The long-term care problem, precautionary saving,

JournalofMacroeconomicsVolume29,Issue1,March2007,Pages60-74doi:10.1016/j.jmacro.2005.04.001|HowtoCiteorLinkUsingDOICopyright©2006ElsevierInc.Allrightsreserved.Permissions&ReprintsThelong-termcareproblem,precautionarysaving,andeconomicgrowthNoriyoshiHemmia,,,KenTabatabandKoichiFutagamicaFacultyofEconomics,HokkaiGakuenUniversity,4-1-40,Asahi-Machi,Toyohira-Ku,Sapporo062-8605,JapanbKobeCityUniversityofForeignStudies,Kobe,JapancFacultyofEconomics,OsakaUniversity,Osaka,JapanReceived10December2003;accepted26April2005.Availableonline22December2006.AbstractThispaperexaminestheinteractionbetweendecisionsaboutfinancingafter-retirementhealthshocksandprecautionarysavingmotives,andhowthisinteractionaffectseconomicdevelopment.Weshowthatatlowlevelsofincome,individualschoosenottosavetofinancethecostofafter-retirementhealthshocks.However,onceindividualsbecomesufficientlyrich,theydochoosetosavetofinancethecostoftheseshocks.Thischangeinindividualsavingbehaviormaygiverisetomultiplesteadystateequilibria.Keywords:After-retirementhealthshocks;Precautionarysavingmotives;MultiplesteadystateequilibriaJELclassificationcodes:E21;H24;O41ArticleOutline1.Introduction2.Individuals’decisionmaking2.1.Individuals’optimizationproblems2.2.DecisionsaboutpayingforARHS2.3.Thesavingproblem3.Equilibrium4.ConcludingremarksAcknowledgementsAppendix1.AppendixAppendix2.AppendixAppendix3.AppendixAppendix4.AppendixAppendix5.AppendixReferences1.IntroductionThecostoflong-termcarethreatensthefinancialhealthoftheelderly.1Forexample,intheUSA,evenwithMedicareandprivatehealthinsurance,theriskofacatastrophicmedicalexpenseislarge.Out-of-pocketmedicalexpensesfortheelderlyin1988wereestimatedtobe$2394perelderlypersonorroughly18%oftheiraveragepercapitaincome.Nearly10%ofelderlyhouseholdsspendafifthormoreoftheirincomesonout-of-pocketmedicalexpenses(Palumbo,1999)and2–3%incurmedicalexpensesexceeding40%oftheiradjustedgrossincomes(FeenbergandSkinner,1994).Nursinghomeexpensesarethemostsignificantlong-termcarecostsfortheelderly.AccordingtoPalumbo(1999),thelikelihoodofatypical65-year-oldpersonenteringanursinghomeduringhisorherlifetimeis43%.Onceadmitted,theaveragestayinalong-termcarefacilityexceedsoneyear.Becausenursinghomecostsarevirtuallyuninsured,admissiontoalong-termcarefacilitycanquicklydepleteone’sfinancialwealth.Therefore,after-retirementhealthuncertaintyshouldprovideyoungindividualswithstrongprecautionarymotivesforsaving.Despitethis,lessattentionhasbeenpaidtothisissueintheliteraturethantoprecautionarysavinginresponsetolifespanandearninguncertainty.Kotlikoff(1989)pointsoutthatthelackofresearchonthistopicmayreflectthedifficultyofpreciselyquantifyingtheeconomicriskofmorbidity.However,recentanalyseshavebeguntoinvestigatethisissuerigorouslyandtheyshowthatafter-retirementhealthuncertaintyhasastrongimpactonindividualconsumption–savingbehavior.Forexample,Palumbo(1999)estimatesthattheuncertaintyoffuturehealthexpensesaloneinducesatypicalfamilytospend,onaverage,7%less.Furthermore,Hubbardetal.,1994,Hubbardetal.,1995andPalumbo,1999showthattheprecautionarysavingmotivesarisingfromfuturehealthuncertaintyplaycrucialrolesinexplainingtheobservedpatternofindividualconsumption–savingbehavioroveralifecycle.Recently,Dynanetal.(2000)foundthathigher(lower)lifetimeincomehouseholdsarelikelytosavealarger(smaller)fractionoftheirincome.Thisimpliesthatthereexistsapositivecorrelationbetweenlifetimeincomeandsavingrate.Consideringtheobserveddifferencesinprecautionarysavingandbequestbehaviorbylifetimeincomegroups,Dynanetal.(2000)explainthisempiricalresultasfollows.Concerningprecautionarysavingbehavior,undertheasset-basedmeans-testedpublicsubsidyprogramssuchasMedicaidandSupplementedSecurityIncome,householdswithlowerlifetimeincomearelikelytoreducetheirsavingsforfuturehealthexpensessoastoqualifyforthesubsidyprogram(Hubbardetal.,1995).Ontheotherhand,householdswithhigher(lower)lifetimeincomespendmore(less)formedicaltreatmentinthecaseofcostlyillness(Newhouse,1977).2Thustheyarelikelytosavemore(less)forfuturehealthexpenses.Concerningbequestbehavior,householdswithhigher(lower)lifetimeincomearelikelytoleavelarger(smaller)financialbequeststosubsequentgenerations(BeckerandTomes,1986andMulligan,1997).Therefore,thecombinationoftheseprecautionarysavingandbequestbehaviorsmayexplaintheobservedpositivecorrelationbetweenlifetimeincomeandthesavingrate.CarollandSamwick,1998andGourinchasandParker,2001,andothersshowthatwealththatisheldforprecautionarysavingmotivesoccupiesalargerfractionoftotalwealthandaccountsforatleast50%oftotalwealth.Moreover,usingOECDdata,JitsuchonandSaito(1995)showthatcross-countrydifferencesinsavingandper-capitagrowthratesarecloselylinkedwiththedegreeofheterogenousuninsuredidiosyncraticshocks.Theseresultsimplythatdifferencesinindividualprecautionarysavingbehavioraccordingtolifetimeincomemayimpactsignificantlyuponthecapitalaccumulationprocessoftheeconomy.Therefore,itisimportanttoinvestigatetherelationshipsamongafter-retirementhealthshocks,individualchoiceofmedicaltreatment,andprecautionarymotivesforsavingi