Long‐term care and myopia: Optimal linear subsidies for private insurance

Abstract

AbstractThis paper studies optimal linear policy directed at private long‐term care insurance in the context where individuals are myopic, that is, underestimate their dependency risk. Without government intervention, myopic individuals underinsure, while the first‐best optimum requires full insurance. To decentralize the first‐best, one needs personalized linear subsidies on private insurance premiums combined with personalized lump‐sum taxes to finance these subsidies and redistribute resources among individuals. In the second‐best setting where only uniform instruments can be used, the determination of the optimal insurance subsidy rate includes three main considerations: standard efficiency concern, correction for myopia, and redistributive concerns. While the correction for myopia pushes for a higher subsidy rate, the analysis of the redistributive concerns is far less straightforward. Overall, the redistributive concerns depend on three main factors: whether wealthier individuals are less myopic, how the probability of dependency varies with wealth and what is the type of absolute risk aversion exhibited by individual preferences.