10/30/2008 05:12 am ET | Updated May 25, 2011

Bayoneting the Wounded

We are just seeing the tip of the iceberg-- the direct consequences, the unintended consequences, the compounding consequences of the Wall Street meltdown and the era of lax regulation. On September 18, the day Lehman Bros. died, Conseco, the Indiana-based insurer lost its $100 million dollar investment in that investment bank. Conseco is also invested in AIG--at this point we don't know what impact the AIG debacle will have on Conseco. We do know that Conseco'a stock has been placed on the SEC's no-short list, and has retreated 40 percent to $4.78 since Sept. 18. Investors may be edgy because the company has seen hard times before for other reasons, having sought bankruptcy protection between 2002 and 2003.

This week, Conseco will again be in the spotlight for reasons having to do with its troubled insurance operations. Tuesday (September 30, 2008) will be a determinative day for Conseco's 149,000 long-term care insurance (LTC) policyholders, and virtually none of them know anything about it. It is the last day to comment on the company's proposal to the Pennsylvania Insurance Commissioner to spin-off of its long term care insurance business. The proposal calls for Conseco Senior Health Insurance Company (CSHIC) to divest itself of its long-term care policies by placing them in an independent trust, Senior Health Insurance of Pennsylvania (SHIP).

More long-term care policies are sold in California than any other state in the country. Bonnie Burns of California Health Advocates, a group protecting seniors on health, insurance and Medicare issues, filed her comments with the Pennsylvania Insurance Commissioner opening her letter with these words: "I am writing to you with alarm," and going on to say ": ..Conseco seeks to establish a new company, Senior Health Insurance of Pennsylvania (SHIP) and dump into it 149,000 of CSHIC's worst performing long-term care insurance policies, creating a virtual death spiral from which there will be no recovery, only a delay of the inevitable insolvency."

What Ms. Burns, and famed insurance professor Joseph Belth (Indiana University) are worried about is this: if Pennsylvania allows Conseco to dump its long-term care book of business, then every other long-term care insurance company in trouble -- and there are lots -- will want the same treatment by their regulators.

LTC insurance is in financial trouble and generally elderly policyholders have already absorbed dreadful premium increases of 60 percent or more in recent years. However, these financial wounds are nothing compared to the hurt that currently looms over them.

A brief history. Long-term care insurance was invented in the 1980's (kind of like credit default swaps invented in the 1990's). Originally, it was primarily designed for coverage of that final stay in the nursing home. The product has expanded with the times and changes in senior living. In its exuberance to sell its new product and carve out a significant market share, insurers ignored the scant actuarial data and experience available with which to price it. Prospective policyholders were known to be sensitive to price, and insurance marketers wanted a product that was less expensive than the competition's. Actuaries obliged them by relying on a game of poker in which they made liberal (and oftentimes unsupportable) estimates of the number of people who would allow their policies to lapse.

These policyholders, so the theory goes, would pay premiums for a few years thereby contributing to reserves but never filing a claim. It was essentially money for nothing-- pure gravy-- and high lapse rate assumptions were used to justify lower premiums. Nothing could possibly go wrong unless policyholders hung onto their policies come hell or high water. And they did.

Twenty years or so later, the chickens have come home to roost. The policyholders are filing claims. And, although long-term care insurance was sold as a product with level premiums-- in other words, your rates aren't going to go up-- because the rates are front loaded, policyholders in the last ten years have experienced 25, 50 and 100% rate increases.

The decision for regulators is complex. The Conseco long-term care business may already be headed for insolvency. Conseco has offered a capital infusion of $175 million as part of the spin-off package. But no one knows if Conseco can make good on their promise. The new "SHIP" as the company would be called, would have to sink or swim on its own-- that means for sure, more premium increases for Conseco policyholders. In the middle of the AIG/deregulation mess, there have been repeated calls for transparency. In his comments filed on September 25, Professor Belth has discussed a Conseco sponsored actuarial report that the Pennsylvania Insurance Department has not released, and Conseco has told Professor Belth is confidential. Transparency, what transparency? Professor Belth believes the report contains solvency projections for the Conseco long-term care unit and the stated need for five big successive rate increases!

And, as I said, the policyholders appear to be in the dark. Professor Belth points out that the Pennsylvania Department has issued no press release, nor sent any direct communications to policyholders. He cites to the fact that two Florida policyholders sent letters of inquiry having heard about the transaction "by accident."

So, what's a regulator to do? What is best for the policyholders? Prof. Belth opined that if the Pennsylvania Department puts the company into insolvency immediately-- which he says is inevitable-- then there is a chance to rehabilitate it or sell the company. If the Pennsylvania commissioner approves the trust Prof. Belth believes the inevitable collapse will be delayed compounding the damage and resulting in liquidation--a very bad option for Conseco policyholders. Word is, likely approval by the Pennsylvania Commissioner.

Perhaps instead of calling the new trust entity SHIP, it should be named the Senior Health Insurance Trust. You figure out the initials.