Today’s Medicare Supplement market is characterized by intense price competition among insurance companies competing for sales in the fast-growing senior market segment. New entrants to the market, as well as existing players using a charter-rotation strategy, are often driving rates down as they try to quickly gain market share – many times in partnership with independent distribution channels.

This competitive pricing has led to rising loss ratios in the industry, with 2023 industry loss ratios exceeding 90% on recently issued policies from 2021‑2023, according to NAIC experience reports.¹ These high loss ratios are often exacerbated by distribution partners that demand top-of-market commission rates and marketing fees, coupled with near bottom-of-market rates, in order to agree to meaningful production commitments.

Many insurance companies with low or stagnant sales are intrigued by the possibility of a new high-growth product in an attractive and rapidly growing senior market segment. For companies already in the Med Supp market utilizing a charter-rotation strategy, sales of the existing charter may have flattened, and they’re scrambling to close-off the existing charter and introduce a new charter with lower rates to re‑invigorate sales growth.

In today’s competitive Med Supp environment, is a low-price strategy an effective use of capital if the goal of a company’s capital allocation strategy is to maximize shareholder value over the long term?

Development of a Low‑Price Strategy

Achieving near bottom-of-market rates in pricing Medicare Supplement in today’s environment often requires a company to set aggressive pricing assumptions, many times related to an assumption that the percentage of policies expected to be underwritten will be significantly higher than industry averages.

How does a company get comfortable with a high underwritten mix assumption in setting its prices? In some cases, the company believes they can incentivize their distribution partners to write more underwritten business through cash incentives or other tactics such as paying higher bonuses for underwritten business versus non-underwritten business, or by providing free or discounted leads that target underwritten business (i.e., “switchers”) as opposed to open enrollees (e.g., individuals first turning age 65). Pricing actuaries may also use certain tactics such as sloping the rates by age so that rates are more competitive for ages with higher underwritten mixes (e.g., ages 68 and above).

While these tactics to achieve an above-market underwritten mix can be useful, and some companies have seen some success, the problem is that many companies in the market are using these same or similar tactics to try to drive more underwritten business – and this makes it very difficult for any individual company to move the needle much on the underwritten mix relative to the overall industry averages.

How Do Companies Typically Respond to Early Adverse Experience?

If sales are strong, many companies will want to implement low rate increases for the first few years to maintain a strong competitive position and keep the sales momentum.

While early low rate increases with higher renewal rate increases may have been contemplated in pricing, most rate filings don’t explicitly disclose this or reflect this in the durational loss ratio patterns filed. Realizing that early loss ratios are running significantly higher than expected, and not wanting to take high rerates, companies may shift their focus to understanding why the underwritten mix is lower than expected and attempt to “correct” the problem(s) they believe are causing the lower underwritten mix.

• They may enhance their distribution incentives for underwritten business.
• They may have discussions with their distribution partner(s) to re‑iterate the importance of a high underwritten mix in keeping rates competitive.
• They may ask their distribution partner(s) to have discussions with agents and/or agencies that are writing a low underwritten mix.

These efforts typically result in limited success, and after a few years the company may decide it can no longer sustain the large losses and significant cash flow strain – and ultimately discontinue new sales of Medicare Supplement. After closing the block, in an attempt to salvage the product and restore the block to profitability, many companies will then start taking high renewal rate increases.

For those companies experienced in the Medicare Supplement market that use a charter rotation strategy, the series of events described above may not be a huge surprise, and despite the financial “hit” they just took, they simply close off the existing charter and re‑introduce a new charter with low rates and no other significant changes to strategy – and go through the cycle all over again. The closed charter likely would undergo high rate increases for a period of years until the loss ratios are back under control.

The Problem with High Rate Increases

A company that is relatively inexperienced in the Medicare Supplement market may not realize how difficult it can be to correct a high loss ratio back to expected priced-for levels. A key complicating factor is that a high rate increase often leads to significant anti-selective lapsation — a tendency for healthy lives to lapse at a higher rate than unhealthy lives — resulting in an adverse change in the health mix of the insureds remaining inforce.

Additionally, depending on the average duration of the business at the time of block closure and the percentage of sales that were underwritten, selection wear-off on healthy lives will likely be another force impacting trends for a few years following the block closure.

Considering both components, it can take several years to start bending the loss ratio curve down, even with rate increases well above trend.

Modeling the Long-Term Profitability of the Low-Price Strategy

Now that we’ve set the stage, let’s get into the question about whether a company can turn a block profitable after significant early duration adverse results and ultimately achieve a return on the block over its lifetime that is positive and (while most likely not meeting the original priced-for profitability target) at least respectable – maybe near high grade corporate bond returns.

While this modeling depends on many future unknown variables, such as medical trends and the ability of the company to get the needed rerates approved, for the purpose of this article let’s narrow the modeling down to two scenarios and evaluate the results.

Modeling Results

Detailed model results are beyond the scope of this article, but let’s take a high-level look at the results of the two scenarios.

Summary

While many companies may be intrigued by the large and growing senior market – along with the relative ease of entering the market with a Medicare Supplement product and a distribution partner promising high sales if the rates are near bottom-of-market and the sales compensation / marketing fees are near top-of-market – the highly competitive nature of today’s market makes it very difficult for companies (especially those without brand recognition) to achieve both high sales and an adequate ROI.

As evidenced in the NAIC data, average 2023 industry loss ratios were approximately 90% on business issued from 2021‑2023. This same number 10 years ago was closer to 75%, demonstrating how competitive and underpriced the market has become.

An early loss ratio of 90% is very hard to overcome, and with anti-selective lapsation and underwriting selection wear-off working against you, it would likely take several years of double-digit rate increases to bend the loss ratio curve back down. These issues are coupled with recent high Medicare Supplement trends and an uncertain future regulatory environment in which more states are considering annual open enrollment rights.

And to further carve into margins, don’t forget the near top-of-market sales / marketing costs needed to get significant production commitments from independent distribution partnerships.

Gen Re Can Help

We realize that some companies are struggling to manage their blocks of Medicare Supplement because of some of the issues addressed in this article. Gen Re is always willing to talk with carriers who need support in rehabilitating poor performing blocks of business or carriers that may be looking to exit the Med Supp space.

Learn more from our whitepaper detailing model assumptions and results.

Endnote

1. National Association of Insurance Commissioners (NAIC), 2023 Medicare Supplement Insurance Experience Summary