Why Did Underwriters Guess So Wrong About Long-Term Care Insurance?
Life insurance and annuities have been around for centuries, providing essential financial protection to individuals and families. However, when we look at long-term care (LTC) insurance, which has been available for approximately fifty years, a fascinating yet concerning story emerges. The nature of LTC insurance often means that individuals do not use it for years, or even decades, after purchasing it. This unique characteristic led actuaries to make certain assumptions about various aspects of the insurance, including lapse ratios, claims incidence, severity, and interest rates. However, these assumptions were often far from accurate, as the actuaries were, in essence, making educated guesses in an immature market.
When LTC insurance policies first began to be sold, the industry was highly uncertain about the future. Actuaries and underwriters had to rely on limited data and assumptions about future claims, which often turned out to be incorrect. As these policies started paying claims after years or even decades, it became evident that the initial assumptions had been overly optimistic. The underwriters, who were essentially guessing, often had to face the consequences of their misjudgments.
Modern Precision in LTC Insurance Pricing
As the market for LTC insurance has matured, actuaries have gained more experience and data. A recent actuarial study by the Society of Actuaries reveals a significant improvement in the industry's ability to price these policies accurately. Today, carriers are taking a much more conservative approach to pricing, which means that LTC policies sold now should be much more stable than those of the past. The study shows that policies built using modern pricing assumptions have only a 10% chance of ever needing a rate increase. This substantial progress is largely attributed to the wealth of claims data available to actuaries now, compared to the limited data they had in the early 2000s. With 16 times as much claims data, it is clear that the industry has advanced significantly in understanding the true risk factors associated with LTC insurance.
Common Misassumptions in LTC Insurance
The primary reason for the underwriters' initial mistakes was a fundamental misunderstanding of how LTC insurance would be purchased and used. Underwriters assumed that young people would deeply contemplate their aging disabilities years before they occurred and value support, ensuring they paid for years to ensure they would be cared for during aging. However, this assumption turned out to be incorrect. The reality is that the only significant buyers of LTC insurance were those much older and who already had an inkling of disability challenges. Insurance products are often less successful when buyers are most likely to use them, particularly in the short term.
The Influence of Long-Term Cancellations
Another significant issue with underwriting LTC insurance was the assumption that the cancellation rate would be higher than it turned out to be. Younger policyholders may not want to keep a policy they don’t expect to use, but after paying in for years, people become more reluctant to cancel, especially when the premiums become more attractive as their risk of needing care increases. This assumption led to overpricing in the early days, as the underwriters factored in a higher likelihood of policy cancellations.
Proven Stability of Modern Pricing
Despite the initial missteps, the modern pricing models for LTC insurance have proven to be far more stable. For instance, a personal experience illustrates this stability. The author has had long-term care insurance for nearly 20 years, and the premium has increased only once. Had the underwriters guessed so wrong, we would have seen requests for further premium increases from state regulators. Instead, the stability of modern pricing models is evident, with a low probability of further rate increases.
As the LTC insurance market continues to evolve, it is becoming more transparent and accurate. With improved data and advanced actuarial techniques, the industry is better positioned to manage risk and provide reliable coverage for those who need it most.
Keywords: long-term care insurance, actuarial assumptions, premium stability, policy pricing, underwriting mistakes