Long-Term Care Insurers: Knowing More Than Your ‘Opponent’

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I’ve said this before, but it bears repeating: be careful in any transaction where the other parties know the deal better than you do.  In most insurance transactions, the company knows more about the transaction than the individuals or firms seeking coverage.  There are exceptions, though, when the model for policyholder claims behavior is not well-understood.  This exists in life and annuity coverages in small ways, and in health, disability, and long-term care coverages in greater ways.

Long-Term Care Insurers: Knowing More Than Your 'Opponent'

The main advantage that a potential life/disability/health insurance buyer has is that he knows the details of his health far better than the insurer does.  Underwriting standards vary across companies, and not all companies are as thorough at checking the health of the insured as the others do.

With life and annuity coverages, outside of life settlements, this risk to the insurance companies is small, because the actuaries expect the potential losses from the hidden knowledge of the insureds, and build it into pricing.  Death is a tough way to make money, and those using it to make money off insurers must pay a heavy price to do so.  When death stares you in the face, it seems kind of callous to say, “How can I make money off this for my heirs?”  Most people realize that there is something more serious going on than making money, when death is near.

But when we deal with health matters, things get more murky, particularly the older we get.  Again, insurers will attempt to determine those that have the greater probability of making significant claims, but the ability to do so is more limited, because people know when they are not well beyond when they have sought medical help in the past.

(This is one reason why Obamacare (PPACA) will end up increasing costs for most healthy people.  By attempting to cover everyone, and limiting the ratio of premiums from the sick to the healthy to a factor of three, those who are healthy will pay a lot more, or find some clever way to drop out.)

As an aside, before the modern health insurers found their footing around 1988, cumulative profits for the industry as a whole was negative.  Since then, they got better at discriminating on what groups/individuals they would cover, and those they would not.

But with long-term care insurance, the insurance industry has not made money to date. Why?  Insurers have consistently underestimated the willingness of people to file claims on their policies.  There is no incentive not to do so, unlike death.

Thus the insurers have been in a battle involving raising premiums on new and old business, with healthier business leaving.  The model doesn’t work, I don’t care what the largest writer Genworth Financial Inc (NYSE:GNW) thinks, when the article says:

Genworth Financial Inc., with about a 33% market share of long-term-care policies sold to individuals, said in May that it is seeking premium increases averaging more than 50% to stave off more losses in its oldest policies.

Genworth also halted sales June 1 through AARP, the older-Americans’ group with a huge pool of potential customers.

“We’ve learned a lot over the last 30 years, and we now believe we have a better ability and more knowledge” to issue policies that “provide significant financial protection to Genworth,” Genworth Chief Executive Thomas McInerney said in an interview.

The insurer started requiring blood tests and other medical screening, which the industry generally hadn’t done before. And it is charging women who apply individually more than men for the first time because women tend to live longer and require more years of care.

That brings me to this summary: don’t own companies that are deep into long term care, like Genworth.  Think of Penn Treaty, and other companies that went bankrupt as a result of long term care.  Long-term care  is not insurable; those insured have too much control over when they make claims.

As for those with long-term care policies, if they are old, keep paying on them, you will likely do well on them when you finally need to draw on the policies.  You have benefits that benefits that can no longer be purchased.  Enjoy the exclusive club you are in.

By David Merkel, CFA of Aleph Blog

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About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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