CCRCs provide care to millions of Americans as they age. These facilities offer not only medical care and living accommodations but also complex embedded insurance products that are poorly underwritten and inadequately regulated.
Many CCRCs have become actuarially insolvent. This creates a systemic problem that may leave elderly residents vulnerable to financial and medical risks in the end. Jack Barker is a finance expert who takes us through the challenges facing this sector and shares with us a proprietary capitalization method that may help to alleviate these issues.
This lifetime care commitment is in line with the charitable objectives of both the original sponsors as well as the current operators. These structures, however, create complex long-term insurance obligations, which most operators do not underwrite and that are not regulated by most states as insurance contracts. Many facilities that issue Type A contracts are under-reserved and have little or no equity to cover unexpected cash flow shortages.
This article’s primary objective is to understand the looming risk of systemic failure in CCRCs due to these deeply embedded but under-regulated insurance products. The second objective is to propose an innovative solution for the industry’s capital and reserve shortages using well-developed catastrophe bond concepts and structures.
The Short Guide to Continuing Care Retirement Communities
Continuing Care Retirement Communities offer residential options for seniors who want to live independently (in an apartment or cottage) and have access to residential amenities and a continuum of long-term care services.
CCRCs were founded more than 75 years ago. In the early 1970s, religious groups created charitable communities that provided lifetime care to their elderly residents for an exchange of their assets. These nonprofit institutions still own and operate a number of CCRCs. However, a variety of for-profit firms have entered the market offering similar services and facilities but without lifetime care guarantees.
The typical CCRC provides the following services for its residents:
Independent housing includes meals, social activities, and scheduled transportation;
Access to doctors, prescription drugs, and rehabilitation services.
Housing and support services for adults in a home, an enriched housing environment, or an assisted living residence.
Residents who are temporarily ill or require long-term care can benefit from skilled nursing services and memory care.
Types of CCRC Contracts
There are three types of CCRC contracts. The three basic types of CCRC contracts are:
Type A contracts for life care: The most expensive contract type, the Type A option, provides unlimited skilled nursing and assisted living care at no additional charge. This contract type includes the promise that the care level will be maintained until death.
Modified Contracts (Type B) This Type of contract offers a set of fixed services for a specified period. Type B contracts have lower monthly fees than Type As but provide similar housing and amenities. After contract maturity, the benefits can continue as needed but at a higher monthly payment.
Type C contracts: These contracts require lower initial enrollment fees than Type A or B contracts, and sometimes none at all. Type C contracts may include some or all the same amenities and residential services, but they are usually paid per diem at market rates for assisted living services.
CCRCs include a number of actuarial risks.
CCRCs are traditionally organized and financed as medical services and real estate companies. However, they also conceptually include multiple implicit products such as annuities and long-term care obligations.
In the past, the industry has faced a challenge because these implied insurance contracts have not been actuarially assessed. The assets available to the sponsors (CCRC Operators) are often insufficient to cover the financial obligations that come with these contracts. Operators rely instead on the high cash flow generated by entry fees, easy access to tax-exempt bond markets, and GAAP going concern accounting to fund their operations and capital expenses. Unfortunately, they don’t set up adequate actuarial reserves for long-term obligations that they either contracted or promised to their marketing literature.
In the event that even a moderate disruption in their entry fees is caused by market forces, many of these facilities will be actuarially insolvent. Since the bondholders have first liens over all the assets of the CCRCs, including the real estate and the future monthly fees of the CCRCs, residents are becoming the most vulnerable unsecured creditors. According to the latest data published by the Commission on Accreditation of Rehabilitation Facilities, the bottom 25% of operators are using Type A contracts.
Many CCRC operators also offer refundable entrance fee plans. These are sold at higher prices than fees that are not refundable. This increases cash flow in the current period in exchange for a promise, unsecured, to refund the majority of entry fees in the future. Most often, these refunds occur at the time of death or when a resident leaves the facility. No cash is exchanged until the new resident replaces the previous one and pays the entry fee.
Actuarial and regulatory responses
As evidenced by papers written in the 1990s, this is a problem that the actuarial profession has recognized. Most of these operators, however, are nonprofits that have little equity capital and rely on cash flow to operate. As a result, there haven’t been many changes made. Further, regulators were historically more concerned with the quality of services than the financial health and solvency of industry players.
This pattern is changing as baby boomers retire and new players begin to evaluate the position and financial health of the industry. Legislation introduced during Florida’s 2017 legislative sessions required operators to maintain an actuarial reserve for future liabilities. The legislation has been reintroduced despite the rejection by the industry. At this point, it seems likely that changes are going to be made in order to deal with the looming issue.
This is a challenge, but the obvious one here is that few operators have the capital or access to it to meet a real actuarial requirement. That brings us to the second section of this article.