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Research Report. Long-Term Care Insurance Combination Products. A Summary: April Carl Friedrich, FSA, MAAA

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2004 Milliman USA All Rights Reserved L I F E Research Report Long-Term Care Insurance Combination Products A Summary: April 2004 Carl Friedrich, FSA, MAAA Because the articles and commentary prepared
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2004 Milliman USA All Rights Reserved L I F E Research Report Long-Term Care Insurance Combination Products A Summary: April 2004 Carl Friedrich, FSA, MAAA Because the articles and commentary prepared by the professionals of our firm are often general in nature, we recommend that our readers seek the advice of an actuary or attorney before taking action. MILLIMAN RESEARCH REPORT June 2004 Long-Term Care Insurance Combination Products A Summary: April 2004 PAGE I. EXECUTIVE SUMMARY II. BACKGROUND III. STAND-ALONE LTCI POLICY CHARACTERISTICS VI. KEY STRUCTURAL CONSIDERATIONS IN DESIGNING A COMBINATION PLAN V. BASE PRODUCT PLATFORMS VI. EXAMPLES OF COMBINATION STRUCTURES VII. POLICYHOLDER TAXATION ISSUES VIII. UNDERWRITING AND CLAIMS CONSIDERATIONS FOR LTCI RIDERS IX. MARKETING AND COMPENSATION X. PRICING, RESERVING, AND COMPANY TAXATION CONSIDERATIONS XI. KEY PLAYERS IN LTCI MARKETS XII. SAMPLE PRODUCTS XIII. SUMMARY MILLIMAN RESEARCH REPORT EXECUTIVE SUMMARY The need for long-term care insurance has become increasingly apparent due to changes in demographics, the growing cost of long-term care services, and financial pressures on the two major public sources providing support for long-term care services, Medicare and Medicaid. However, insurance industry experience with stand-alone long-term care insurance plans has not been totally favorable. A number of insurance companies once significant in the long-term care insurance (LTCI) market have withdrawn from that market due to concerns regarding morbidity risk, interest rate risk, and regulatory and consumerism concerns in the senior market. However, the insurance industry is increasingly offering combination products that offer various advantages over stand-alone designs, and that may allow the industry to access a broader range of the population. This report summarizes the key considerations in designing such products, various forms that may be utilized, and a range of issues that must be addressed to assure the ability to successfully construct, price, and market this business. Key design considerations include whether LTCI benefits reduce other policy benefits or are independent, whether they are filed to be in compliance with long-term care (LTC) requirements, the charge structure to be utilized, and whether the LTCI benefits are structured to be Tax Qualified LTCI. LTCI benefits can be provided via riders to fixed, variable, or equity indexed plans of various product lines. Carriers have introduced a variety of LTCI rider designs to Universal Life (UL), Variable Universal Live (VUL), whole life, deferred annuities, and immediate annuities. The base plans may also simply allow for a conversion or a guaranteed insurability option to a LTCI product. Different markets are accessed through these differing structures, and a variety of insurance coverages are being enhanced through these combination designs. This report discusses policyholder taxation issues related to various designs, and identifies some tax issues that have not been clearly resolved. 1 Marketing and compensation considerations, underwriting and claims, and pricing issues are explored. Many of these issues highlight the complexity of LTCI itself, in addition to the challenge of adding such coverage to other insurance. At the same time, the appeal of different structures in addressing consumers needs is made apparent through this report. Despite some of the challenges to successfully pursuing these alternatives to stand-alone LTCI, continued and substantial expansion with new, creative LTCI combination product designs is to be expected over the next several years. This report provides a reference for identifying the considerations necessary in the design of a successful LTCI combination plan. 1 This represents the views of the author, and should not be interpreted as the views of Milliman. Consideration of tax issues requires the review of a qualified tax advisor. June 2004 MILLIMAN RESEARCH REPORT 1 BACKGROUND The need for long-term care insurance (LTCI) in the United States is becoming increasingly apparent. Of those individuals who live to age 65, almost half of that population will need formal nursing home confinement. 2 Although many of those individuals will have relatively short-term needs, a substantial percentage will require care for one year or longer. The cost of nursing home confinement ranges from $100/day to $300/day, with significant variation by state as well as by scope and the quality of services provided. The 2003 MetLife market survey shows a nationwide average of $158/day for semi-private nursing home care, and $181/day for a private room. The cost of home healthcare, although typically lower, can equal or exceed the nursing home averages in some situations. Medicare only covers certain acute medical care components of long-term care (about 17% of all LTC). Medicaid covers LTC only if assets are depleted (about 43% of all LTC), and only for services provided in nursing home facilities. On average, individuals and families currently pay for roughly 23% of all LTC, with private insurance and other sources covering 17%. The population over age 65 is the most rapidly growing segment of the US population. The number of LTCI policies in force in 2002 was 5.7 million, up from 800,000 in 1987, but that is a small fraction of the population that would benefit from LTC insurance. New long-term care insurance sales totaled 1.4 million policies in 2000 and 2001 combined. Only one-fourth of new sales are through employers. Statistics indicate that over 40% of total long-term care services are provided to those under age Many of these individuals have congenital conditions that inflate these statistics; however the potential for extended longterm care needs for those under age 65 who may be insurable should not be ignored. In addition, the cost of longterm care insurance increases substantially with advancing issue age, and the coverage can become prohibitively expensive for substantial segments of the population if it is not purchased until an advanced age. In addition, the ability to qualify for LTCI coverage declines with advancing age. The appreciation of the need for long-term care insurance is still low for those below age 65, and the willingness to pay for such coverage at a younger age is similarly low. Although some inroads were made in recent years through group insurance programs, these still represent a small portion of the market, as noted above, and they are generally not supported by employer contributions. In addition, tax advantages supporting long-term care insurance are not substantial at this point in time. In addition to these factors, insurance industry experience with stand-alone long-term care insurance plans has not been totally favorable. There are a limited number of insurance companies in the market due to concerns regarding morbidity risk, interest rate risk, lapse and mortality risk, capital requirements, and regulatory and consumerism concerns in the senior market. Claims experience has actually been favorable for companies with sophisticated underwriting, although a few companies were hurt by lack of underwriting expertise. 2 Health Insurance Association of America 3 US Office of Personnel Management, MILLIMAN RESEARCH REPORT June 2004 Many major companies in the LTCI market over the long-term have seen persistency levels much higher than originally contemplated. This has caused pricing problems due to the level premium, increasing claim cost characteristics of LTCI that make the product lapse-supported. In other words, within certain constraints, lower lapse rates imply reduced profitability because more insureds retain their coverage into policy durations in which annual claims costs exceed annual premiums. In addition, interest rate levels dropped well below original pricing levels, exacerbating in force pricing problems, given the fact that companies had not typically hedged against the risk of declining interest rates. Although enhanced investment strategies may limit the risk related to reductions in interest rates relative to new business, there is a cost to such strategies, in addition to the complexities of execution of those approaches. As a result of the factors above, there are a modest number of carriers offering the coverage, with over 70% of the business concentrated among the top 10 companies. Finally, rate stabilization regulations are also putting pressure on underwriting companies to strengthen initial premium rates and reduce the probability of rate increases. In conjunction with these requirements, it is expected that there will be a reduced ability to secure rate increases in the event of adverse experience. Over the last 15 years, there has been an expansion of alternatives to purchasing stand-alone LTCI coverage. The insurance industry is increasingly beginning to offer combination products with various advantages over standalone designs, and that may allow the industry to access a broader range of the population. In many cases, these approaches reflect attempts to reduce the cost of LTCI by accelerating the payment of other insurance coverage upon inception of qualified LTC services to the insured, thereby addressing the customer s immediate needs. In other cases, they attempt to consolidate the steps in the consumer s insurance purchasing decisions and reduce the insurance company s marketing costs. In addition, with many designs, the ability to pre-fund the premiums for LTC insurance through another insurance vehicle is achieved. These products, in many cases, also have characteristics that mitigate some of the risks for insurance companies, allowing them to gain experience with the underwriting, marketing, and claims administration necessary for the coverage, generate relevant statistics to help them understand various aspects of the product, and develop a comfort level with the risk. June 2004 MILLIMAN USA RESEARCH REPORT 3 STAND-ALONE LTCI POLICY CHARACTERISTICS There are several key structural considerations in designing a combination plan. Before reviewing these, it is first appropriate to summarize the typical components of stand-alone LTCI coverage. Policy benefits are typically limited by daily, weekly, or monthly maximums, specified by the insured at issue within company-defined limits, and often are limited to expenses incurred. Maximum benefit periods are specified in years or dollars, and elimination periods commonly apply prior to benefit eligibility. Policy benefits may be limited to situations involving confinement in a qualified range of facilities, or may also include at-home care. As a result of Internal Revenue Code incentives later in this report, modern policies typically include requirements that services be provided as a result of the inability of the insured to perform at least 2 of 6 activities of daily living (ADLs), or as a result of cognitive impairment. Inflation protection must be offered as an option under the National Association of Insurance Commissioners (NAIC) LTC Model Regulation requirements. This benefit increases the daily maximum by fixed percentages every year (with lifetime maximums correspondingly increased). Many ancillary benefits are common, including waiver of premium, care advisory services, care provider discounts, bed reservation benefits, and respite care benefits. Shared care benefits, where a policy s maximum benefits can be accessed by either of two insureds, have recently become popular. Policies filed to comply with LTCI regulatory requirements may not feature premiums that are expected to increase by age above age 65. Rates are typically guaranteed renewable, meaning the coverage cannot be cancelled but the company may, under certain circumstances, increase rates. Lifetime level pay plans have been the standard premium structure, but limited pay designs are increasingly being offered, despite the fact that this restricts an insurer s ability to pursue rate increases where warranted by experience (because the policy is effectively paid-up after the limited pay period). Spousal discounts are common and growing in magnitude, reflecting in part the benefits of a spousal caretaker, and indirectly reflecting the sex-distinct claim cost differentials that are not reflected in standard unisex rates. Affinity group discounts are also fairly common, often supported by compensation reductions. 4 MILLIMAN RESEARCH REPORT June 2004 KEY STRUCTURAL CONSIDERATIONS IN DESIGNING A COMBINATION PLAN In designing a combination product that includes long-term care insurance, the following key questions need to be addressed. Will LTCI benefits be independent of the base plan, or will they represent an acceleration of base policy benefits, possibly with extensions of benefits beyond the base plan maximums? One of the major advantages offered by some combination products is that they provide benefits that in many situations reduce other benefits available from the other insurance coverage featured in the combination plan. The most typical example is with a life insurance base plan, featuring an acceleration of benefits if LTC services are required. These are often paid out as a fixed percentage (between 2% and 5%) of the life face amount per month while qualifying LTC services are provided. Payment of the LTCI benefit reduces the life face amount, so the cost of the LTCI benefit is the cost of acceleration of payment of the ultimate life insurance benefit assumed to be paid. In many policies, a pro-rata portion of the payment is deemed to be a partial penalty-free surrender of cash value. This results in a substantial reduction to the cost of LTCI benefits offered, making accelerated life benefits much more affordable than stand-alone coverage. In some cases, these benefits are packaged with accelerated benefits payable upon diagnosis of a terminal illness or a critical illness, although adding these additional benefits within the same rider adds to the cost and may create some tax questions. On the other hand, such a structure reduces death benefits payable, thereby diverting funds from the life insurance beneficiary, when in fact the need for life insurance may be increased in the event that LTC services are required. In addition, there may be inherent limits to maximum LTCI benefits payable when they are defined in terms of other insurance coverage, thus making these structures only a partial solution in covering LTC costs. Many plans limit accelerated LTC payments to as little as 50% of the life face amount. Because of the concerns above, it is increasingly common to see independent LTCI riders offered and sold together with an accelerated benefit rider. Will the LTCI coverage be filed in compliance with LTCI health requirements, or as a de minimus add-on to base plan? Different states may impose different requirements. In general, the broader the LTCI coverage, the more likely it is that states will require compliance with LTCI laws and regulations. The NAIC Accelerated Benefit Model Regulation allows for the addition of accelerated benefits to a life product, including benefits for long-term care services, so long as the insurer obtains a signed acknowledgement of concurrence for pay-out from the owner, assignee, or beneficiary. In addition to the NAIC Accelerated Benefit Model, the NAIC Long-Term Care Insurance Model Act includes provisions governing combination life and long-term care insurance policies. The life policy illustration must include an explanation of how the longterm care insurance benefits interact with other components of the policy, an illustration of the amount of the benefits, all long-term care insurance exclusions, a statement that inflation protection is not available (if applicable), and other disclosures. June 2004 MILLIMAN RESEARCH REPORT 5 The NAIC Long-Term Care Model Regulation addresses replacements when a life policy is involved. The insurer must follow the LTCI replacement guidelines when a life policy with LTCI benefits replaces a standalone LTCI policy. Both life insurance and LTCI replacement guidelines must be followed when a combination life/ltci policy replaces a like policy. Life insurance policies that include long-term care insurance benefits funded by a reduction in death benefits need not meet loss ratio requirements if several criteria are met, including but not limited to certain illustration requirements, the filing of an actuarial memorandum, compliance with life nonforfeiture requirements, and a guaranteed interest rate on the underlying life coverage that is not reduced by virtue of the long-term care insurance benefit. The policy is not subject to the same rate increase disclosure and pricing requirements as a stand-alone LTCI policy when the long-term care insurance benefits are incidental to the life policy and other basic requirements are met. To be incidental, the value of the LTCI benefits over the lifetime of the policy must be less than 10% of the total value of the policy benefits. There is also a special exemption for combination policies meeting the illustration and disclosure requirements above, with the delivery of a shopper s guide not required for such policies. What is the charge structure for the LTCI benefit? If the coverage is structured to comply with all terms and requirements of stand-alone LTCI coverage, the cost must be level for all years beyond age 65. If the LTCI benefit is configured as a de minimus add-on to base coverage, charges for the benefit could be based on a base plan cost of insurance (COI) set-forward, a yearly renewable term charge, fees expressed as basis points on account values, a level premium or other variations. Some designs are constructed such that no charges are necessary. For example, some policies discount the payout amount compared to the reduction of death benefits being accelerated. Other forms treat the pay-out as a lien against the policy and charge interest. Another distinction is whether there is an explicit charge for the LTCI benefit, in which case it may be removable, or whether the cost is embedded in the base plan pricing. How is the LTCI benefit to be structured in light of policyholder taxation issues? The Health Insurance Portability and Accountability Act of 1996 (HIPAA) provides for favorable tax treatment of premiums and benefits for tax qualified (TQ) long-term care insurance policies. Tax qualified plans are treated as accident and health insurance under the Internal Revenue Code Section 7702B. Also, any life insurance accelerated benefit paid when an insured meets the definition of a chronically ill individual (defined as suffering from a cognitive impairment or two or more ADL impairments expected to last at least 90 days) may be excluded from gross income for tax purposes if certain requirements laid down by HIPAA are met, including either 7702B requirements for TQ plans, or the requirements of section 101(g) for other plans. Compliance with only section 101(g) requirements, however, does not grant full TQ long-term care status to accelerated benefits, and hence does not extend the favorable tax treatment of premiums associated with TQ plans. Benefits from reimbursement-based TQ plans (i.e., where benefits are capped at expenses actually incurred) are excludible from taxable income. Benefits from per diem-based TQ plans are excludible from taxable income up to amounts that vary by year (in 2003, the cap is $230 per day). In addition, to the extent that unreimbursed medical expenses plus health insurance premiums and LTCI premiums exceed 7.5% of taxable income, premiums for TQ LTCI plans (and unreimbursed LTC expenses) are deductible up to certain limits based on age as defined in the tax law. 6 MILLIMAN RESEARCH REPORT June 2004 Also, the HIPAA legislative history suggests that premiums paid by employers of regular C corporations for tax qualified LTCI plans are fully deducti
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