By Jack Cumming
It’s common for older people to want to protect themselves against the contingencies of aging, principally those requiring long-term care—cognitive decline, loss of function, dependency, etc. The ready availability of responsive services if they are needed can provide peace of mind. An industry has grown up to respond to these needs, and a subset of that larger industry is of particular interest to actuaries—the entrance fee continuing care retirement industry.
This article is about the actuarial oversight of entrance fee continuing care contracts. Entrance fees can be thought of as equivalent to single premium life annuities in that they are expected to generate a lifetime income stream to offset fees for services that would otherwise be required. Without entrance fees, senior housing would be little different from standard rental housing with enhanced amenities and care services. The states do a good job of regulating the health and safety aspects, but the state can fall short in addressing financial responsibility and contractual equity. Financial responsibility is central to the work of actuarial professionals, so actuaries are uniquely positioned to assist in making sure these enterprises can fulfill their obligations.
Readers have likely heard of continuing care retirement communities (CCRCs). These are attractive living environments offering lifelong residence and a carefree lifestyle in which people can age with good food, good friends, good times, and good living. The designation CCRC is attributed to an actuary, Walt Shur, who now lives in such a community. The industry has sought recently to rebrand CCRCs as “Life Plan Communities,” in the belief that the words “care” and “retirement” hurt marketing. In deference to Walt Shur, an actuary of great distinction, this article follows the traditional terminology.
Isn’t a Lifetime Commitment Actuarial?
By now you may be thinking, as I did when I moved into a CCRC 12 years ago, that anything that offers lifelong protection against contingencies, especially age-related contingencies, is inherently actuarial. Of course, it is actuarial. This is especially applicable to entrance fee CCRCs. The earliest CCRCs, and many still in operation today, also guaranteed that the rate would remain materially the same regardless of the onsite care services that a resident required. Rather than developing the skills to manage such financial risks, some CCRC operators have abandoned such resident protections, reasoning that people shouldn’t have to pay, even stochastically, for services that they don’t use. That rationalization, of course, runs contrary to the rationale for insurance.
Some actuaries do work in the field, but most provider organizations don’t use actuaries, instead managing their business as though eldercare were a pure cash flow operation. After all, those large entrance fees provide a sizable boost to cash flow.
There is an actuarial standard of practice (ASOP) promulgated by the Actuarial Standards Board for CCRCs—ASOP No. 3, Continuing Care Retirement Communities—as a guide for preparing actuarial reports. But those reports by themselves, of course, do not assure that CCRCs will hold actuarial reserves, model actuarial contingencies to assure availability of resources, use actuarial principles in pricing, or even have a positive balance sheet. Also, ASOPs and accounting codifications tend to focus more on enterprise concerns rather than consumer interests—individual equity in the case of CCRCs. Moreover, many CCRCs qualify as nonprofits and operate with a negative net asset position, meaning that entrance fee investments in continuing care contracts are often at inordinate risk at the time they are made. Some CCRCs use entrance fees as though they were equity investments even though entrance fee contracts are not regulated as securities.
Some states require CCRCs that offer care-inclusive contracts to obtain an actuarial report every five years, or in some instances every three years. Many of those are simply sought for compliance purposes and remain unheeded on the shelf. The accounting profession permits a life-expectancy-based amortization of nonrefundable entrance fees, though some entrance fees (nominally called refundable) are amortized over the life of the buildings. Under the accounting rules, investment earnings on entrance fees simply accrue to the benefit of the enterprise as though the consumer had no reasonable expectation of a return on investment.
All entrance fee contracts, however, involve a lifetime commitment. In return for a substantial contractual down payment in the beginning, customers are assured that their recurring fees thereafter will be lower. Like single premium life annuities, some entrance fee contracts have refund features. Others, similar to some life annuities, include coverage of long-term care. There is no reason in my view why entrance fees could not be regulated as insured annuities, but they are not.
The Actuarial Mission
As actuaries, we have a professional responsibility to serve the public beyond the narrow interests of how we get paid or telling clients what they hope to hear. That is epitomized in the Academy’s mission: “to serve the public and the United States actuarial profession.” That professional responsibility takes on special meaning when the regulatory structures are vague, as is the case with CCRCs. Well-intentioned, optimistic managements may elevate wishful thinking above financial soundness.
Actuaries help clients and employers to wend their way through the intricacies of regulation. When those regulations are nonexistent, weak, or convoluted, as is the case with CCRCs, the easy course is for actuaries to churn out credible numbers and to hope that decision-makers use their work product wisely. When that work product is a report every five years, it’s reasonable to conclude that other parameters are driving decision-making. It’s common to hear senior housing CFOs, representing the interests of their employers, declare that “cash is king.” They run the enterprise on cash flow, overlooking accounting strictures and ignoring actuarial concepts altogether. The amounts of money involved are significant, with many customers required to sell their homes to raise sizable entrance fees. Those large entrance fees ensure that cash is plentiful. Even so, such enterprises can fail and be forced to reorganize.
The ‘Refund’ Anomaly
A particular anomaly is a form of refund contract that is common in the tax-exempt sector of the entrance fee CCRC industry. Typically, refunds do not become payable when the residential unit is vacated after death or the resident moves out. Instead, many “refund” contracts state that refunds will be paid within 30 days once a new entry fee has been received and the unit is re-occupied. That process can take several years. The American Institute of Certified Public Accountants (AICPA) reasons that no refund liability need be booked because “the CCRC’s own funds will never be used to make the refunds to the prior resident; instead, the CCRC is effectively facilitating the transfer of cash between the successor resident and the prior resident.” This allows a start-up CCRC to amortize such refundable entrance fees into income during the early years. While the Financial Accounting Standards Board has recently adopted more rigorous rules, the effects are just now rippling through the industry, and residents report that many CCRC executives dismiss the increased refund liabilities as merely an accounting transaction without materiality.
Actuaries will recognize that this situation creates a financial cascade in which later payments are used to pay those who leave the arrangement early. It negates the principle, sometimes referred to in actuarial circles as Weeks’ Axiom,
that each actuarial cohort should be financially self-sufficient. Rufus Weeks recognized early on that in a trust business, as many actuarial enterprises are, equity among cohorts is as important an ethical consideration as is pricing adequacy. In other words, each generation of participants (more particularly each stochastic cohort) should fund the expected value of its participation. Instead, in under-capitalized CCRCs, later generational cohorts are expected to fund benefits for prior cohorts. The early participants—residents in the case of senior housing—pay less and receive more than do later participants. Later participants are also deprived of the benefit of any investment earnings that might otherwise have accrued.
An Industry in Trouble
The senior housing industry in general and CCRCs in particular are divided into tax-exempt and tax-paying sectors. Each of these two segments has financial challenges reflective of the industry’s culture and mindset. For the tax-exempt “nonprofits” there is a tendency to underprice. Capital adequacy is not a topic that is even discussed. Not
surprisingly, many nonprofits are undercapitalized. The for-profits depend heavily on REITs (real estate investment trusts) for their financing, which presents a challenge in pricing the operating side of the business. REITs are investment companies seeking to maximize return on investment. In the leases they give to operators, the REITs press for maximum terms. Thus, for-profit operators not only have to price up to cover REITs’ leasing terms, but they also must meet the downward price pressure created by the tax-exemption-advantaged competitive pricing of the nonprofits.
The result is a mess. Increasingly, undercapitalized tax-exempt CCRC enterprises face insolvency and are forced to reorganize financially. This financial reorganization generally results in extending the terms of the debt or increasing future resident fees to make up for lost entrance fees due to underpricing, over-expending, or extravagance. In the absence of philanthropy, or unless the debt providers agree to take a loss, the residents pay the price for mismanagement. Nevertheless, with rare exceptions, residents or their representatives have no material voice in the financial decisions impacting them. (Of interest to actuaries is a personal observation that those CCRC provider enterprises that work seriously with consulting actuaries are, as a very general rule, better positioned financially than are their peers that operate without actuarial input.)
The consequence is that the entrance fee senior housing industry struggles to attract investors and is often risky for residents. Without sufficient capital, the industry falls short of meeting the needs of an aging American population. Without access to the capital that would be needed to meet demand, waiting lists for entrance are common.
Historic Parallels With Life Insurance
CCRCs today are in a similar condition to that of the life insurance industry in 1870. While 1870 may seem remote in time for today’s actuaries, the statistics tell a tale worth noting. Of 127 life insurance companies in existence at the end of 1869, 91 shuttered over the course of the ensuing decade—that’s a failure rate of 71 percent. Lester W. Zartmann, a Yale professor, explained:
“Chief among these causes was the newness of the idea, and the almost universal ignorance even among those who were in control of the companies as to the basic principles of the business. False assumptions were made in conducting the business and deceitful results followed.”
Not surprisingly, the actuarial profession came into being not long after the tumultuous decade of the 1870s to apply scientific principles to the pricing and reserving of life insurance companies. The National Association of Insurance Commissioners (NAIC) came into existence in 1871; its first act was to develop a uniform annual statement to ensure fair accounting, requiring life insurance companies to make reserve deposits to protect their policyholders.
While this history is from long ago and the life insurance industry that we know today is financially sound and trustworthy, there are parallels for today’s entrance fee CCRC industry to be drawn from those long-ago lessons.
- First, enterprises offering contracts with human life contingencies, as is the case with entrance fee contracts, need to have adequate capital to create a reasonable expectation that promises made can be promises kept.
- Second, pricing needs to be sufficient to cover the full range of lifetime commitments for the entire population covered by the enterprise.
- Third, those enterprises promising service availability need to ensure that sufficient capacity is maintained to assure fulfillment of those promises.
- Fourth, balance sheet actuarial reserves need to be maintained consistent with the operating, selection, and other characteristics of the enterprise.
- Fifth, there is a need for scientific experience monitoring and periodic (usually annual) repricing.
- These are all undertakings that have traditionally fallen under the purview of actuaries.
What Might Be Done?
Given the congruence of entrance fees with single premium insured annuities, it’s logical that the NAIC might develop the regulatory framework for CCRCs just as it has developed sound regulation for life insurance. I know that the American Academy of Actuaries regularly appears at NAIC meetings and believe volunteers could be positioned to assist in whatever research is needed as the NAIC studies this issue.
We’ve already seen that there have been challenges in developing principled GAAP accounting for the entrance fee CCRC industry. Most of these challenges can be accounted for by the absence of the actuarial perspective in the development of the codifications that govern the industry. One way to ensure actuarial integrity would be to extend statutory accounting to the entrance fee CCRC industry in much the same way that a modicum of statutory accounting has been applied by many states to charitable gift annuities. As is now the case with entrance fees, charitable gift annuities were a largely untidy realm until an actuary, George Huggins, brought order to the practice.
There are merits to the prepayment model for old age contingencies, as in the entrance fee model for continuing care. This is especially true when that model truly covers the financial exposures of old age long-term care, as with traditional care-inclusive CCRC contracts. A responsible, actuarially based prepayment model matches resources to life needs. This is an industry that can provide a valuable alternative for aging Americans. Such a framework requires a sound regulatory foundation, so that Americans can trust that promised benefits can be delivered as they fall due. While long-term care insurance has struggled, that is less the case with care-inclusive CCRCs.
While the care-inclusive model can be costlier than what most members of the public expect, the need is nevertheless there. If we can bring financial soundness to the high-value, market-based end of the socioeconomic spectrum, we can learn from that success how to extend similar benefits to those of lesser means. Already underway are some intriguing efforts to address the needy, including the Programs for All-Inclusive Care for the Elderly (PACE). Actuaries can provide the thinking and the leadership to assure that no American need to worry about catastrophe in aging.
By contributing to the development of a sound entrance fee CCRC industry, the actuarial profession can not only create opportunities for actuaries, it can also accomplish for aging Americans the financially trustworthy programs that actuaries have always developed. The American actuarial profession, through its professional bodies, has the know-how and the professional standing to place the entrance fee CCRC industry onto a sound footing and to help resolve the financial challenges that the industry now faces. There are many opportunities for actuaries in this developing industry if we but take the lead to bring scientific principles of equity, trust, and integrity to its conduct.
Jack Cumming, a member of the Academy and a fellow of the Society of Actuaries, is research director for the National Continuing Care Residents Association. In addition to his actuarial qualifications, he is by examination a Certified Aging Service Professional. Cumming is himself a CCRC resident, and he publishes and presents frequently in eldercare contexts.
 https://www.aicpa.org/content/dam/aicpa/advocacy/financialreporting/downloadabledocuments/finrec-comment-letters/ep-comment-letter-fasb-revrec.pdf, p. 6.
 Edward W. Marshall, Distribution of Surplus, The Actuarial Society of America, 1937, p. 18; T.A.S.A., IX, 310.
 Very recent prominent examples are Air Force Village West dba Altavita Village in Riverside, CA; Westchester Meadows in Valhalla, NY; and University Village Tampa in Florida.
 TSA XXXVI (1984), p. 353.
 Yale Readings in Insurance, New Haven, 1909, pp. 77-96.