Long-Term Care: Bearing the Brunt of the Boomers

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Long-term care continues to be one of the key credit risks facing the insurance industry. Rising claim costs, limited morbidity experience, and the recent fall in interest rates have renewed investor concern about the adequacy of reserve levels across the industry.

The evolution of the long-term care product

Long-term care ("LTC") was first introduced in the 1970s as nursing home insurance, but has evolved over the years into its current form as coverage of expenses for assisted living facilities or home health care. Traditional health insurance does not cover LTC expenses, and Medicare and Medicaid provide limited coverage only if certain criteria are met.1

Problems with this product line have primarily been driven by legacy LTC policies that were underwritten prior to the financial crisis under a set of assumptions that over time has proven to be too aggressive, leading to deficient reserve levels. In recent years, insurance companies have adjusted the original assumptions to more conservative levels reflecting actual experience, and this has resulted in substantial reserve charges.2 If current assumptions continue to prove aggressive relative to actual experience, insurers will need to further bolster reserve levels which could reduce cash flow dividends from operating subsidiaries, erode holding company liquidity, and lead to higher leverage. Collectively, these factors could contribute to wider credit spreads.

The primary assumptions supporting LTC liabilities include:

  • Morbidity - the frequency and severity of claims
  • Mortality - the length of the claim period
  • Discount rate - the interest rate governing the present value of reserves that need to be held to support future claims
  • Lapse rate - the rate at which policyholders allow the policy to lapse
  • Premium rate - regular payments from policyholders to insurers to keep the policy in-force

Current issues facing long-term care insurers

Several factors have contributed to higher-than-expected LTC claim costs including rising health care costs, longer life expectancy, and lower lapse rates. According to the US Department of Health and Human Services, the cost of long-term care in assisted living facilities has increased approximately 67% over the past 15 years.3 This has contributed to the steady rise in incurred claims over the past decade (Exhibit 1), alongside the growing number of policyholders that have reached claim-paying ages. Of particular concern, industry loss ratios are moving towards the 100% level above which capital positions will begin to deteriorate. Low interest rates have also prevented insurers from growing reserve levels meaningfully over the years, and the recent decline in interest rates has pressured companies to reduce discount rate assumptions, resulting in additional reserve charges during 3Q19 earnings.4,5 Finally, lapse rates have been lower than expected, increasing the ultimate level of claims.

Exhibit 1: Increasing annual loss ratios

Source: NAIC Annual LTC Experience supplement; S&P Global Ratings research

Insurance companies are combatting the effects of deteriorating loss ratios by increasing premium rates (or reducing benefits for the same level of premiums), but these requests have to be vetted and approved by the state regulators, who are becoming increasingly more coordinated in their review process and have been more willing to approve these requests as industry claim trends have worsened. The pace and magnitude of future premium rate increases will be critically important in determining the adequacy of reserve levels as we move closer to peak industry claim years, which aren't expected for another 10-15 years.6

Assessing LTC risk

The degree of LTC risk for a given insurance company depends on several factors including the firm's concentration to LTC policies, the specific pricing and characteristics of the LTC block, current assumptions, actual loss experience, and the company's ability to achieve future premium rate increases. Generally speaking, insurers with a larger concentration to LTC policies, more aggressive assumptions, and whose LTC block is characterized by an older average attained age and more burdensome benefit features (e.g. limited-pay policies, inflation protection, etc.) will have higher risk, and insurers will need to support these policies with a higher ratio of reserves per active life. Also, firms that have acquired LTC exposure via reinsurance may have more difficulty achieving rate increases, as it will involve the coordination with the primary underwriters of these policies.

The future of long-term care

Investors should continue to focus on morbidity trends across the industry and for specific insurers. Given the limited number of LTC policies currently on claim7, the degree of variability around morbidity assumptions continues to be very high. Unexpected and adverse morbidity experience in future quarters could be a precursor to additional reserve charges. In addition, discount rate assumptions may need to be gradually reduced from current levels if interest rates sustain at these low levels for an extended period of time. On the other hand, insurers should continue to push and receive approval for premium rate increases on underperforming LTC blocks, which should help to offset some of the negative effects of worsening morbidity trends and lower discount rates on reserve levels.

1Eisenberg, Richard. "Medicare, Medicaid and Long-Term care: Your Questions Answered." Forbes, November 2017. 

2Japsen, Bruce. "GE Won't be the Last Insurers to Pay Billions in Long-Term Care Charges." Forbes, October 2018. 

3"Genworth's 15th Annual Cost of Care Survey Shows Continuing Rise in Long Term Care Costs." Genworth. October 2018. 

4Childers, Angela. "CNA reports Q3 profit decrease on after-tax charge." Business Insurance. October 2019. 

5Gryta, Thomas. "GE Posts Loss on Restructuring Charges but Raises Cash-Flow Goals." WSJ. October 2019. 

6S&P. "Following the Trail of U.S. Insurers' Long-Term Care Assumptions." January 10, 2019.

7JP Morgan. "Long-Term Care, Putting recent disclosures in perspective." March 21, 2019.

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Taylor Kraemer

About Taylor Kraemer

Taylor Kraemer, CFA, is a credit research analyst on the Financial team responsible for global credit analysis of investment grade and high yield securities within his coverage universe. He has nine years of industry experience and joined the firm in 2019.  He is a CFA® charterholder.