On May 2nd, the interest rate yield on a 10-year treasury note was yielding just 1.63%. As of today, the yield has soared to 2.64%. Why? And why is an increase in interest rates good for LTC insurance?
The reason for the increase is well documented. The Federal Reserve as indicated it is getting close to ending its bond-buying program program (otherwise known as "printing money") towards the end of 2013. The fed is looking at an improving housing market and economy and wants to touch the brakes on cheap money to make sure another housing or asset bubble doesn't develop. There are also fears about future inflation as well. The news sent stocks briefly tumbling and sent interest rates higher to reflect the feds position.
This is good news for LTC insurance. The extended low interest rate environment has been tough on LTC pricing, affecting both new and in-force policies. According to findings by the actuarial firm Milliman, it is estimated that a 1% decrease in long-term rates equates to a 10% to 15% higher premium rate needed on LTC Insurance. Look at the graph below to see how the trends have been going.
As a simplistic example, let's say a 50 year old bought a LTC policy back in 1991 and the insurance company priced the plan with an assumption of 7% interest rate. That would have been prudent because 10 year treasuries in 1991 were yielding about 8%. Because the policyholder is so young, the carrier needed to buy another 10 year bond in 2001, but they were only able to get a yield of 5.5%. When they bought another bond in 2011, that rate was only 2%. The result in this declining rate environment is that the carrier would have to raise the premiums on that policyholder to make sure that enough money was set aside to pay claims.
So now, with rates so low, what is the impact of a rising interest rate environment? Well, if current polices are priced with very low rate assumptions and rates go up, the impact will be more revenue to the insurance company and a very low chance of a policyholder needed a rate increase.
Most policyholders will be happy with not getting rate increases. However, John Hancock has created a policy feature in their product that allows policyholders to "share the wealth" in a rising interest rate environment by increasing their benefit pool. The plan is called Benefit Builder, and for those interested a video is posted below describing the features and background.