Addressing the incompleteness of long-term care insurance

 With rapid population ageing, expenditure on long-term care – that is, care and assistance for old-age dependent elderly – has risen faster than health expenditure. Perhaps surprisingly, this increase is far more due to population ageing than to changes in people’s health (Colombo and Mercier 2012, Breyer et al. 2011).

Available data suggests that relative spending on long-term care relative to the GDP in OECD countries is at 1.5% in 2008, and projections indicate that it is set to double or even triple by 2050 depending on different assumptions made (Colombo and Mercier 2012). In the US, the Congressional Budget Office noted that expenditures for nursing homes, home healthcare and other long-term treatment already accounted for 8.5% of all US healthcare spending.

It is estimated that 35%-50% of the elderly population will use long-term care in their lifetime (Frank 2012). Yet, unlike healthcare, insurance coverage for long-term care in most OECD countries is incomplete, which leaves people in need of care having to rely either on public support when available and they qualify (after needs and means testing), or if they can afford it, to self-insure such needs. This is so much the case that in Europe, Figure 1 seems to suggest that with the exception of the Netherlands, most people expect to pay for long-term care at old age.

Figure 1. Who will pay for people’s long-term care?

Question: “Imagine an elderly father or mother who lives alone and can lo longer manage to live without regular help because of her or his physical or mental health condition. In your opinion, what would be the best option for people in this situation?”

Source: Eurobarometer.

 

The case for insurance

There is an efficiency case for some form of risk pooling. Insurance for long-term care is welfare improving compared to self-insurance – through precautionary savings or asset accumulation (Frank 2012). However, important demand-side factors (Brown and Finkelstein 2011, see a special issue devoted to long-term care) impose significant limits to the expansion of private insurance. Despite this, the increasing importance of the elderly as a voter group in some European counters may put some additional pressure to finding a response to the “long-term care insurance conundrum”.

Although population-ageing bites, in times of austerity, it’s difficult to conceive a widespread government programme expansion to finance long-term care. For instance, programmes that entitle the population to free long-term care such as the one in Scotland appears run out of funding in 2013 and, similarly the Spanish funding is not guaranteed beyond 2015. In the US, proposals to introduce a long-term care insurance reform under the so-called CLASS Act did not fly.

In this column I argue that in addressing the issue of incomplete insurance, three features appear to be the most abiding ones:

1. Insurance crowding out by the state and society,
2. Cognitive limitations in understanding the nature and magnitude of the risk, and
3. Inefficiencies in the design of LTC insurance contracts.

1) Social and public insurance crowding out

Informal care is still the main source of provision in practically all western countries – not just in low-income countries where informal arrangements are the only source of care (Colombo and Mercier 2012). Given that such arrangements define a status quo, proposals to expand both social and private insurance need to overcome the existing entrenched social norms guiding intergenerational caregiving appear to inhibit insurance market development (Costa-Font 2010b, Costa-Font and Courbage 2011). This feature qualifies as a form of societal crowding out, whereby family ties and social norms impede the development of insurance contracts. Similarly, the development of public insurance programmes can have some, even though limited, effect on the development of an insurance market (Brown and Finkelstein 2004).

2) Cognitive limitations

An individual’s insurance decision is subject to some level of cognitive constraints, that include shortsigntedness and limited temporal preferences as well as some form of risk denial given the unpleasantness of being long-term care dependent. Similarly, lack of knowledge and some influence of misconceptions of risks (Frank 2012) suggest that improved transparency on long-term care insurance markets can potentially reduce efficiency losses.

3) Insurance contract design

Insurance contracts face the challenge of counteracting moral hazard incentives to claim long-term care benefits, especially when such benefits are paid in cash. Most insurance contracts, such as the existing schemes in Germany try to address this problem by introducing cost sharing schemes and tend to reduce the amount of cash benefits compared with ‘in kind’ benefits. However, such schemes do not appear to be financially sustainable either as originally designed and have triggered a reform in 2008 to expand social insurance contributions. Similarly, to address problems of moral hazard and sustainability, the 2011 Dilnot Commission in the UK (Department of Health 2011) proposes a publicly financed deductible scheme of £35,000 to qualify for public support, which only solves the catastrophic nature of long-term care but fails to address the core of the insurance problem.

Similarly, evidence suggest the presence of private insurance underwriting (Frank 2012) as well as adverse selection, given that individuals that are more at risk are more likely to seek insurance. In Europe, governments respond to a rising demand by restricting the eligibility criteria to those with a higher need in exchange (Ellegård 2012), or by passing the blame on to subnational or local governments without adequate funding (Costa-Font 2010a).

Policy implications

Addressing the incompletes of long-term care insurance requires the design of an insurance contract that deals with crowding out problems. Unlike other proposals, it should be a simple arrangement that everyone can understand and it should deal with underpinning perverse incentives either through cost sharing schemes or by restricting the eligibility criteria, but overall it should be as transparent and stable as possible to allow people to make the right choice for their long-term care.

References

Breyer, F, J Costa-Font and S Felder (2011), “Does ageing really affect health expenditures? If so, why?”, VoxEU.org, 14 May.

Brown, J and Finkelstein, A (2011). "Insuring Long Term Care in the US", NBER working Paper 17451

Brown, JR and A Finkelstein (2004), “The Interaction of Public and Private Insurance: Medicaid and the Long-Term Care Insurance Market”, NBER Working Paper No. 10989.

Colombo, F and J Mercier (2012), “Help Wanted? Fair and Sustainable Financing of Long-term Care Services”, Applied Economic Perspectives and Policy, 34(2):316-332.

Costa-Font, J and Christophe Courbage (eds.) (2011), Financing long-term care in Europe: institutions, markets and models, Palgrave Macmillan.

Costa-Font, J (2010a), “Family ties and the crowding out of long-term care insurance”, Oxford Review of Economic Policy, 26(4):691-712.

Costa-Font, Joan (2010b), “Devolution, diversity and welfare reform: long-term care in the ‘Latin Rim’”, Social Policy & Administration, 44(4):481-494

Department of Health (2011). Commission on Funding of Care and Support. http://www.dilnotcommission.dh.gov.uk/

Ellegård, LM (2012), “Making Gerontocracy Work: Population Aging and the Generosity of Public Long-term Care”, Applied Economic Perspectives and Policy, 34(2):300-315

Frank, R (2012), “Long-term Care Financing in the United States: Sources and Institutions”, Applied Economic Perspectives and Policy, 34(2):333-345.