Underwriting Reassessments Drive Long-Term-Care Reform
After years of public scorn for massive premium increases and internal wrangling over mispriced contracts, new forms of long-term care (LTC) coverage are seeing a notable uptick in sales.
Professional and public organizations are digging deeply into the underwriting and actuarial assumptions that were behind traditional LTC policies in hopes of avoiding the same mistakes for the newer hybrid or combination contracts that are based on annuities or permanent life insurance with riders for LTC and disability.
There is, however, not yet any good answer for what to do with the traditional policies that remain in force.
“The cost has never really been a low as people wanted it to be, and carriers were never able to capture the [younger and healthier] people looking ahead.” — Robert Kerzner, president and CEO, Limra, Loma and LL Global
Robert Kerzner, president and CEO of Life Insurance Marketing & Research Association (Limra), Life Office Management Association (Loma), and LL Global, said that traditional LTC coverage was caught between multiple mandates.
“The cost has never really been a low as people wanted it to be, and carriers were never able to capture the [younger and healthier] people looking ahead,” he said.
“The LTC contracts sold were primarily to those close to the age where they would use them. So the business never really got off the ground. There were never a lot of carriers and also not a lot of distribution.”
External factors exacerbated the struggles of traditional LTC coverage. Two in particular were killers: low lapse rates and low interest rates.
“What were the lessons learned?” Kerzner asked rhetorically. “The industry did not have a lot of historical data. We all want to be innovative. I push the industry to innovate. But consumer behavior is not always logical. Another factor was medical breakthroughs. Those changed the game.”
The ideas for LTC 2.0 — hybrid or combination contracts — came from research as sales and premiums for traditional policies shriveled.
“People don’t like paying for insurance and getting nothing back,” said Kerzner. While one of the criticisms of traditional coverage was that they were too complicated, he said, the riders and options on combination contracts are seen as adding value.
Bruce Stahl is vice-chair of the LTC Reform Subcommittee of the American Academy of Actuaries, which expects to publish its analysis and recommendations of LTC by the end of the year.
He is frank about the value of what amounts to forensic underwriting in LTC. “It is helpful to understand the assumptions of the ’80s and ’90s. People made assumptions that were at the time reasonable estimates. The assumptions being made now on newer contracts are more conservative,” especially regarding interest and lapse rates.
“In the early ’90s, the assumption was that lapse rates for LTC coverage was going to behave like Medicare supplement policies, which were about 6 percent at the time. Actual lapse rates for traditional LTC contracts have been less than 1 percent. That has had a strong effect because of more benefits paid out.”
“Insurance companies are designed to be profitable. If traditional LTC is not profitable, it won’t be offered.” — Jesse Slome, executive director, American Association for Long Term Care Insurance
Jesse Slome, executive director of the American Association for Long Term Care Insurance, said that it is difficult to document the traction that hybrid LTC contracts are gaining because they are so new, and also because they are spread among permanent life and annuities.
“No one is really tallying the data, but at the Limra-Loma Conference in New Orleans [where he was chair of a panel discussion in September], I was told by carriers that on something between 50 percent and 80 percent of their new life policies, the insured checks the option to get an LTC payout.”
Slome is forthright about the future of the line. “Insurance companies are designed to be profitable. If traditional LTC is not profitable, it won’t be offered. If hybrids are, they will be offered.”
That still leaves the question of what becomes of the early adopters from the ’80s and ’90s, the ones who thought they were being economical and responsible and are clinging to their traditional contracts at the confounding lapse rate of less than 1 percent.
For years, the financial press has been full of horror stories of premium increases of 50 percent, 60 percent and in some cases more than 100 percent. Carriers have been bombarded with outraged complaints, as have regulators and even Slome’s organization.
“What to do about old policies?” asked Slome. “I don’t know. But I suspect the few carriers remaining in that market are counting on state regulators continuing to approve premium increases, and also counting on interest rates rising. Shares of Genworth [the largest issuer of traditional LTC contracts] have become in effect a type of interest-rate play.”
After the Fire
The raging wildfire that roared through Fort McMurray in Alberta, Canada, in May and June was so fierce it burned the entire country’s economy.
As a result of the fire, Canada’s GDP experienced its worst dip since the depths of the Great Recession. Losses from the blaze resulted in a 1.1 percent economic contraction in the second quarter. The Bank of Canada cut the country’s economic outlook for the year due to the catastrophe that stopped production at oil sands facilities, forced the evacuation of about 94,000 people and destroyed 2,400 buildings.
The most recent estimate by Property Claim Services puts the insured losses at about $3.6 billion — but while more than 5,000 commercial insurance claims (about $1 billion) are included in that estimate, the hard-hit oil sands producers report few insured losses.
VIDEO: The wildfire had a devastating impact on businesses in the area.
At the peak of the fire, 10 oil and gas producers were temporarily shut down, while work at another one was reduced, said Paul Cutbush, senior vice president, catastrophe management, Aon Benfield Canada.
Even though 1.2 million barrels a day, or about $65 million daily, was lost during that month-long shutdown while the fire was nearby, “no one is talking about any oil and gas claims,” Cutbush said.
That position was made official by Suncor, one of the largest operators that was shut down due to the evacuation, and saw its production reduced by about 20 million barrels because of it.
“The company incurred $50 million of after-tax incremental costs related to evacuation and restart activities,” according to the company’s Q2 earnings report, “which was more than offset by operating cost reductions of $180 million after-tax while operations were shut in.”
It’s not just the lack of damage, said Cutbush. BI policies typically have a waiting period before policies are triggered. That period typically is 60 to 90 days, but since the marketplace is very competitive, he said, it’s possible that some of the oil and gas producers had a 30-day waiting period.
Even so, the evacuation orders issued May 3 that shut production around Fort McMurray — the hub of Canada’s oil sands extraction and processing facilities — only lasted three to four weeks, depending on their location, he said.
“A lot of companies went back online 30 days after the fire,” Cutbush said. “I think if you see any claims, it will be those [insurance] writers who have more competitively agreed to do 30-day waiting periods. But it’s still too early to tell.
“It’s risk management but it’s net retained non-insured risk management.”
The energy companies’ facilities were protected by the effectiveness of the “fire breaks” built to divert the wildfires, he said.
Emphasis on Safety
“The core of Fort McMurray exists because of the oil sands,” said Bill Adams, vice president, Western and Pacific for the Insurance Bureau of Canada (IBC). “There is a strong focus on safety in those operations, and most of the people in and around Fort McMurray have that in their blood.
“I am not sure any other community in North America could have accomplished the same as that town did.”
From a risk mitigation perspective, Adams said, “this incident really set a new benchmark for what can go wrong when you build a municipality in a boreal forest. We have never seen an event like this that affected so much infrastructure.
“Assessing this fire will definitely give us a new understanding, and many municipalities will have opportunities to avail themselves of the learnings.”
Andrew Bent, manager of enterprise risk management for the Alberta Energy Regulator, also praised the energy companies.
“The operators were fantastic. They knew they were part of the community and they were fast to take in some of the more than 88,000 people who had to be evacuated,” he said.
“As regulator for the industry, we require all operators to have emergency response plans in place.
“Those plans vary with the nature of the operator from site-specific to more general contingency planning. Even so, we were dealing with an event of unprecedented scale. The fire moved very quickly and behaved very unusually from a risk-management perspective.”
The Alberta Energy Regulator had its own risk to manage as well: Bent said the staff’s families had to be evacuated.
“Once we had that secure, we swung into our role of industry support. We were in day-to-day contact with the operators and coordinating with the provincial command center. We had to understand the local situation for the operators and ask for their specific information.”
From previous smaller forest fires, regulators and operators knew that there was actually little external fire danger to mine lands, if any. Given the wide, if ugly, swathes of cleared land around the processing plants, there was little external fire danger to those either.
Still, regulators gave a general, but not blanket, emergency authorization for operators to build berms around their properties without having to file permits in advance. Actions would be reviewed afterward for environmental and safety compliance.
“The oil sands companies had better fire breaks than the towns themselves,” said Cutbush of Aon Benfield.
In addition to homes and two hotels, the wildfire destroyed three camps used by subcontractors to house oil and gas workers, which should be covered under property policies. Other direct damage from fire and smoke should also be among the covered commercial claims, he said.
Remarkably, no deaths were directly attributable to the fires.
Ethan Bayne, chief of staff for the Provincial Wildfire Recovery Task Force, said the area was “lucky the fire spared major elements of the region’s infrastructure. That includes the major hospital, the water treatment facilities and the airport.”
He credited local officials and industries, notably the oil sands producers, with being responsive and responsible. “The province ran an operations command center for the fire response. In the event, private fire apparatus from industry were deployed.”
In all, about 40,000 claims have been filed from wildfire that began May 1 and was finally declared under control on July 5.
It was the costliest insured wildfire on record in North America, and the costliest insured natural catastrophe in all of Canada, according to PCS, resulting in about double the claims filed after the 2013 floods in Southern Alberta.
Standard & Poors reported that primary insurers “generally have sufficient available reinsurance coverage, adequate capital adequacy, and enough group-level support (for certain subsidiaries) to absorb the losses. However, insurers with a smaller premium base and more concentrated or outsize exposure to Alberta could face some strain and their ratings may come under pressure.”
A number of insurance-linked securities funds were also hit by losses from the wildfire, but it’s unclear as to the extent.
While fires continue to burn — there are forest fires all summer, every summer, in Canada and the U.S. — the focus in and around Fort McMurray has shifted firmly to recovery.
In the near term, the commercial focus is on rebuilding and restoration of the temporary housing needs to get business and industry back to capacity.
The IBC coordinated an effort by 40 or so underwriters handling claims to arrange a single contractor to demolish and clear damaged structures in the area.
The Alberta Energy Regulator recovery team is working with operators on start-up operational plans while monitoring regional air quality to ensure there is no risk to public safety or the environment, according to the agency.
Fewer than 1,000 of the nearly 90,000 people evacuated have returned following the lifting of the provincial state of emergency.
“From previous wildfires we have learned, unfortunately, that recovery is not quick and it is not linear,” said Bayne. “There are unforeseen and unforeseeable complications and delays.”
Fort McMurray is accustomed to boom and bust cycles, Bayne said, “but what we are facing now is a scale never before seen.”
“At the peak boom time of the oil sands development, the region saw 600 homes completed in a year. But even if we can repeat that, it would take more than three years to rebuild 1,900 homes. The short-term housing need is already being addressed.”
He added that the first milestone in provincial recovery will be a formal recovery plan due to be released in the middle of September. It will include preliminary assessments of the incident, and also a first look at major needs for recovery.
“I cannot emphasize enough our thanks and appreciation of the oil sands industry, the indigenous communities, and the Red Cross,” said Bayne. “Our role has just been to coordinate the work they have done with the regional municipalities.” &
Waves of bankruptcies convulsing the coal industry in the United States leave billions of dollars in mine remediation costs potentially unfunded, and raise ominous questions for both tactical insurance and strategic risk management.
Dozens of coal companies are in court-supervised reorganization or liquidation, some of them for the second time in just a few years.
Many had taken advantage of the Surface Mining Control and Reclamation Act of 1977, or SMCRA, a federal law that allowed self-bonding in lieu of surety bonds, dedicated cash reserves or other provisions for environmental obligations.
Self-bonds are legally binding corporate promises without separate surety or collateral, available only to entities that meet certain financial tests.
In response to the volatility in the coal industry and recent bankruptcies, the Office of Surface Mining Reclamation and Enforcement (OSMRE), part of the Department of the Interior, sought public comment in response to a petition from WildEarth Guardians asking the office to consider restricting or eliminating self-bonding.
Specifically, the group wants to prevent coal companies with a history of financial insolvency, and their subsidiaries, from using “self-bonding” as a means to ensure disturbed lands are restored after mining operations are completed.
VIDEO: There are many challenges when working to remediate abandoned mines.
OSMRE received more than 117,000 comments on the petition to restrict or eliminate self-bonding, and announced on Aug. 16 that it would begin the rulemaking process to “strengthen regulations on self-bonding to help ensure that companies are financially able to restore lands disturbed by coal mining when extraction operations are completed.”
“The U.S. coal market is dramatically different from when our self-bonding regulations were last updated 30 years ago,” said OSMRE Director Joe Pizarchik.
“This is a turbulent time of energy transformation in our country, of declining use of coal and increased use of cheaper natural gas and renewable energy. These conditions have exposed the limitations of the current self-bonding rule and we have a responsibility to protect the public’s interest by keeping up with these changes.”
Requests for public comment on similar initiatives are underway in several states for mines under their jurisdiction; states where taxpayers could be on the hook for cleanup costs for busted mines if bankruptcy courts do not set those funds high enough in the hierarchy of expenses to be paid.
Within the broader economic and social dislocation in the near-collapse of a major industry, there are two key questions for insurance markets and risk managers.
On the commercial side, will the surety and broader insurance markets have the capacity and the willingness to underwrite billions in new coverage for an industry with a notorious past and a checkered future?
In risk management, there is a larger question of whether the 1977 self-bonding provisions were flawed from the start, or whether they were functional until overwhelmed by the tsunami of corporate failures in recent years.
“We know that there are many companies that rely on the surety bond market for meeting their compliance obligations,” said Tom Sanzillo, director of the Institute for Energy Economics & Financial Analysis (IEEFA), based in Cleveland.
“We imagine that would expand significantly if there were new regulations that restricted or even eliminated self-bonding for coal companies.”
In response to an inquiry from R&I, an OSMRE representative stressed that, “self-bonding remains a legal option sanctioned by [SMCRA] as a means that a qualified company can guarantee reclamation. There are cases in which self-bonding guarantees have been replaced by surety and collateral bonds.
“In addition, it is important to note that no operator currently in operation with self-bonds has ceased operations and forfeited on the bonded obligations. OSMRE stands committed to ensuring that mine operators will be held accountable to complete the legally required reclamation when or if they complete mining operations.”
The forthcoming rulemaking process is intended to modify “self-bonding eligibility standards, including for parent and other corporate guarantors, to include criteria that are more forward looking, instead of only focusing narrowly on past performance.”
It also will require an independent third-party financial review of self-bonded entities, establish the percentage of self-bonds supported by collateral and provide regulatory authorities with better tools to obtain replacement bonds when a self-bonding entity no longer meets the eligibility criteria.
However, federal rulemaking, even the simplest, is a long and complex effort. Congress can also amend SMCRA to modify the bonding system.
“What we have here is a [self-bonding] system that is flawed in many respects, and the industry’s decline exposes those flaws graphically,” Sanzillo said.
“When I saw the OSMRE statement expressing concern about possible collusion between state regulators and coal companies,” he said, “I nodded, because we did an initial study on the self-bonding program in Texas several years ago and found that it was completely inadequate,” he said.
In addition to West Virginia, Texas recently became one of the states that intervened in bankruptcy proceedings pressing for full funding of remediation costs.
In Texas, the IEEFA findings were submitted to the state Railroad Commission, which has jurisdiction over coal mining, and the legislature.
“We had a robust discussion,” said Sanzillo, “and they took some diligent action, including requesting $1 billion in notes from one debtor-in-possession financing.”
OSMRE added that the State of Texas successfully navigated the problems associated with self-bonding, through its actions with respect to Luminant, the largest electricity producer in Texas, in 2011-2012.
The Railroad Commission, the state attorney general’s office, and the operator devised a way to have Luminant replace several hundred million dollars in self-bonds with collateral bonds when the company declared bankruptcy.
In a recent large bankruptcy case involving Alpha Natural Resources, “the West Virginia Department of Environmental Protection has been very vocal that the $1.1 billion in remediation costs have got to be addressed in the reorganization plan,” said Ted O’Brien, CEO of Doyle Trading Consultants, a coal-industry advisory.
Reorganized as Contura Energy Inc., the producer will contribute up to $100 million to help Alpha’s ongoing reclamation activities, according to published reports.
“What this down market is revealing is that there is far more coal being claimed as reserves than is economically available for mining. Insurance companies should ask if the valuations that are being reported to them are valid,” Sanzillo said.
“Any insurer looking into coal as a new market may get some pushback from other stakeholders,” said O’Brien, “but there has always been a market for surety, if you have someone willing to get their hands dirty. Coal is not going away. ” &