies to do somethingdifferent and pursue market segmentation with focus.
John L. Timmerberg, ASA, MAAA, is president of Timmerberg & Associates, Inc.