My name is Brad Paulis and I am a partner with Continuing Care Actuaries. I am a member of the American Academy of Actuaries, an Associate of the Society of Actuaries and a Fellow of the Conference of Consulting Actuaries. I have been providing consulting services for over 25 years. My clients have included over 450 CCRCs and at Home Programs nationally, long-term care and health insurance entities, as well as large self-funded health insurance programs.
I have reviewed the proposed changes to Chapter 651 issued on December 2nd, 2016 and the revisions to the proposed changes issued January 27th, 2017.
Additionally, I have had discussions with the Office of Insurance Regulation, other industry actuaries, LeadingAge Florida, providers, management companies and developers.
My thoughts on the current proposed changes issued January 27th, 2017 are as follows:
- I understand OIRs concern and their desire to protect residents in the event that adverse experience occurs.
- From a technical standpoint, I think it is important to clearly define terms used in the regulation. For example, Section 34 describes “net equity shall be the book value, assessed value, or current appraised value within 12 months prior to the end of the fiscal year, less any depreciation and encumbrances.” While subtracting encumbrances is reasonable, depreciation should only apply to book value, and not assessed or appraised value.
- Another example is the Contractual Liability Reserve. The Actuarial Standard of Practice No. 3 calculates liabilities on an aggregate basis using best estimate assumptions. Historically, separate liabilities are not carved out and the liabilities are not equivalent to insurance statutory reserves. I read the regulation as it followed this historical calculation of liabilities; however, I have had discussions with other actuaries who interpreted the regulation differently, requiring a higher standard of calculating liabilities. This ambiguity is not desirable from a regulatory or industry standpoint.
- It is important that the declaration of legislative intent found in section 13 is modified. It is through this lens that the rest of the regulation flows. While it is important to recognize the insurance component of CCRCs, this should not be viewed in isolation. CCRCs are a unique blend of the residential component with a risk bearing entity.
- The actuarial industry has contemplated this unique blend of risk. A task force of industry professionals including representation from the regulatory side developed an Actuarial Standard of Practice specific to CCRCs. The Actuarial Standards Board had a choice to promulgate standards similar to insurance companies, but chose a different route in recognition of the complex nature of CCRCs. The resulting standard was Actuarial Standard of Practice No. 3 which is titled “Continuing Care Retirement Communities.”
- The proposed regulation 651 goes beyond what is required in the Actuarial Standard of Practice No. 3. It is possible for a community to receive a positive actuarial opinion while still being under reserved according to this revised regulation. The level of cash reserves contemplated in the proposed changes are unprecedented in the industry and don’t exist in any other state’s reserve requirements.
- This level of cash reserves will make the product more expensive for the seniors of Florida.
- Another state also promulgated regulations over 15 years ago with greater requirements than Actuarial Standard of Practice No. 3, although not in the cash reserves. The end result has been a vastly underserved market by CCRCs. Developers will move into unregulated markets that don’t provide the same social safety net as CCRCs.
- A recently published article in the Senior Housing Forum titled “Controversy in Florida” discussed these proposed regulations. The article stated that “some tax-exempt CCRCs specifically use residents’ entrance fees to repay startup financing loans, which means that they start their existence with impaired balance sheets.” I do not agree with this statement. A CCRC is fundamentally different from the other risk bearing entities mentioned in the article. The blend of the residential component with the healthcare and refund risk components make CCRCs a unique business. A CCRC paying debt with refundable entrance fee proceeds is replacing an interest-bearing liability with a non-interest bearing liability. There is nothing inherent in this transaction which causes the balance sheet to be impaired, and it is a prudent practice for the CCRC and ultimately benefits the CCRC resident in lowering operating expenses. In fact, our Actuarial Standards of Practice dictate that we treat future debt payments and projected future refunds paid in the same manner.
- I am concerned about the unintended consequences of the proposed regulation.
- This regulation will require higher fees. In addition to the added annual expense required to comply with the regulation, additional fees will be required to establish and maintain cash reserves that are currently not required.
- The regulation encourages communities to make poor business decisions. Communities that defer paying off debt and defer capital expenditures will have higher cash reserves. Both decisions place the community at a greater financial risk.
- One multi-community provider told me they view the greatest risks for a CCRC are:
– fill and occupancy risk;
– leverage; and
– not investing into the building and physical plant.
The proposed regulations encourage communities to make business decisions that increase each of these risks for a community.
Ultimately, these regulations may lead to more CCRCs with financial problems. Another multi-community provider told me she thought that “new communities will not get built … and this type of legislation will also likely force more communities into bankruptcy.”
- The crux of the concern lies in what assets can be used to cover the liabilities of the CCRC. The Actuarial Standard of Practice No. 3 allows for the full building value to be used as an offset to the liabilities of the CCRC. The proposed regulation only allows 50% of net equity to be used, and this is still limited to no more than 70% of the net liabilities of the community.
- My belief is that Actuarial Standards of Practice No. 3 and the reliance on the actuarial opinion is sufficient. One of the advantages of the actuarial study over an audit is the early warning the study provides. This enables communities and regulators to respond to adverse experience in a prudent manner. It is imperative to allow communities the flexibility to address adverse experience while providing appropriate oversight.
– I am supportive of regulations that protect our consumers and providers. My specific recommendations concerning the revision to Chapter 651 include:
– Reword section 13 to recognize the unique blend of the residential component with a risk bearing entity. The liability as defined in the Actuarial Standard of Practice No. 3 and asset offset should be followed versus regulating CCRCs as an insurance company.
– Rely on an actuarial opinion every three years including sensitivity analyses with appropriate oversight for communities with a qualified or negative opinion.
- In my professional opinion, this is sufficient from a regulatory standpoint. In the event that the language on the Contract Liability Reserve remains, it is important for the following changes to be made:
– increase the 50% of net equity allowed to be used and the 70% of the net liability that can be covered by fixed assets. This will decrease the additional cash requirement currently contained in the proposed regulation.
– Before implementation, I encourage a stress test on the impact to operating communities be conducted.
– Additionally, there will be less of a shock to the industry if there is a 10-year phase-in of the funding of any new cash reserves for both existing communities and new communities that will be developed.
Brad Paulis, ASA, FCA, MAAA
Continuing Care Actuaries