Insights Blog

Long-Term Care Insurance: A Lousy Deal

August 18, 2016
Long-Term Care Insurance: A Lousy Deal Mattias Zomer

On August 14, 2016, Financial Times' reporter Alistair Gray describes consumer "fury" over insurance companies' efforts to increase premiums for long-term care, sometimes doubling the cost.

by Tony Webb, ReLab Research Director

Consumers thought they were doing the right thing because Medicare, the government health insurance program for the elderly, does not cover the cost of long-term care. The cost of care exceeds the financial capacity of most elderly households. Many uninsured households end up impoverished and dependent on Medicaid, the government health insurance program for the indigent. These costs are a signficiant factor driving increases in Medicare expenditure. 

Is private long-term care insurance a means of both providing financial security to the elderly and reining in Medicaid costs? The answer is "no," for three reasons.

First, more than a quarter of all households with long-term care insurance at age 65 lapse their policies prior to death. For these households, long-term care insurance is worse than useless. They pay premiums for many years, often receiving nothing in return. Worse, those who lapse are the households most likely to subsequently require care.

Second, for each dollar in premiums paid, only 60 to 70 cents is paid out in benefits. This is not because long-term care insurers are making big profits - they are not. The remaining 30-40 cents is eaten up by the high costs of doing business - employing actuaries, underwriters, paying sales commission, and so on. In contrast, administrative costs represent less than one percent of Social Security expenditures.

Third, private long-term care insurance doesn't achieve the basic purpose of any insurance, namely to transfer risks from the individual to the insurer. This is because insurers have the right to increase premiums if they are able to convince their state insurance regulator that they got their actuarial assumptions wrong. Although a household purchasing insurance reduces the risk posed by long-term care costs, it takes on an entirely new risk, namely that the insurer increase its premiums. Insurance may do little to reduce the household's overall risk exposure.

So why allow insurers to increase premiums? The policy justification is that if insurers were not permitted to increase premiums, they might exit the market, and worse, might become insolvent. But allowing insurers to increase premiums makes it impossible for households to evaluate the merits of purchasing coverage. The household has no idea whether the company quoting the lower premium really represents better value, and whether it would be better off not purchasing coverage at all. We are not convinced that a prohibition on premium increases would result in insurers refusing to offer coverage. But even if it did, we may be better off with no market at all than with a market characterized by high lapse rates, high administrative costs, and little effective risk transfer.