Academic journal article Journal of Risk and Insurance

In Sickness and in Health: An Annuity Approach to Financing Long-Term Care and Retirement Income

Academic journal article Journal of Risk and Insurance

In Sickness and in Health: An Annuity Approach to Financing Long-Term Care and Retirement Income

Article excerpt

ABSTRACT

We examine the implications of the positive correlation of mortality and disability for the benefits of combining an immediate income annuity with long-term care disability coverage at retirement ages. Specifically, we show that combining the two products could reduce the cost of both coverages and make them available to more persons by reducing adverse selection in the income annuity and minimizing the need for medical underwriting for disability coverage. We find that minimal underwriting, excluding only those who would be eligible for disability benefits at purchase, would increase the potential market to 98 percent of 65-year-olds, compared with only 77 percent under current long-term care insurance underwriting practice. After the 2 percent representing the worst risks for high disability payments is excluded, simulated premiums for the combined product are lower by 3 to 5 percent than total simulated premiums for stand-alone income annuities and underwritten long-term care disability insurance purchased separately. We estimate premiums for all persons at age 65 and age 75 and premiums by gender at age 65. We also investigate the value of such a combined benefit to various subgroups of prospective purchasers and the implications of possible errors and moral hazard in the reporting of disability status and making claims.

INTRODUCTION

As the baby boom generation nears retirement, concerns are increasing as to how the larger and longer-lived cohorts that will be turning 65 over the next 20 to 30 years will finance their long-term care needs. Retirement health and income security policies typically are considered separately. Disability requiring long-term care is an issue that links the two because it can result in catastrophic costs but generally is not insured. Median family income for those age 65 or older in 1998 was $23,000--$33,000 for married couples and $16,000 for unmarried persons (Social Security Administration, 2000). Although two-thirds of retirees received some income from assets, asset earnings at the median was only about $2,000 and accounted for only 20 percent of aggregate income for those age 54 and older (Social Security Administration, 2000). With private rates for nursing home care averaging between $35,000 and $50,000 per year in 1997, depending on the level of care and type of facility (Gabrel, 2000), a lengthy stay c ould be a financial disaster for many retirees. Home care can be a lower-cost and more desirable long-term care solution when appropriate. However, it also can pose a substantial threat to financial security, particularly for those with more severe disability or complex medical conditions requiring expensive skilled care.

Although Medicare and private supplementary health coverage reduce the financial risks associated with acute healthcare for nearly all elderly people, no similar, nearly universal public or private coverage exists for long-term care. The welfare-oriented Medicaid program is the primary public funder of long-term care, but it reaches only those with the lowest income and assets. Medicare finances long-term care only under limited circumstances. Private long-term care insurance still plays a minor role. No more than 5 to 7 percent of the elderly hold policies (Coronel, 1998; American Academy of Actuaries, 1999). Numerous proposals for extending public coverage for long-term care were unsuccessful during the 1980s and as part of reform efforts of the early 1990s. More recently, policy has focused on private solutions for all but those poor enough to qualify for Medicaid.

Meanwhile, although Social Security continues to be a mandatory inflation-adjusted annuity paid out over the lives of retired workers and their spouses, employer-sponsored pension plans are shifting from the defined benefit form to the defined contribution form. A life annuity traditionally was the only payment option in defined benefit plans but typically is not even offered as a distribution method in defined contribution plans. …

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