Risk Based Horizon Scanning

LTCI has suffered for lack of risk-based long-term horizon scanning to the detriment of its clients. This is first in a forensic series of posts.

In the best case, the LTCI regulatory apparatus has proven itself inadequate concerning principles of risk-based long-term horizon scanning. A worse case would be if the carriers’ scheme was intentional and sufficiently subtle to dupe the regulatory agencies. The worst case is that neither carrier or regulatory apparatus is aware of long-term horizon scanning.

Risk-based horizon scanning

It is a formal effort and ability to identify risks or  assumptions that could go wrong to the best plan. Often, you hear the industry’s standard lament (excuse) for rate increases: (1) interest rates too low, (2) claims projections were understated, and (3) inadequate lapse rates. May I ask whether there were any sensitivity analyses performed as is customary for any mathematical modeling endeavor? Stress tests? Apparently not. This goes in the book as a major product design defect for failing to meet standards of basic commercial modeling.

Our recent efforts in Time Series Analysis (TSA), a forensic tool, have been revealing.  Our first post on TSA was LTCI Time Bandit which explains some key metrics (SUP, SDN, CEP) used below. The case below makes a point about long-term horizon scanning.

The experiment below concerns the rate filing history of carrier AEG though it can be any carrier (book). Since 2012, numerous AEG filings have lifetime loss ratios lingering in the range of 102% – 118%, with 106% being the most recent. Sustaining this range when the minimum statutory lifetime loss ratio (MLLR) is 60% (or 80%) can guarantee year after year filings for rate increases as AEG has done — 10 rounds of increases since 2009 many on the mild side 10% or 15%, sometimes overlapping. Cumulatively they amount to ~3.3x original premium. What a business!

Cloning Experiment

For this experiment, we took a 2012 rate filing (AEGJ-128207180), cloned it, and gave it an artificial filing date of 2020. Both were given the same rate history. Applying our Consumer View app, we find both the original and the clone have a Step Down (SDN) of ~1.92, a validation of the cloning procedure. SDN assumes: PHs are not responsible for past losses; identifies a level premium given carrier’s claims history and expense projections (CEP); the so-called fair premium is a multiple of a PH’s original premium.

Outcome

The 2020 clone Step Up (SUP) was 11.96 : 5.09 or 2.35x the 2012 filing (SUP). The corresponding annualized compounded increase necessary in 2020 to achieve the minimum statutory lifetime loss ratio (MLLR) is 20% whereas only 14% in the 2012 case.

Policyholder’s vulnerability to rate increases in the 2020 clone case has nothing to do with the industry’s standard lament! It is exclusively due to  a dwindled PH count, shouldered with the burden to correct the book to the MLLR in a shortened time window. If we were to clone 2012 as a 2025 case, the results would be significantly worse.

The current flawed LTCI modeling framework is a great scheme for carriers, even if they do not perform risk-base horizon scanning. Why make the effort? More work and they are already winning. Not such a great scheme for regulators/NAIC, whether or not they are aware of it.

Author: Samuel Cuscovitch

Research scientist / strategist.