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To borrow or insure? Long term care costs and the impact of housing

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  • Shao, Adam W.
  • Chen, Hua
  • Sherris, Michael

Abstract

We assess the impact of housing, the availability of reverse mortgages and long-term care (LTC) insurance on a retiree’s optimal portfolio choice and consumption decisions using a multi-period life cycle model that takes into consideration individual longevity risk, health shocks and house price risk. We determine how much an individual should borrow against their home equity and how much to insure health care costs with LTC insurance. We introduce an endogenous grid method, along with a regression based approach, to improve computational efficiency and avoid the curse of dimensionality. Our results confirm that borrowing against home equity provides higher consumption in earlier years and longevity insurance. LTC insurance transfers wealth from healthy states to disabled states, but reduces early consumption because of the payment of insurance premiums. Housing is an illiquid asset that is important in meeting bequest motives, and it reduces the demand for LTC insurance for the wealthy. We show that the highest welfare benefits come from combining a reverse mortgage with LTC insurance because of strong complementary effects between them. This result highlights the benefits of innovative products that bundle these two products together.

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  • Shao, Adam W. & Chen, Hua & Sherris, Michael, 2019. "To borrow or insure? Long term care costs and the impact of housing," Insurance: Mathematics and Economics, Elsevier, vol. 85(C), pages 15-34.
    • Handle: RePEc:eee:insuma:v:85:y:2019:i:c:p:15-34
    DOI: 10.1016/j.insmatheco.2018.11.006
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    Cited by:

    1. Xu, Mengyi & Alonso-García, Jennifer & Sherris, Michael & Shao, Adam W., 2023. "Insuring longevity risk and long-term care: Bequest, housing and liquidity," Insurance: Mathematics and Economics, Elsevier, vol. 111(C), pages 121-141.
    2. Michel Fuino & Andrey Ugarte Montero & Joël Wagner, 2022. "On the drivers of potential customers' interest in long‐term care insurance: Evidence from Switzerland," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 25(3), pages 271-302, September.
    3. Yung-Tsung Lee & Tianxiang Shi, 2022. "Valuation of Reverse Mortgages with Surrender: A Utility Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 65(4), pages 593-621, November.
    4. Fehr, Hans & Hofmann, Maurice, 2020. "Tenure choice, portfolio structure and long-term care – Optimal risk management in retirement," The Journal of the Economics of Ageing, Elsevier, vol. 17(C).
    5. Badescu, Alexandru & Quaye, Enoch & Tunaru, Radu, 2022. "On non-negative equity guarantee calculations with macroeconomic variables related to house prices," Insurance: Mathematics and Economics, Elsevier, vol. 103(C), pages 119-138.
    6. Michael Sherris, 2021. "On Sustainable Aged Care Financing in Australia," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 54(2), pages 275-284, June.
    7. Mengyi Xu & Jennifer Alonso Garcia & Michael Sherris & Adam Shao, 2022. "Insuring Longevity Risk and Long-Term Care: Bequest, Housing and Liquidity," ULB Institutional Repository 2013/340821, ULB -- Universite Libre de Bruxelles.
    8. Daniel Dimitrov, 2022. "Intergenerational Risk Sharing with Market Liquidity Risk," Tinbergen Institute Discussion Papers 22-028/VI, Tinbergen Institute.
    9. van Bilsen, Servaas & Laeven, Roger J.A., 2020. "Dynamic consumption and portfolio choice under prospect theory," Insurance: Mathematics and Economics, Elsevier, vol. 91(C), pages 224-237.
    10. Koo, Bonsoo & Pantelous, Athanasios A. & Wang, Yunxiao, 2022. "Novel utility-based life cycle models to optimise income in retirement," European Journal of Operational Research, Elsevier, vol. 299(1), pages 346-361.

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    More about this item

    Keywords

    Life-cycle model; Individual longevity risk; Long-term care insurance; Residential house; Reverse mortgage;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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