Assumption review could lead to chargesExcerpts from the new study by Moodys Investor Service, which looks at the health of the Long Term Care insurance industry. Visit here for the full report.
As insurers undertake LTC actuarial assumption reviews in 2019, we believe those with outdated and less defendable assumptions will likely make adjustments to align with evolving industry experience and longer-term investment return assumptions, potentially leading to a decline in GAAP margins. Those insurers with insufficient or depleted margins would need to take earnings charges. As we have indicated previously, a small change in actuarial assumptions can significantly impact margins, and ultimately reserves, for a long- duration product such as LTC.
Whether insurers exposed to aggressively priced legacy LTC blocks can avoid taking charges will depend on factors such as the path of interest rates, morbidity, older age mortality, utilization, and views on the continued willingness of regulators to provide rate increases. For 2019, key factors impacting GAAP loss recognition testing (LRT) and reserve adequacy are insurers’ success in achieving rate increases embedded in margins, and assumptions about morbidity, morbidity improvement, and discount rates.
For GAAP loss recognition, discount rates are typically based on best estimate views of reinvestment rates and current earnings rates (depending on the age of the block). The decline in interest rates over the past year could trigger changes in insurers’ investment return and discount rate assumptions as the companies undergo loss recognition and then asset adequacy testing in 2019.
Morbidity is another key assumption to watch. Many insurers have little credible experience with claims on policies for which policyholders are just now reaching the peak age to receive benefits and, as such, companies need to make long-term assumptions with limited company-specific data. Views on older age morbidity (as well as mortality) continue to evolve and need to be periodically reviewed and updated. While an insurer’s morbidity improvement needs to be evaluated in the context of its underlying morbidity assumptions, morbidity improvement assumptions for GAAP loss recognition testing range from 0% at CNA and Prudential to 1% or above per year for over a decade at UNUM, General Electric, and other insurers.
A positive offset to low interest rates: premium rate increases helping to protect LTC margins; continued dialogue among regulators is constructive
Premium rate increases remain of paramount importance for insurers with underperforming LTC blocks. The industry’s LTC challenges are intensified the longer regulators take to approve premium rate increases because insurers have less time to capture increased premiums. Loss ratios will continue to deteriorate, exacerbating the need for future rate increases, yet making it harder for insurers to have the time necessary to achieve the needed increases. Our review of LTC rate increase requests indicates that insurers have been achieving rate increases in line with their expectations, and in some cases above their assumptions.
One recent take-away from our discussions with market participants is that most state insurance regulators realize the importance of dealing with the pressures in LTC and are being more coordinated in their rate review process. Regulators along with the NAIC are looking at making information requests consistent and standardizing the review process. We believe that most regulators will grant at least some rate increases where they are actuarially justified, because they realize that the longer they delay rate increase approvals, the greater the needs could be in the future. How accommodative regulators may be should LTC experience deteriorate further is still an open question.
Upcoming GAAP accounting changes could have material impact on LTC reserves, but not cash flow
Upcoming changes to GAAP reporting will significantly change the accounting for LTC as well as life insurance and annuity products. Specifically, The Financial Accounting Standards Board’s (FASB) update to the accounting standard for long-duration contracts, Accounting Standards Update (ASU) 2018-12, is expected to be effective in 2022 for financial statements filed by public companies. GAAP LTC reserves could be disproportionately impacted at the time of the adoption of the new standard because the long duration of the business will result in a material impact on insurers’ GAAP equity, the result of using a market rate for upper-medium grade (A- rated) fixed-income instruments to discount insurance liabilities. Specifically, at current rate levels, LTC blocks would place downward pressure on GAAP equity at adoption of the updated FASB standard. Furthermore, assumptions and discount rates used for calculating reserves for these products will be updated regularly, leading to increased earnings volatility.
We do not generally expect implementation of the new standard to affect ratings, since the new accounting standard only affects GAAP accounting and not the underlying economics. However, to the extent the accounting standard leads the company to take actions it would not have taken otherwise, reveals new risks, or hampers a company’s ability to raise capital, it could affect our view of the company’s creditworthiness.
Read the full report here.