Is Public Long-Term Care Insurance Necessary?

Journal of Risk and Insurance, June, 2000 by Kazutoshi Miyazawa, Panos Moudoukoutas, Tadashi Yagi

ABSTRACT

This article examines the need for public long-term care (LTC) insurance within an overlapping generations model. The discussion revolves around two items: financing methods and inefficiency of privately provided LTC insurance. Special attention is paid to the inefficiency caused by the individual behavior regarding health investment under a privately provided LTC insurance system. The authors' analysis shows that this inefficiency is improved by introducing public LTC insurance.

INTRODUCTION

Faced with the prospect of a rising elderly population and healthcare expenses, Japan recently introduced a public insurance policy to provide monetary and service benefits to qualified individuals older than 65 and in some cases older than 40. [1] The cost of this policy is to be borne by the central, prefectural, and local governments and to be paid by individual and corporate contributions. [2] Japan has also been trying to expand its program of building up in-house and residential facilities for the elderly (McCarthy, 1997).

Japan is not the only country to introduce a public long-term care (LTC) insurance policy. Under Medicare and Medicaid, the United States federal and state governments also provide LTC benefits such as nursing-home care to qualified individuals, especially to those of low income. [3] Canada has a similar program run by the ten provincial governments (Greb et al., 1994). France, Germany, Luxembourg, and every OECD (Organization for Economic Cooperation and Development) country either has separate LTC programs or is in the process of introducing them (see Hennessy and Wiener, 1996).

But is government intervention in this area necessary? In other words, are there any inefficiencies in providing LTC privately? If yes, what form should government intervention take?

The need for government intervention in the provision of LTC can be rationalized in various ways. The provision of public LTC insurance is necessary to reduce the burden on families, especially in countries with rising female labor-force participation and with minimal private insurance. Indeed, even in the U.S., where health insurance markets are developed, a very small fraction of the elderly have LTC insurance (Scanlon, 1992). Some economists attribute the failure of individuals to buy LTC insurance to lack of public awareness about the potential benefits of LTC insurance (Bacon et al., 1989). Others attribute the lack of demand for LTC insurance to the strengthening of relations between parents and children and the provision of bequests as a substitute for LTC insurance (Zweifel and Struwe, 1996). A third group attributes the low demand for LTC insurance to the lack of interest of private insurance providers in underwriting LTC policies because of high risks and the provision of certain government programs for LTC. Cutler (1993), for instance, argues that private insurers are reluctant to underwrite LTC policies because the large intertemporal variability of the cost of LTC makes it difficult for underwriters to diversify risk within a cohort. [4] However, Pauly (1990) argues that individuals will not purchase LTC insurance even if it is available at actuarially fair premiums because Medicaid lowers the expected utility of private insurance and therefore reduces the demand for it.

Another important controversy surrounding the public provision of LTC is financing. Some countries like Finland, New Zealand, and Great Britain rely mainly on tax-favorable treatment of LTC. Other countries, such as Germany, France, and Japan, rely on social insurance contributions levied on employers and employees. [5]

Joining the controversy surrounding the provision and financing of LTC, this article examines the need for public LTC insurance within an overlapping generations model. The discussion revolves around two items: financing methods and inefficiency of privately provided LTC insurance. Special attention is paid to the inefficiency caused by individual behavior regarding health investment under a privately provided LTC insurance system. Davies and Kuhn (1992) examined the welfare effect of a social security program in a moral hazard economy induced by health investment. Philipson and Becker (1998), using the idea of mortality-contingent claims, argued that annuities involve moral hazard effects that increase longevity. Such inefficiency arises from the limitation of calculating the market rate of return which is affected by change in the probability of illness in relation to health investment behavior.

Contrary to the previous academic literature, in this article the motivation for introducing public LTC insurance is related to public expenditure on medical services. Medical expenditure tends to increase in an aging society. The article will show that the introduction of public LTC insurance improves the efficiency of private medical expenditure and reduces the burden of maintaining health.

The remainder of the article is in two major parts. The next section develops a two-period model without incorporating health investment behavior and compares and contrasts private vis-a-vis public provision of LTC insurance. In particular, the section explores the merits of different ways of financing public LTC insurance. The other section of the article incorporates individual health-investment behavior into the model and examines the inefficiency of privately provided LTC insurance and the merit of public LTC insurance. A further section summarizes the discussion and concludes the paper.