6.4
Profit Margin We developed a business financial projection using asset share data from a mixture of nursing home only and comprehensive LTC plans. The financial projection reflected historical as well as expected future sales patterns for the industry. We also calibrated the projection with historical incurred claim loss ratios from the LTC Experience Forms. Over the next ten years, the average pre-tax profit from the financial projection is 11%. From the survey, the average response is also approximately 11%. This corresponds to an approximately 7% after-tax profit.
6.5
Target Loss Ratio The target loss ratio represents the starting loss ratio from which deviations are modeled. We used a 75% target as suggested by the financial projection over the next 10 years. This target included both incurred claims (60%) and changes in active life reserves (15%). Since the source of variation is the observed incurred claim loss ratios, this implies a constant change in active life reserve as a percentage of current premiums. The Group considered this an acceptable model simplification since variations in active life reserves are assumed to result from factors (such as persistency) other than statistical fluctuations. The Group also checked other outputs from the financial projection for reasonableness. Investment income was equal to 21%8 of premium and the expense margin (including commissions and premium tax) was equal to 35%. A 35% tax rate is assumed on profits and losses. The group felt that these assumptions were reasonable given the underlying growth rates and time horizon of the model. Over the effective period of the simulation, the statutory income statement, expressed as percentages of premiums, is as follows: Premiums Investment Income Claims/Reserves Expenses
8
100% 21% 75% 35%
Pre-Tax Profits Tax
11% 4%
After-Tax Profit
7%
Since the target loss ratio includes both claims incurred and changes in active life reserves, it can be expected that investment income will increase as a percentage of premium over the study period. A constant investment return percentage provides a margin for conservatism in the model. 23