The Next Expensive Entitlement: Long Term Care Costs

It has been amazing to watch the evolution of the healthcare debate – including the brazen willingness of Congress to push forward with a price tag over $1 trillion.  (Aren’t these the same legislators who are up in arms over the $700 billion TARP?)  Even worse the bills are riddled with gimmicks that disguise the reality of a much higher price tag.  Consider, for the moment, the proposed Community Living Assistance Services and Supports (CLASS) Act that is embedded in the reform.

Now, let me stipulate at the outset that long-term care (LTC) costs are a serious issue. Nearly 20 percent of seniors are subject to chronic impairment, a rate that rises to 55 percent among the oldest of the old (those 85 years of age and older).   The financial reflection of these physical needs was the spending of $135 billion in 2004, or roughly $15,000 per senior in need of LTC. Even more striking is that even among the severely impaired, a majority receive care only from “donated services”; i.e., care from friends or family members such as a spouse or child.

Who picks up this bill? In the private sector: (1) donated services – the private, non-market service provision and financing; (2) out-of-pocket payments (private, self-insurance); and (3) private LTC insurance under $1,000 a senior. Government spending is quite substantial with Medicaid providing $5,500 and Medicare $4,000 per senior.

The LTC problem will get harder, not easier. First, the demand for LTC services will rise along with the demographic shift in the United States.  Second, the suppliers of those donated services – largely spouses and daughters – will be working and less able to provide these LTC services.  One solution would be to foster private sector solutions through flexible regulations that focus on outcomes – appropriate care, improvements in impairment, etc.

The most important thing is that the financing of the costs of future LTC services be met by “pre-funding” – accumulating in advance the funds needed to pay these bills. Why is pre-funding important?  From the perspective of insurance, pre-funding allows for greater sharing of risks.  Costs are distributed not only over a group of people – perhaps only the senior himself or herself, but perhaps also the family, friends and informal network – but over a large number of years.  By spreading risks more broadly, the costs of LTC place a smaller demand on the overall annual lifestyles of those paying the bills.

From the perspective of the overall economy, pre-funding serves to raise national saving.  Each additional dollar of national saving provides another dollar that can be devoted to investing in equipment, structures, education and labor skills, or innovation and other technologies.  These types of investments are the foundation of economic growth, and that growth is ultimately the source of better standards of living for seniors and workers alike.

Finally, the costs of greater LTC spending could be financed by private LTC insurance policies.  Because private insurers accumulate and hold financial reserves against the costs of LTC services claims, this approach provides pre-funding of LTC costs.   At the same time, widespread use of LTC insurance would spread risks broadly across the population – in exchange for premium payments, elders would spread the costs to shareholders, debt holders, and financial market participants across the society.

Unfortunately, the CLASS Act goes exactly the wrong direction. In return for a monthly premium that begins at $65, the CLASS Act provides a daily cash benefit averaging just $50. (Meanwhile a 2009 survey of long term care costs found the current average daily cost of a private nursing home room in the United States is approximately $203.)

The responsibility to keep the CLASS Act entitlement afloat falls to the Secretary of Health and Human Services, who would have to raise the payroll tax rate. The Congressional Budget Office, American Academy of Actuaries and the Society of Actuaries all agree that the initial monthly payroll tax would need to be set between $110 and $160.

Where does that leave us?  The CLASS Act would create a new government entitlement.  Worse, this proposed program is not financially viable. It would continue the pay-as-you-go tradition and would not generate pre-funding that is so economically important.  Unfortunately, a budget gimmick collects the payroll taxes before it starts paying benefits, so its advocates are hiding behind an illusion of fiscal solvency.  No one should be fooled.