Modeling Disability in Long-Term Care Insurance

Long-term care (LTC) costs and, in particular, those arising under an LTC insurance contract, are difficult to estimate. This is because of the complex effects of the processes of aging—disability and cognitive impairment. As disability is a gradual, as opposed to a discrete, process, and as the effects are sometimes reversible, a fairly complex model is necessary to capture its nature. This paper concentrates on modeling the disability process of aging only and, in particular, fully incorporates the recovery process as dictated by the data. With the recovery process modeled, the effect on the estimated model costs of disability of the common simplifying assumption that recoveries can be ignored is easily assessed.This paper has twin objectives: (1) to present novel methodology, the penalized likelihood, for using interval-censored longitudinal data, such as the National Long-Term Care Study, to parameterize Markov models; and (2) to estimate the costs arising under an LTC insurance contract in respect of disability. The model is also used to show that ignoring recovery from disability can lead to significant overestimation of LTC insurance costs—suggesting that claims underwriting in LTC insurance may be an important factor in managing claims costs.