How Does the Risk of Incurring Out-of-Pocket Medical Costs Affect the Value of Annuities?
This paper critically appraises the literature on the impact of the risk of incurring out-of-pocket health-care costs, primarily long-term care costs, on the value of annuitization and the optimal annuity share of financial wealth. A limitation of the literature is its focus on unmarried individuals. Care costs affect the finances of the surviving spouse and likely substantially increase the optimal annuity share for married couples because Medicaid spousal protection rules favor annuitized over unannuitized wealth. Models excluding housing wealth also understate the optimal annuitized share because housing wealth can be liquidated to pay for care costs, which reduces the need to retain liquid financial assets. Annuities providing enhanced benefits when in long-term care will likely appeal only to the upper-middle class; for lower-wealth households, much of the benefit of long-term care insurance accrues not to the policyholder but to the government in the form of lower Medicaid outlays.
Out-of-pocket health-care costs and long-term care (LTC) costs are two of the largest financial risks faced by middle-class older Americans. This paper reviews the literature on the impact of those costs on the value of annuitization and the optimal share of financial wealth to annuitize. The paper also reviews a related literature that quantifies the amounts households might theoretically be willing to pay for annuities that provide enhanced benefits while they are in care.