Introduction to the Special Issue on Long‐Term Care Insurance and Health Insurance

Abstract

The articles published in this special issue cover several dimensions of two insurance markets that are characterized by major imperfections such as high transaction costs, information asymmetries, and low competition. Furthermore, insurance premiums are high and coverage is limited. On the international scale, the supply of both private long-term care insurance and health insurance is limited, whereas populations are aging. According to Jeffrey Brown and Amy Finkelstein, there are important demand- and supply-side limits to the size of the U.S. private long-term care insurance market, and it is not clear how public policies could improve the situation in the short run. They document that only 4 percent of long-term care expenditures are reimbursed by private insurance policies. Brown and Finkelstein estimate that premiums in this market are very high relative to benefits that policies provide. For example, they estimate that, on average, the typical policy purchased by an average 65-year-old (about the average age of buyers) and held until death has a load of 18 cents; in other words, the typical policy will pay, on average, only 82 cents in expected present discounted value of benefits for every dollar paid in the expected present discounted value of premiums. Once they take into account that individuals often stop paying premiums at some point after purchase, the estimated load rises considerably from 18 cents on the dollar to 51 cents on the dollar. These high loads can reflect asymmetric information, limited competition, and/or high administrative costs. High premiums can also be linked to expensive benefits. Two factors may explain why average claims are high in the United States (Kessler, 2008). The insurance payment structure reimburses assistance costs using complicated cost-plus contracts instead of simple fixed-sum payments where clients (or their agents) can manage the assistance budget, as they do in France or Spain (Guillen and Pinquet, 2008). Moreover, this form of assistance cost reimbursement is subject to ex post moral hazard from the beneficiaries and service providers. This potential form of moral hazard (Picard, 2000; Dionne, Giuliano, and Picard, 2009) supplements the adverse selection and ex ante moral hazard already documented in this market by Finkelstein and McGarry (2006). Cost control expenses should then be very high in this market, which is another source of high premiums. These supply-side problems may contribute to the limited size of the private market. Brown and Finkelstein also present numerous demand-side factors that may explain the small size of the private insurance market even in the presence of a potentially high-risk situation for the decision makers: limited consumer knowledge, state-dependent preferences, and potential substitutes for private formal insurance such as Medicaid (Pauly, 1990; Brown and Finkelstein, 2008) or even the use of home equity to finance long-term care expenditures (Davidoff, 2008). In this issue, Thomas Davidoff shows that if consumers typically liquidate home equity only in the event of illness or very old age, long-term care insurance and annuities become less attractive and may become substitutes rather than complements. The reason for this is that the marginal utility of wealth drops when an otherwise illiquid home is sold, an event correlated with the payouts of both financial products. He concludes that extending the market for home equity products may contribute to expanding the market for long-term care insurance. These results were obtained without a bequest motive and with state-dependent preferences. Complementarity between annuities and long-term insurance should be weaker if a bequest motive exists (Pauly, 1990). Asymmetric information can also affect the relationship between annuities and long-term care insurance. David Webb examines the markets for long-term care insurance and annuities when there is asymmetric information and costs of administering contracts. …