CLASS Long-Term Care Insurance and Adverse Selection

Last Friday, Health and Human Services Secretary Kathleen Sebelius announced the demise of a key component of the ObamaCare health care overhaul. The CLASS Act (short for Community Living Assistance Services and Support) was a form of long-term care insurance. It was designed to help cover the cost of continuing in-home care. Its intent was to keep seniors and others who are unable to attend to their own basic daily needs out of more expensive in-patient facilities. And, it was supposed to pay for itself with the premiums provided by voluntary enrollees.

The failure of CLASS can be attributed to a phenomenon the insurance industry calls adverse selection
the tendency of people with the highest risk to purchase insurance in greater amounts than people with a lower risk. Kind of like somebody waiting till the dam breaks before buying flood insurance.

Ideally, in a free-market system, healthy people would purchase long-term care insurance in their younger, more productive years as a hedge against future need. As with any other kind of insurance, the larger the pool of people paying in, the more the insurer could spread its risk. Over time, the insurer would invest premiums and amass sufficient capital to pay benefits to plan subscribers. As with life insurance, the incentive would be to buy into the pool when you’re young and healthy for more affordable premiums. Wait till you were older or ailing, and you’d pay considerably more.

But CLASS was not a free-market insurance program. It was run by the federal government, with all the problems inherent in that sort of proposition. First of all, there was a rigid, absolute minimum benefit of $50 a day, but absolutely no aggregate or lifetime benefit limit. Benefits would be payable ad infinitum for “as long as an individual remains eligible.” Just about anyone making $1,200 a year could enroll but, because it was structured to be entirely self-financed, the initial premiums were quite high – estimated to range from $235 to $391 a month. Since enrollment was voluntary, CLASS didn’t attract many young, healthy people willing to fork over that kind of premium, which actually exceeded what was available for long-term care coverage in the private market. Their absence in the pool pretty much ensured that premiums would go even higher – so high that nobody could afford it, least of all the older or ailing folks who needed it NOW. In fact, according to an HHS report, CLASS would have had to charge $3,000 a month to be self-sustaining.

Unless everyone was required to purchase CLASS insurance, the program was doomed from the start to collapse quickly without significant infusions of tax-payer subsidy. Sensing that the American public isn’t in much of a mood for another mandate or another tax-payer bailout right now, Secretary Sebelius wisely pulled the plug on CLASS.


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