Nathaniel Hendren says consumers can usually predict their future LTC use than insurers can. (AP Photo/New York City Opera, Carol Rosegg)

Long-term care insurance (LTCI) agents and insurance company executives know in their guts that the people who have a hard time qualifying for LTCI tend to be a high-risk group of consumers.

But an economist at Harvard University, Nathaniel Hendren, now has explored how undisclosed information about health problems and other risk factors affects the individual LTCI market in a formal academic working paper posted by the National Bureau of Economic Research.

Hendren also looks at how consumers’ hidden knowledge of risk factors — “private information” — affects the individual disability insurance market and the individual life insurance market.

In theory, people who end up getting individual LTCI or other individually underwritten insurance products could be hiding as much dirty laundry as rejected applicants.

In the real world, rejected applicants seem to have more private information that could affect the applicants’ need for LTCI, disability or life insurance benefits, Hendren says in the paper, which is based on a chapter from a thesis he wrote while at the Massachusetts Institute of Technology.

The rejected applicants appear to have so much private information that, even if insurers did try to sell the applicants coverage designed for high-risk buyers, the insurers “would be so heavily adversely selected that it wouldn’t deliver positive profits, at any price,” Hendren says.

For the applicants who do get coverage, the amount those applicants would have to pay to compensate insurers for private information seems to be close to zero, Hendren says.

For the rejectees, the “implicit tax” needed to compensate the insurers for the effects of private information seems to be 42% in the individual life market, 66% in the individual disability market, and 82% in the LTCI market, Hendren says.

Hendren also found evidence that even healthy individuals begin to accumulate private information at age 80.

In the introduction to the paper, Hendren notes that 4 large U.S. health insurers rejected about 1 in 7 of the applicants who applied for individual or family health coverage from 2007 to 2009, and that an LTCI carrier concluded in 1995 that about 12% to 23% of 65-year-olds already had health problems that would keep them from qualifying for commercial LTCI coverage.

Economists normally would expect to see insurers try to get the business of people with health problems by offering them coverage with prices set to adjust for a higher level of risk, Hendren says.

“Regulation does not generally prevent risk-adjusted pricing in these markets,” Hendren says. “So why not simply offer them a higher price?”

Hendren said private information has such a big effect that it kills off big parts of the life, disability and LTCI markets.

To help readers understand the term “private information,” Hendren gives the example of a woman who has had a stroke and is no longer able to qualify for private LTCI coverage.

She “may know not only her personal medical information (which is largely observable to an insurer), but also many specific factors and preferences that are derivatives of her health condition and affect her likelihood of entering a nursing home,” Hendren says. “These could be whether her kids will take care of her in her condition, her willingness to engage in physical therapy or other treatments that would prevent nursing home entry, or her desire to live independently with the condition as opposed to seek the aid of a nursing home. Such factors and preferences affect the cost of insuring nursing home expenses, but are often difficult for an insurance company to obtain and verify.”

To analyze the effects of private information, Hendren came up with mathematical descriptions of the conditions in which private information would keep any individual insurance sales from occurring, by creating situations such that the “willingness of an individual to pay for a small amount of insurance is less than the pooled cost of providing this insurance to those of equal or higher risk.”

“When this no-trade condition holds, an insurance company cannot offer any contract, or menu of contracts, because [the company] would attract an adversely selected subpopulation that would make them unprofitable,” Hendren says.

Hendren also came up with equations that describe the distribution of private information.

Hendren then used data from the University of Michigan’s well-known Health and Retirement Study survey series and data on applicants rejected by the major insurers, to see if and when “no-trade” conditions really occurred in real individual insurance markets.

Hendren also looked at how well the “public information” insurers did have about the applicants matched with actual rejection rates, and he came up with a statistical test to estimate how much better the likely rejectees would be at estimating their losses than the insurers would be. 

In the past, Hendren says, some researchers studied insurance underwriting and found little evidence of private information leading to adverse selection in the individual life or individual LTCI markets.

Hendren says he can do a better job of estimating the effects of adverse selection — and show that adverse selection would be a problem if insurers opened their arms to the rejectees — because his approach includes the rejectees as well as the applicants who end up with coverage.

An 82% “implicit tax” probably eliminates the LTCI market for the LTCI rejectees, because researchers have found that few consumers are willing to pay a markup of more than 60% for LTCI, Hendren says.