In the first part of this post, we noted the rise in long-term care insurance premiums. We’ll know turn to the reasons why.
Although the popular press has widely blamed rising long-term care insurance premiums on “unexpected” claims from long-term care insurance companies, the reality is that rising costs of long-term care itself have played only a limited role in premium increases.
The true drivers of premium increases—or more accurately, why older blocks of long-term care insurance policies are generating such losses as cumulative premiums exceed cumulative claims—is that long-term care insurance has had “surprisingly” low lapse rates, and it has been difficult for insurance companies to generate much investment return on their premiums collected in the current interest rate environment.
As discussed previously on this blog, early on insurance companies anticipated that long-term care insurance would be like most other types of insurance, where more than 5% of policy owners end up allowing their policies to voluntarily lapse (due to change of mind, change of circumstances, change of financial situation, etc.).
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However, in practice, the lapse rate has been more like 1% to 2%, which means insurers remain on the hook for far more of their late 1990s and early 2000s policies than they ever expected. As claims come in, they payouts are higher than expected, not simply because costs are higher, but because more people actually held their policies to claim than expected.
Similarly, as insurers expected 5% or higher lapse rates and only got 1% to 2%, so too have insurers suffered as interest rates have dropped from more than 5% down to the 1% to 2% range. This has been a significant problem, given that the fundamental business model of insurance is to collect premiums, invest them, and use the aggregate premiums plus growth to pay out future claims.
When growth is much lower than expected as interest rates fall (since most long-term care insurers invest in bonds), there simply isn’t as much money available to cover claims down the road.
Viewed another way, when interest rates are low, insurers need to charge more up front, to make up for the reduced growth; except 10 to 15 years ago, insurers didn’t know rates would be this low, so they failed to charge enough up front, and are now suffering because of it. Estimates from the American Association for Long Term Care Insurance (AALTCI) are that every 1% decrease in interest rates leads to a 10% to 15% increase in required premiums!
Thus, as lapse rates continue to be low, and interest rates continue to be low, insurers find the pricing on their old policies to have an increasingly severe shortfall, leading the companies to go back to the state insurance departments to request a premium increase to ensure the financial strength and viability of the insurer. Planning For Premium Increases Going Forward