A Long-Term Commitment.

Before selecting a long-term-care insurance policy, agents and their clients should have a grasp of six important, but commonly misunderstood issues.

The long-term-care insurance industry has changed rapidly over the past decade. Likewise, many of the issues and decisions that agents need to make on behalf of their clients also have changed.

There are six key issues that are sometimes controversial and often misunderstood by agents and their clients. The first two issues deal with choosing policy benefits. The other issues are rate guarantees, premium adequacy, employer group long-term-care insurance and nontax-qualified policies.

Compound Cost of Living

The current National Association of Insurance Commissioners model law requires every long-term-care insurance applicant to be offered the 5% annually compounded cost-of-living adjustment protection, more commonly known as the COLA benefit. Over the years, many have applied an incorrect rule of thumb for using the COLA benefit. This rule suggests that compounded COLA be used only for those under age 70. For those between ages 70 and 75, the recommended approach is to add the simple COLA. But for those over age 75, the recommendation is to purchase extra daily benefits, rather than purchasing the COLA benefit.

This rule of thumb is directly attributable to the difficulty in selling high premiums to older clients. In the early 1990s, when COLA protection was first mandated as an offer to all applicants, the typical applicants were in their early 70s, much older than the average buyers today. Also many of the agents selling this coverage were part of a career-agency system. Therefore, to assure the continued success of the long-term-care insurance career agent, it was necessary to develop a logical approach to selling COLA that would discourage its purchase at the older ages, where policy sales were already difficult and expensive.

From an actuarial perspective, the proper approach for a typical healthy applicant is to purchase the COLA benefit regardless of issue age, even if a lower daily benefit must be purchased to keep the premium affordable. In fact, the best way to analyze this proposition is to compare the daily benefit purchased without COLA to the daily benefit that can be purchased for the same premium with COLA.

For example, at age 80, one could purchase a $140-per-day benefit without COLA for about the same price as a $100-per-day benefit with COLA. After just seven years, the $100-per-day-with-COLA benefit will have increased to more than $140. Further, if this presumably healthy 80-year-old outlives life expectancy and goes into the nursing home at 95, the benefit and, presumably, the cost of care will be well over $200 per day.

Anyone considering the purchase of long-term-care insurance should buy the lifetime 5% compound COLA benefit, regardless of issue age. The applicant can then be confident that the benefit level initially purchased will cover costs at a relatively constant level throughout life, rather than facing an increasing out-of-pocket expense every year as the insured becomes less healthy and, thus, more likely to require long-term care.

Benefit Period

All applicants must choose an appropriate benefit period. This choice can dramatically affect the premium level. Since the average stay in a nursing facility is about 2.5 years, many agents recommend a three- or four-year benefit period. As with the COLA benefit, the evolution of this poor advice is easy to understand. Long-term-care insurance policies are expensive regardless of what benefits are purchased, especially at the older issue ages. Clearly, consumers do not want to give up policy benefits, such as home care, or buy less than what they consider to be a fully adequate daily benefit. So when the cost of the coverage becomes an issue, it is often easier to purchase a shorter benefit period.

The average length-of-stay calculation is dependent on how the stay is defined. For example, the average length of stay for all stays of one day or longer is only 521 days, or about 17 months. This 1.5-year figure used to be the most commonly quoted average stay. On the other hand, the average stay for all stays longer than one year is 6.2 years. Interestingly, the currently quoted average stay of 2.5 years is based upon all stays of 90 days or longer.

The relevant consideration, however, is not the average stay but the risk of a catastrophic stay. If a four-year benefit period is purchased, then clearly a confinement significantly in excess of that time would be catastrophic. Since there is more than a 10% risk that a confinement will last more than four years, it is important to purchase a long benefit period, preferably lifetime.

Rate Guarantees

Rate guarantees are becoming more common every year. They are proving particularly effective as a marketing method for a company to provide the applicant with peace of mind that premiums will not increase. Rate guarantees also serve as a strong indicator of the underlying adequacy of the premium structure.

Unfortunately, except in the case of noncancellable policies, this is more illusion than reality. For applicants underwritten with appropriate underwriting standards and methodology, the initial premiums will be adequate for at least five to 10 years after issue. Thus, a rate guarantee of 10 years, the longest currently available from any carrier, still allows the company plenty of time to increase rates and recover from any underpricing.

A rate guarantee can actually serve to destabilize future rates and increase the risk of an assessment spiral, where the healthy lives lapse their coverage and the remaining higher percentage of claimants cause even more rate increases. This happens because the rate increase is deferred by the rate guarantee, thus causing the increase to be exponentially greater when later implemented and often leading to an assessment spiral.

In fact, a rate guarantee actually serves only as a marketing tool, creating the impression of adequacy and safety, where otherwise the rate structure might be subject to question. It is a particularly useful marketing device for carriers that have performed rate increases on past blocks of business. It creates the impression, through the rate-guarantee structure, that future rate increases are unlikely.

Premium Adequacy

Determining which policies are adequately priced is one of the toughest tasks facing agents and their clients. Since it is so difficult, many feel that they should just dose their eyes, pick the lowest price and hope for the best. But there are some definite corporate and product indicators that the educated consumer or agent can examine to determine the adequacy of a company's pricing structure. Among the corporate factors are the carrier's size and ratings, its attitudes toward the consumer as compared with maintaining profitability targets, its expertise with long-term-care insurance and, most importantly, the company's historical long-term-care insurance loss ratios. In terms of the product design, aspects to consider include underwriting structure, premium rates, benefits and commissions. Careful analysis of all these elements will enable agents and their clients to judge which policies are most likely to maintain premium adequacy.

Interestingly enough, the actual premium charged is one of the lesser considerations in determining premium adequacy. Perhaps the most important factor is the underwriting structure. Allowing just a few extra uninsurables per thousand applicants to be issued a policy, whether due to ignorance, inefficiency or lack of proper underwriting information or standards, can easily cost more than 20% additional premium.

Although analyzing the underwriting style and expertise of any company is difficult, most experienced long-term-care insurance agents are aware of the companies that underwrite loosely, make exceptions for important agents or clients, or forgo medical records so they can issue policies more expediently. These companies should be considered only when a client cannot qualify for one of the more rigorously underwritten policies, since the eventual cost of any policy form will be based on the collective experience of the insureds with that policy form.

Stated another way, the goal for any particular applicant should be to purchase a policy where the majority of insureds are at least of comparable health, so that on average the applicant is receiving a subsidy from the other insureds, rather than providing one to the rest of the group.

Another important indicator of premium adequacy, and perhaps the easiest to use objectively, is the Long Term Care Insurance Experience Reports, published annually by the NAIC. The first section of this report shows the durational loss-ratio experience for every company. This allows an easy comparison of experience by duration, rather than just in the aggregate, and will readily expose companies whose experience is out of line with the rest of the industry. In particular, it is important to focus on the actual loss ratios, since the anticipated loss ratios match closely to the actual for virtually all companies.

There are several more subtle indicators of premium adequacy. Analyzing the policy-benefit structure is one of these. A policy that offers significantly richer or more easily accessible benefits should have correspondingly higher premiums. Similarly, commission structures that in aggregate provide more commission will require correspondingly greater premiums to support them.

Perhaps the most difficult part of this process is analyzing the company. A company with a history of absorbing or at least sharing the cost of its mistakes to maintain a quality reputation is more likely to provide stable premiums. Conversely, an aggressive, profit-oriented company is more likely to choose aggressive premiums at the outset as well as increase them to the full extent necessary to maximize profitability.

Employer Groups

Employer groups traditionally have been able to secure higher-quality medical programs for their employees often with little or no underwriting than the employees could obtain for themselves. Likewise, most people assume that employer groups providing access to group long-term-care insurance will provide their employees with cheaper premiums, easier underwriting and comparable or better benefits than the employees could obtain independently. This assumption is due, in large part, to the buying power of the employer and the generally lower group commissions.

Inferior Policies

Unfortunately, for many voluntary-purchase, employer-endorsed programs, the advantages obtained in the group medical marketplace are missing. In fact, many voluntary-purchase group policies are inferior to the corresponding individual policies. Voluntary-purchase group long-term-care insurance is probably the most extreme example of this. Not only are the products generally inferior in benefit choice and premium structure, they also lack the tax advantages a cafeteria plan can offer to most other group voluntary-purchase benefits. Even though there is a strong likelihood that new tax legislation will allow group long-term-care insurance to be elected under a cafeteria plan within the next few years, it is also likely that a full above-the-line deduction for individual long-term-care insurance will be enacted at the same time, eliminating any tax advantage for group long-term-care insurance.

There are several other inherent disadvantages facing group long-term-care insurance. First, and foremost, is the difficulty of getting employees to voluntarily purchase at an acceptable election rate. Penetration for group long-term-care insurance is rarely greater than 15%, and often much less. This makes the solicitation costs much more expensive than would normally be the case for other group product offerings.

Also, group long-term-care insurance plans typically limit the benefits options that are offered, both for simplicity in explaining options and to minimize exposure when limited underwriting approaches are utilized. This often makes the group long-term-care insurance benefit offering less attractive than its individual counterpart. With initial premium levels a major concern to a successful group long-term-care insurance enrollment, many group long-term-care insurance plans de-emphasize compound COLA and instead offer a pay-as-you-go guaranteed insurability buy-up option. Also, lifetime benefits are often not offered or emphasized, while single- or 10-pay options are almost never available.

For these reasons, group long-term-care insurance generally should be avoided. The purchasers in this type of program usually will wind up with a less benefit-rich and premium-stable program. Instead, employers should seek out a fully underwritten, individual long-term-care insurance program with--if available--a group-endorsed discount.

Tax-Qualified vs. Nontax-Qualified

The debate over tax-qualified vs. nontax-qualified policies has been raging unabated since the federal government passed the Health Insurance Portability and Accountability Act in 1996. The two camps on either side of this issue are well defined, and neither tends to accept the logic or predictions of the other. But there are a few facts that both sides should accept without challenge. Among these, two stand out as particularly important.

First is the concept that nontax-qualified policies provide more easily accessed and often richer product features. Unless the initial premiums are proportionately higher, then premiums for nontax-qualified policies will need to be increased significantly in the future, perhaps to unaffordable levels. The other undisputed fact is that companies issuing nontax-qualified policies are subject to an accelerated federal income tax relative to those same companies issuing tax-qualified policies. This is due to the requirement under HIPAA that nontax-qualified policies use two-year preliminary term tax reserves instead of the one-year preliminary term tax reserves allowed for tax-qualified. The effect of this accelerated tax over the first 10 policy years is an extra 2.5% expense for the company on sales of nontax-qualified policies relative to otherwise identical tax-qualified policies.

Those considering long-term-care insurance should purchase tax-qualified policies. It is likely that tax-qualified long-term-care insurance premiums soon will be income-tax deductible, and there is still a small but real risk that nontax-qualified long-term-care insurance benefits will be subject to income-tax liability.

The responsible purchase of long-term-care insurance is a tough proposition for both the agent and the client. There are many factors to be considered, even after the client has become convinced that long-term-care insurance is an appropriate purchase.

James M. Glickman, FSA, CLU, is president and chief executive officer of LifeCare Assurance Co., a long-term-care reinsurer based in Woodland Hills, Calif.