Investment strategy for Long Term Care Insurance (LTCI)

[Trevor]

Hi,

I attempted the ST1 2009 September past paper, Q7ii.
This is about describing the investment strategy/backing assets for pre-funded LTCI which benefits can be either fixed monetary amount or indemnity basis.

As a pre-funded product, I am aware of the 2 phases: accumulation (before benefit payment) and claiming phase (after the long-term care definition is triggered. So my idea goes as:
Accumulation phase (pre-claim):
There is no benefit payment at all. The only outgo to meet are:

• Ongoing expenses, renewal commissions (Guaranteed Index) - Matched with real assets (corporate bonds, properties, equities)
• Possibly surrender value outgo for a pre-funded product - Matched with short term liquid assets (cash, fixed interest securities) as surrenders can happen anytime under a short notice
• Possibly the need to build up sufficient cash value to fund the claiming phase, so invest in equities for excessive returns. This is possible since a accumulation phase should be long enough to take investment risks.

Claiming phase (post-claim):
In addition to expenses, now we need to match the:
Fixed benefit (Guaranteed Monetary amount) - Matched with fix interest/government bonds + corporate bonds
Indemnity benefits (indemnity) - Long term indemnity in this case (unlike ST in PMI), so match with equities, corporate bonds



However I am struggling to understand the examiner's report.
There are pre & post-claim periods quoted too, but I am confused:

1. Why there are benefits, both long term guaranteed and indemnity, in the pre-claim phase?
2. If benefits are already paid in the "pre-claim" phase, then what is left for post-claim?
   In the solution, it discusses short term liabilities for this post-claim phase.

My understanding of a pre-funded LTCI is it is considered a long term product, for both the accumulation and claim payment phase.
The purpose of LTCI is to hedge against longevity risks. In particular, the long term care costs whilst being alive.
Therefore, neither of the phase should be considered short term (although probable shorter longevity due to impaired life).

Is there something I am missing out to understand the examiner report?

Trevor

 

[Mark Willder]

Hi,

I attempted the ST1 2009 September past paper, Q7ii.
This is about describing the investment strategy/backing assets for pre-funded LTCI which benefits can be either fixed monetary amount or indemnity basis.

As a pre-funded product, I am aware of the 2 phases: accumulation (before benefit payment) and claiming phase (after the long-term care definition is triggered. So my idea goes as:
Accumulation phase (pre-claim):
There is no benefit payment at all. The only outgo to meet are:

• Ongoing expenses, renewal commissions (Guaranteed Index) - Matched with real assets (corporate bonds, properties, equities)
• Possibly surrender value outgo for a pre-funded product - Matched with short term liquid assets (cash, fixed interest securities) as surrenders can happen anytime under a short notice
• Possibly the need to build up sufficient cash value to fund the claiming phase, so invest in equities for excessive returns. This is possible since a accumulation phase should be long enough to take investment risks.

Claiming phase (post-claim):
In addition to expenses, now we need to match the:
Fixed benefit (Guaranteed Monetary amount) - Matched with fix interest/government bonds + corporate bonds
Indemnity benefits (indemnity) - Long term indemnity in this case (unlike ST in PMI), so match with equities, corporate bonds



However I am struggling to understand the examiner's report.
There are pre & post-claim periods quoted too, but I am confused:

1. Why there are benefits, both long term guaranteed and indemnity, in the pre-claim phase?
2. If benefits are already paid in the "pre-claim" phase, then what is left for post-claim?
   In the solution, it discusses short term liabilities for this post-claim phase.

My understanding of a pre-funded LTCI is it is considered a long term product, for both the accumulation and claim payment phase.
The purpose of LTCI is to hedge against longevity risks. In particular, the long term care costs whilst being alive.
Therefore, neither of the phase should be considered short term (although probable shorter longevity due to impaired life).

Is there something I am missing out to understand the examiner report?

Trevor

Hi Trevor

We are looking at the investment strategy for a block of existing business. so some policies will already be claiming and some will be in the pre-claim stage.

For the policies that are already claiming we effectively have an immediate annuity. So we match with suitable short-term bonds.

for the policies in the pre-claim stage we effectively have a deferred annuity. So we need bonds to provide an income starting in the future (when the claim starts).

Best wishes

Mark

 

[Trevor]

Hi Mark,

Thanks for the explanation, seems like it is just the matter of different perspectives.

However, even if we look at it a a book of LTCI business,

pre-claim
These policies may have very long term until benefits are payable, why do we worry about matching the benefit now?
ie: why do we attempt to match guaranteed benefit liabilities using bonds when we can use equities to maximise return now, and then worry about matching when they start claiming? (subject to the insurer's risk apetite).

post-claim
I am not sure if we should consider LTCI policies that are claiming a long term or short term liability:

It may be short term because those who met the claim definition are already in "pretty bad" health,
In such case, we would use short term bonds for fixed benefit LTCI, and cash for indemnity benefit LTCI.

However it could be long term due to antiselection, one will buy the LTCI only if they think they will outlive the insurer's expectation, or at least be worried about living too long.
In such case, we would use medium/long term bonds for fixed benefit LTCI,
in such case we would match the indemnity benefit payments using real assets instead, eg: properties (2019 SP1 CMP, Chapter 28 page 10).

 

[Mark Willder]

Hi Mark,

Thanks for the explanation, seems like it is just the matter of different perspectives.

However, even if we look at it a a book of LTCI business,

pre-claim
These policies may have very long term until benefits are payable, why do we worry about matching the benefit now?
ie: why do we attempt to match guaranteed benefit liabilities using bonds when we can use equities to maximise return now, and then worry about matching when they start claiming? (subject to the insurer's risk apetite).

post-claim
I am not sure if we should consider LTCI policies that are claiming a long term or short term liability:

It may be short term because those who met the claim definition are already in "pretty bad" health,
In such case, we would use short term bonds for fixed benefit LTCI, and cash for indemnity benefit LTCI.

However it could be long term due to antiselection, one will buy the LTCI only if they think they will outlive the insurer's expectation, or at least be worried about living too long.
In such case, we would use medium/long term bonds for fixed benefit LTCI,
in such case we would match the indemnity benefit payments using real assets instead, eg: properties (2019 SP1 CMP, Chapter 28 page 10).

Hi Trevor

If we used equities to cover the liabilities then we'd be exposed to a big risk of equities falling in value and so wouldn't be able to match later on. So we can only invest in equities if we have sufficient free assets to cover this risk. It's always best to cover the matching assets first., We can then mention mismatching for higher expected return briefly at the end.

Claims in payment are going to be relatively short - the average life expectancy in a care home is only around two year. Anti-selection doesn't change this. This is a pre-funded policy so we know that all the lives are healthy initially. The policyholders do want to protect themselves from living longer than expected, eg 4 years instead of 2 years, but that's still short term bonds.

Best wishes

Mark

 

[Trevor]

I see, that makes a lot more sense now. Thanks Mark.

Last question, in the examiner report there is a section about "Premia" discussing future premium income.
I don't think this is a cash outgo to be matched against. Is this part saying we could use future regular premium income from policies that are in the pre-claim phase?
eg: using regular premium income to pay part of the benefit outgo, leaving a smaller benefit amount to be matched against using investment income from matching assets.

 

[Mark Willder]

I see, that makes a lot more sense now. Thanks Mark.

Last question, in the examiner report there is a section about "Premia" discussing future premium income.
I don't think this is a cash outgo to be matched against. Is this part saying we could use future regular premium income from policies that are in the pre-claim phase?
eg: using regular premium income to pay part of the benefit outgo, leaving a smaller benefit amount to be matched against using investment income from matching assets.

Yes, that's exactly right.