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Crumbling Economics Undermine Long-Term Care Offerings

Editor’s Note: This article originally appeared online in December on our website’s Current Commentary blog.

All publicity may not be good publicity after all, the long-term care (LTC) insurance industry discovered recently.

The industry had named November “National Long-Term Care Insurance Month,” hoping to raise awareness of the “need” for the product. However, the bulk of the month’s press focused on the woes of two key insurers, MetLife and John Hancock, and instead raised awareness of the industry’s struggles.

In early November, MetLife announced that it would stop selling LTC insurance as of Dec. 30, 2010. Although it continues to provide coverage for current policyholders, it no longer writes new policies. It will also discontinue new enrollments in group policies and multi-life plans starting next year.

Meanwhile, John Hancock asked state regulators for an average rate increase of 40 percent on most of its existing policies. The insurer also plans to raise the price of new policies by 24 percent this year. John Hancock has stopped selling policies to employers who offer the insurance as an employee benefit, but — unlike MetLife — it will continue to sell individual policies, as long as it can find anyone willing to pay its new rates,.

There was no single event in November that crumbled MetLife’s and John Hancock’s business. The two announcements were just the latest signs of the LTC insurance industry’s slow decay. The problem is not the economy or any other environmental factor; rather, it is that selling LTC insurance is unprofitable.

The purpose of insurance is to spread the cost of a highly unlikely and catastrophic (read costly) event across a group of people. Instead of risking a potentially large loss, the insured takes a small, known loss in the form of a premium. The key is that the event must be unlikely. If it is too common, affordable premiums will not be able to cover the cost of the claims and still leave a profit for the insurer.

As any insurance salesperson would acknowledge, as we age, our likelihood of needing long-term care approaches certainty. The risk no longer fits the “unlikely” category, and insurance becomes an inefficient and inappropriate solution.

As claims increase, the insurer passes the cost on to the policyholders in the form of higher premiums. Increasing the premiums, however, is only a temporary patch. Once premiums go up, those who are at lower risk abandon their costly policies, leaving an even higher-risk pool to share the costs and exacerbating the funding problems.

Persistently low interest rates have hastened the industry’s deterioration. Insurers have been unable to earn sufficient rates on their investment portfolios to fund policy payouts and therefore have had to rely even more on premiums. According to the American Association for Long Term Care Insurance, insurers need to increase premiums 10 to 15 percent to make up for each 1 percent drop in interest rates. It is unlikely that interest rates will rise enough in the near future to ease the stress on insurers.

MetLife vows that its current long-term care policyholders will not be affected by its recent decision. They will still be covered as long as they pay their premiums, the company says, and may even be able to change their coverage terms depending on what their particular policies permit. However, it is unlikely that those currently insured will be entirely unscathed. Without a younger, healthier group of insured individuals entering the pool, MetLife will have difficulty finding the cash to cover its claims. As a result, it will most likely have to raise premiums on its remaining long-term care policies to cover its costs.

In its press release, MetLife acknowledged that LTC insurance in its current form cannot balance financing claims with its business goals. In other words, the business is unprofitable. However, MetLife suggested that it may return to the market if a profitable product is ever developed.

That profitable product might take the form of a hybrid policy, one that combines an annuity or life insurance contract with a traditional LTC policy. Several insurers are already beginning to offer policies of this sort. Hybrids are more likely to attract lower risk customers because, even if a policyholder never needs long-term care, he or she still gets a guaranteed payout. This makes the business more likely to be profitable and sustainable.

While hybrid policies are more defensible than traditional LTC insurance, I am hesitant to recommend them. The health care industry is too dynamic to be easily predictable, and these are still relatively new, untested products.

We all face a number of potential expenses in our old age: We may need to help support children or grandchildren; we may need to renovate a house that is also aging; or we may just be unable to resist buying a vacation home on the beach. There is no reason to treat the possibility of needing long-term care any differently from these other possible expenses. In all cases, one should recognize the need for funds and save and invest appropriately throughout one’s lifetime. Relying on a flawed insurance product is not going to help.

If you enjoyed this article, be sure to check out Palisades Hudson’s books, The High Achiever’s Guide To Wealth and Looking Ahead: Life, Family, Wealth and Business After 55. Both are available in paperback and as e-books.