An industry in transition prepares for the future
by J.J. Bowman
Mr. Bowman is affiliated with John Hancock Financial, in Boston. Visit johnhancock.comMost people expect to live a long life. As they prepare for retirement, they save and invest so that they can cover their future expenses.
If they have not also prepared for their potential long-term care needs, however, the fruits of this labor can disappear quickly. Care can be costly, regardless of setting, and counting on medical or disability insurance, government programs, or family members may not be enough.
Long-term care insurance was developed approximately 30 years ago to help consumers mitigate this risk. The carriers that led the way were primarily life companies, which recognized that long-term care insurance was a way to help their customers fill a gap in their overall retirement planning.
But like many young industries, long-term care insurance has had some significant growing pains. Many carriers have faced or are facing a choice: change the product design or exit the market.
Good intentions, unexpected results
There are a number of factors that led to the industry’s current challenges. To begin, the products originally sold in the 1980s included a number of features that proved to be unsustainable, such as policies issued with unlimited benefits. In addition, carriers offered policies with too many bells and whistles which contributed to the cost of coverage.
Other factors included claims experience, lapse rates, and interest rates. Actual long-term care usage and expenses proved difficult to predict many decades into the future. Many companies, if not all, are now beginning to see that their ultimate level of claims is higher than originally expected. Adding to poor claims experience was the fact that lapse rates were lower than expected.
And finally, falling interest rates became the new reality, leaving carriers unable to offset unanticipated claims with higher investment returns. The result was large, unexpected pricing adjustments for insureds, which gave consumers pause and made some advisors hesitant to recommend the product.
Reinventing long-term care Insurance
As the U.S. population continues to age and the need for long-term care continues to grow, now is not the time to give up on addressing this risk with insurance. Carriers can learn from past experience, and reinvigorate the industry. We can develop products that are sustainable for insurance carriers and still provide excellent value to consumers. It is time to rethink the coverage in terms of plan design and investment strategy.
One insurer’s path
As a major carrier in the industry with a long track record of successful innovations, John Hancock has taken a new look at long-term care insurance. The result is our most recent product offering, Performance LTC. The following overview discusses how we came to develop its component parts, and by sharing it, we hope it may spur further discussion and add new life to long-term care insurance product development across the industry.
As we considered the elements of the new policy’s plan design, we took care to retain those aspects of long-term care coverage that represent the core value of the product, like providing benefits in a wide range of settings.
Performance LTC features a built-in 3% Compound inflation benefit (with a 5% Compound Inflation Option also available) and continues to offer core benefits like International Coverage and the Bed Hold Benefit, as well as optional features such as SharedCare. We then set out to lower costs by replacing or restructuring other benefits, like Waiver of Premium and the Additional Stay at Home Benefit.
The second step was to address the issue of future volatility by adding a more conservative morbidity margin. The goal of this design is to reduce the likelihood of large scale unexpected rate increases in the future. Any portion of the margin that is not needed is automatically passed back to the insured by way of a Flex Credit.
The Flex Credit1 concept is central to our new plan design. Flex Credits are composed of an Interest Component, based on actual investment performance, and an Insurance Component, based on actual claims experience.
The method for calculating Flex Credits has been placed on file with our state regulators and to the extent that actual claims experience is better than priced for, the company passes back the gain, or “upside,” in claims experience.
The Declared Rate, which is used in calculating the Interest Component, can never be less than 0.5% below the actual portfolio rate of return. Flex Credits can be deferred and stored in a “Flex Account” which can grow with interest and be used in future years to:
- Reduce premiums (Net Premiums = Policy Premiums – Flex Credits2)
- Pay for services that can help them remain at home, like home modifications or emergency medical response systems3
- Offset expenses during the Elimination Period, to avoid out-of-pocket expense
- Reimburse long-term care expenses in excess of policy benefit amounts
- Provide up to a return of premium upon death or lapse4
Re-examining the policy investment structure
As we looked at modernizing the LTC Insurance policy design, we also looked at revising the product’s underlying investment strategy and how investment returns impact the policy. Many traditional long-term care insurance products are supported by an investment mix weighted heavily toward fixed income (i.e., corporate and government bonds).
Given that long-term care insurance carries liabilities that can span 30-40 years or more, we sought a more diversified strategy with an underlying mix that includes a broad array of fixed income and alternative long-duration assets, such as real estate, power & infrastructure, private equity and timberland.
As with any investment strategy, it is not without risk. If investment results are worse than originally illustrated, the Net Premiums required could be higher than expected. This risk is presented on each illustration in the “Adverse” scenario and can also be shown by creating a “Custom” illustration assuming a lower Declared Rate.
Introducing increased transparency and flexibility
We also recognized that one of the most difficult aspects of the need to increase premiums for existing insureds was that, for many, the increase came as a complete surprise. Even though we offered insureds options to mitigate the impact of the increases, we felt there was more we could do going forward.
Therefore, we worked to enhance our communication and frequency of this communication to our insureds. We decided that we would base our communication and disclosure strategy on the disclosure tenants of the NAIC Life Illustration Model Regulation. We made the following changes to help ensure that insureds have the information they need and a number of options to choose from to effectively manage their long-term care insurance in the future:
- Sales Illustrations provide prospects with multiple hypothetical scenarios so they can have a better idea of how their premiums would be impacted by both positive and adverse experience
- Annual Statements will provide updates of these scenarios so insureds will have the most current expected performance
- The option to defer Flex Credits for later use allows insureds to use their Flex Credits immediately to pay lower net premiums or they can defer them to enhance their benefits or reduce future net premiums later on
- The option to levelize benefits allows insureds to significantly reduce their net premiums if they decide to stop the 3% compound benefit increases
John Hancock continues to view the need for long-term care as a significant unprotected financial risk. We believe that Performance LTC’s affordability and its inherent flexibility will help position the product as another financial planning tool that may expand the audience of potential buyers.
But more important, we are optimistic that when carriers offer products that are both affordable and stable, we can reinvigorate our industry so we can continue to offer insurance solutions that will allow our customers to face the future with confidence. ◊
Footnotes:
1. Flex Credits are calculated according to a formula that takes into consideration the Company’s insurance and investment experience. John Hancock’s calculation method is on file with the applicable regulator. Negative Flex Credits will not decrease the Flex Account, but will be carried forward until they are offset by positive Flex Credits.
2. Policy Premiums are the contractual premiums which increase annually through age 90. Insureds have the option to pay up to their Policy Premiums each year. Net Premiums are what insureds pay out of pocket for coverage, once their Flex Credits are applied. Flex Credits are not guaranteed.
3. Eligible services are limited to Home Modifications, Emergency Medical Response Systems, Durable Medical Equipment, Caregiver Training, Home Safety Check, and Provider Care Check.
4. The Flex Account payable upon death or lapse is capped at total premiums paid in order to meet the requirements of a tax qualified long-term care contract.
The 3% compound inflation benefit is NOT built-in. What is built-in is an annual 3% guaranteed purchase option. Premiums go up when you exercise the option. If you do not exercise the option, it is discontinued until after your 91st birthday.