A common reaction to the option of self-funding long-term care benefits is that it seems too risky. There are three important elements that drive the cost of long-term care benefits. These are the cost of the benefits, the investment earnings on the fund, and the lapse rates of employees dropping their coverage. Variation in each of these items represents risk to a self-funded plan. Let’s focus on the cost of benefits risk and the underlying morbidity involved.
Long-term care is limited to a fixed daily amount for any individual who is impaired either physically (measured by ADLs) or cognitively. The rate of such impairment is reasonably predictable and has been significantly improving with time. The most recent evidence suggests that not only are people living longer, but they are also living longer without impairments. Thus, much like life insurance (or pension coverage), the risk of fairly predictable human events is not the critical risk associated with the coverage.
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The National Long-Term Care Survey has sampled the rates of ADL impairment since 1982. Table 1 shows a steady decline in these rates from 1982 to 2004, the most recent year of the study.
Over the 22 years of history shown in this table, the average disability rate has declined by an average of 1.7% per year, and the rate of decline has accelerated to 2.2% per year in the most recent five years. Hence, the risk of being on claim is decreasing over time, which reduces the overall morbidity risk for the self-funded plan. Some insurance companies recognize a 1% improvement per year, often for a limited number of years, whereas some insurance regulators do not allow this assumption in the pricing of a long-term care product. Of course, an employer can introduce risk into its plan by assuming too great of an improvement (or finding other ways to under-fund their plan), so it is important to strike the right balance.
Why is true group long-term care so important?
- Many Americans will have no way to pay for long-term care services when they are needed.
- Insurance for long-term care will not become widespread if only available on an individual basis, which means that the change will need to come first from employers.
- Group coverage needs to include employer contributions to make it affordable to employees and vesting to make it affordable to employers.