The Effect of Co-payments in Long Term Care on the Distribution of Income and Risk

Motivation:

In the Netherlands, a country with one of the most extensive and expensive public long term care systems, concerns about rising costs have led the government to increase the level of co-copayments. An interesting feature of these co-payments is that they are income- and wealth-dependent. This dependency enables the fine-tuning of the financial impact of co-payments across income- and wealth groups, but it also distorts saving and annuitization decisions of individuals.

We use a unique dataset to estimate synthetic lifecycle paths of long term care spending over the lifecycle. We analyze how different types of co-payments affect consumption and saving, and how they redistribute income across income groups. We also consider the effects of the co-payment schemes on the optimal annuitization share of pension wealth. The financial wealth of Dutch elderly consists largely of annuitized pension wealth. In the case of co-payments, full annuitization might not be optimal, as people want to hold some of their wealth in cash to finance their health care costs. Moreover, differences in the co-payment rates for (pension) income and financial wealth might distort the annuitization decision.

Methods:

Modeling long term care expenditures over the lifecycle is challenging because of their very uneven distribution and limited availability of long panel data. We use a semi-parametric nearest-neighbor approach to estimate lifecycle paths of long term care spending. We use extensive administrative data that includes information on long term care spending, household status, income, and wealth for the entire Dutch population. The resulting lifecycle paths have a similar distribution, in terms of income, initial wealth, and long term care costs as the Dutch population.

The estimated paths are inputs in a stochastic lifecycle decision model for retirees. This model determines optimal consumption and saving behavior of elderly for different levels of initial wealth and pensions, taking into account their financial risk. We use the model to analyze the effects of different forms of income and wealth dependent co-payments on average consumption and welfare (certainty equivalent consumption) across income groups.

Findings:

We find that, compared to a fully premium financed system, a fixed co-payment of 25% of care costs decreases average lifetime consumption of the elderly with the lowest financial means by 11 %, and welfare (certainty equivalent consumption) by 16 %. For the elderly with the highest financial means, welfare loss is only 2 %. An income dependent co-payment, raising the same amount of revenues as the fixed one, leads to a much smaller loss in consumption for the poor (3 %), while increasing the loss for the richest to 3.5 %. An income- and wealth-dependent co-payment reduces welfare loss for the poorest even further. For the richest, welfare loss is equal to the loss in the income-dependent case: holding financial assets becomes less attractive, leading to an increase in average lifetime consumption, while at the same time decreasing protection against care costs, leading to a welfare loss. Co-payments decrease the optimal annuitization rate. The annuitziation rate is lowest when co-payments only depend on (pension) income.