The Interaction of Public and Private Insurance: Medicaid and the Long-Term Care Insurance Market

Jeffrey R. Brown, Amy Finkelstein
2004 Social Science Research Network  
numerous seminar participants for helpful comments and discussions. We are especially grateful to Jim Robinson for generously sharing his data on long-term care utilization and for helpful discussions, and to Norma Coe for exceptional research assistance. We also thank Qian Deng and Chiao-Wen Lin for programming assistance. ABSTRACT We show that the provision of even incomplete public insurance can substantially crowd out private insurance demand. We examine the interaction of the public
more » ... f the public Medicaid program with the private market for long-term care insurance and estimate that Medicaid can explain the lack of private insurance purchases for at least two-thirds and as much as 90 percent of the wealth distribution, even if comprehensive, actuarially fair private policies were available. Medicaid's large crowd out effect stems from the very large implicit tax (on the order of 60 to 75 percent for a median wealth individual) that Medicaid imposes on the benefits paid from private insurance policies. Importantly, Medicaid itself provides an inadequate mechanism for smoothing consumption for most individuals, so that its crowd out effect has important implications for overall risk exposure. An implication of our findings is that public policies designed to stimulate private insurance demand will be of limited efficacy as long as Medicaid continues to impose this large implicit tax. 1 Most insurance in the United States is provided by a mix of public and private sources. Often the public insurance -although heavily subsidized from the individual's perspective -offers only limited insurance protection. This holds true in many other countries as well, where public insurance against risks such as longevity and medical expenditures usually provides only partial coverage. In this paper, we show that even a very incomplete public insurance program can have substantial crowd-out effects on demand for more comprehensive private insurance. As a result, public provision of insurance has the potential to reduce overall insurance coverage and thus increase overall risk exposure. We examine the interaction of 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 (CBO, 2004). Real expenditures for long-term care are projected to triple over the next 35 years due to rising medical costs and the aging of the baby boomers (CBO, 1999). 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 (CBO 2004, National
doi:10.2139/ssrn.631881 fatcat:ohyzksojejeklfnlpqpcwyvhxy