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Long-Term Care Financing


The financing of long-term care services comes from a patchwork of funds from the federal, state, and local levels, and from private dollars, primarily paid from the consumer's own pocket. According to data from the Centers for Medicare & Medicaid Services (CMS), almost $115 billion dollars were spent on long-term care (not including Medicaid waiver expenditures) in 1997, with the majority (72 percent) covering nursing home care and institutions for people with mental retardation. Public resources (primarily Medicaid and Medicare) accounted for 62 percent of institutional coverage and 56 percent of home care. Other federal programs (funded by the Title 20 of the Social Security Act, Older Americans Act, and the Department of Veterans Affairs) accounted for less than 4 percent of total long-term care spending. Approximately one third of long-term care expenditures were attributable to out-of-pocket expenses, with private insurance covering only 5 percent of nursing home expenditures and perhaps as much as 11 percent of home and community-based expenditures (primarily medically oriented home health care).

Informal care

Estimates of formal spending for long-term care do not place a dollar value on the vast amount of unpaid care, including the value of wages foregone by family caregivers. The major long-term care provider is the family and, to a lesser extent, other unpaid informal caregivers. According to data from the 1994 National Long-Term Care Survey, more than seven million Americansmostly family membersprovide 120 million hours of unpaid care to older adults with functional disabilities living in the community. If these caregivers were paid, the cost would be between $45 billion and $94 billion a year.

The overwhelming majority of noninstitutionalized older adults with disabilities (about 95 percent) receive at least some assistance from family and friends. Approximately two-thirds rely solely on unpaid help, primarily from wives or daughters. As disability increases, elderly persons receive more informal care. Eighty-six percent of older adults at greatest risk for nursing home placement live with others and receive almost sixty hours of informal care per week, supplemented by a little over fourteen hours of paid assistance. Although reliable statistics are not available, many family members provide assistance to elderly relatives living in nursing homes, and others engage in long-distance caregiving arranging for the care of a parent or other relative who lives far away.


Medicaid, the federal/state health insurance program for the poor, is the major public program covering long-term care for older adults. Elderly persons with low incomes and few assets (or those who deplete their assets paying for long-term care) are entitled to nursing home coverage and home health care, and, depending on state program rules, they may have access to home and community-based services. Since the mid-1970s, states have had the option to offer personal care services (assistance with activities of daily living such as bathing, dressing, and eating) under their Medicaid state plans. In 2000, twenty-seven states offered this option to eligible older adults. In 1981, Congress authorized the waiver of certain federal requirements to enable a state to provide home and community-based services (other than room and board) to individuals who would otherwise require nursing home care. This allows states to fund a range of services, including case management, homemaker services, home health aide services, personal care, adult day health care, rehabilitation, and respite care to help keep older adults and younger people with disabilities out of institutions. All states have waiver programs which are subject to approval by CMS, the federal agency that administers Medicaid. In 2000 there were 242 such programs. It is important to note, however, that two-thirds of the 11 billion dollars in waiver services in 1999 were spent on people with mental retardation and developmental disabilities. The remaining third supported services for older adults, younger people with physical disabilities, and other populations.

Despite the public's tremendous interest in, and preference for, care in the home, Medicaid continues to exhibit a strong bias toward institutional care. Out of the 59 billion dollars spent by Medicaid on long-term care in 1997, a little less than one quarter was spent on home and community-based services. Three quarters of the states devoted less than 15 percent of their long-term care resources to noninstitutional services, and in half the states the home and community-based share was less than 8 percent.

The home and community-based care sector, however, has experienced tremendous growth, with spending on these services increasing much faster than spending on nursing home care. Between 1993 and 1994, for example, total Medicaid spending for long-term care increased by just 9 percent, while spending for waivers and the personal care option benefit increased by 26 percent. Much of the growth in these services is due to the implementation and expansion of Medicaid waiver programs. A small but growing number of states are spending at least 20 percent of their long-term care resources on home and community-based services.

Several states, notably Oregon and Washington, have explicitly recognized nursing homes as the setting of last resort, and have intentionally reduced the number of nursing home beds. They have successfully used Medicaid waivers to place many elderly persons with serious disabilities in alternative assisted-living facilities and adult foster homes. Both states also use Medicaid dollars to support extensive care-management programs that help to keep many older adults in their own homes.

State and local funding

In addition to dollars that states use to match federal Medicaid expenditures (approximately 17 percent of all long-term care expenses in 1995), many states augment or create their own programs with state funds. Pennsylvania and New Jersey, for example, have relatively large home and community-based care programs supported mainly by lottery dollars. A number of local communities have also been successful in raising funds for long-term care services. Hamilton County, Ohio (the Cincinnati metropolitan area) supports services for older adults with disabilities through a county levy enacted under the leadership of the local Area Agency on Aging (AAA). In 1997, the AAA's Elderly Services Program spent 17 million dollars in levy funding for homemaker services, personal care, home-delivered meals, care management, adult day care, and transportation. This agency was able to convince both elderly and younger county residents that the levy for long-term care services was necessary, given the continuing cuts in federal funds, and that the dollars would benefit the entire community, not just older adults.


Although not considered a major supporter of long-term care services, Medicare, the universal health insurance program for most older adults and a subgroup of younger people with disabilities, pays a substantial part of skilled nursing facility and home health care bills. The Medicare nursing home benefit is limited to one hundred days, post-hospitalization, for individuals who need continued skilled nursing care and/or skilled rehabilitation. Home health visits are limited to persons who need skilled nursing care on a part-time or intermittent basis. In 1998, 10 percent of total Medicare spending was attributed to nursing facility and home health care. Between 1990 and 1998, Medicare spending for care in skilled nursing facilities increased more than 500 percent and spending for home health care increased 250 percent.

In the mid-1990s, Congress began to express concern about the growth in spending on home health care and about evidence that, due to liberal interpretations of definition and scope of service, Medicare was providing more long-term, nonskilled personal care than the program was intended to provide. There was also anecdotal and case-study evidence that providers participating in Medicaid home care programs were being encouraged by states to help their clients become eligible for Medicare home health benefits in order to reduce state costs for long-term care. Congress responded to these concerns by enacting provisions in the Balanced Budget Act of 1997 that significantly reduced payments to home health agencies, that cracked down on fraud and abuse, and that attempted to return the program to its post-acute care roots. Several studies indicate that this legislation has been successful in reducing the number of visits and the duration of the home care episode, but the impact on elderly consumers' access to care and on quality outcomes is uncertain.

Private long-term care insurance

Private long-term care insurance pays only a small part of the bill1995, such insurance covered less than 6 percent of all long-term care costs. The market grew during the 1990s, however, and the total number of policies increased from 800,000 in 1987 to almost 5 million in 1996. A 1997 survey conducted by the Health Insurance Association of America (HIAA) indicated that the number of policies purchased increased by more than 600,000 in 1996 alone, the largest number of policies ever sold in one year. The estimated total of 5 million, however, is cumulative; the number currently in force is a fraction of those ever sold, and could be even smaller given the high lapse rate (i.e., insured individuals dropping policies) seen in this industry.

In 1996, approximately 80 percent of the 5 million policies were individual policies. The remaining 20 percent were policies sold either through employer groups or as part of a life insurance packageup from less than 3 percent of the market in 1988. Half of all individual policies had been sold in only nine states. In 1996, the average annual premium for a person at age sixty-five who purchased basic long-term care insurance (covering four years of nursing home care or home health care beginning after the first twenty days of care) was $980. The premium rose to $1,321 with nonforfeiture protection, to $1,829 with 5 percent compounded inflation protection, and to $2,432 with both additional protections.

Controversy has raged around private long-term care insurance since 1990. The private sector has argued that public programs will never meet the demand and that individuals with financial means should not be encouraged to shelter or spend down their assets to become eligible for Medicaid coverage. Consumers and regulators have expressed concern about the lack of affordability and fraudulent marketing practices. A 1997 Consumer Reports article suggested that only 10 to 20 percent of the elderly can afford long-term care insurance, noting that premiums for two adequate policies bought at age sixty-five cost $3,500 per year, or 13 percent of the median annual income of elderly married couples. Whether this figure reflects a high or low proportion of a couple's annual expenditure depends on how much money (primarily assets) the couple has and what else they must buy.

Many observers have suggested that private long-term care insurance might play a more significant role in financing these services if an employer-based group market develops. Premiums for long-term care insurance sold through employers are lower than those sold as individual products because: (1) employers can market to younger people, (2) costs of administration are lower and there are no agent commissions, and (3) employers might use bargaining power to reduce insurers' profit percentages. Employer-based products also offer less stringent health screening criteria or eliminate medical under-writing entirely. A group market, furthermore, offers increased ease and comfort of purchase due to the fewer coverage decisions required. According to the 1997 HIAA survey, 1,532 employers were offering long-term care insurance to their employees and retirees by the end of 1996; up from seven in 1988 and 1,260 in 1995.

Financing trends

A number of initiatives at the federal, state, and provider levels seek to use public funds creatively to provide an array of services to older adults with chronic disabilities. One major trend is the integration of acute and long-term care funding streams to allow for better management of care across the service spectrum. The most ubiquitous example of this activity is the Program of All-Inclusive Care for the Elderly (PACE), a managed care approach to providing long-term care for disabled older adults who are eligible for Medicaid and are nursing home certifiable. Participating providers receive a lump-sum payment for each elderly beneficiary that integrates Medicare and Medicaid reimbursement to allow maximum flexibility in meeting the primary care and long-term care needs of the consumer. Additional distinguishing features of this program include: (1) provider assumption of financial risk in caring for the older adult within the monthly capitation payment; (2) integrated service delivery, with adult day care as the focal point; (3) care management through the use of interdisciplinary care teams, from physicians to the van driver; and (4) a vigorous attempt to keep individuals in community care and out of nursing homes. The Balanced Budget Act of 1997 made PACE a permanent Medicare category, and there are ongoing efforts by providers and some states to expand the number of sites across the country. The potential for this model, however, to address the financial as well as the delivery concerns of millions of older adults who need long-term care will remain limited unless policymakers and providers figure out how to expand the scale and scope of the program in an efficient manner.

Motivated by escalating Medicaid budgets and growing numbers of elderly and younger disabled enrollees, many states have expressed interest in the integration of acute and long-term care. They are particularly concerned about their dual eligible populationindividuals eligible for both Medicaid and Medicarewho account for about 17 percent of the states' Medicaid enrollees and 35 percent of program expenditures. By the late 1990s, nineteen states, most notably Arizona, Maine, Minnesota, Texas, and Wisconsin, had some type of integration initiative. The Robert Wood Johnson Foundation and the Centers for Medicare & Medicaid Services are sponsoring evaluations of these programs and demonstrations in other states, but results will not be available for some time. Meanwhile, the rhetoric of integration will continue, as policy-makers, providers, and researchers struggle to implement the details.

Consumer direction in home and community-based care is another trend that is slowly emerging as a financing option for older adults. This concept originated in the independent living movement of younger people with physical disabilities and the self-determination movement of people with mental retardation and developmental disabilities. Both of these movements opposed institutionalization and demanded more consumer control over services. Consumer direction emphasizes privacy, autonomy, and the right to manage one's own risk. Aside from leveling the playing field between institutional and home and community-based care, a growing number of policymakers see it as a potential way to save money through more efficient allocation of resources and through flexibility in how, where, and by whom care is delivered. Policy options range from consumer involvement in planning and decision-making to the ultimate in consumer directionproviding cash benefits to beneficiaries and/or their families and letting them purchase their own services and supports.

Most of the consumer direction programs have been implemented at the state level, through Medicaid waiver authority and state-funded personal-assistance service programs. The Cash and Counseling Demonstration and Evaluation, a five-year program jointly funded by the U.S. Department of Health and Human Services and the Robert Wood Johnson Foundation in 1997, is testing the efficacy of cashing out the Medicaid home and community-based waiver benefit in Arkansas, Florida, and New Jersey. A randomly-assigned group of beneficiaries is receiving a cash benefit that is a slightly discounted monetary equivalent of a package of personal care services provided by an agency to a control group of beneficiaries. A rigorous evaluation is under way to assess the impact on elderly and younger consumers and on state coffers. Special attention is focused on how individuals spend the dollars and the extent to which this option might compromise quality.

U.S. policymakers have been comfortable with cash benefits for certain subpopulations, such as veterans and workers with disabilities. Over the past five years, several federal legislators and the current and previous presidents have included within large tax bills which were never passed a three thousand dollar, nonrefundable tax credit for people needing long-term care or for family members caring for them. This proposal would provide consumer-directed benefits, that is, a cash refund. Policymakers have been less supportive of direct payments to allegedly "undeserving" individuals who receive public benefits due to their financially disadvantaged status. Concerns about misuse of dollars as well as potential liability for unforeseen mishaps, such as abuse of elderly clients by privately hired workers or deaths of older adults because of insufficient or inappropriate service delivery, have impeded the growth of this trend in the United States.

The future of long-term care financing

Based on data from the Long-Term Care Financing Model and the National Long-Term Care Survey, the Congressional Budget Office (CBO) estimates that inflation-adjusted expenditures for long-term care for older adults will grow by 2.6 percent annually between 2000 and 2040. Expenditures are expected to reach 207 billion dollars in 2020 and 346 billion dollars in 2040. Projections beyond the next twenty years, however, should be viewed with caution because of uncertainties about demand, as well as about the scope and costs of services in the future. These estimates, for example, assume an average decline of 1.5 percent per year in the rate of disability. If the prevalence of disability among older adults remains constant, total expenditures in 2040 will be about 40 percent higher than the CBO estimate.

After thirty years of debate about financing, it is almost certain that the United States will maintain its patchwork approach by experimenting with different ways to balance public and private funding. Medicaid will continue to be the primary source of public funding, and the federal and state governments will rely increasingly on the tax code to achieve incremental reform, including tax credits for caregivers and care recipients and tax breaks to encourage the development of a private insurance market. Although tomorrow's elderly population, on average, will be wealthier than today's, there will be much variation within each generation of older adults. It is important to note that, because of the connection between low income and disability, those most likely to need long-term care in the future will also be the least likely to be able to pay for services out-of-pocket. A wealthier and more educated population will probably want more choices, and financing strategies that offer flexibility in how resources are used should appeal to more elderly Americans and their families.

Robyn I. Stone

See also Area Agency on Aging; Caregiving, Informal; Consumer Directed Care; Financial Planning for Long-Term Care; Health and Long-Term Care Program Integration; Home Care and Home Services; Long-Term Care Insurance; Medicaid; Medicare; Nursing Home.


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Health Economics

Health Economics


An enormous expansion in the scope and effectiveness of medical care services to diagnose and treat diseases began in the 1930s with the scientific research and development techniques that produced the first antibiotics. Those advances have been followed by continual changes in the organization of the institutions that constitute the supply and demand sides of the medical service industry, continual changes in pricing and payment mechanisms, and continual growth in the amount of nations resources that are allocated to medical services.

Theses changes have been universal among countries, even in the presence of substantial heterogeneity in institutional and market structures for health care delivery and financing. The United Kingdom and the United States are examples of nations with very different structures. In 1946 the United Kingdom established universal, government-funded medical insurance, and hospital and medical specialists services are produced by the government. In the United States, medical insurance is not universal; government expenditure is substantial, but provides coverage for only selected populations; physician practices are privately owned and organized on a for-profit basis; and most hospitals are privately owned but organized as nonprofit-based corporations. Yet, between 1960 and 2004, total health care expenditure as a share of gross domestic profit doubled in the United Kingdom and tripled in the United States (Organisation for Economic Co-operation and Development 2007).

Health economics applies the tools of microeconomics to individual and societal decisions regarding the allocation and distribution of resources to the production of health and health care services. Kenneth Arrows 1963 article Uncertainty and the Welfare Economics of Medical Care established health economics as a field by making the case that virtually all of the special features of the medical care industry stem from the prevalence of risk and uncertainty, arguing that the failure of the market to insure against uncertainties has created many social institutions in which the usual assumptions of the market are to some extent contradicted (Arrow 1963, p. 946).

Demand- and supply-side analysis is the primary theoretical tool in health economics. On the demand side, health is characterized as a stock of human capital (Schultz 1961; Becker 1962) that produces both direct utility and investment servicescapacity to functionover the life cycle. With aging it depreciates naturally and is increasingly subject to shocks from diseases. Replacement health cannot be purchasedit must be produced by combining personal resources such as time and health-affecting behaviors with purchased health or medical care services (Grossman 1972). On the supply side, purchased health care services are regulated by government and produced in hospitals, physicians offices, and clinics, and long-term care facilities by physicians, nurses, and other medical care providers using pharmaceutical and other diagnostic and treatment technologies.

The role of third-party payorspredominately employers and governmentsconstitutes a distinguishing feature of health economics. Given third-party payors, consumers often are not aware of the full range of alternative health care services and do not directly face, or even know, the resource costthe full priceof their health care. Most consumers are enrolled in managed care type plans that have contracts with providers. Those contracts influence providers treatment decisions by specifying which services are covered and what the payment mechanism is between the plan and medical services provider; the consumer does not see the plan-provider contract.

Health economics draws on tools used in several other fields to address this configuration of health and health care institutional characteristics: from public finance, the major government role; from labor economics, the major employer role; from industrial organization, restricted entry and nonprofit organizational form; and from econometrics, quantitative answers to policy-related questions. Variations of cost-effectiveness analysis are more frequently used by health economists in nations such as the United Kingdom, where government-financed third-party coverage is complete.

Much growth in the field of health economics is policy oriented. This can be attributed to the fact that governments are major third-party payors and face the fiscal implications of the costs associated with the expansion in the scope of medical care services. Thus, the research has focused on societal decisions regarding the efficient (cost-containing) allocation of resources to the production of health care services. Research concerning the distributional component of enhancing social welfare (Arrow 1963) has received much less attention in health economics. This has implications for policy because there is substantial evidence of nonrandom heterogeneity in health stock and health outcomes among demographic groups. Racial and ethnic health disparities continue to persist whether health care coverage is universal and provided by government, as in the United Kingdom (Townsend and Davidson 1982), or provided through fragmented systems of imperfect markets that include private and government third parties, as in the United States (U.S. Department of Health and Human Services 2000).

Viewed as human capital, investment in the health of the most vulnerable members of society may be a powerful tool for promoting growth. Public investment in programs that eliminate acquired immunodeficiency syndrome (HIV/AIDS) enhances social welfare and facilitates economic growth in developing African countries. Programs that increase breast-feeding enhance the health of infants and thereby generate positive long-term returns. But John Akin and colleagues reported that in Sri Lanka, highly educated mothers from families in the highest income or asset categories were among the least likely to breast-feed (Akin, Bilsborrow, Guilkey et al. 1981); thus the social rate of return from investment in health may be particularly high for developing countries, but the economic and policy issues are complex. Additional health economics studies can help clarify these issues.

SEE ALSO Arrow, Kenneth J.; Developing Countries; Development Economics; Disease; Health in Developing Countries; Microeconomics; Modernization; Public Health; Risk; Sanitation; Uncertainty


Akin, John, Richard Bilsborrow, David Guilkey, et al. 1981. The Determinants of Breast-Feeding in Sri Lanka. Demography 18 (3): 287307.

Arrow, Kenneth J. 1963. Uncertainty and the Welfare Economics of Medical Care. American Economic Review 53 (5): 941973.

Becker, Gary S. 1962. Investment in Human Capital: A Theoretical Analysis. Journal of Political Economy 70 (5, pt. 2): 949.

Grossman, Michael. 1972. On the Concept of Health Capital and the Demand for Health. Journal of Political Economy 80 (2): 223255.

Law, Sylvia A. 1974. Blue Cross What Went Wrong? New Haven, CT: Yale University Press.

Schultz, Theodore W. 1961. Investment in Human Capital. American Economic Review 51 (1): 117.

Townsend, Peter, and Nick Davidson, eds. 1982. Inequalities in Health: The Black Report. New York: Penguin Books.

U.S. Department of Health and Human Services. 2000. Healthy People 2010. 2 vols. 2nd ed. Washington, DC: U.S. Government Printing Office.

Alvin E. Headen Jr.

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