To Borrow or Insure? Long Term Care Costs and the Impact of Housing

39 Pages Posted: 22 Dec 2015 Last revised: 13 Feb 2018

See all articles by Adam Wenqiang Shao

Adam Wenqiang Shao

University of New South Wales - ARC Centre of Excellence in Population Ageing Research (CEPAR); Milliman

Hua Chen

University of Hawaiʻi at Mānoa

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies; UNSW Australia Business School

Date Written: January 2018

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 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.

Keywords: life-cycle model, longevity risk, long-term care insurance, residential house, reverse mortgage

JEL Classification: G21, G22, I13, I31, J26, R31

Suggested Citation

Shao, Adam Wenqiang and Chen, Hua and Sherris, Michael, To Borrow or Insure? Long Term Care Costs and the Impact of Housing (January 2018). Available at SSRN: https://ssrn.com/abstract=2707350 or http://dx.doi.org/10.2139/ssrn.2707350

Adam Wenqiang Shao (Contact Author)

University of New South Wales - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

CEPAR, Level 3
East Wing, NICTA Building, UNSW
Sydney, New South Wales NSW 2052
Australia

Milliman ( email )

One Pennsylvania Plaza 38th Floor
New York, NY 10119
United States

Hua Chen

University of Hawaiʻi at Mānoa ( email )

2404 Maile Way, E-602e
Honolulu, HI 96822
United States
(808) 956-8063 (Phone)
(808) 956-9887 (Fax)

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies ( email )

UNSW Business School
Risk and Actuarial Studies
Sydney, NSW 2052
Australia
+61 2 9385 2333 (Phone)
+61 2 9385 1883 (Fax)

HOME PAGE: http://www.asb.unsw.edu.au/schools/Pages/MichaelSherris.aspx

UNSW Australia Business School ( email )

Sydney, NSW 2052
Australia

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