Long-Term Health Care: Is Social Insurance Desirable?
Gokhale, Jagadeesh, Leovic, Lydia K., Economic Commentary (Cleveland)
The aging of the U.S. population portends steep increases in the demand for health care services well into the next century. Although many Americans rely on public health programs and private health insurance to provide financial protection for a diverse group of medical risks, the availability of such support for long-term disabilities is woefully inadequate. As of 1992, fewer than 10 percent of those age 65 or older were covered by private long-term care insurance.(1)
Expenditures on long-term care can be economically devastating for the families of disabled persons and may potentially sap public budgets. Total spending on nursing home services stood at $60 billion in 1991, of which more than half was financed by federal, state, and local governments (see figure 1). (Figure 1 omitted) Policymakers engaged in reforming the country's health care system must bear in mind that as the baby boom generation ages, the problems associated with ensuring adequate long-term care will be exacerbated.
This Economic Commentary explores the underlying reasons for the private insurance market's failure to cover long-term care risks adequately. It also evaluates several proposals for funding long-term care through social insurance. We contend that none of these proposals considers the potential negative economic impact of the intergenerational wealth redistribution implicit in social insurance schemes.
PROBLEMS FACING PRIVATE INSURERS
At the individual level, long-term care is best financed by purchasing insurance because future needs are uncertain and the potential costs are enormous. In 1990, the average annual cost of a nursing home stay was between $25,000 and $35,000.(2) The private market for insuring long-term care expenses is extremely thin, however. Only 2.4 million long-term policies were sold in 1991, of which just 8.7 percent were employer sponsored. In the same year, direct payments by individuals accounted for 43 percent of nursing home receipts.
Much of the failure of the long-term care insurance market can be traced to the twin problems of adverse selection and moral hazard. Both concern the pricing of insurance for a group of potential purchasers whose chronic disability risk is unknown, and both significantly increase the costs of private insurance.
In general, the probability of requiring extended care rises markedly with age.(3) Thus, most young persons opt out of purchasing such coverage even at extremely low prices. This means that individuals who do buy long-term care insurance -- older Americans -- are precisely those with the highest risk of requiring extended care in the near future.(4)
The inability to sell long-term care insurance to young people compels an increase in the price at which private providers can profitably offer coverage to the elderly. Even among the elderly, relatively healthy individuals may choose to forgo coverage, driving up the average risk of disability among the remaining pool of potential purchasers The increase in the price of insurance caused by such an "adverse selection" of the riskiest individuals into the pool of potential buyers means that many elderly Americans cannot afford long-term care insurance (see table 1). (Table 1 omitted)
The moral hazard problem refers to the change in individuals' behavior after purchasing insurance. For example, a person who buys long-term care insurance may not protect his health to the same extent as someone who does not. Because a significant amount of extended care is currently provided by relatives, pricing long-term insurance at lower rates may mean less care by family members and higher-than-anticipated claims on insurers.
A third important reason for the limited availability of private insurance is the difficulty of predicting increases in the cost of extended medical care. This applies particularly to nursing home services, which account for the largest share of long-term care outlays (82 percent in 1988). …