Will Tax Credits Sell Long-Term Care Insurance?

(I posted this yesterday on my TaxVox blog, but those interested in long-term care may be interested as well)

Long-term care insurance has been a model of market failure. The need for care in frail old age or disability seems to be the ideal insurable event. Two-thirds of those over 65 will need some assistance before they die and 20 percent will need it for more than five years. Yet only about 6 million people own this insurance, and few seem interested in buying.

To boost sales, the industry has pushed for all sorts of government assistance. A federally-funded marketing effort called the Own Your Own Future campaign has tried to raise public awareness of the need for coverage. A joint state/federal program called the Partnership Program attempts to more closely link private long-term care insurance with Medicaid. And about three dozen states now offer tax incentives for the purchase of insurance (30 provide a deduction, 7 give credits, and 3 give both).

Now, in the context of health reform, carriers are pushing for new federal tax subsidies–either a credit or inclusion of long-term care insurance as part of an employer’s overall benefit plan. Making this insurance a benefit in such a “cafeteria plan” would allow workers to buy coverage with pre-tax dollars, significantly reducing their costs.

The question is: Do tax subsidies encourage people to buy insurance? The answer seems to be: Not much. In a forthcoming paper, David Stevenson and others at the Harvard Medical School compare purchase rates in states that have tax subsidies with those that do not. They found sales are about 10 percent higher where buyers can get a tax break. Credits increase the participation rate by about 20 percent while deductions make no significant difference at all. Oddly, people are more likely to buy in states with low level credits than in those with more generous credits.

Their results track an earlier paper by Anne Cramer and Gail Jensen, and another by my Urban colleague Rich Johnson that also found that demand for this insurance does not respond very much to lower prices.

The purpose of these subsidies is to reduce Medicaid costs, which states share with the federal government. The idea: Private insurance can at least delay the time when someone needs to go on to Medicaid by picking up some nursing home or home care expenses.

But this benefit to states may not outweigh the costs of providing the tax breaks. Harvard’s Gopi Shah Goda finds consumers may be more responsive to tax subsidies than other research concludes, but still estimates that $1 in state tax expenditures produces just 84 cents in Medicaid savings, half of which go to the federal government.

Because federal tax rates are much higher than state rates, a federal subsidy might be worth more to consumers. And including this insurance in a cafeteria plan may increase worker awareness of the product. On the other hand, these incentives are most likely to encourage wealthy consumers to buy, the very population least likely to qualify for Medicaid. And, like most tax subsidies, a big chunk will end up in the pockets of people who would have purchased the insurance anyway.

The apparent failure of these state tax breaks is something Congress should keep in mind as it weighs whether to expand federal tax breaks for this insurance.