Asymmetric Information, Long‐Term Care Insurance, and Annuities: The Case for Bundled Contracts

Abstract

AbstractThis article examines the markets for long‐term care insurance and annuities when there is asymmetric information and there are costs of administering contracts. Individuals differ in terms of their risk aversion. Risk‐averse individuals take more care of their health and are relatively high risk in the annuities market and relatively low risk in the long‐term care insurance market. In the long‐term care insurance market, both separating and partial‐pooling equilibria are possible. However, in the stand‐alone annuity market, only separating equilibria are possible. We show, consistent with the extant empirical research, that in the presence of administration costs the more risk‐averse individuals may buy relatively more long‐term care insurance and more annuity coverage. Under the same assumptions, we show that equilibria exist with bundled contracts that Pareto dominate the outcomes with stand‐alone contracts and are robust to competition from stand‐alone contracts. The remaining empirical puzzle is to explain why bundled contracts are such a small share of the voluntary annuity market.