Long-Term Care Insurance: Federal Program Has a Unique Profit Structure and Faced a Significant Marketing Challenge
Released: 2006-12-29T00:00:00

Letter

Background

Long-term care, which may include care provided in nursing homes, assisted-living facilities, or a person’s home, can be expensive. In 2005, the average cost of a year in a nursing home was more than $70,000, and in 1999, according to the most recent data available, the average length of stay was between 2 and 3 years. Long-term care insurance helps individuals pay for costs associated with long-term care services. Yet relatively few individuals have obtained coverage. As of 2002, about 9 million people nationwide had obtained long-term care insurance. To help federal employees, retirees, and others obtain coverage, the federal government began offering long-term care insurance in 2002.

Long-Term Care Insurance

Long-term care insurance helps pay for the costs associated with long- term care services. People can purchase long-term care insurance directly from carriers that sell products in the individual market, or they can enroll in plans offered by employers or other groups. For a specified premium that is designed—but not guaranteed—to remain level over time, the carrier agrees to provide covered benefits under an insurance contract.

Long-term care insurance premiums are affected by many factors, including the benefits offered and the age and health status of the applicant. Carriers review the health status of the applicant during the underwriting process. Carrier assumptions about interest rates, mortality rates, morbidity rates, and lapse rates—the number of people expected to drop their policies over time—also affect premium rates. Carriers set premium rates to cover the anticipated cost of enrollee benefits (which means paying approved claims), administrative costs (which includes marketing costs, claims handling, overhead, and taxes), and profits.

Few claims are expected to be submitted during the early years of an enrollee’s long-term care insurance policy. As a result of underwriting, it is unlikely that many people could meet the eligibility requirements to buy a policy yet submit an approved claim within 3 years. Industry experts suggest that the rate of claim submissions begins to increase after about 3 to 7 years.

Claims experience is one of many factors—such as interest rates and lapse rates—that affect the long-term financial outlook of a long-term care program. While having a lower-than-expected claims experience is a positive financial indicator, if the claims experience is significantly lower than expected over the long term, then it is possible that the premiums are too high. On the other hand, in accordance with the National Association of Insurance Commissioners (NAIC) premium-setting guidelines, it may be appropriate to project the claims experience assuming moderately adverse results to protect against the need to raise premiums.

Insurance carriers’ long-term care insurance profits—defined as the excess of revenues over expenses—are affected by many factors, including the amount of risk the insurance carrier assumes. In general, the more risk a carrier assumes, the greater the carrier’s expected profits. Over time, carriers’ ability to meet or exceed their initial projections regarding interest rates, mortality rates, morbidity rates, and lapse rates, as well as their ability to contain costs, ultimately affects their profits. Carriers are also subject to state requirements, which may affect their ability to realize profits.

Long-Term Care Insurance Marketplace

Long-term care insurance is sold in two primary markets—the individual and group markets. Of the nearly 9 million policies sold as of 2002, the most recent year for which data were available, about 80 percent were sold through the individual market, and the remaining 20 percent were sold through the group market. Sales in the group market are growing faster than sales in the individual market. In March 2006, 13 percent of full-time employees in private industry had access to employer-sponsored long-term care insurance benefits; 20 percent of employees of establishments with 100 or more employees had access to this benefit.

The individual market includes plans sold by insurance carriers to individuals, usually through agents or brokers. Individuals may choose benefits from a range of options offered by the carriers, including the duration and amount of daily benefit payments. Those who purchase coverage through the individual market typically pay the full premium. The carrier generally owns program assets and bears the risk of insuring enrollees for the terms of enrollees’ policies.

The group market includes long-term care insurance plans offered to individuals through employers and other groups, such as professional associations. In this market, the groups usually design the benefits, and enrollees are often given some benefit options from which to choose, including the duration and amount of daily benefit payments. However, benefit options offered in the group market tend to be fewer than those offered in the individual market. Individuals who purchase long-term care insurance in the group market typically pay the full premium, similar to those who purchase coverage in the individual market.

Employers and other groups typically contract with insurance carriers to provide long-term care insurance to qualified individuals. These contracts may be time-limited, lasting, for example, 3 to 5 years. Under these contracts, carriers are usually required to bear the risk of insuring enrollees for the terms of enrollees’ policies; the term of enrollees’ policies may be independent from, and therefore longer than, the length of an employer’s contract with a carrier. These carriers also generally own all program assets. As a result, if a carrier’s contract with an employer was not renewed, the carrier would usually be required by its contract to continue insuring those individuals for whom it issued policies.

Several large carriers dominated the long-term care insurance coverage sold in the individual and group markets, as of December 31, 2005. While the long-term care insurance industry experienced 18 percent annual growth in the number of policies sold from 1987 through 2002, the industry has experienced a downturn in more recent years, according to industry experts. Specifically, carriers faced several challenges, including higher-than-expected administrative expenses relative to premiums; lower- than-expected lapse rates, which increased the number of people likely to submit claims; low interest rates, which reduced the actual return on investments below what had been assumed; and new state regulations that limited direct marketing by telephone. As a result, beginning in 2003, for example, many carriers in the individual market raised premiums, left the marketplace, or consolidated to form larger companies. In addition, many carriers have revised the assumptions used in setting premiums, taking a more conservative approach that has led to higher premiums, while state regulators have increased their oversight of the industry.

Federal Long Term Care Insurance Program

The federal government began offering a group long-term care insurance program in 2002 whereby certain eligible individuals affiliated with more than 125 federal agencies may apply for coverage. Individuals eligible for the Federal Long Term Care Insurance Program include federal and Postal Service employees and retirees; active and retired members of the uniformed services; qualified relatives of these individuals; and certain others. Almost 19 million people were estimated to be eligible for coverage as of October 15, 2001. With more than 214,000 current enrollees as of September 2006, the federal program is the largest employer- sponsored group program in the nation. When the Federal Long Term Care Insurance Program began, eligible individuals could apply for enrollment during two specified periods: an early enrollment period held from March 25, 2002, through May 15, 2002, and an open enrollment period held from July 1, 2002, through December 31, 2002. Following the open enrollment period, eligible individuals could apply for coverage at any time. As is typical for other plans sold in the group market, enrollees pay the entire cost of their premium. As we noted in our March 2006 report, the federal program offered benefits similar to those of other long term- care insurance products, usually at lower premiums for comparable benefits, and the federal program’s early enrollment and claims were lower than initially expected.

OPM oversees the federal program, and Partners administers the program in accordance with the requirements of a 7-year contract between OPM and Partners. The contract, signed December 18, 2001, defines key administrative requirements, including OPM’s oversight of the program and how payments for the federal program’s expenses, as well as payments that are earmarked as profits, are determined. Unlike other contracts between employers and carriers, the federal program’s contract includes requirements for the management of federal program assets— that is, the funds collected as premiums and used to pay claims—because the federal program does not give Partners ownership of federal program assets.

By statute, OPM’s contract with Partners is for 7 years and is not automatically renewable. At the end of the 7-year term, OPM can either renegotiate the contract with Partners, or allow the contract to terminate and select a new carrier. If a new carrier is selected, Partners must transfer all federal program enrollees and assets, including any positive or negative returns related to the experience of the program, to the federal program’s next carrier. However, if OPM does not contract with another carrier, Partners would continue insuring the individuals who enrolled in the federal program through Partners. In this case, the federal program’s assets would remain available to Partners to pay for claims and expenses.

Federal Program Has a Unique Profit Structure

The federal program has a unique profit structure that is explicitly defined in the contract between OPM and Partners. This profit structure consists of three distinct annual payments to Partners to compensate Partners for the risks it assumes under the program’s 7-year contract. Of these payments, two are based on a percentage of the premiums collected during the year and one is based on the average annual assets of the federal program. (See table 1.) These three payments are allowed only if premiums are sufficient to cover the federal program’s current claims and expenses. In contrast to the federal program, profits realized by carriers offering other long-term care insurance plans generally are not based on explicit profit structures. Instead, under the terms of their contracts, carriers assume the risk of insuring enrollees for the terms of enrollees’ policies and own program assets—and are thus able to realize profits or losses according to the experience of the programs they insure.

The federal program guarantees one annual premium-based payment to Partners. This payment equals 3.5 percent of the premiums collected in a year. For other long-term care insurance plans offered in the group and individual markets, carriers’ profits were generally not guaranteed, according to carrier officials and industry experts. Similar to the federal program, one source of carriers’ revenue is enrollee premiums, which include an amount for anticipated profits. However, carriers may realize profits or losses according to the experience of the programs they insure, subject to applicable state regulations.

The federal program links the second annual premium-based payment to OPM’s evaluation of Partners’ performance. This payment can equal up to 3 percent of the premiums collected in a year. Under an agreement which amended the contract between OPM and Partners and became effective beginning fiscal year 2006, OPM evaluates Partners’ performance each year on 21 short-term performance measures across 4 categories: administrative expense savings, customer service, enrollment experience, and responsiveness to OPM. Each performance measure has a corresponding payment equivalent to a percentage of the total performance-based payment of 3 percent of premiums. If Partners’ performance does not meet stated expectations in a measure, the payment corresponding to that measure is placed into a retained profit account. In addition, every 3 years, OPM evaluates Partners’ performance in two long- term performance measures: return on investment and claims experience. If Partners meets expectations in one measure and funds are present in the retained profit account, one-half of the amount present in the retained profit account is paid to Partners. If Partners meets expectations in both measures and funds are present in the retained profit account, the total amount present in the retained profit account is paid to Partners. As of September 2006, Partners has been awarded the full performance-based payment each year since the federal program began. Appendix I provides a complete list of the performance measures used for the federal program.

Unlike the federal program, most other sponsors of plans offered in the group market usually did not link carrier profits to performance evaluations, according to carrier officials and industry experts. Carrier officials estimated that about 10 percent to 20 percent of employers required their long-term care insurance carrier to relinquish a certain percentage (for example, 2 percent to 4 percent) of premiums if their performance did not meet agreed-upon expectations. However, employers may require carriers to guarantee a certain level of performance in their contracts to ensure that enrollees are provided with standard levels of service, according to state officials. These performance measures and guarantees may include those related to the timeliness of underwriting decisions and call center performance. The federal program used all of the performance measures that industry experts and carrier officials cited as those commonly used throughout in the group market, in addition to other measures such as administrative expense savings and claims experience.

The federal program’s third payment is guaranteed and is based on the average annual assets of the program. This annual payment—0.3 percent of the average annual assets of the federal program—is defined in the contract between OPM and Partners as a profit payment. The federal program developed this payment to recognize that insurers in general are required to hold risk-based capital. Risk-based capital is the capital that an insurance carrier is required to hold in reserve, separate from any other funds used to back insurance liabilities or other lines of business, to protect the carrier from insolvency. OPM does not require Partners to use the third payment to fund risk-based capital and both OPM and Partners consider this payment another form of profit for administering the program. Similar to the federal program, carriers use enrollee premium funds to fund risk-based capital requirements, according to OPM officials. However, risk-based capital may be considered an expense to carriers.

Federal Program Used Marketing Efforts Generally Similar to Those Used for Other Plans but Faced a Significant Challenge

The federal program used marketing efforts that were generally similar to those used for other plans sold in the group market. For example, the types of marketing efforts used for the federal program and other plans offered in the group market, according to our review of federal program documents and the carrier and state officials we spoke with, included mailing information directly to the homes of eligible individuals, sending e-mails to eligible employees at work, posting information on a Web site, hosting employee and retiree seminars, and working with affinity groups whose membership consists of eligible individuals.

Of these efforts, carrier officials we spoke with told us that direct mail, which may include a personalized letter, is a critical marketing effort for long-term care insurance plans. One carrier official also explained that direct mail was so critical to the carrier’s marketing strategy that it generally would not work with employers who neither provide the home addresses of employees nor assist in mailing materials to employees.

The federal program faced a significant challenge in sending information directly to eligible individuals, particularly through direct mail. Specifically, the federal program was initially unable to mail information directly to the homes of about 60 percent of the program’s core group of eligible individuals that Partners deemed most likely to enroll in the federal program—including nearly all active federal civilian employees— because neither OPM nor Partners had the home addresses of these individuals. OPM officials told us that a centralized database of this information does not exist. According to OPM officials, OPM did not request federal employees’ home address information from other federal agencies because they felt it would be too burdensome to comply with certain Privacy Act requirements and gather accurate information from each of the agencies in a timely manner. Despite this challenge, the federal program initially mailed information directly to the homes of those for whom it had addresses, which included about 40 percent of the program’s core group of eligible individuals, as well as other non-core groups such as retired military personnel and annuitants under the Civil Service Retirement System and the Federal Employees Retirement System, according to our analysis of Partners’ data. As of October 2006, Partners officials noted that direct mail efforts were still limited because of the federal program’s inability to mail information directly to the homes of most active federal civilian employees. Before signing its contract with OPM, Partners was aware of the federal program’s limitations regarding direct mail.

As a result of the federal program’s limited ability to send direct mail to many eligible individuals, the federal program relied heavily on marketing efforts that were less direct and less personalized, including sending information to federal employees through agency benefits officers and working with affinity groups. Because neither OPM nor Partners has direct access to federal employees through e-mail, Partners has worked with more than 150 agency benefits officers to distribute program information to federal employees through e-mail, internal office mail, or other means. For example, Partners relies on agency benefits officers to send e-mails about the federal program. While Partners officials may be notified by agency benefits officers when they send program information, Partners is unable to determine whether all eligible federal employees receive this information. In addition, Partners has worked with several affinity groups, such as Federally Employed Women and the National Active and Retired Federal Employees Association, to educate their members about the need for long-term care insurance and to advertise in publications and at sponsored events. Through these efforts, Partners has gained direct access to the groups’ members.

Claims Experience in the Federal Program Increased but Remained Lower Than Expectations

In the federal program’s fourth year, claims experience—the amount of claim payments per enrollee and the number of paid claims per enrollee— increased from that of the program’s third year, but remained lower than Partners’ expectations as established in its contract with OPM. This increase was generally consistent with trends since the federal program began in 2002. As we reported in March 2006, claims experience in the federal program’s first 3 years was lower than the initial expectations set by Partners. Our analysis of Partners’ data showed that claims experience also remained lower than expected for the federal program’s fourth year. As of March 31, 2006, the end of the federal program’s fourth year, the federal program had cumulatively paid 44 percent of the expected amount of claim payments per enrollee and 41 percent of the expected number of claims per enrollee, across the 4 years, as shown in table 2. Figure 1 shows the amount of claims payments per 10,000 enrollees. As of August 2006, Partners had not determined why the claims experience was lower than Partners’ expectations. Claims experience is one of many factors—such as interest rates and lapse rates—that affect the long-term financial outlook of a long-term care insurance program. While it is generally expected that the number of claims submitted in the first few years of a long-term care insurance program will be a small portion of the total number of claims submitted over time, the rate of claim submissions usually begins to increase after about 3 to 7 years, according to industry experts.

Concluding Observations

Our findings from two reports together show that the Federal Long Term Care Insurance Program compared favorably with other plans, has a unique profit structure, and used marketing efforts that were generally similar to those of other plans, but faced a significant challenge. Specifically, our initial report found that the federal program offered benefits similar to those of other long-term care insurance products, usually at lower premiums for comparable benefits. In this, our second report, we examined other components of the federal program’s competitiveness, including the federal program’s profit structure and marketing efforts. We found that the federal program has a unique profit structure, created to compensate Partners for the risks it assumed for the program. The risks borne by Partners, however, are not as great as those assumed by carriers selling other plans because, unlike with other plans, the federal program’s assets are owned by the program, not by the insurer. Because of this structure, the program does not link Partners’ profits to the overall experience of the program. Rather, the program guarantees some profit payments, links some profit payments to OPM’s evaluation of Partners’ performance, and requires Partners to assume a potentially time- limited risk, after which all program assets and enrollees may be transferred to another carrier. Insurance carriers’ profits are linked to the amount of risk they bear, and Partners assumes less risk for insuring the federal program than do carriers for insuring other long-term care insurance plans. Therefore, the federal program’s profit payments would likely be lower than the profits realized by carriers selling other plans. In addition, while the federal program used marketing efforts that were generally similar to those used for other plans sold in the group market, the program faced a significant challenge in providing personalized marketing communications directly to eligible individuals and instead relied heavily on other marketing efforts.

In our initial report we found that the federal program’s claims experience—the amount and number of claims payments per enrollee— was lower than expected in the first 3 years of the program. While it is generally expected that the number of claims submitted in the first few years of a long-term care insurance program will be a small portion of the total number of claims submitted over time, a program’s claims experience is one of several factors that may affect the long-term financial outlook of the program. In response to our recommendation in the initial report that OPM analyze the claims experience and assumptions affecting premiums to inform forthcoming contract negotiations, OPM indicated that it intended to provide updated information on claims experience and premium setting in its written recommendation to Congress before entering into the next contract for the administration of the Federal Long Term Care Insurance Program. Partners’ current contract with OPM for the administration of the federal program ends December 31, 2008. After reviewing a fourth year of claims data, we note that the program’s claims experience increased from that of the program’s third year, but still remains lower than Partners’ expectations. These results underscore the importance of our prior recommendations that OPM analyze the claims experience and assumptions as it considers its recommendations to Congress regarding a future contract.

Agency Comments

We provided a draft of this report to OPM and Partners. In its written comments, OPM generally agreed with our findings. OPM’s comments are reprinted in appendix II.

With regard to the program’s unique profit structure, OPM stated that now that it has more operating experience with the program, it plans to reexamine the profit structure as it renegotiates or rebids the contract for the administration of the program. OPM agreed that the marketing efforts for the federal program are more challenging for Partners than for other insurers because, among other reasons, home addresses for federal employees are generally not available. OPM noted that this will continue to be a constraint for the program in the future. In addition, OPM highlighted, as we noted in our draft report, that the ratio of actual to expected claims experience has narrowed and stated that it would continue to closely monitor the claims experience of the program. We support this effort and continue to encourage OPM to analyze the program’s claims experience and ensure that premiums and actuarial assumptions about future claims reflect the experience of the program.

In its comments, Partners highlighted certain distinct aspects of its profit structure that we noted in our draft report, including that Partners does not own federal program assets and that a profit payment is contingent on meeting specific performance standards that Partners characterized as exceptionally high for the insurance industry in general. Partners also stated that profit payments are paid only if the federal program’s assets are sufficient to cover the risks incurred by the program, as our draft report noted. Regarding the marketing efforts used for the federal program, Partners noted that the terrorist attacks of 2001 and the anthrax scare, which caused heightened security at federal buildings, added to the marketing challenge acknowledged in the report. We revised the report to reflect these circumstances. Finally, Partners commented, and as we noted in our draft report, that in addition to a program’s claims experience, premium rates are affected by a number of factors, including lapse rates and interest rates.

OPM and Partners provided technical comments and clarifications, which we incorporated as appropriate.

We are sending copies of this report to the Director of OPM and interested congressional committees. We will also provide copies to others on request. In addition, this report is available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please contact me at (202) 512-7119 or dickenj@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix III.

Appendix I: Performance Measures Used for the Federal Long Term Care Insurance Program

The Federal Long Term Care Insurance Program makes some profit payments to Long Term Care Partners LLC (Partners) according to the Office of Personnel Management’s (OPM) evaluation of Partners’ performance. Beginning in fiscal year 2006, OPM evaluates Partners’ performance each year on 21 short-term performance measures across 4 categories: administrative expense savings, customer service, enrollment experience, and responsiveness to OPM (see table 3). Every 3 years, OPM also evaluates Partners’ performance in two long-term performance measures: claims experience and return on investment (see table 4).

Appendix II: Comments from the Office of Personnel Management

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Acknowledgments

In addition to the contact named above, Christine Brudevold, Assistant Director; Patricia Roy; Timothy Walker; and Rasanjali Wickrema made key contributions to this report.

Related GAO Products

Long-Term Care Insurance: Federal Program Compared Favorably with Other Products, and Analysis of Claims Trend Could Inform Future Decisions. GAO-06-401. Washington, D.C.: March 31, 2006.

Overview of Long-Term Care Partnership Program. GAO-05-1021R. Washington, D.C.: September 9, 2005.

Long-Term Care Financing: Growing Demand and Cost of Services Are Straining Federal and State Budgets. GAO-05-564T. Washington, D.C.: April 27, 2005.