Long-term care may strain U.S. government finances

Long-term care (LTC) represents one of the largest uninsured financial risks facing elderly U.S. residents, and may offer a huge potential market for the insurance industry. More than 12 million citizens — of whom about 6 million are over age 65 — require some sort of LTC, straining individual and government finances.

LTC refers to regular assistance for people with chronic illnesses, mental and/or physical disabilities that takes place both in nursing homes and at home. Unlike other healthcare services, LTC is primarily intended to help with daily activities rather than to treat medical conditions. Overall demand for LTC is expected to expand massively over the next 50 years, as the number of U.S. residents over the age of 85 — who are most likely to need LTC — is projected to rise from 5.3 million in 2006 to 20.9 million in 2050.

Rapidly growing industry

The LTC industry is both growing quickly and offering more alternatives to the traditional nursing home. For example, the number of adult daycare centers has doubled since the 1980s, and there is a significant push to undertake “culture change” to make nursing homes less like hospitals. On the other hand, the necessary expansion of LTC services is currently being constrained by:

• staffing shortfalls — nurses are in short supply, and too few physicians specialize in geriatrics; and

• insufficient funding — nursing homes, in which Medicaid funds care for 66 percent of the patients, lose an average of $13 per Medicaid patient per day, according to a Lewin Group analysis.

Surging LTC spending

Spending on LTC, at roughly 10 percent of national health expenditures, is large and increasing. However, LTC expenditures are difficult to measure because free care provided by family and friends is hard to gauge and value. More than half of the disabled elderly rely exclusively on informal, unpaid care. Nevertheless, estimates by Georgetown University’s Health Policy Institute still put national spending on LTC, excluding unpaid care, at $206.6 billion in 2005 — $129.8 billion on nursing home care and $76.8 billion on home care.

LTC costs can be debilitating for the elderly and their adult children. The national average cost of a private room in a nursing home is almost $80,000 per year. Yet according to the Congressional Budget Office (CBO), only 7 percent of seniors in 2000 had annual income over $50,000. Clearly, the elderly rely heavily on other sources to finance LTC spending:

• Public spending. In 1998, about 60 percent of all LTC spending was funded by either Medicare (20 percent) or Medicaid (40 percent). Medicare’s LTC coverage is limited mainly to 100 days of medically necessary care in a nursing home following a hospital discharge. Medicaid covers nursing home LTC, but only for those with low incomes and low assets — about 56 percent of elderly nursing home residents in 1997. Most seniors are eligible for Medicaid-provided LTC only after they exhaust their wealth (called “spending down”) and are subject to a “look-back” period on asset transfers to prevent them from giving away assets to meet eligibility criteria.

• Private spending. “Self-insurance,” or private savings used for out-of-pocket expenses, accounts for about a quarter of all LTC spending. In addition, private LTC insurance covers 7 percent of total expenditures.

Insurance market

Given the uncertain and expensive nature of LTC, simple economic theory suggests that risk-averse individuals should purchase LTC insurance. Paradoxically, the private LTC insurance market remains small: In 2002, only about 6 million people had private LTC insurance. The demand for this type of insurance is slack for several reasons:

• Inadequate consumer knowledge. Consumers underestimate the risks of foregoing insurance. Kaiser Family Foundation surveys indicate that one-third of respondents underestimate the cost of nursing home care. In addition, many wrongly assume that Medicare or Medicaid automatically covers LTC expenses.

• Cheaper substitutes. Free family care, financial transfers from children, and Medicaid all offer cheaper alternatives to LTC than private insurance.

• Coverage limitations. Private LTC insurance may not appeal to consumers because of certain uninsurable risks. For example, it does not generally insure against increases in LTC costs — most policies offer a predetermined cash benefit.
Moreover, most LTC policies provide benefits for a limited time only, so some policyholders may exhaust their benefits before death. Finally, because LTC insurance has only been offered for approximately 30 years, insurers are somewhat inexperienced. Thus policyholders could suffer unexpected premium increases when insurers adjust their actuarial forecasts.

• High ‘load.’ Published economic research suggests that private LTC insurance has an unusually high “load” (51 cents) meaning that an average 65-year-old with a typical policy held until death gets only 49 cents in benefits from every dollar paid in premiums, in expected present discounted value terms. One reason for the high load is the high administrative costs associated with individual policies.

Nonetheless, despite its small size, the private LTC insurance industry is growing, and the share of total LTC expenditures covered by private insurance is increasing. According to the CBO, the number of policies written yearly more than doubled from 1988 to 2001.

Policy implications

Policymakers are searching for ways to resolve the issues surrounding LTC financing. One possibility is to create public LTC insurance, as Japan did in 2000. However, this kind of solution has not been popular in U.S. policy debates; rather, state and federal governments are considering two broad approaches:

• Private insurance. The private LTC insurance market could potentially be stimulated by encouraging a standardization of policies and offering tax incentives for people to purchase coverage.

• Public spending. Another approach is to control public LTC spending. This has the added bonus of lowering the “crowd-out effect” on private spending, but it may reduce the quality of care as nursing homes cut costs to cope. Doing so requires putting more limits on eligibility and restricting the services covered by Medicare and Medicaid. For instance, because home- and community-based services are much cheaper than nursing home care, Medicaid benefits will inevitably shift toward the former.

A recent federal example of these efforts is the Deficit Reduction Act (DRA) of 2005, which came into effect in January 2007. The DRA lifted the moratorium on state partnership programs — under such programs, for people who outlive their LTC insurance policy, assets equal to the benefits paid out by the policy are exempted for qualification for Medicaid LTC coverage. The DRA also gave states more discretion over enrollment and eligibility restrictions for home and community-based LTC Medicaid services.

Industry outlook

Any decline in elderly disability rates due to advances in medical care will be outweighed by the number of aging baby boomers and accelerating healthcare costs. Indeed, the CBO projects that LTC expenditures for the elderly will quadruple by 2050. If private LTC insurance coverage remains limited:

• the welfare of the elderly will decline, as could the wealth of their adult children, due to onerous LTC out-of-pocket spending;

• Medicaid spending on LTC will have to rise, putting enormous strain on government budgets; and

• the existing infrastructure, already suffering from low standards — 16 percent of nursing homes have serious deficiencies in quality, according to a 2005 Government Accountability Office report — may deteriorate further.

Oxford Analytica is an international consulting firm providing strategic analysis on world events for business and government leaders. See www.oxan.com .