Medicaid and the Long-Term Care Insurance Market

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The presence of Medicaid is sufficient to explain why at least two-thirds of all households would prefer not to purchase private long-term care insurance

Most health insurance in the United States is provided through a mix of public and private sources. Often the public insurance - although heavily subsidized from the individual's perspective - offers only limited protection. This holds true in many other countries as well, where public insurance against risks such as longevity and high medical expenditures usually provides only partial coverage.

In The Interaction of Public and Private Insurance: Medicaid and the Long-Term Care Insurance Market (NBER Working Paper No. 10989), authors Jeffrey Brown and Amy Finkelstein examine the relationship between public and private insurance for one of the largest uninsured financial risks facing the elderly in the United States today: long-term care expenditures. At $135 billion annually, long-term care expenditures represent over 8.5 percent of total health expenditures for all ages, or roughly 1.2 percent of GDP. Real expenditures for long-term care are projected to triple over the next 35 years because of rising medical costs and the aging of the baby boomers. Private insurance reimburses only 4 percent of long-term care expenditures, while about one-third of expenditures are paid for out-of-pocket. To put this in perspective, for the health sector as a whole, private insurance pays for 35 percent of expenditures, and only 17 percent are paid for out of pocket.

The authors investigate how Medicaid affects the demand for private long-term care insurance by estimating a risk-averse individual's willingness to pay for a long-term care insurance contract; they use detailed actuarial data on the risk of long-term care expenditures, information on the current structure of the public Medicaid program, and the characteristics of existing private insurance policies. Their results are broadly consistent with the patterns observed in survey data, in terms of the limited fraction of the elderly who buy insurance, and the patterns of coverage by gender and by wealth.

Brown and Finkelstein report three main findings. First, the presence of Medicaid is sufficient to explain why at least two-thirds of all households would given the presence of Medicaid, individuals almost regardless of their wealth prefer not to purchase private long-term care insurance, even if it is available at actuarially fair prices. Thus, even if there were no other factors limiting the size of the market, potential market failures are eliminated and comprehensive insurance policies are available at actuarially fair prices, most individuals still would not want to buy these policies because of the existing Medicaid program. One important implication of this finding is that, absent changes to the Medicaid program, this finding underscores the fundamental role of Medicaid in limiting the demand for private insurance. It also suggests that correcting whatever market failures of supply may exist in the private long-term care insurance market is unlikely to substantially increase private insurance coverage.

Second, the authors demonstrate that Medicaid's large crowd-out effect stems from the fact that -- because of its design (specifically, means testing and its status as a secondary payer) -- a large portion of the premiums for private insurance for most individuals go to pay for benefits that are redundant with what Medicaid would have paid if the individual had not bought private insurance. The authors refer to this as the "implicit tax" that Medicaid imposes on private insurance, which they estimate to be quite large. For example, for the median male (female), Medicaid imposes an implicit tax rate of about 60 (75) percent. The authors suggest that recent state and federal reforms designed to stimulate demand for private insurance are unlikely to have much impact because they fail to adequately reduce this implicit tax.

Third, since Medicaid itself provides far from comprehensive insurance, reliance on public insurance alone leaves most individuals exposed to substantial out-of-pocket expenditure risk. For a median male (female), for example, the authors find that Medicaid leaves approximately 40 (30) percent of expected long-term care expenditures uninsured. More importantly, Medicaid's eligibility rules make it difficult for an individual to smooth consumption over time. This indicates that a public insurance system can substantially crowd out private insurance, even when the public insurance itself only provides limited coverage against risk exposure. As a result, public provision of insurance has the potential to reduce total insurance coverage and thus to increase overall risk exposure.

The authors suggest that recent state and federal reforms designed to stimulate demand for private insurance are unlikely to have much impact. In contrast, policy changes that substantially reduce or eliminate Medicaid's implicit tax will be needed to stimulate the private market.

-- Les Picker