Long-Term Care Insurance

The feasibility of private long-term care insurance is central to the public policy debate over financing long-term care. The failure of the private market, even with public subsidies, to insure a substantial portion of the population has a bearing on the public sector's role in financing long-term care. The larger the share of the population with adequate private insurance, the less likely that public resources will be needed to provide long-term care to those in need. But very little about any private market is purely private. Public resources are often used to support or improve the private market, regulate the market, and ultimately help consumers. This is true for private long-term care insurance as well. The market for private long-term care insurance has been expanding at a rapid rate, but not as fast as the population is aging, and hence a growing proportion of the population is getting older without pooling their financial risks of needing long-term care.

Why long-term care is an insurable event

Saving for an event whose occurrence and costs are predictable is very efficient. Preparing for an event involving known financial consequences, however, is not the same as preparing for an unpredictable event with unknown costs. Either too much or too little is likely to be saved. Those who set aside the most that they might need are quite likely to save too much and therefore deprive their families of other goods and services needed over their lifetimes. More than likely, most people would underestimate the costs, thereby depriving themselves of other opportunities, and still not have sufficient resources when care is needed.

Since the future need for long-term care is not known, and since, if needed, its cost is not predictable, self-funding for this contingency is inefficient. Sharing the financial risk through insurance—either public or private—is more efficient. This is the basic function of insurance where large groups of people pool the financial risks of the group. No one person in the group bears the full cost of care and everyone in the group shares in financing the care for those who end up needing it. Despite the existence of long-term care insurance in local markets since the 1960s, relatively few people have purchased long-term care insurance to pool the financial risk of needing long-term care. Since Medicare does not cover most long-term care needs, this leaves most people purchasing their own long-term care and then turning to the state Medicaid program for assistance if impoverished.

What is long-term care insurance?

Long-term care insurance is conceptually more like whole life insurance than health insurance. Health insurance is for a fixed term (usually the month in which the insurance is purchased) and it covers necessary medical care during that time as well as any ongoing expenses related to that episode in which care is needed. Long-term care insurance, on the other hand, provides for a fixed payment toward long-term care services once long-term care is needed. There are specific triggers, which are often tied to measures of activities of daily living or ADLS. But the amount of the benefit is most often tied to the site of care and not the level of functional disability. Moreover, the amount of benefit is predetermined by the consumer, for example, $100/day for a nursing home stay and $50/day for care at home. Most policies offer consumers the option to allow the benefit amount to increase with inflation, but often the inflation index is either a fixed percentage (for example, 5 percent) or tied to general inflation and not necessarily the increase in the cost of long-term care.

The price of the policy depends on the options chosen and the age at which the policy is initially purchased. This age at which the policy was first purchased determines the price of the policy for as long as the policy is held. Assuming a 5 percent compounded inflation benefit and a nonforfiture benefit, a policy purchased at age forty, for example, might cost $770 a year; while the same policy initially purchased at age sixty-five would cost $2,305 a year (Chart III-13 in Congressional Research Services Long-Term Care Chartbook, 2000). If bought at age forty, the premium will be one-third of what it will cost if the individual waits until age sixty-five to begin buying the policy with the same benefits. This significant price difference arises because the forty year old has a significantly lower risk of needing long-term care in the short-run and because of the longer period in which premium payments on the part of the forty year old will grow.

For example, let's assume a forty-year-old and a sixty-five-year-old buy the same long-term care policy. Further assume that they maintain the policy and that they both need nursing home care at age eighty-five. This will be twenty years for the sixty-five year old and forty-five years for the forty year old. Over the course of the forty-five years the forty year old will have paid $26,950 in long-term care insurance premiums. Over the course of the twenty years, the sixty-five year old will have paid $46,100 in long-term care insurance premiums, for the same benefit.

Although the forty year old will have paid less, the value of the premiums to the insurance company will be worth more. Take for example the first year's premium. The forty year old paid $770 and the sixty-five year old paid $2,305. When the forty year old is eight-five, that initial premium will have grown in tax-free investments held by the insurance company—assuming an 8 percent rate of return—to be worth $27,845, while the first year premium paid by the sixty-five year old will only be worth $11,356 to the insurance company.

Employer-provided or employer-organized group purchases

In a voluntary private insurance market, employer-provided or even employer-sponsored benefits offer a very natural and efficient way to pool risk, achieve marketing and administrative savings, and effectively negotiate better terms and plan designs. Employers devote tremendous resources choosing and negotiating plan arrangements. Generally, larger employers have been able to obtain more comprehensive benefits for a lower "premium" than smaller employers, and virtually all employment-based groupings offer more coverage for the same "premium" as do individual policies. Such efforts are, of course, voluntary, although encouraged by the labor market and tax policy.

Long-term care insurance has not been sold as a "term" product but as a "whole life" type product, meaning that its price is contingent on the age at which the policy was initially purchased and not the current age of the policyholder. For this reason, long-term care insurance is substantially less expensive when purchased at a younger age. Unfortunately, to maintain this premium, one must retain the policy until it is needed, perhaps thirty years after the initial purchase. Maintaining the value of any employee benefit when moving from one employer to another is a substantial hurdle, but is particularly problematic with a product like long-term care insurance.

For most insurance products, such as health care, disability, and even life insurance, the insurance protection is often limited to a relatively short period of time such as the month in which the premium is paid. The vested rights of pension benefits might be transferable, but the value remains at what it was the day the employee left the firm. Only the cash-value of defined contribution plans are relatively easy to move, but here too there are complications when much of that value is in company-held equity, particularly when the company is privately held.

Individual market

Voluntary, even tax-subsidized, individual markets for insurance require substantially more marketing and information gathering by both the consumer and the insurer. For insurers these costs are either added to the premium or taken from the benefit. As a result, some individuals might not be eligible and the premium may be prohibitive. Further, adverse selection and moral hazard are much more substantial issues for the insurer in the individual market and hence they design both the application process and the product with these concerns in mind. Other limitations of private long-term care insurance include denial, misunderstanding of coverage, underwriting as well as the competing demands for savings that families face (i.e., housing, education, and retirement). People who need long-term care and people with medical conditions that could eventually require some assistance have usually been denied coverage.

In a survey of buyers and people initially interested in long-term care insurance who ultimately decided not to buy it, it is clear that the reasons for buying and for not buying are quite complex. Among buyers, the most important reason was to protect assets, but less than one-third identified this as an important reason. About 19 percent indicated a desire to avoid dependence on others, but nearly one-quarter had other reasons. On the other hand, of those who had investigated purchasing a long-term care insurance policy but chose not to, more than one-half (54 percent) indicated that the cost was a very important reason and another 30 percent indicated that the cost was an important reason in their decision not to buy (Health Insurance Association of America, October 2000). Other reasons cited by the non-buyers were suspicions about insurance companies, a lack of understanding about the risk of needing long-term care, confusion about what the government does and does not now cover, and general lack of knowledge about the policies.

It has been difficult, at best, to sell long-term care insurance to older people. It is even more difficult to sell it to younger people. This is particularly unfortunate, since this is when premiums are the least expensive. Moreover, while the probabilities of needing long-term care increase with age, nearly half of the long-term care population is under the age of sixty-five.

Growth of the long-term care insurance market

Since the mid-1990s, the number of long-term care insurance policies sold has nearly doubled. The vast majority of policies sold (80 percent) are sold in the individual market rather than in the employer-group market. This reflects the relatively easier sell of long-term care insurance to older people than to younger, workingage people.

In 1984, sixteen insurance companies had sold 125,000 long-term care insurance policies in select states (Friedland). By 30 June 1998, 119 insurance companies were selling long-term care insurance policies nationally and over 5.8 million policies had been sold (Health Insurance Association of America, March 2000). Employers have been relatively slow to either provide or help organize the provision of long-term care insurance to their employees. Prior to June 1987, no employers offered long-term care insurance to their employees, and as of 30 June 1998, there were over 2,100 employers offering long-term care insurance to their employees, retirees, and often to the parents and in-laws of their employees.

Policies sold and policies in force are not, however, the same. People stop paying their premiums and hence the policy ceases to provide coverage. Not much is known about lapse rates, but clearly some people are opting for a new policy and, given the older ages at which these polices are purchased, some people have died. One analyst has estimated that the number of policies in force is about half the policies sold (Cohen). Even if everyone held all of the policies ever sold to those age sixty-five and older, then one could imply that about 18 percent of the elderly have some form of long-term care insurance protection. Of course the reality is far fewer have such insurance. Moreover, about 45 percent of the long-term care population is under the age of sixty-five (CRS and The Urban Institute). Therefore, if one narrows the population at risk to everyone age forty-five and older, then long-term care insurance has covered less than 7 percent of the most relevant market.

It is quite likely that the employer-sponsored market will change dramatically in the first decade of the twenty-first century. The largest employer, the federal government, is in the process of organizing the availability of long-term care insurance to their employees and their retirees, as well as dependents of employees, and even the parents of employees. There are an estimated 6.5 million federal employees and retirees. Adding spouses and parents suggests a potential market of 13 million people, not only learning more about long-term care insurance but also having the opportunity to purchase long-term care insurance on a group basis.

Private insurance and long-term care

So far, private long-term care insurance has had virtually no impact on the organization or delivery of long-term care. This is because most of the financing for long-term care is either through Medicaid, Medicare, or directly from those needing long-term care. In 1998, Medicaid, the largest public payer of long-term care services, accounted for 45 percent of all long-term care expenditures. Medicare financed 16 percent overall. Families directly financed 27 percent and private insurance, from all types of private insurance, financed less than 7 percent of long-term care. Most private insurance payments, however, are not yet from long-term care insurance. Analogous to Medicare, the financing of long-term care is from the acute health insurance plans (and Medicare HMOs) using long-term care services, often as an alternative to inpatient hospital care.

Public sector support and influences on the private market

Insurance is licensed and regulated by each state. The federal government has had regulatory authority when the insurance is provided through most employer-provided benefit plans. Tax-favored employee benefits are regulated by the federal government, but this regulation has been primarily focused on ensuring that employee benefits are not provided in a way that favors one class of employees over another.

Until 1996 the federal tax code did not recognize long-term care as a tax-exempt employee benefit. This has resulted in a great deal of ambiguity concerning the tax treatment of premiums paid, the tax treatment of benefits received by policyholders, and the treatment of the reserves accumulating to pay future long-term care benefits (especially prior to 1989). Much of the ambiguity stemmed from the fact that the preferential tax treatment of health insurance was derived from a 1954 definition of medical care, which was so explicit to leave lawyers wondering if assistance to function on a daily basis or to remain independent despite chronic conditions would be included. That is, so much of the definition was related to the diagnosis and treatment of a disease to render serious questions about nonmedical services even when they were necessary because of a medical condition.

If it had been clear that long-term care is covered by the medical definition, then long-term care insurance could be treated like health insurance. Health benefits in a health insurance plan are not treated as either federal or state taxable income, and if the premiums are paid by an employer the premiums are not treated as taxable income either. Long-term care insurance relies on prefunding, much like whole life insurance, but clearly long-term care insurance pays benefits prior to death. In the case of whole life insurance, the insurers intend to invest the premiums in a reserve fund that is used to pay benefits. The earnings on those reserves are not taxed at the federal level and often not at the state level and hence premiums are lower than they otherwise would be.

The Health Insurance Portability and Accountability Act (HIPPA) of 1996 made long-term care insurance explicit in the federal tax code (Tapay and Feder). In so doing, the federal government defined long-term care insurance in ways in which states had not. This actually created two kinds of long-term care insurance. That which is only state approved and that which is both state approved and qualified for preferential tax treatment by the federal standard. While each state has its own standards to define long-term care, no state had established standards like those in HIPPA. For example, to be federally qualified, the long-term care insurance policy must pay benefits if the policyholder has limits in two or more activities of daily living. Most states that have such a standard use a criterion of limitations in three or more activities of daily living.

While HIPPA added clarity for the tax treatment of long-term care insurance policies that meet federal standards, it may have inadvertently left even more uncertainty for state-licensed policies that do not meet the federal standards. Furthermore, tax preferences not only lower the cost of the policy, they imply an implicit signal from the government that suggests an endorsement of long-term care insurance. This is seen as critical for selling insurance by insurance industry experts who have acknowledged just how difficult it has been to sell long-term care insurance policies, especially to people under the age of sixty-five.

Potential for the future

Relatively few people have purchased long-term care insurance polices. While the market potential is enormous, public policies may be necessary to further encourage this market. A long-term care financing system that depends on some proportion of the population purchasing insurance may want to focus on public policies that also inform and protect consumers from making inappropriate purchases. This may include public information, tax incentives, or even direct subsidies for the purchase of private insurance.

The real potential for long-term care insurance lies in educating people about the risk of long-term care and their options to pool this risk. In order for the private market to be effective at pooling this risk, large portions of people in their forties and fifties need to purchase policies and continue to make annual premium payments until they are in their eighties. Given what we know about individual purchases of other insurance, including health insurance, this is not likely to happen unless substantial numbers of employers are able to encourage most of their workers to obtain insurance through their workplace. Only then will private long-term care insurance begin to have a significant impact on the financing and delivery of long-term care. However, even if more people started buying long-term care insurance today, it will take another twenty years before these purchases begin to affect the financing and delivery of long-term care.

As our population ages, long-term care expenditures are expected to increase dramatically. Estimates by the Congressional Budget Office suggest that for just the elderly, long-term care expenditures are expected to increase from $123 billion in 2000 to $346 billion in 2040 (in 2000 dollars) (Hagen). The Congressional Budget Office estimates that regardless of how much private long-term care insurance expands between now and 2020, Medicaid spending will still increase substantially. Assuming an increase in private long-term care insurance spending, Medicaid spending would have to increase from $43 billion today to $75 billion in 2020 (in 2000 dollars) to maintain current levels of service to low and middle-income elderly people. If there is no appreciable expansion in private insurance spending, Medicaid long-term care expenditures for the elderly is estimated to increase to $88 billion by 2020 (Hagen).

For individuals, however, private long-term care insurance is the only option for pooling the financial risks of long-term care. Unfortunately, this is a limited and biased option. The benefit that is purchased is usually cash to be used to pay for care and not access to care itself, and the value of this benefit is greater when the policy is initially purchased and less when it is likely to be needed. That is, despite the "inflation" protections that can be purchased, the benefit value is not likely to increase with the risk-adjusted cost. This is because the "inflation" factor is independent of the real costs of care and the inflation benefit is financed in the premium. Moreover, not everyone purchases the inflation benefit for his or her policy. Nevertheless, these policies do pool some of the risks and this is more effective than saving for the contingency of long-term care, which most people are not doing anyway.