Lapse of Long-Term Care Insurance Coverage in the US

Despite significant financial loss and implicit cost associated with a long-term care insurance (LTCI) policy lapse, cancellation of a LTCI policy prior to becoming eligible for benefits is a common phenomenon in this market. Using data from the 1996-2012 Health and Retirement Study (HRS), I investigate why do individuals let their LTCI policy lapse and suffer a financial loss of premium paid with the resumed risk of long-term care expenditures in the future. In this paper, I show that individuals could let their LTCI policies lapse due to competing financial needs within household, expected utilization of long-term care services and poor financial decision resulting from cognitive impairment. I predict individuals’ lapse decision based on the present discounted value of expected utility of retaining LTCI coverage versus dropping the coverage. I also examine the characteristics of individuals for whom a suspect choice can be identified under incomplete information. I find that individuals with higher competing financial needs within household and less wealthier are more likely to lapse their LTCI policies and make suboptimal decision regarding maintaining the coverage. Individuals with lower cognitive status are more likely to drop their policies while individuals with longer expected utilization of home health care and higher risk of needing nursing home care are less likely to drop the policy. Finally dynamic analyses of ex-post risk of using long-term care suggest that individuals who drop their LTCI coverage are more likely to use nursing home care than individuals who were otherwise equivalent at the time of purchase but maintained their coverage. This finding contradicts earlier evidence that inefficiencies in the private LTCI market in the US is primarily due to reclassification risk and the market is adversely selected. JEL Classification: I13; C11; C18