Are fair premiums key to private LTC insurance?

I give John Goodman credit for writing about actual policy options for improving long term care (LTC) policy in the wake of the demise of CLASS (Avik Roy also has a post; I blogged last week about Stuart Butler’s suggestions). I am glad conservatives are entering the fray on what they are for in LTC.

However, I think the premise of one of John’s 5 suggestions is wrong, and wanted to point it out since he linked to a post of mine as support for it:

Allow Insurers to Price Risk Accurately. The principal reason for the failure of CLASS is community-rated pricing. Everyone was going to be charged the same premium, regardless of expected long-term care expenses.

I think this is wrong. The primary problem with CLASS was not community rating, but adverse selection (only bad risks would sign up). It is true that community rating would have made CLASS even more attractive for poor risks, but if you had a massive risk pool, you wouldn’t only have poor risks and community rating would work just fine. Consider two possibilities:

  • Adverse selection and pricing due to true risk. For example, if you changed CLASS only by allowing for the assignment of an actuarially fair individual premium. In this case there is no community rating, but you also wouldn’t expect a functioning insurance market to develop because no one could afford the premiums due to adverse selection; you would be assigning premiums to only a sliver of those at (high) risk. All insurance markets need good risks to balance bad ones.
  • Forced risk pooling. This could be done either through a mandate, or we could borrow some of the auto-enroll procedures from Rep. Paul Ryan’s Patients’ Choice Act (essentially soft mandates that we agree to call something else). If a large number of persons were forced/nudged into the risk pool, then a market for LTC insurance could probably develop. If you got enough people into the risk pool, then a second step of assigning an actuarially fair premium could make the market more efficient, but of course there is a tradeoff between the transaction costs of assigning a more correct premium and the benefits of the fairness achieved. Once the pool got large enough, it is probably not worth it.

Assigning an actuarially fair premium makes sense within the (poorly) functioning LTC insurance market, especially since it is voluntary. However, the only way to get such a market started from nothing is forced risk pooling of some sort. Whether such a step is worth it or not depends on how bad you understand the default system to be.


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