CALIFORNIA PUBLIC EMPLOYEES RETIREMENT SYSTEM LONG TERM CARE PROGRAM ij ANNUAL ACTUARIAL VALUATION E AS OF JUNE 30, 2062 Prepared by: September 6, 2002 Steven J. Pummer, F.S.A,, MAAA. Ronald M. Wolf, F.S.A,, MAAA, Biltinghase ‘Tawers Perrin (CalPERS 016817TABLE OF CONTENTS ‘Summary. Plan Performance... Valuation Approach Valuation Assumptions... Valuation Results sau. Reliances and Li i 2. 3. 4. 5. 6. Appendices A~Mortality Study Detail B — Lapse Study Detail C~Claim Incidence Study Detail tions... Dillinghast = Taner Porn (CaPERS 0164181, SUMMARY. The CalPERS Long Term Care Program the “Program") offers long term care (“LTC”) insurance coverage to active and retired employees, their spouses, siblings, parents, and parents-in-law of the State of California and other public ‘employers within California. Tillinghast - Towers Perrin ("Tillinghast"), as part of its ongoing actuarial support of the Program, has performed this annual valuation of the Program as of June 30, 2002, We recommend that Program premium rates be increased for both policies in force and for new issues, as follows: = a single percentage for all policies, to reflect the adverse affect of investment results on all policies and to provide that all policies make some contribution to increase Program surplus = additional percentages for certain plans and issue ages (primarily plans with inflation protection and younger ages at issue) to reflect the material adverse affect of low voluntary lapse rates on these segments of the Program. ‘We will work with CalPERS Long Term Care Program staff to determine the percentages which will be presented to the CalPERS Health Benefits Committee for consideration at a future meeting. 1 CaIPERS_016419History of Plan Activity AS of the valuation date, June 30, 2002, 165,567 members were covered by the CalPERS LTC Program. This includes an estimated 6,889 members whose applications were still in process when this report was prepared. Only 10,408 members have terminated since the inception of the Program and 1,144 were disabled as of the valuation date, Enrollment continues to be strong among both active employees and retirees, ‘The number of applications received during the 2002 enrollment period, to the enrollment in recent estimated to be approximately 20,000, years. The continued enrollment volume and the exceptionally low rate of voluntary terminations (less than 2% per year ~ and less than 1% per year in the fourth and later policy durations) are strong endorsements of the excellent value which CalPERS members perceive in the LTC Program. simi Members continue to be more likely to purchase the most comprehensive and higher priced coverage options, especially at the younger ages. The average annusl premium is $1,223, about the same as last year's average of $1,221, Premium rate levels are unchanged since inception of the Program. Indicators accounting for the increase in the average annuel premiums include increased benefits (daily benefit amounts) and changes in the coverage eligibility provision (Partnership 2 ADL nursing home coverage effective January 1, 2002). Partially offsetting the increase in the average ennual premiums is a lower average issue age. For the 2002 enrollment period, the average issue age was 55 whereas the average issue age of active enrollees from prior years is 58, Through June 30, 2002, the Program has accumulated $732 million in assets (at market value) held by the CalPERS Long Term Care Trust. The sources and uses of funds for fiscal year ("FY") 2002 (July 1, 2001 - June 30, 2002) and for the Program inception to June 30, 2002 are as follows: Tilingbast- ‘Tapwers Perrin 2 CalPERS 016420Sources/Uses of Funds ($000's) Inception to. Fy2002 6/30/02 Premium income $187,454 $876,747 “Investmentincome = (61,119) 18,110 Marketing and administration (13,803) (92,890) Benefits paid (28,632) (71,381) Net Increase in Funds $ 83,900 $731,576 Valuation Approach We describe briefly below the approach that we have used in the past, as well as an additional approach or test that we have performed in this valuation for ‘the first time. : Because the CalPERS Long Term Care Program must be totally self- ‘supporting, it is important that the financial condition of the Program be monitored closely. If experience, either incurred or expected, indicates an actuarial loss in the Program, the CalPERS Board of Administration should act to adjust future premiums to maintain the Program’s financial health. This valuation estimates the liabilities of the Program, represented by the: Present value of future benefits; plus Present value of future expenses; less Present value of future premiums. Tilingbast~ Towers Perrin 3 (CaIPERS_016421,The Program maintains essets to offset its liabilities. If assets and liabilities are ies are equal and ‘equal, the Program is in balance; that is, if assets and liat all valuation assumptions are exactly realized in the future, current assets plus future premiums would meet all benefit and expense obligations as they come due. If there is @ deficit (liabilities in excess of assets}, it can be recovered only through future actuarial gains or increases in future premiums, To avoid miner adjustments on an annual basis, the CalPERS Board of Administration has adopted a policy that it will consider rate adjustments only if an adjustment of 5% or more is indicated —that is, only if the difference between abilities and assets, as a percentage of the present value of future premiums, exceeds 5%, This annual actuarial valuation is based on the best information available at the time the veluation is performed. Assumptions chosen are those that we believe are the most appropriate for the valuation considering: actual CalPERS Program experience = industry experience = Tillinghast’s judgment, including consideration of the self insured nature of the CalPERS Program and the risks involved in writing long term care ("LTC") insurance, All known members are included in the valuation, including those 6,889 members with applications in process at the valuation date, Although exact census data was not availabie for all of the members to be enrolled in FY2002, count of applications processed or received prior to August 6, 2002 was used so their effect on the Program could be approximated. As of August 6, 4 CaIPERS_016422iB 2002, 18,848 applications had been received for the 2002 enrollment. Of these a 7,382 were already approved by underwriting and included in the data we a received. An additional 8,066 applications were still in process. We have f assumed that 76% of the applications (or 6,130) will be accepted. We have . also added 759 policies that have been approved by underwriting but were f not included in the data we received. Flow Testing Analysis - The valuation approach described above, We have performed this additional analysis and have considered the results in forming our recommendations. Refinement in Method ~ For the FY2002 valuation we changed our projection platform from our original spreadsheet model to TAS Tillinghast Actuarial Software" ("TAS"), The TAS software is written and maintained by Tillinghast for use on client assignments and also is licensed to clients worldwide. : 5 ‘Tis Tewwers Perris CoIPERS 016423,Since Program inception, we have studied Program experience and have modified valuation assumptions accordingly. The effects of some of these modifications, such as claim incidence rates and voluntary lapse, have had very material effects on estimated Program liabilities. Likewise, the TAS software is considerably more refined and allows us to better reflect more refined assumptions and to better model a larger, more complex book of in force contracts. It also allows for the asset liability cash flow testing analysis described above. Therefore, we have now moved our projection platform from the original spreadshest model to our TAS software. Moving the projection to TAS resulted in a reduction in estimated present value of future benefits and expenses of $180 million and an increase in estimated present value of future premiums of $73 million, or a decrease in net Program liabilities of $253 million, Valuation Assumptions The assumptions used in the June 30, 2002 valuation are based on the results of detailed experience studies of the Program's experience, which were completed during the second quarter of 2002 and included ali of the Program's experience since inception, as well as the level of admini expenses as of the valuation date, We also took into account our knowledge rative Tiliinghast~ Towers Baris 8 CaIPERS_016624of industry experience, as we felt appropriate. Some key assumptions, and a refinement in our methodology, have resulted in changes from our prior =" valuations and are described below. 3 Voluntary termination (lapse). The voluntary lapse rates of the Program continue to be materially lower than expected at inception of the Program and are even a little lower in our 2002 experience study than in our 2001 study. Following is a summary of average lapse rates employed in this and recent valuations, Annual Lapse Rate Valuation 1 1998 8.0% 1999/2000 34 z 2001 28 5 2002 2a 3 Lower voluntary lapse rates generally result in higher Program claim costs, reserves and premiums, = Claims incidence. Overall actual claim incidence rates (reflecting the likelihood of going on benefit status, regardless of care setting) continue to be materially lower than claim incidence rates expected at Program inception. However, our 2002 experience study indicated a somewhat higher level of morbidity than in the 2001 study. For the first time, we felt that the volume of historical Program claim experience was credible enough to conduct an analysis by policy duration as well as by age. As a result, we lowered our assumed incidence rates for attained ages 60 to 80 but increased our selection factors (which reflect the effects of initial underwriting) for issue ages 65 and over. The following ey table presents aggregate incidence rate assumptions, expressed on an ‘Tiinghast © Towers Perrin 7 (CaIPERS_016425actual to expected basis, for the current and prior valuations and experience studies. to Expected” inciden: & Yor Valuation ‘Experience Inception 160 NA 1999/2000 100 70" 2001 80 57 t 2002 70 64 "Bases on the 2000 velution assumetions ovEsimate For the 2002 valuation, assumed valuation incidence rates have been set a considerably closer to (but still higher than) measured experience rates than was done in prior valuations. f = Mortality. We first performed a brief study of Program mortality in 2001, We repeated that study in 2002. The results showed mortality at near 50% of expected, much lower than what we have observed in the industry. We eat this time, For the do not regard this experience as being fully cre 2002 valuation, we reduced the actual to expected ratio in ultimate policy i durations from 100% to approximately 85% and decreased our select factors slightly. These changes result in an increase in Program = lavestment earnings rate. An additional key valuation assumption is the } _ investment earnings rate. Since inception, the assumed annual investment _ I ; Bittinghast {Powers Perrin 8 CalPERS _016426(primarily moving some domestic equities to international equities). The _rate of return expected by Wilshire for the recommended investment mix 87.31% _ Based on the above information and our judgement, we have lowered the valuation investment rate of return assumed in the future from 8% to The While some of these individual assumption changes have @ significant impact insurers oflong term care are currently using for pricing and valuation, due primarily to the CalPERS investment strategy including @ significant portion (near 65%) of assets in equities. recommends a Valuation Liability increase (Decrease) Assumption Changes ———_sMillions)____. Lower investment earnings rate 127 Lower lapse rate 63 Lower incidence of claims 111) Lower mortality 170 Total 278 ‘Total change does not equal sum of changes due 1 inter-dependence of assumptions. Tillinghast = Dowers Bertin 8 CalPERS _016427Valuation Results Based on the valuation assumptions and methods employed and the census ji data as of June 30, 2002, the following present values were calculated. a Present Value at E June 30, 2002 {S millions) 1. Present value of future benefits 2,618 2. Present value of future expenses 252, 3. Present value of future premium (PVFP) 1,887 4, Valuation liabilities (1. + 2. - 3.) 983 5. Valuation assets 768 6 Valuation surplus (deficit) (5. - 4.) (218) } (7. Surplus (deficit) asa % ofPVFP (5. +3.) = (11.4%) ‘The current Program status is an estimated deficit of $215 million, which is a significantly larger deficit than the estimated deficit of $77 million on June 30, 2001. A reconciliation is provided below. t Surplus (Dé iS ions) f 1, June 30, 2001 Valuation (77) 2 Investment Income Below Expected (113) g 3. Assumption Changes (278) : Refinement in method 253 June 30, 2002 Valuation (215) We also found that premium rates adjusted to reflect the new valuation assumptions, for plans with inflation and for younger ages at issue, would be considerably larger than those currently charged, The higher rate level is Filtinahast: iors PETTI nns 10 CaIPERS_016428,é G caused primarily by the effect of voluntary lapse rates being lower than 9 expected. Recommended Program Changes © Cash Flow Risk - The use of a static investment rate of return does not allow for the risk of asset volatility causing the Program to run out of = funds. Our assetiabilty scenario analysis indicates that the likelihood that WW CalPERS_016829= Other Assumptions - The only key assumption in the valuation having a demonstrable positive margin is the claim incidence rates, with @ margin of about 9%, or about $210 million at June 30, 2002. If future Program mortality experience occurs at the most recent observed Program level (which we currently regard as not fully credible), Program liabilities at June 30, 2002 would increase by approximately $260 million. According to the Program's policy contracts, insureds may elect to have their benefits reduced in lieu of having premiums increased. We will work with CalPERS Long Term Care Program staff to determine recommenced percentage rate increases whose goal will be to achieve the following objectives. = Increase the reported surplus position of the Program to a positive amount which is estimated to achieve a cash flow testing pass rate of at least 80%. 12 CalPERS _016430Minimize the likelihood of needing to raise Program rates again in the foreseeable future, = Result in reasonable rate equity by plan and issue age. We continue to endorse the pursuit of new members for fiscal 2002/03, which should serve to increase the expense efficiency of the program and also to make program experience studies more credible for better financial management. ‘Tillinghast ~ Towers Perrin 8 CalPERS _0164312, PLAN PERFORMANCE The LTC Program continues to maintain strong enrollment, Enrollment as of June 30, 2002 (including an estimate of new members based on applications in process) is estimated to be 165,557. Member Statistics Inception to June 30, 2002 Voluntary Terminations 10,408 Deaths 4,674 June 30, 2002 Disabled 1144 June 30, 2002 In-Force 165,567 As discussed in prior reports, this increased membership is important to the Program for several reasons, Because expenses are not directly proportional to membership, higher enroliment means lower expenses per contract. Also, a continued influx of new members maintains a balance in the risk pool and provides greater stability in Program reserves. The increase in enrollment is a result of two factors. The first is the continued marketing success of the Program, with approximately 20,000 applications expected in 2002. Second, voluntary terminations — which are only 6% of all members after eight years of Program operations - are well below industry averages. This low termination rate is a strong endorsement of the value of the CalPERS LTC Program as perceived by its members. Tabie 2.1 at the end of this section shows a distribution of enrollees, by plan and age, as of June 30, 2002. The plan codes used in those tables refer to the following plans: Tillinghast = Tenvers Perr 14 CaIPERS_016432Qn C3 - Comprehensive; 3 year maximum; no inflation C3i - Comprehensive; 3 year maximum; 5%fyear inflation f CL - Comprehensive; no lifetime maximum; no inflation Cli - Comprehensive; no lifetime maximum; 8%/year inflation N3 = Nursing home only; 3 year maximum; no inflation N3i_ = Nursing home only; 3 year maximum 5%/year inflation NL = Nursing home only; no lifetime maximum; no inflation NLi - Nursing home only; no lifetime maximum; 5%/year inflation P1 = Partnership; 1 year maximum; 5%/year inflation P P2 - Partnership; 2 year maximum; 5%/year inflation Other key enrollment statistics are shown in Table 2.2. The most comprehensive coverages continue to be the most popular. For example, 72% elect comprehensive {ie., nursing home and home care) plans, versus 23% electing nursing home only plans (the remaining 5% purchase Partnership plans), Unfimited lifetime maximum plans account for 77% of the total, and plans with an automatic inflation escalator account for 71% of the total. The choice of plans also reflects the price sensitivity of buyers; that is, the 3 purchase of more comprehensive plans decreases at the older ages, where their premiums escalate rapidly. For example, the following chart compares the purchase patterns of members by issue age for age 70 or over (14% of all members}, age 50-69 (65% of ali members) and age under 50 (21% of all members). Titingias- Towers Perrin «6 CalPERS 016433Issue Issue — issue f Age Age Age 70 ‘ Under50 50-69 or Over f Purchase nursing home only coverage Th 24% = 44% Purchase unlimited lifetime maximum 1% 77% 56% Purchase automatic inflation 5% 72% + 48% Partnership plans 2% 4% = 9% While members age 70 or over are only 14% of all members, they have Purchased 28% of the Partnership policies. The issue ages of new members reflects the pattern of many other employer group offerings: the purchase of a long-term care insurance is most likely among the older active employees and younger retirees — compared with other employer group offerings, however, the CalPERS Program has @ much stronger relative showing among retirees than actives. This fact may be attributed to the lack of a single cohesive employer and to the resulting challenge in communicating to active employees. ~~ active employees (and their spouses) have been more involved in f recent application periods. the average issue age is decreasing. a a ny Baek Bain a CalPERS 016434‘The rate of voluntary withdrewals has been significantly below the valuation assumptions historically (which is an unfavorable deviation). For this reason, valuation lapse assumptions were substantially reduced in 1999 and further reduced in 2001 and 2002. Based upon the CalPERS Program experience analysis completed in 2002, the aggregate experience, since Program inception, indicates an actual first year lapse rate of 2.7% and the ultimate lapse rate is near 0.3%. Tillinghast - Towers Perrin. 17 CAPERS (16435,TABLE DT CalPERS Long-Term Care Program Distribution of Members by Plan and Age as of June 30,2002 t Issue 1 Plan# Plan <40. 4950-89 70-79 8 3 0.0% 0.3% 1.2% 1.6% 7 cai 0.1% 0.7% 2.1% 07% 13 cu 22% 4.9% 1.7% " chi 4.0% 11.5% 19.0% 2.0% . 10 NB 0.0% 0.4% 1.3% 7 8 Nai 0.0% 0.2% 0.8% 0.6% i. 14 NL 0.0% 0.2% 0.8% 1.7% 2 NLi 0.2% 1.0% 3.6% 1.7% 1 Pt 0.0% 0.1% 0.3% 0.5% 3 P2 0.1% 0.3% — 0.8% 0.5% Totwl 5.1% 12.3% Ditinghase = Tomors Berrie 18 CalPERS_016436TABLED CalPERS Long-Term Care Program Member Statistics As of June 30, 2002 Number of Members* Active Disabled Total Male Female Coverage options Comprehensive plans 72.1% Nursing home only plans 23.4% Partnership plans 45% Automatic infiation option 71.0% Unlimited lifetime maximum 713% Average age at issue (since inception) 58 Average age at issue (FY2002 enrollment) 55 Average premium $102/month * Includes applications stil in process as of 8/3/2002 Pillinghasr~ Tinwers Perrin, 9 CalPERS_0168373. VALUATION APPROACH Because the CalPERS Long-Term Care Program must be totally self-sufficient, itis important that the financial progress of the Program be monitored closely, If experience indicates an actuarial deficit in the Program, the CalPERS Board cof Administration will need to act quickly to adjust future premiums to maintain the Program's solvency. ‘The current valuation process established by the CalPERS Board requires that abilities be valued annually, based on current Program benefits and premiums, with Program represented by the: Present value of future benefits; plus Present value of future expenses; less Present value of future premiums. Premiums were originaliy calculated so that, at the time of issue, future benefits and expenses would be exactly equal to future premiums, creating a zero liability at issue. However, because premiums are level but benefits increase dramatically with age, premiums will significantly exceed benefits and expenses in the early years. The excess funds collected in these early years produce reserves that must be set aside for future years when benefits will exceed premiums. If all assumptions are realized and the Program ‘operates as projected, the accumulated assets will exactly equal Program liabilities each year, and no adjustments to the Program will be needed. 20 CAPERS 016438In reality, the amount of accumulated assets will not be equal to amounts a originally planned or estimated. This can occur for many reasons, such as: A @ Varying claims experience will reduce assets either more or less than expected; | Varying withdrawal or death rates will cause premium income to be more or less than expected; and reduced withdrawals will increase the exposure to future benefit costs; Differences in the number of members will affect the average expense per member, due to the graduated administrative fee schedule; The actual rate of return on investments may be greater or less than the rate projected. At the same time, the calculation of liabilities will vary due to changes in 19 either emerging Program experience or e of future future essumptions, reflect f experience studies from other sources that may be indi ‘expected experience in the CalPERS Program. This annual valuation monitors the effect of changes in both accumulated assets and Program liabilities. It estimates the actuarial surpius or deficit, calculated as the difference between assets and liabilities, on the valuation date, lf there is an actuarial deficit, it can only be recovered by either (a) future favorable experience that produces actuarial gains, or {b) increases in future premiums. Since future experience gains cannot be depended on, the effect on future premiums of an actuarial deficit is expressed as: Biingbast: | Bowers Perrin 2 CaPERS_016039—Program Liabilities - Assets _ Present Value of Future Premiums. Itis not advisable for CalPERS to make constent premium adjustments due to minor actuarial deficits, especially since future experience could reverse such 2 deficit. Therefore, the CalPERS Board of Administration has established a ., an actuarial guideline that if the above ratio is greater than minus 8% (i. deficit exists which will require @ premium increase of 5% or more to restore actuarial balance}, premium action will be taken. The Board has not established a formal guideline for actuarial surpluses; 2 surplus of 5% or more should also be reviewed for possibie corrective action. This action could be in the form of either increased benefits or decreased premiums. Cash Flow Testing Analysis - The valuation approach described above, which we have used since the Program's inception, measures only liability cash flows. It does not measure the risk associated with prolonged adverse fluctuation in asset values occurring when Program liability cash flows turn negative, possibly causing the Program to run out of funds. Commercial LTC insurance regulations and current actuarial standards of practice require that “cash flow testing” or “asset adequacy analysis” be done is risk. The analysis basically involves forecasting both asset and to estimate t liability cash flows over a large number of random economic scenarios, to. assess whether there are sufficient funds available under most of the scenarios. The analysis makes specific provision for the asset allocation recommended to the Program by Wilshire and Associates (“Wilshire”) in September, 2002. Tilinghast - ‘Towers Perrin 22 CalPERS 016440We have performed this additional analysis and have considered the results in forming our recommendations. Refinement in Method - For the FY2002 valuation we changed our projection platform from our original spreadsheet model to TAS Tillinghast Actuarial Software™ (“TAS"). The TAS software is written and maintained by Tillinghast for use on client assignments and also is licensed to clients worldwide. ‘At the inception of the Program nearly 9 years ago, information and tools to financially manage the Program were less credible end refined than what is available now. The initial pricing and valuation assumptions were near guesses, as very little experience on insured LTC plans was aveilable (especially for a large population in one state). No professionally written vendor software that accommodated the complexities of LTC was available, 80 spreadsheet tools were developed. Since Program inception, we have studied Program experience and have ‘modified valuation assumptions accordingly. The effects of some of these modifications, such as claim incidence rates and voluntary lapse, have had ies. Likewise, the TAS. software is considerably more refined and allows us to better reflect more very material effects on estimated Program fiabil refined assumptions and to better model a larger, more complex book of in force contracts. It also allows for the asset liability cash flow testing analysis Gescribed above. Therefore, we have now moved our projection platform from the original spreadsheet model to our TAS software. Moving the projection to TAS resulted in a reduction in estimated present value of future benefits and expenses of $180 million and an increase in estimated present value of future premiums of $73 million, or a decrease in net Program liabilities of $253 million, Towers Perrin Filingbase 23 CAPERS 016441j 3.1 Present Value Calculations ‘The present value calculations needed to compute Program liabilities consider expected future benefits, expenses and premium revenue discounted (at an assumed investment rate) to the current valuation date. The discount rate used reflects the expected earnings rate on assets created by the excess of Premiums over benefits and expenses in the early years. The present value calculations consider all future variables that affect the members’ continued participation in the LTC Program, as well as the benefits or expenses they will ~ generate. Key assumptions include: ® Discount (investment earnings) rate 1 @ Claim incidence (probability of becoming disabled) Claim severity (expected duration in benefit, the setting care received; ¢.6., home care or nursing home, and the amount of benefit) Mortality Voluntary termination Expenses The effect of these assumptions will vary depending upon the specific benefit design of each pian, so present values are calculated separately for each plan and age at issue. Present value calculations are then applied individually to each member, based on that member's plan, age at issue and duration since issue. Separate present value calculations, using disability continuance tables, are applied to all disabled members, based on their plan, age and time since disability commenced, Diingtast - Towers. ere 24 CAPERS 0166423.2 Asset Valuation Because a large portion of Program assets are invested in equities or other assets that may experience short term volatility, the Program surplus may be unduly sensitive to the timing of the valuation date. To avoid this, an asset valuation approach is used which smoothes the recognition of investment gains or losses, thus creating @ more stable asset valuation from yeer to year. ‘The following approach has been used in the LTC Program valuation since inception. MV, = — Market value of assets at date of current valuation Ie, = Expected investment income (at valuation interest rate) 1A, = Actual investment income (including realized capital gains and losses, plus any increase (decrease) in unrealized gains and losses since prior valuation) Gu, Investment gain (loss) for current year lA-1E, vA, MV, ~ GL, prior years’ unamortized gains (losses) Investment gain (loss) is amortized over 2- 5 years, depending upon its percentage of valuation assets (ie., GL, + VA\), according to the following Tanners Perrin. table: Percent Year GLY VA) Current | t+1 t+2 t+3 tH o%-s% | 50% | 5% ~ 10% 33% 10%- 15% | 25% 25% 25% 216 20% 20% 20% 20% Titinghast © 2 CaIPERS_016443,Then, i VA = Valuation assets at date of current valuation “ = VA, + current year amortization of GL, In no case shall VA, be less than 85% of the current market value of Program assets (MV,), nor more than 105% of the current market value of Program assets. If it is, the amortization of gains or losses shall be immediate to the extent necessary to bring the valuation assets to within this acceptabie range. ‘Towers Pervin 28 (CaIPERS_0164444, VALUATION ASSUMPTIONS, Assumptions as to voluntary termination (lapse), mortality, claim incidence, and investment earnings rate used in the 2002 valuation have been modified to reflect the Program's experience through 2002. Other assumptions are the same as in the 2001 valuation. A detailed discussion of these revised assumptions is set forth below. 4.1.7 Voluntary Termination (Lapse) Rates Based upon the 2002 experience study, the lapse assumption has been modified to reflect a lower level of lapses. Lapse experience and assumptions vary by age. The average lapse rate weighted by experience is provided below. Policy 2001 Valuation Program 2002 Valuation Year Assumptions Experience Assumptions 1 2.8% 2.7% 2.7% 2 1.8% 1.5% 1.5% 3 1.1% 1.0% 1.0% 4 5% 1% 7% B+ 5% 3% 3% industry lapse experience also continues to decrease with ultimate lapse rates ranging from .5% to 1.5%. Fa CaIPERS_o164454.1.2 Claims Incidence Overall actual claim incidence rates (reflecting the likelihood of going on benefit status, regardless of care setting) continue to be materially lower than Claim incidence rates expected at Program inception. However, our 2002 experience study indicated a somewhat higher level of morbidity than in the 2001 study. For the first time, we felt that the volume of historical Program claim experience was credible enough to conduct an analysis by policy duration as wall as by age. As a result, we lowered our assumed incidence rates for attained ages 60 to 80 but increased our selection factors (which reflect the effects of initial underwriting) for issue ages 65 and over. The following table Presents aggregate incidence rate assumptions, expressed on an actual to expected basis, for the current and prior valuations and experience studies. 20 Expected* Incidence Year Inception 1999/2000 100 7o* 2001 80 57 2002 70 84 Bas an th 2000 valuation estumtions “Exits For the 2002 valuation, assumed valuation incidence rates have been sot considerably closer to (but still higher than) measured experience rates than was done in prior valuations. Tinghass Towers Perrin a CalPERS 016446& Revised sample incidence rates are shown below: Probability of Claim Ratio of 2001 Valuation 2002 Valuation 2002 to 2001 Age Assumptions Assumptions Assumptions 3 0003, 0008 1.00 7 45 0007 .0007 1.00 55 0013 0012 92 . 6 0040 0032 80 | 8 0140 0126 90 : a 0545 0530 97 5 35 1128 1128 1.00 4.1.3 Mortality ies We first performed a brief study of Program mortality in 2001. We repeated that study in 2002. The results showed mortality at near 50% of expected, much lower than what we have observed in the industry. We do not regard fl this experience as being fully credible at this time. For the 2002 valuation, we reduced the actual to expected ratio in ultimate policy durations from 100% to ) approximately 85% and decreased our select factors slightly. These changes resuit in an increase in Program liabi 4.1.4 Investment Earnings Rate (CoIPERS_016447Based on the above information and our judgement, we have lowered the valuation investment rate of return assumed in the future from 8% to 7.5%. While some of these individual assumption changes have a significant impact on Program liabilities, their combined effect is an increase in valuation liabilities of $278 million. The effects of the most significant assumption changes, expressed as an increase or decrease in valuation liabilities, aro: 30 CaIPERS 016443Valuation Liability Increase (Decrease) Assur a ($ Millions) Lower investment earnings rate 127 Lower lapse rate 63 Lower incidence of claims (ty Lower mortality 170 Total 278 “Total change does not equal eum of chenges due to inter-dependence of assumations. a CalPERS 0164495. VALUATION RESULTS &.1 Calculation of Present Values Lk Based on the veluation assumptions discussed in the previous section, and the census date for both active and disabled participants provided as of June 30, 2002, the following present velues were calculated (in millions of dollars): Present Value as of June 30, 2002 {S Millions) 1, Present value of future benefits Active 535 Disabled 83 2,818 2. Present value of future expenses \ Active 247 i Disabled it 252 3. Present value of future premium* 1,887 4, Valuation liabilities (1.+2.-3,) 983 * This represents premiums for both current actives and disableds expected fo return to premium paying status. 5.2 Valuation Assets and Surplus ‘Table 5.2.1 shows a summary financial statement for the CalPERS Long-Term Care Program at June 30, 2002. This statement shows a fund balance of $732 million on June 30, which is the current market vaiue of assets, including unrealized capital gains and losses. Table 5.2.2 shows the adjustment of these i ‘assets to compute the valuation assets (calculated as explained in Section 3) Dilinghase - ‘Towers Perrin ae (CaIPERS_016450,8 of June 30, which are $768 million. The remaining unrecognized losses will be amortized over the next three years, Comparing the valuation assets to the Program's valuation liabilities of S983 million, there is an estimated actuarial deficit of $215 million. As a percent of ‘the present value of future premiums ($1.887 billion}, the deficit is (11.4%). This indicates that, if the valuation assumptions are exactly realized, premiums need to be increased 11.4% to restore actuarial balance of the Program. According to the guidelines established by the CalPERS Board of Administration, premium action is necessary if the deficit ratio, noted above, is outside the range of plus or minus 5% <== TABLE S27 CalPERS Long-Term Care Program Fiscal Year 2002 Financials ($ millions} Inception 2002 30.6/30/02 Premium income $188 $877 Investment Income 61 19 Total Income 127 996 Benefits Paid 29 n Expenses ures 8 58 Underwriting Costs 2 12 Marketing and Other 3 _23 Total Expenses 4 93 Net Contribution to Fund 84 732 Beginning Fund Balance 648 o Ending Fund Balance 732 732 ss Tittingoase = avers Perrin. 33 (CalPERS_016451# TABLES22 t CalPERS Long-Term Care Program Valuation Assets as of June 30, 2002 ($ Millions) : 1. Marks au of assets on Jue 30, 2002 132 j 2 Expected investment ncare © 3. Acwalimestment income (et 4, Actatalgintoss) = (3)~(2) 073) 5. Por year unamertzed amoun's 2 Prin valuation assets = (1) (4) (5) 67 1. Pescant = (4)/(8) (03%) 6 Gurent year amorteation able baton” (89) Valuation assets as of June 35, 2002 788 me 7003 2008 : Prior yous 22) ° ° ! Carne year 6-8 12 A e108 ° 6) : 10% 15% 2 i @ 8 219% ° ° cess of 1058 cop? 155) Tota (99) (19) @ * Valuation assets are capped at 105% of the current market velue of Program assets. Immesiate amortization is required to bring valuation assets within 5% of market value 5.3. Cash Flow Testing Results ‘Our asset/liability scenario analysis indicates that the likelihood that current assets would be adequate to fund future cash flows is about 71%. While regulatory and professional guidelines as to @ favorable result are unspecified, & we typically look for an 80% "pass rate”. Tillinghast ‘Tawwers Perrin a4 CalPERS 0164525.4 Analysis of Gains and Losses A total actuarial loss occurred in the Program during FY2002 of $138 million, This loss is comprised of current losses during the fiscal year and valuation losses at the year end valuation, Current Losses ~ The current loss of $113 million resulted from investment losses for the year (including unrealized capital gains) of $61 million being $113 million less than expected investment income of $52 million. Deviations in actual results from expected for premiums, claims and expenses, as well as the effect of new issues, were small and offset one another. Valuation Losses - The net valuation loss of $25 million was comprised of a loss of $278 million due to change in assumptions and a $253 million gain due to refinement in method. ‘The $278 milion loss due to change in assumptions was the net result of losses due to changes in mortality, voluntary lapse, and investment earnings rate and a gain due to change in claim incidence rate, as shown in the table below, Tillinghast - Pe CaIPERS_016453,Valuation Liability increase (Decrease) f Assumption Changes ($ Millions) “ Lower investment earnings rate 127 Lower lapse rate 63 Lower incidence of claims (11) fl Lower mortality 170 . Total 278 "Total change does not equal sum of changes dus to inter-denendence of assumptions. These changes in assumptions are based on updated experience studies tu performed by Tillinghast and, in the case of the investment earnings rate, by Wilshire and Associates ~ and, on Tillinghast’s judgement and industry knowledge. Descriptions of the studies are presented in the summary. t Detailed results for the mortality, lapse and claims incidence studies are presented as Appendices A, B and C. ‘The gain due to refinement in method is described beginning on page 23. Towers Perrin 36 (CaIPERS 0164546, RELIANCES AND LIMITATIONS In performing this valuation, Tillinghast - Towers Perrin has relied upon the R accuracy and completeness of various data and information provided by CalPERS and its long-term care administrator, The Long-Term Care Group. While we have reviewed th i we have not performed an audit of it. The information relied upon includes ited to the following. formation received for general reasonableness, nh but is not necessarily = Files of long-term care policies and claims in force as of June 30, 2002. A = Assets and related information for the long-term care program as of June 30, 2002, = Results (number of applications) during the 2002 application period including pending applications as of June 30, 2002. This valuation report has been prepared for the benefit of the CalPERS Board of Administration and its administrative management staff. While we [ understand that utilization of the report may be governed by California laws or regulations, we respectfully request that copies be provided only to those 1 parties who request @ copy and who have a legitimate need to receive it, id ‘The valuation and related financial projections in this report involve the making of estimates over a long period of time. Actual experience will vary, perhaps materially, from the projected amounts. Such variation may especially apply to long-term care insurance which does not have a long history as an insured coverage in the United States. Pilinginse- Toners Perin et CaIPERS_016485eg nn: sly sso ET, CaIPERS 016456 necmnapggeng On BS ERT RR soma eer ze sng ventana nou 8Scena esmana ree vanes ~asOg TAL avseren, aisereed anyon 2 i pages, aeersres, Seeseraces neensesezsg a Fee ! a TE sors entra so ny ssid ae Sora y a u CalPERS _016457! ll eeeeigesad 3 ‘Ri i TY ERE ORTTTRS OTT Ao seg in fn aude zea mse weoig o> weL-B00y gua awonaaay CaIPERS 016458