One session of the European Science Days summer school involved a presentation on long-term care (LTC) from Volker Meier. The main question is why is there so little demand for LTC insurance in the United States as well as in other countries? Below are some explanations as to why the LTC insurance market is so small and why–when people do buy LTC insurance–do they make the purchase so late in life:
- Loading factors. If loading factors are too high, this may possibly justify government intervention. However a paper by Brown and Finkelstein (JPubE 2007) finds that loading factors are comparable to those of life annuities. Meier claims that if there are fixed loading costs, purchasing later in life can save on these costs. However, I believe that these most insurance contracts likely have a fixed and variable loading factor even if economists do not typically model it this way, and this fixed loading cost explanation is likely a poor one.
- Adverse Selection. It seems likely that individuals have some information regarding the probability they will need LTC in the near future. Most individuals purchase health insurance because there is a non-trivial probability that they will become sick each year. Most younger individuals in good health, however, will not need LTC in the next year. Even if one falls sick, it may be years before LTC is needed. Thus, if one can predict the need for LTC with near certainty two years in advance, no one would purchase LTC insurance.
- Medicaid. In the U.S., Medicaid pays for about 40% of nursing home stays (Forbes). Thus, poor people have no incentive to purchase LTC insurance since Medicaid will pay. The middle class can run down their assets in the case where they need LTC and have Medicaid foot the bill. Thus, only for the rich will purchase LTC insurance in the United States in order to protect their accumulated assets.
- Proposal: Matching life insurance with LTC insurance. Peter Zweifel proposed this idea which seems logical. Individuals who live past 65 can use the proceeds from their life insurance policy to pay for LTC insurance. However, there would seem to be significant problems with insurance companies pricing LTC years in advance. Further, healthy individuals who reach age 65 may simply prefer to use the life insurance proceeds to spend on other things. This is especially true if LTC needs are predictable a few years in advance.
Care in a nursing home or care at home
Much debate in Europe and the U.S. has wondered whether paying family members to care for the elderly can save taxpayers money and increase the quality of care. Dr. Meier creates a model with the following characteristics:
- Individuals fall sick and the cost to care for them is variable. Individuals who go to the nursing home have a cost of Kn, while individuals can also receive care at home for a cost of βiKh, where βminKh < Kn < βmaxKn.
- βi can depend on the dependent’s opportunity cost or the seriousness of the disease. Thus, we would predict that individuals with better paying jobs and individuals who’s parents have more serious diseases will prefer to put their parents in nursing homes compared to at-home long term care.
- Another problem with paying individuals to care for their parents at home is the issue of fraud. Individuals can claim to be helping their parents cope with some diseases in order to receive extra cash, even though the work they do may be minimal or non-existent.
- Meier finds that it is optimal to offer two types of LTC insurance contracts. The first is for full insurance for nursing home care. Another insurance contract will give partial insurance for care at home. The premium for the first contract will be more expensive than for the second. The partial insurance will help to discourage fraud. Meier claims that this is how the German public long-term care insurance operates.
- Brown and Finkelstein (2007) “Why is the Market for Long-Term Care Insurance So Small?” J Pub Econ forthcoming
- Pauly, M.V. (1990) “The rational nonpurchase of long-term-care insurance.” J Pub Econ 98, 153-168.