Thursday December 9, 1999
The following article by Center for Long-Term Care Financing President Stephen A. Moses was published in the December 1999 issue of LTC News & Comment, a monthly newsletter on long-term care financing issues. (Visit LTC News & Comment on the web at www.larsonltc.com). The article was excerpted from the Center for Long-Term Care Financing's 1999 white paper "The Myth of Unaffordability: How Most Americans Should, Could and Would Buy Private Long-Term Care Insurance." Order a copy of the The Myth report from the Center [$34.95; free to media and legislators] by contacting us at 206-447-1340 or firstname.lastname@example.org.
"Why People Purchase Private Insurance"
The purpose of insurance is to replace the small risk of a catastrophic loss with the certainty of an affordable premium. Insurance companies help people achieve this objective by spreading and pricing risk. For example, if there is one chance in a million that I will be hit by a truck resulting in a $1 million loss, that event--unlikely as it might be--would devastate me financially as an individual. I would gladly pay $2 to make such a risk disappear. So would millions of other people. Therefore, an insurance company can sell this protection to me and to 999,999 others, make a nice profit, and perform a valuable public service in the process. That is spreading risk.
But what if five of the insurance company's million beneficiaries are hit by trucks instead of just one? Then the company would have collected only $2 million in premiums, but would owe $5 million in claims, a $3 million loss. To know what to charge for insurance protection, companies must measure, record and analyze extensive (actuarial) data on the incidence and frequency of the insurable event. They must answer the question: What is the probability that the insurable event will occur and what will be the cost if it does? That is pricing the risk.
Both spreading risk and pricing risk are critical economic functions. One of the main differences between social insurance and private insurance is that, although both spread risk, only private insurance prices risk in a meaningful way. Private insurers have a legal and fiduciary responsibility to their insureds. They must price insurance coverage at a level sufficient to accumulate reserves adequate to pay carefully anticipated claims rates. Private policyholders possess legal contracts, enforceable in a court of law, that assure them recourse in case of dispute, malfeasance or insolvency by the insurance company.
Social insurance, on the other hand, offers none of these protections. Social Security and Medicare, for example, are notorious for growing exponentially beyond their original cost projections. Socially insured people have no legal recourse or protection against increases in premiums (payroll taxes), decreases in benefits (program cutbacks), or the imposition of means tests (welfarization). Indeed, a majority of Americans now believe that these bulwarks of traditional social insurance will not be there in full when they need them in the future. Serendipitously, as confidence in social insurance declines, the private market economy is booming and consumer confidence is at an all time high.
In America's mixed economy, social insurance is usually considered a safety net and not a first line of financial defense. When savings, investment, pensions and private insurance prove inadequate, we look to social insurance to pick up the slack. Unfortunately, however, the very existence of compulsory social insurance may debilitate the effectiveness of private financing vehicles. People purchase insurance if they perceive they are vulnerable to a large financial loss. What matters is their perception, not the magnitude or reality of the risk. Real risk, if unperceived, will not impel people to insure. Real or not, perceived risk, may cause people to insure.
Social insurance creates a perception of low risk thereby reducing
the demand for private insurance protection. Private insurance
marketing struggles to create a perception of risk, but to the
extent the risk is not real, the task is daunting and unproductive.
The worst of all possibilities is when social insurance or welfare
has desensitized the public to a risk against which the private
insurance industry is trying to sell protection (i.e., loss of
assets), while another greater risk (i.e., access to quality care)
goes unperceived and uninsured by either social insurance or private
insurance. That is precisely the situation with long-term care.