The Market for Private Long-Term Care Insurance

By Finkelstein, Amy | NBER Reporter, January-February 2007 | Go to article overview

The Market for Private Long-Term Care Insurance


Finkelstein, Amy, NBER Reporter


Long-Term Care Risk

Long-term care expenditures represent one of the largest uninsured financial risks facing the elderly in the United States. Expenditures on long-term care, such as home health care and nursing homes, accounted for 8.5 percent of all health care spending in the United States, and about 1.2 percent of GDP in 2004. (1) These long-term care expenditures are projected to triple in real terms over the next few decades, in large part because of the aging of the population. (2)

Long-term care expenditures are distributed unevenly among the elderly population. Therefore they represent a significant source of financial uncertainty for elderly households. Only about one third of current 65-year-olds will never enter a nursing home. However, of those who do, 12 percent of men and 22 percent of women will spend more than three years there; one in eight women who enter a nursing home will spend more than five years there. (3) These stays are costly: on average, a year in a nursing home cost $50,000 in 2002 for a semi-private room, and even more for a private room. (4) Standard insurance theory suggests that the random and costly nature of longterm care makes it precisely the type of risk that would make insurance valuable for risk-averse individuals.

Yet most of the expenditure risk is uninsured. Only 4 percent of long-term care expenditures are paid for by private insurance, while one third are paid for out of pocket. (5) By contrast, in the health sector as a whole, private insurance pays for 35 percent of expenditures and only 17 percent are paid for out of pocket. (6)

The limited insurance coverage for long-term care expenditures has important implications for the welfare of the elderly, and potentially for their adult children as well. These implications will only become more pronounced as the baby-boomers age and as medical costs continue to rise.

The limited private insurance market also has implications for government expenditures. Because more than one third of Medicaid expenditures are already devoted to long-term care, (7) policymakers are increasingly concerned about the fiscal pressure that further growth in long-term care expenditures will place on federal and state budgets in the years to come. As a result, there is growing interest in stimulating the market for private long-term care insurance.

There are a host of potential theoretical explanations for the limited size of the private long-term care insurance market. (8) On the demand side, limited consumer rationality--such as difficulty understanding low-probability high-loss events (9) or misconceptions about the extent of public health insurance coverage for longterm care--may play a role. Demand also may be limited by the availability of imperfect but cheaper substitutes, such as the public insurance provided by the means-tested Medicaid program, financial transfers from children, or unpaid care provided directly by family members in lieu of formal paid care. (10) On the supply side, market function may be impaired by such problems as high transactions costs, imperfect competition, asymmetric information, or dynamic problems with long-term contracting.

This article briefly summarizes a rapidly growing body of empirical work dedicating to improving our understanding of the private long-term care insurance market in the United States, and why that market is currently so small.

The Functioning Of Private Long-Term Care Insurance: High Prices, Limited Benefits

To understand the small size of the private long-term care insurance market, Jeff Brown and I start by examining what the available policies in this market are like. (11) We find that the typical policy that is purchased covers only about one third of the expected present discounted value of long-term care expenditures. Moreover, this policy is provided at premiums that are "marked up" substantially above expected benefits. …

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