- The Rate-Stability and Reserve Adequacy Dilemma
As indicated above, in 2016 the NAIC concluded the Study, to gain a comprehensive understanding of LTC and to examine the issues facing the private LTCi market in the U.S. The Study compiled the research and findings of several experts in the LTC and LTCi space, including “thought leaders and researchers in the fields of LTC and insurance, state insurance regulators and other policymakers, insurance industry executives as well as consumer advocates . . . .”[11] Not surprisingly, the Study discusses the dilemma faced by LTCi carriers in maintaining rate stability and reserve adequacy on in-force policies for which actual experience has been adverse to original pricing assumptions. To help understand the rate-stability problem, it is useful to provide an overview of how LTCi policies are priced and regulated.
State insurance laws impose certain requirements on LTCi policies that limit the ability of carriers to respond to adverse claims experience. Specifically, in addition to requiring that initial premiums be designed to remain level for the life of the insured[12], state laws require that LTCi policies be guaranteed renewable, i.e., the insurer cannot cancel the policy if the policyholder continues to pay premiums.[13] Insurers are permitted to adjust premium rates on a class-wide basis only where actual experience contradicts original pricing assumptions; however, such adjustments to premium rates are subject to regulatory approval.[14]
Counterbalancing the requirement for level premiums, the amount of claims paid per-capita does not remain constant but, instead, increases dramatically over the life of a policy.[15] Generally, the increase in the number of claims can be attributed to four factors:
- The incidence of becoming disabled or cognitively impaired (and triggering LTC benefits) increases by attained age.
- Underwriting selection wear-off. Most LTCI policies are underwritten . . . based on health conditions [of the insured at the time of policy issuance]. Claim costs [may] increase [over the course of the policy] as the effect of this initial risk selection wears off . . . .
- Marital status changes. Long-term care claim costs are much higher for people who live alone [as opposed to] married couples. This generally occurs because healthy spouses will tend to provide informal care for disabled spouses. Policies issued to married couples have lower initial claims costs. When one spouse dies, however, claim costs for the surviving spouse [may increase to] the same rate as persons who live alone.
- Inflation protection benefits. Many LTCI policies contain inflation protection benefits. State laws and regulations require [insurers to offer an inflation guard rider] that automatically increases benefits by 5% . . . each policy anniversary (with a level premium rate) . . . .[16]
As a result of the disconnect between generally stable premiums and consistently-increasing claims, premiums will surpass the cost of claims in the early stages of a standard policy; however, the opposite will occur for the book of business as policyholders age and the frequency and severity of claims increase.[17] To fund the later increase in claims, insurers create a reserve by setting aside and investing the premiums received during the early policy years, which are then used to fund policies once the cost of claims exceed the premiums being collected.[18] Accordingly, for LTCi to remain viable, original pricing assumptions must accurately gauge future claims costs, so as to create sufficient reserves to fund additional claims occurring in later years. Unfortunately, the original assumptions upon which some of the older in-force policies were priced has not accurately predicted future claims costs and, as a result, the majority of those policies on the market have not generated sufficient reserves to cover actual claims costs.
Indeed, “[v]irtually all insurers issuing LTCI policies prior to the mid-2000s have observed adverse experience on these policies when compared to pricing assumptions.”[19] The historical assumptions upon which those policies were priced, and which proved to be incorrect, can be summarized as follows:
- Low lapse and mortality rates. Long-term care insurance is a lapse supported product. If voluntary lapse and mortality rates are lower than expected . . ., there will be more policies in-force at later policy durations than were expected when the policies were priced. Because of the mismatch of level premium rates and claim costs that increase steeply by policy duration, the additional premium collected from the greater number of in-force policies will not be enough to fund the additional claims occurring at later years.
- Interest rates. The assets held in reserve to fund future cash out-flows . . . are expected to generate investment income. If this investment income is less than expected, the assets, together with premium collected, will not be sufficient to fund
. . . future benefits and expenses.
- Morbidity. Morbidity is comprised of three factors: 1) claim incidence rates;
2) length of claim; and 3) benefit utilization. While [a report by the United States Department of Health and Human Services upon which the Study relies] does not directly list specific assumptions used in earlier pricing [calculations], it does state that publicly available data sources generally were used to develop assumptions. In general, these sources did not include experience for assisted living facilities, which have become a highly utilized care setting, and which result in a longer . . . claim [duration as compared to] . . . nursing homes. Although this trend by itself generally is not enough to have a severe impact on reserve adequacy, it can compound the level of reserve deficiency when combined with lower lapse [rates], mortality issues and lower investment earnings.[20]
To offset future losses and attempt to restore reserve adequacy, the majority of LTCi carriers have undertaken corrective measures, such as: (1) requesting premium rate increases; (2) offering benefit reductions; or (3) recognizing losses.
Premium rate increases are perhaps the most common, albeit limited, method of offsetting future losses. Rate increases are prospective in nature and generally prove less effective for older policies “because the amount of premium collected in later years is much less than benefit payments and there are fewer policyholders paying premium, which causes the level of rate increase needed to restore reserve adequacy to be very large.”[21] Such high levels of rate increases are generally viewed by regulators and insurers to be unfair to policyholders and, as a result, most approved premium rate increases do not completely restore reserve adequacy by themselves.[22]
To avoid or mitigate the negative consequences of rate increases, many insurers have chosen to offer their policyholders the option to reduce benefits. This option will sometimes be offered in lieu of, or in conjunction with, premium rate increases. This means that policyholders are given the option of reducing their daily benefit, benefit period, or other benefit options, such as inflation protection.[23]
Finally, when all else fails, carriers may need to supplement reserve deficiencies with profits from other products or lines of business.[24]
Taken together, the level-nature of premiums, limited ability of carriers to adjust premium rates, and limited and problematic options available to carriers who are under-reserved, create a dilemma for LTCi carriers that will continue to plague the industry as the number of baby boomers entering retirement increases. The following discussion on the Toulon case provides an example of the kinds of complex legal and practical issues that arise when carriers decide to implement rate increases and policyholders challenge the carriers.
- Toulon v. Continental Casualty Company
On February 12, 2016, the United States District Court for the Northern District of Illinois dismissed with prejudice a putative class action lawsuit filed against Continental Casualty Company (“CNA”) challenging the propriety of premium rate increases CNA imposed on certain LTCi policies it marketed and sold across the United States.[25] Plaintiff Sophie Toulon alleged that CNA intentionally priced its LTCi policies at artificially low rates using unreasonable lapse rate assumptions to entice lower-income individuals into purchasing those policies, thereby allowing CNA to collect premiums while those insureds were unlikely to file claims.[26] When insureds became more likely to file claims, CNA allegedly increased its premiums to unaffordable levels.[27] As is illustrated below,
Ms. Toulon asserted legal theories against CNA that relied on extrinsic materials outside of CNA’s LTCi policies to support her allegations that CNA defrauded her and thousands of other similarly situated individuals.
According to Ms. Toulon, CNA made fraudulent misrepresentations and omissions in its LTCi Personal Worksheet (the “Worksheet”) which applicants, such as Ms. Toulon, completed in connection with the purchase of a “Preferred Solution” LTCi policy sold by CNA.[28] Ms. Toulon argued that the Worksheet, which was intended to help determine whether the LTCi policy was suitable for applicants, was designed with a more nefarious purpose in mind.[29] Specifically, Ms. Toulon alleged CNA designed the Worksheet to deceive customers into believing CNA would cap future premium rate increases under its Preferred Solution policies to 20% or less.[30] In support of her allegations, Ms. Toulon relied on certain statements contained the Worksheet and an accompanying notice, which provided, in pertinent part:
- The company has a right to increase premiums in the future;
- The company has sold long term care insurance since 1965 and has sold this policy since 1998;
- The company has not raised its rates for this policy;
- However, the company did raise rates by 15% in 1995 on long term care policies sold seven to 12 years ago that provided essentially similar coverage; and
- Have you considered whether you could afford to keep this policy if the premiums were raised, for example, by 20%? [31]
Ms. Toulon alleged that, despite being aware it would need to increase premiums in excess of 20% in the future, CNA intentionally failed to disclose that information to customers in an effort to make the product seem more affordable.[32] Ms. Toulon purchased the policy in 2002.[33] CNA later informed her that premiums were set to increase by 76.50% and she filed the lawsuit in response. CNA moved to dismiss Ms. Toulon’s First Amended Complaint and, on August 18, 2015, the court dismissed the complaint without prejudice.[34]
In dismissing Ms. Toulon’s fraudulent misrepresentation claim, the court found that none of the statements identified by Ms. Toulon were actually false, especially considering that CNA conspicuously “advised [her] that it had the ability to raise premiums” and did so “without any qualification.”[35] Importantly, the court noted the 20% figure that CNA included in the Worksheet came from an Illinois Department of Insurance regulation that governs the content of the Worksheet.[36] Moreover, the court stated that the reference to a 20% increase was a hypothetical question that “cannot be read as a limit on [CNA’s] discretion or as a promise of any kind.”[37] Accordingly, the court rejected Plaintiff’s arguments that “by mentioning any figure at all, defendant committed itself to premium increases in that ballpark alone.”[38] The court further held that “it would not be reasonable to infer that [CNA] was falsely promising to never raise premiums beyond 20%.”[39]
The court also dismissed Ms. Toulon’s fraudulent omission claim after finding that CNA did not have to disclose its rate increase plans because no fiduciary or special relationship existed between CNA and Ms. Toulon as a matter of law.[40] The court reasoned that to hold otherwise would lead to a fiduciary or special relationship being created “anytime an established insurer sold a policy to an elderly person who was not sophisticated in the ways of insurance and that [CNA] complied with Illinois’s ‘suitability’ requirements.”[41]
Lastly, the court dismissed Toulon’s claim under the Illinois Consumer Fraud and Deceptive Business Practices Act[42], stating “[a]n act will not be said to be deceptive when the plaintiff is explicitly alerted to the complained of result.”[43] Again, the court emphasized CNA’s unqualified disclaimer to policyholders that it had the ability to raise premiums in the future.[44]
Following the dismissal without prejudice of the First Amended Complaint, Ms. Toulon filed a Second Amended Complaint, which included new allegations of fraud based on the alleged misrepresentations contained in the Worksheet and accompanying notice.[45] Ms. Toulon also relied on additional language in her Policy, which stated that CNA “may” change premium rates, and argued that “by presenting the possibility of an increase in her premium, [CNA] misled her as to both the probability and magnitude of such an increase.”[46] The court rejected that argument and held that Ms. Toulon’s theory “requires an unreasonable logical leap and cannot be the basis for a fraudulent misrepresentation claim.”[47] The court ultimately granted CNA’s motion to dismiss the Second Amended Complaint with prejudice.[48] Ms. Toulon has since filed an appeal of the court’s decision with the Seventh Circuit Court of Appeals.[49] The Seventh Circuit has not issued an opinion in that case as of this date.
Toulon highlights one group of problems that have arisen as a result of inaccurate pricing assumptions that were made on LTCi blocks before 2005. Although the court in Toulon ultimately ruled in favor of CNA, the carrier was forced to mount a costly defense of its decision to raise premium rates—a decision that was implemented after obtaining the approval of the Illinois Department of Insurance. Viewing the issue from the plaintiff’s perspective, allegations can be asserted that consumers purchase LTCi policies with the expectation that their premiums will remain level for life. They can also assert that policyholders purchase coverage as an investment over a significant period of time. Significant premium increases require them to make a difficult choice—pay the increased premium (if they can afford it) or lose the benefit for which they bargained so long ago.
- Conclusion
The provision of LTC is one of the most important, yet problematic, social challenges facing our country. Overall improvements in health and longevity have drawn focus to the need to provide solutions for consumers to obtain health and senior care services at an affordable price. Due to the length of time stakeholders need to project and estimate health care and daily living needs, the nature and advancement in life-saving and life-prolonging medical care, and the costs thereof, it is extremely difficult to formulate and implement achievable solutions that accommodate availability and affordability needs of consumers, while maintaining insurer solvency. If LTCi is to remain viable, carriers will need to attract new consumers by offering them a product at a price designed to remain affordable and constant over time. Unless the public can be convinced that carriers are pricing LTCi such that carriers will not be required to adjust premiums drastically at some future date, prospective purchasers, especially younger buyers, will be dissuaded from purchasing LTCi and carriers will likely continue to struggle with the solvency issues that have defined the past decade for the private LTCi industry as a whole.