Journal of Financial Planning: April 2013
As the long-term-care (LTC) insurance industry continues to struggle in today’s low interest rate environment, a growing number of clients who bought long-term-care insurance in the past are getting notifications of premium increases—and often they’re very significant increases, even from major companies like Genworth, John Hancock, Prudential, and MetLife.
While the rate increase may be a shock, the reality is that in many cases the coverage is still cheaper than it would be to buy the policy anew in today’s marketplace—which essentially means that even with the premium increase, continuing the LTC coverage can be a pretty good deal.
Nonetheless, in some situations the premium increase makes the insurance unaffordable, forcing clients to decide how to modify and reduce the coverage to maintain the original premiums. When such reductions are necessary, most clients should choose to reduce the benefit period, and older clients may reduce the rate on the inflation rider as well; most clients will probably want to avoid reducing the daily benefit amount.
The good news is that given how much more expensive LTC insurance is in the current marketplace, it’s drastically less likely there will be premium increases on today’s new policies. However, it’s still necessary to properly deal with and navigate the rate increases that are occurring on coverage purchased years ago.
How Rate Increases Work
Qualified long-term-care insurance (eligible for tax-free benefits under the Internal Revenue Code) must be guaranteed renewable—meaning as long as premiums continue to be paid, the insurance company must continue the client’s coverage, and they cannot single the client out to either cancel his or her coverage or raise the premiums.
However, rates on insurance that are guaranteed renewable can be increased by going to a state’s Department of Insurance and requesting a premium increase for an entire class of policies, such as “all policies issued to people age 55–64 in the year 1998,” and if your client falls into that group, the client’s rates can be increased.
Given that state insurance departments have to agree to premium increases, which aren’t exactly popular, why do they ever approve them? Because in situations where the premiums are too far below anticipated claims, there’s a risk that the insurance company could be rendered insolvent and unable to fully pay all claims to all policyowners. It’s better to have a rate increase that ensures policyowners get all their benefits than keep premiums in place at the risk of rendering the policies partially or entirely defunct.
Notably, though, what premium increases do not allow is for companies to make up prior losses or increase the premiums so far that the insurance company can make a big profit going forward. Premium increases tend to merely be enough to ensure that the company remains solvent and capable of fully paying all claims for all policyowners. Of course, there is some uncertainty to the projections, so it’s conceivable that the insurance department may approve a rate increase large enough that the insurance company will enjoy some extra profits.
But in practice, the opposite seems to be the case; state insurance departments have been so unwilling to push through premium increases (unless absolutely necessary) that often the increases are huge when they do occur because the insurance company has been undercharging for so many years. Some companies have ultimately had to go back later and ask for another premium increase, because the first increase was so conservative for existing policyowners that it still wasn’t enough to ensure solvency (much less any profits) for the insurance company.
What to Do When a Premium Increase Occurs
Given all the steps involved for an insurance company to get a premium increase approved, what should clients do when the notification arrives?
The good news is there are usually more choices than just “pay the new premium,” or “get rid of the policy.” To give policyowners flexibility in how to handle a rate increase, insurance companies usually offer several options, including:
- Keep the policy as-is and just pay the new premium
- Keep the current premium and reduce the policy’s daily benefit amount to the extent necessary to bring benefits in line with cost (for example, from $250/day down to $200/day)
- Keep the current premium and reduce the policy’s benefit period to the extent necessary to bring benefits in line with cost (for example, from a five-year benefit period down to four years)
- Keep the current premium and reduce the policy’s benefits inflation rate (if the policy included an inflation rider) to the extent necessary to bring benefits in line with cost (for example, from a 5 percent inflation rider down to a 3.5 percent inflation rider)
- Cancel the policy
The bad news is that more choices make the decision more complex. Although not every insurance company and premium increase situation will include all five options—the requirements for what is made available vary by state, and some insurance companies offer more flexibility than others—most companies will offer at least one or two of the options in the middle, in addition to the first and last.
Which choices are most appealing? Various factors should be considered:
1) Keep the policy as-is and just pay the new premium. In general, this is the most appealing option, if it’s affordable. For instance, think of the situation in another context, as though the cable company came forward one day and said:
“Our apologies, we just discovered an error in our billing. Although you currently receive the 187 premium channel cable service, we have been billing you for the 114 channel basic service. Having discovered our error, we unfortunately need to raise your rates to charge you for the 187 premium channel service you are receiving. Alternatively, if you wish, you can drop your service down to the 114 channel basic service that you have been paying for all along, and we’ll continue to charge you the same amount. Either way, we will not charge you anything for all the years we accidentally gave you the premium service for the basic cost.”
If you want the 187 premium channel cable service, and can afford it, you should go ahead and pay for it even after the price is corrected. It is frustrating that you can’t get the same features for the original cost, but the original pricing was wrong, and the new pricing is correct. The new pricing can still be a good value for the benefits you receive.
This is especially true in the long-term-care insurance context, because policies getting premium increases are generally still much less expensive than the coverage would cost new today.
For instance, a policy for $200/day with lifetime benefits that might have cost $2,000/year if purchased in 2001 might get a premium increase notification of 50 percent with the premium jumping to $3,000/year. Yet a comparable policy today for the same benefits for the same age could easily cost upwards of $4,000/year (and in fact, lifetime benefits aren’t even available anymore). In other words, even after the premium increase, most older policies are still cheaper than equivalent new policies today. Of course, if the client actually bought the policy 12 years ago, then the daily benefit would not be $200/day but would be up to about $350/day with inflation adjustments; getting that policy new in today’s marketplace could cost nearly $7,000!
So while a surprise premium increase from $2,000 to $3,000 may be a very unpleasant shock, it still may represent a fantastic deal for the coverage going forward. If the policy is still affordable, it is almost always a good financial decision to keep the coverage at the new rates (assuming, of course, that the coverage is still needed in the first place).
2), 3), and 4) Keep the current premium and reduce the policy’s daily benefit amount, benefit period, or inflation rate to the extent necessary to bring benefits in line with cost.
When the premiums are not affordable after an increase, the next choice is to select an option that will decrease (but not cancel) coverage, to bring benefits down to the point where they are aligned with the original premium.
Given the options for what to reduce, the first choice in most cases should be the benefit period, especially if it is five or more years in duration. The reason is simple: the average long-term-care insurance claim is only about 2.8 years (1,040 days), according to the American Association for Long-Term Care Insurance. The median claim is even shorter, as the average is distorted by a small number of extremely long claims. While it’s true that there is some risk that your client could be the next ultra-long claim, the odds are against that happening, and that owning a long benefit period will simply mean paying for a lot of coverage duration that will never be used. In a scenario where the premiums are unaffordable, paying for coverage for an unlikely claim duration should be the first thing to go.
The next option to consider reducing, in most scenarios, is the inflation rate on the policy. If the client has already had the policy for about 10 years or more (as that’s often how long it takes before premium increases begin), the client has already gotten a lot of leverage out of the inflation rider, is older, and unfortunately is closer to the point where he or she may either make a claim sooner or die sooner, limiting the value of the inflation rider going forward. This is contingent on age, though: the older the client is, the more appropriate it is to consider reducing the rate on the inflation rider. Clients in their 70s and especially 80s might consider a reduction in the inflation rate; clients in their 60s should be cautious about reducing the inflation rate; clients in their 50s or younger (although premium increases on such policies are rare in the first place) should not reduce their inflation rate as the impact could be severe over a multi-decade period (it would be better to just reduce the daily benefit amount and let it compound back up with a full inflation rate).
The option of last resort for most clients—except perhaps those who bought the policy when they were very young—is to reduce the daily benefit amount. In most situations, clients only buy enough coverage to, at best, meet the average cost of care in their area, so it should be last on the list for cutting. Verify whether your client’s coverage is still in line with typical costs in the area by checking out the Genworth Cost of Care data. Be certain to look at the client’s current inflation-adjusted benefits and not the original benefit amount.
5) Cancel the policy. As a true choice of last resort, if the coverage is unaffordable it simply can be cancelled. Given the ways that coverage can be reduced to stay level with current premiums, though, this should only be selected if there has been a change in needs such that the coverage is no longer necessary (for example, wealth has increased to the point that the client can afford to self-insure and has chosen to do so).
The Bottom Line
Getting a notice of a premium increase on a long-term-care insurance policy is certainly not pleasant, especially because it only occurs when the situation is serious—which unfortunately means the magnitude of the increase is usually somewhere between “large” and “very large” when it arrives.
Nonetheless, the fact remains that even after premium increases, an older long-term-care insurance policy is still usually much less expensive than what a comparable new policy would cost in today’s marketplace, and still represents a tremendously leveraged way to pay for long-term-care insurance. After all, if the client ultimately makes a claim of $250,000, $500,000, or more, the financial benefits will be fantastic regardless of whether the coverage cost $2,000/year or $3,000/year. So if possible, the best deal when a premium increase occurs is to keep paying the new premiums.
To the extent a premium increase is unaffordable, though, something must be done. It’s important first to be certain that the client understands why the premium increase has occurred, and what it does (keeps the company solvent to pay policyowners going forward) and does not do (help the company make up for lost profits).
On the plus side, because new policies today are even more expensive than old policies with premium increases, the risk of future rate increases on today’s newly purchased long-term-care insurance is the lowest it’s ever been. While rate increases are an unfortunate reality for those who purchased coverage years ago when the insurance was first offered, such increases will soon be a thing of the past.
Michael E. Kitces, CFP®, CLU®, ChFC®, RHU, REBC, is a partner and the director of research for Pinnacle Advisory Group. He is the publisher of the e-newsletter The Kitces Report and the financial planning industry blog Nerd’s Eye View through his website www.Kitces.com. He also serves as practitioner editor of the Journal of Financial Planning. Follow him on Twitter at @MichaelKitces.