Long‐term care and intrafamily moral hazard: Optimal public policy

• DOI: http://doi.org/10.1111/jpet.12338
• Date: 01 December 2019
• Published date: 01 December 2019
• Author: Justina Klimaviciute

Received: 24 July 2017

|

Accepted: 14 September 2018

DOI: 10.1111/jpet.12338

ORIGINAL ARTICLE

Long‐term care and intrafamily moral hazard:

Optimal public policy

Justina Klimaviciute

1,2

1

Department of Economics, University of

Liège, Liège, Belgium

2

Faculty of Economics and Business

Administration, Vilnius University, Vilnius,

Lithuania

Correspondence

Justina Klimaviciute, Vilnius University,

Faculty of Economics and Business

Administration, Sauletekio al. 9, II r., Vilnius

10222, Lithuania.

Email: justina.klimaviciute@evaf.vu.lt

The paper studies optimal public long‐term care (LTC)

policy in the context of intrafamily moral hazard

suggested by Pauly. The model considers a representa-

tive family consisting of an adult child and her elderly

parent who might become dependent, in which case he

places a special value on the LTC provided to him by his

child. Since the child’s caregiving is decreasing in the

amount of insurance coverage, the parent prefers to

underinsure, which is socially suboptimal. The child’s

choice of caregiving is also inefficient since she does not

internalize its positive effect on the parent. The paper

tackles these inefficiencies and shows that intrafamily

moral hazard is a sufficient justification for public

intervention targeted at insurance. If not necessarily

for the introduction of mandatory public insurance, then

at least for the taxation or subsidization of private

insurance premiums.

1

|

INTRODUCTION

Long‐term care (LTC) is an issue which is gaining more and more importance in the societies of today.

LTC can be described as the care for people who are dependent on the help of others in their basic daily

activities (such as dressing, bathing, eating, etc.) and consists of both health and social care which can be

provided both formally (by paid professional caregivers) and informally (by family members or friends), at

home and in special institutions. Since the need for this kind of care is highly related with age,

1

the growing

significance of LTC‐related questions stems primarily from the current demographic trends, namely, the

population ageing.

2

J Public Econ Theory. 2019;21:1037–1055. wileyonlinelibrary.com/journal/jpet © 2018 Wiley Periodicals, Inc.

|

1037

1

For instance, around half of all LTC users in the OECD countries are over 80 years old (Colombo, Llena‐Nozal, Mercier, & Tjadens, 2011).

2

It is expected that in the OECD countries the share of the population aged 80 and over will increase from 4% in 2010 to 9.4% in 2050 (compared to 1% in

1950; Colombo et al., 2011).

One of the most stunning issues associated with LTC is the so‐called LTC insurance puzzle created by a surprisingly

low demand for private LTC insurance. Even though the risk to become dependent is high

3

and the potential LTC

expenses are large,

4

only few individuals buy private LTC insurance. A number of different reasons possibly explaining

this puzzle have been suggested in the literature. Those potential explanations range from the ones assuming perfect

individual rationality (e.g., the high price of insurance or crowding out by the state) to the ones that consider the

nonpurchase of insurance as irrational (such as myopia, ignorance, or denial of dependence).

5

While it seems that none

of the proposed factors alone is able to entirely explain the puzzle, each of them might be playing some role in the issue.

Therefore, it is important that these potential problems are well understood so that effective ways can be found to solve

(or at least reduce) them.

This paper is concerned with one of these potential problems. In particular, it is the problem of intrafamily

moral hazard, which was proposed as a possible explanation for the LTC insurance puzzle by Pauly (1990). The idea

of the intrafamily moral hazard argument is the following. In case of dependence, expenditures on formal LTC

reduce the dependent person’s wealth (and thus the bequest that will be left to his/her children). The children can

help to avoid these formal care expenses (and thus protect the future bequest) by providing care to their parent

themselves. However, if the parent has LTC insurance, the cost of formal care is (at least partly) covered by the

insurer. Thus, LTC insurance also protects the parent’s wealth (and the future bequest),

6

which results in the

children having less incentive to provide care themselves. This reduction in children’s caregiving incentives due to

the parent’s insurance coverage is precisely what is called intrafamily moral hazard. In light of such situation, a

parent who prefers being taken care of by his/her children rather than by unknown formal caregivers might be

discouraged from buying LTC insurance.

Whereas the argument is developed with little formalization in Pauly (1990), Zweifel and Strüwe (1998)

provide a more rigorous model for this idea and show that it is indeed reasonable to believe that the

intrafamily moral hazard effect might be a cause of the nonpurchase of LTC insurance.

7,8

Building on Zweifel

and Strüwe (1998), Klimaviciute (2017) shows that the problem of intrafamily moral hazard and,

consequently, of the nonpurchase of LTC insurance is reduced if insurance contracts with fixed cash

benefits are used instead of those which reimburse a proportion of LTC expenditures. More precisely, it is

shown that fixed benefits eliminate intrafamily moral hazard completely if children “like”providing care to

their parents and they mitigate the phenomenon if children “dislike”care provision.

9

Thelattercaseimplies

that the problem can be reduced but not totally avoided. Moreover, the case of children “disliking”care

provision seems to be highly possible given the evidence about potential negative effects associated with the

3

The estimates of the probability for a 65‐year‐old person to enter a nursing home at some time before his/her death range between 35% and 49%

(Brown & Finkelstein, 2007).

4

For instance, a nursing home stay in the United States costs between $40,000 and $70,000per year, while the average cost in France is around €35,000

per year (Taleyson, 2003).

5

For recent surveys of potential explanations for the puzzle, see Brown and Finkelstein (2011), Cremer, Pestieau, and Ponthie`re (2012), and Pestieau and

Ponthie`re (2012).

6

Pauly (1990, 1996) names the protection of one’s bequest as the main function of LTC insurance.

7

Meier (1995), building on an earlier version of Zweifel and Strüwe’s (1998) paper, considers a possibility for dependent parents to manipulate their

bequests in addition to their insurance coverage. He also concludes that Pauly’s (1990) scenario cannot be ruled out.

8

Courbage and Zweifel (2011) suggest looking at intrafamily moral hazard as at a two‐sided phenomenon, arguing that apart from the just described

effect of insurance on the incentives for children (one side of the phenomenon), the second side exists in that parents may purchase less insurance if they

can rely on the caregiving effort of their children. However, the caregiving effort in their paper is modeled as a preventive one that helps to keep the

parent out of a nursing home (which more generally can be seen as actually preventing a need for LTC). In the present paper, I consider the children’s

caregiving as the provision of care when the parents’need for LTC has already materialized and focus on the first side of the phenomenon (the incentives

for children), as suggested by Pauly (1990).

9

The terms like and dislike are used to reflect different situations in terms of the overall utility or disutility that children derive from care provision. In

general, caregiving might at the same time be associated both with a certain degree of disutility and with a certain degree of utility (coming, for instance,

from altruistic feelings or the appreciation of the time spent with the parent). Thus, the cases “children like providing care”and “children dislike providing

care”can be seen as shortcuts to reflect, respectively, the situation when the utility of caregiving offsets the disutility and the situation when the disutility

of caregiving offsets the utility.

1038

|

KLIMAVICIUTE