The Impact of Medical and Nursing Home Expenses and Social Insurance Policies on Savings and Inequality

The objectives of this paper are 1) to assess the impact of medical and nursing home expenses on life-cycle savings and wealth inequality in the U.S., and 2) to quantitatively evaluate the effects of alternative old-age social insurance policies in a general equilibrium framework. We consider a life-cycle model where individuals face uninsurable labor earnings risk, out-of-pocket medical and nursing home expense risk and survival risk. Partial insurance is available through three social insurance programs: welfare, Medicaid and a pay-as-you-go social security system. We find that out-of-pocket health expenses amplify precautionary savings against survival risk and that nursing home expenses drive the savings behavior of wealthier individuals. The dominant role played by nursing home expenses is primarily due to differences in the degree of social insurance available for medical versus nursing home expense risk. We find that elimination of private medical and nursing home expenses through public health care would reduce the capital stock by 20 percent. We also find that while the welfare program for workers has little effect on savings behavior in the presence of large out-of-pocket expenses, Medicaid and old-age welfare programs crowd out over 60 percent of life-cycle savings and dramatically increase wealth inequality. Furthermore, we find that social security amplifies the effect of OOP health expenses on wealth accumulation. Overall, we conclude that out-of-pocket health expenses play an important role in wealth accumulation on aggregate and across the permanent income distribution.