The Policy Sold on Assumptions That All Went the Wrong Way
Long term care policies sold decades ago were priced on assumptions about how long people would keep them, how long they would live, and what interest rates would be. All three assumptions were wrong in the same direction.
What the Policy Covers
Long term care insurance pays for assistance with daily living: home care, assisted living, or nursing facility care, typically triggered when the insured cannot perform a defined number of activities of daily living or has a cognitive impairment.
The need is real and the cost is substantial. Extended care is among the largest financial risks facing an older household, and it is not covered by ordinary health insurance or, beyond limited circumstances, by Medicare.
The insurance was designed to address exactly that gap, and the industry that sold it nearly destroyed itself doing so.
The Three Assumptions
Pricing a policy sold at sixty and claimed at eighty five requires forecasting several decades ahead. Insurers made three assumptions and each was wrong in the direction that cost them money.
| Assumption | Expected | Actual |
|---|---|---|
| Lapse rate | Several percent annually | Close to one percent |
| Claims incidence and duration | Lower | Higher, people lived longer needing care |
| Investment returns on reserves | High single digit | Collapsed with interest rates |
The lapse assumption was the most damaging and the least intuitive. Insurers priced assuming a meaningful share of policyholders would stop paying and forfeit coverage, as happens with life insurance.
Almost nobody lapsed. Policyholders who had paid premiums for twenty years, approaching the age when they might need the benefit, held on. The insurer was left paying claims on nearly every policy it wrote rather than on a fraction.
Lapse based pricing means the product is partly funded by customers who pay and never claim. When customers understand the product well enough not to abandon it, that funding disappears, and the price was always wrong.
The Rate Increases
Policies were sold as guaranteed renewable, meaning the insurer cannot cancel an individual policy or single somebody out for an increase. It can raise rates on an entire class of policyholders with regulatory approval.
Insurers did so, repeatedly, with cumulative increases on some older blocks exceeding a doubling or more.
The position for a policyholder receiving one is genuinely difficult. Paying the increase costs far more than budgeted. Dropping the policy forfeits decades of premiums. Reducing benefits keeps the coverage at a lower level, which is what insurers offer as an alternative and what most people take.
State regulators approving these increases faced a real dilemma, since refusing them risks insurer insolvency, and insolvency means guaranty association coverage at limits below the policy benefits.
Who Left the Market
The commercial consequence was an exodus. The number of insurers selling standalone policies fell from over a hundred to a handful.
Several large insurers placed their blocks into runoff, meaning no new sales and ongoing administration of existing policies. One major insurer long term care block became large enough relative to its capital that the parent company restructuring was driven substantially by it.
The remaining products are priced far more conservatively, with realistic lapse assumptions and lower investment return assumptions, which makes them considerably more expensive and much less likely to require future increases.
What Replaced It
The market shifted toward hybrid products combining long term care benefits with life insurance or an annuity.
The structure addresses the objection that drove many people away from standalone policies, which is paying premiums for decades and receiving nothing if care is never needed. A hybrid pays a death benefit if the care benefit is unused, so the money is not lost.
They also typically carry guaranteed premiums that cannot be increased, which is the direct response to the rate increase experience.
The cost is that they require a substantial single premium or a large committed payment stream, which excludes many buyers, and the care benefit per dollar of premium is generally lower than a standalone policy of the same cost.
The Honest Position for a Buyer
The underlying risk is real. A meaningful proportion of people reaching older age will need extended care, and the cost of several years of it can exhaust a household savings.
The options are self funding, which requires substantial assets; relying on the means tested public programme, which requires spending down assets first; a hybrid policy, which is expensive and predictable; or a standalone policy from the remaining carriers, priced on assumptions that are far more conservative than the ones that failed.
What is no longer available is the product that caused the problem: cheap coverage priced on the assumption that most people would abandon it.
The Bottom Line
Long term care insurance was mispriced on three assumptions that were all wrong in the same direction, and the most consequential was assuming policyholders would lapse. They did not, which meant the product was funded by a subsidy that never arrived, and the resulting rate increases fell on people who had paid faithfully for decades. The market that exists now is smaller, more expensive, and priced on assumptions that reflect what actually happened, which is the only sense in which the episode ended well.