CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

APRIL 2004

Financing

Long-Term Care

for the Elderly

CBO

© Royalty-free/Corbis

The Congress of the United States O Congressional Budget Office

CBO

Financing Long-Term Care

for the Elderly

April 2004

A

PAPER
Notes

Numbers in the text and tables of this report may not add up to totals because of rounding.

All years are calendar years unless otherwise noted.
Preface

Over the next several decades, the population of U.S. seniors—people aged 65 and 

older—is expected to grow rapidly, more than doubling by 2040 while the population as a 

whole grows by about one-third. That surge will probably produce a similar increase in the 

demand for long-term care (LTC) services—the personal assistance that enables people who 

are impaired to perform daily routines such as eating, bathing, and dressing. Today, seniors 

finance such services from a variety of sources, including personal savings, care donated by 

friends and family, private insurance, and public programs such as Medicaid and Medicare. 

This Congressional Budget Office (CBO) paper—prepared at the request of the House Budget Committee—summarizes the current state of financing for long-term care, identifies some 

of the issues affecting it both now and in the future, and considers policy alternatives that 

address the mix of private and governmental sources of financing for LTC costs. In keeping 

with CBO’s mandate to provide objective, impartial analysis, this report contains no recommendations.

Stuart Hagen of CBO’s Health and Human Resources Division prepared the paper under the 

supervision of Steve Lieberman and James Baumgardner. The paper benefited from comments 

by Brenda Spillman and Joshua M. Wiener of the Urban Institute, Harriet Komisar of Georgetown University, and Jeffrey R. Brown of the University of Illinois at Urbana-Champaign. 

Leah Mazade edited the paper, and Christine Bogusz proofread it. Maureen Costantino prepared the paper for publication and designed the cover, and Annette Kalicki produced the 

electronic versions for CBO’s Web site (www.cbo.gov).

Douglas Holtz-Eakin

Director

April 2004

Summary ix

1 The Current Context of Long-Term Care Financing 1

Personal Resources 2

Public Long-Term Care 

Insurance Programs 5

The Income Standard 6

The Asset Standard 7

Income and Asset Rules for

Married Couples 7

2 Major Issues in the Financing of Long-Term Care 13

Demographic Trends

Affecting the Demand for

Long-Term Care Insurance 13

Factors Affecting the Demand for

Private Insurance 16

3 Policy Approaches to Long-Term Care Financing 23

Restrict Growth in Long-Term Care Spending by

Medicaid and Medicare 23

Improve the Functioning of the Market for Private 

Long-Term Care Insurance 27

CONTENTS
vi FINANCING LONG-TERM CARE FOR THE ELDERLY

A An Overview of Long-Term Care Services 33

B Recent Policy Initiatives Affecting

Long-Term Care Financing 37
CONTENTS vii

Tables

S-1. Primary Financing Sources for Care of Elderly Nursing 

Home Residents, 1997 xi

1-1. Impaired Elderly People, by Level of Impairment

and Sources of Assistance, 1994 4

1-2. Long-Term Care Expenditures for the Elderly, by 

Source of Payment, 2004 5

1-3. Average Annual Premiums for Private Long-Term

Care Insurance, 2002 8

2-1. Probability of Nursing Home Use by Elderly People 

Over Their Remaining Lifetime 15

3-1. Average Annual Premiums for Policies of the Partnership for

Long-Term Care, 2004 30

A-1. Elderly Nursing Home Residents, by Age and Sex, 1997 34

A-2. Average Length of Stay of Current Elderly Nursing Home

Residents, by Age and Sex, 1997 34

A-3. Average Length of Stay of Discharged Elderly Nursing

Home Residents, October 1996 to September 1997 35

A-4. Average Duration of Care of Elderly Home Health Care

Patients, 1996 35

A-5. Elderly Home Health Care Patients, by Age and Sex, 1996 36

Figures

S-1 Estimated Percentage Shares of Spending on Long-Term Care

for the Elderly, 2004 x

S-2 Percentage of Households with Seniors, by Seniors’ Nonhousing

Net Worth, 2000 xii

1-1. Estimated Percentage Shares of Spending on Long-Term Care

for the Elderly, 2004 3

1-2. Long-Term Care Insurance Policies Sold, 1988 to 2001 5

1-3. Average Medicaid Payments for Long-Term Care, Selected States,

Fiscal Year 2000 9

1-4. Medicaid’s Expenditures on Long-Term Care for Elderly 

Beneficiaries, Fiscal Years 1992 to 2004 10

1-5. Medicare’s Expenditures on Long-Term Care for Elderly 

Beneficiaries, Fiscal Years 1992 to 2004 11
viii FINANCING LONG-TERM CARE FOR THE ELDERLY

1-6. Average Medicare Payments for Long-Term Care, Selected States,

Fiscal Year 2001 12

2-1. People Aged 65 and Older as a Share of the U.S. Population,

Selected Years, 1900 to 2050 14

2-2. CBO’s Projections of Impaired Seniors as a Share of the 

Elderly Population, 2000 to 2040 15

2-3. Average Family Size, 1940 to 2040 18

Boxes

1-1. Activities of Daily Living and Instrumental Activities of Daily Living 2

1-2. Financial Eligibility Requirements for Medicaid Coverage 6

2-1. Long-Term Care Expenditures for Nonelderly People 16

3-1. Expanding Public Programs That Finance Long-Term Care 24

3-2. Comparing the Financial Impacts of a Partnership Policy

and Other Insurance Options 28
Summary

Preparing for the possible costs of future impairment 

and long-term care is a task that everyone faces as they 

age. The probability of losses in physical functioning increases with age—dramatically so for the population aged 

65 and older. About 19 percent of seniors experience 

some degree of chronic physical impairment. Among the 

very old, those aged 85 or older, the proportion of people 

who are impaired and require long-term care (LTC)—the 

personal assistance that enables impaired people to perform daily routines such as eating, bathing, and dressing—is about 55 percent.

Losses in a person’s ability to function day to day is a natural part of the aging process, and those losses become 

more severe as people get older. Impaired people who 

need long-term care usually need it for a long time—in 

some cases, until they die. But people may also use the 

same kinds of services constituting long-term care for relatively short periods, such as during their convalescence 

from a hospitalization or from an injury or illness. That 

characteristic of LTC services tends to complicate an understanding of the issues related to LTC financing. For 

example, health insurers cover certain long-term care services, such as home health care, to aid beneficiaries in recovering from specific medical events. But they generally 

do not cover LTC services that are needed because of either nonspecific causes related to old age or as a result of 

chronic, or “long-term,” impairment.

Currently, elderly people finance LTC services from a variety of sources including private resources—personal savings, care donated by friends and family, and LTC insurance—and with assistance from public programs such as 

Medicaid and Medicare. Incentives inherent in that financing structure have led to increased reliance on—and 

spending by—those public programs and may have discouraged seniors and younger Americans from purchasing LTC insurance to pay for their care. In recent years, 

lawmakers have implemented various policies (for example, tax-advantaged treatment of the premiums for LTC 

insurance) to help people pay for their long-term care; 

they have also instituted incremental reforms of public 

LTC financing programs to control costs and improve the 

programs’ effectiveness. But the demographic changes 

projected for the coming decades—in particular, the 

growing shares of the population accounted for by seniors 

and the very old as well as alterations in the structure of 

families—raise doubts about whether the current distribution of LTC financing and the incentives those financing sources include can support increased demand for 

long-term care without heightening budgetary strains.

The Current Context of Long-Term 

Care Financing

A person preparing for possible future long-term care 

needs has several options from which to choose. One alternative is to “self-insure” by setting aside personal savings and assets and then supplementing those personal resources with the donated, or free, care of family and 

friends. In fact, the majority of impaired seniors rely 

solely on donated care and their own savings. The value 

of donated care probably exceeds that of any other category of LTC financing but is difficult to quantify in dollar terms. In 2004, out-of-pocket spending (excluding 

donated care) is expected to account for about one-third 

of total estimated LTC expenditures (see Summary Figure 

1). The Congressional Budget Office (CBO) estimates 

that total expenditures for LTC services for the elderly in 

2004—excluding the value of donated care—will total 

about $135 billion, or roughly $15,000 per impaired

senior. 

An individual who self-insures retains maximum flexibility and control over his or her savings and assets but must 

bear the full financial risk of impairment, which will depend on the extent and duration of functional losses. Sig-
x FINANCING LONG-TERM CARE FOR THE ELDERLY

Summary Figure 1.

Estimated Percentage Shares of Spending on Long-Term Care for the Elderly, 2004

Source: Congressional Budget Office.

a. Values are calculated on the basis of how much such care would cost if it were provided through formal means. Estimates are from 

Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, Administration on Aging, Informal Caregiving: Compassion in Action (June 1998), inflated to 2004 dollars.

nificant impairment can leave little, if any, wealth for bequests or other uses. Nursing home care in 2003, for example, cost an average of $181 per day for a private room 

(or about $66,000 annually); a visit by a home health 

aide averaged $18 per hour.

Seniors in general are not well prepared to pay for their 

long-term care needs. In 2000, for instance, only about 7 

percent of seniors had income in excess of $50,000 

(about the cost then of a year’s stay in a nursing home).1

In 1997, more than half of nursing home residents were 

poor enough to qualify for Medicaid coverage (see Summary Table 1). Apart from their housing wealth, most seniors have only a modest amount of savings (see Summary Figure 2).

Given the financial consequences of impairment, some 

people may prefer to pay a certain, smaller amount rather 

than bear the risk of a potentially large financial loss, and 

they can do so by purchasing private long-term care insurance. Purchasing insurance allows people to share the 

risk of needing long-term care with other people who 

have a similar “risk profile” (a generally similar likelihood 

of requiring care). In 2004, spending from private LTC 

insurance, which is a relatively new insurance product, is 

expected to account for about $6 billion, or 4 percent, of 

total LTC expenditures. That share could grow in the future as more people purchase private coverage and current 

policyholders become impaired and draw on their benefits.

Underlying the set of decisions a person makes in preparing financially for future long-term care needs is the availability of publicly funded programs for long-term care, 

primarily Medicare and Medicaid. In 2004, the portion 

of total LTC expenditures attributable to those two programs together is likely to reach nearly 60 percent. Medicare does not cover long-term care per se but has become 

a de facto LTC financier through its coverage of care in 

skilled nursing facilities (following hospitalization) and 

its home health care benefit. Medicaid is the dominant

 Medicaid

 (35%)

Medicare

 (25%)

 Private

 Insurance

 (4%)

 Out-of-

 Pocket

Payments

 (33%)

 Other

 (3%)

 Medicaid

 (22%)

Medicare

 (16%)

 Private

 Insurance

 Out-of-Pocket (3%)

 Payments

 (21%)

 Other

 (2%)

Informal

 Care

 (36%)

Without Informal Care With Informal Care a

1. CBO’s calculations were based on U.S. income tax data for 2000. 

See also CBO’s publication Baby Boomers’ Retirement Prospects: An 

Overview (November 2003).
SUMMARY xi

Summary Table 1.

Primary Financing Sources for Care of 

Elderly Nursing Home Residents, 1997

Source: Congressional Budget Office based on Celia S. Gabrel, 

Characteristics of Elderly Nursing Home Current Residents and Discharges: Data from the 1997 National Nursing Home Survey, Advance Data no. 312 (Centers for 

Disease Control and Prevention, National Center for 

Health Statistics, April 25, 2000).

a. Residents’ financing as of one month before being interviewed.

public insurance program for long-term care. Not only 

does it cover the care of people with very low income, but 

its eligibility rules permit middle-income people—even 

seniors whose income in retirement leaves them fairly 

comfortable—to qualify for coverage by exhausting, or 

“spending down,” their income and assets. Thus, people 

who fail to make their own preparations for long-term 

care needs can eventually qualify for Medicaid if they become impaired.

Major Issues in the Financing of

Long-Term Care

Future demographic changes are likely to result in increased demand for long-term care, placing growing fiscal 

pressure on the public programs that pay for much of it 

today. Those changes may also indirectly affect informal 

care by reducing the number of people who might provide LTC services. In addition, the current financing 

structure creates incentives that discourage people from 

preparing to finance their own care, encouraging them to 

rely instead on public LTC insurance.

Demographic Factors Affecting the Demand for 

Long-Term Care Insurance

As the aging of the baby-boom generation causes seniors’ 

share of the population to rise from 12.6 percent in 2000 

to 20.5 percent in 2040, the demand for long-term care 

services is virtually certain to increase. Part of the basis for 

that expectation is that the share of people aged 85 and 

older—those with the greatest probability of using longterm care—is projected to grow from 1.6 percent in 2000 

to 3.8 percent in 2040. The population’s aging will also 

cause a decline in the share of the population who are of 

working age—and who pay the bulk of the taxes that 

support public programs for the elderly. In 2000, the ratio of people of working age to people of retirement age 

was 4.7. In 2040, that ratio is forecast to fall to 2.6.

Other projected demographic changes may also influence 

aspects of private LTC financing. Life expectancy is continuing to rise, which implies that people may require 

long-term care for longer periods. Also, families are expected to be smaller in 2040 than they are today, and if 

current trends continue, a greater proportion of women 

may be in the labor force. That change could make informal care less available (women provide the majority of 

such care) and thus place additional pressure on public 

and other private sources of LTC services.

Factors Affecting the Demand for Private 

Long-Term Care Insurance

Several factors may be contributing to the relatively modest share of LTC financing provided by private insurance. 

The availability of Medicaid is a significant element; 

other factors include the inability to insure against certain 

risks associated with long-term care and potential adverse 

selection in the LTC insurance market.

The availability of Medicaid benefits for long-term care 

skews people’s decisions about purchasing private coverage. Many people who believe that they could meet the 

financial qualifications for Medicaid may view it as a substitute for private insurance. The public coverage that 

Medicaid provides is not a perfect substitute; for example, 

it does not protect a person’s wealth (people are generally 

obliged to exhaust their own resources before becoming 

eligible for coverage) and may not be able to provide the 

same quality of care and array of choices that would be 

available to someone with private LTC insurance. But 

many people may prefer to accept those drawbacks rather 

than pay premiums for private insurance.

Medicaid’s free coverage may also deter people from purchasing private insurance even if they do want to protect 

their assets or secure higher-quality care than they could 

receive through Medicaid. Medicaid is a means-tested 

program; people who set aside savings or obtain private 

insurance cannot qualify for benefits for as long as their

Payment Sourcea

Medicaid 56.1

Medicare 15.1

Other Government Assistance

and Charity 2.0

Private Insurance

and Other Personal Sources 26.0

Unknown 0.9

As a Percentage of 

All Residents
xii FINANCING LONG-TERM CARE FOR THE ELDERLY

Summary Figure 2.

Percentage of Households with Seniors, by Seniors’ Nonhousing Net Worth, 2000

(Percent)

Source: Congressional Budget Office based on the Census Bureau’s 1996 Survey of Income and Program Participation (updated to 2000 dollars). 

private resources last. The more people save or the more 

insurance they purchase, the less likely they are ever to 

qualify for Medicaid benefits. Thus, people who buy insurance pay more than just the premiums; they also give 

up the value of future Medicaid benefits for which they 

might have been eligible.

People may find private LTC insurance unattractive because it does not protect them against certain kinds of 

risks pertinent to long-term care. Most important, a typical policy does not guarantee that policyholders’ benefits 

will be large enough to allow them to purchase the services they desire if they need care at some point in the future. Insurers cannot accurately forecast LTC costs 20 or 

30 years from now. Consumers can obtain a degree of 

protection from inflation in medical costs by purchasing 

coverage that increases annually at a specified rate—typically 5 percent. But there is no insurance against the additional risk that prices might grow at a faster pace. Another risk that insurance cannot protect consumers from 

is the possibility that the insurance carrier itself will not 

be in business in the future, when the benefits may be 

needed. (The states afford some protection against that 

risk by requiring insurance carriers to meet certain financial criteria intended, in part, to reduce the risk of future 

insolvency.) In both those respects, Medicaid may compare favorably with private insurance: it pays for a defined 

set of LTC services instead of providing a monetary benefit and, in spite of future budgetary pressures, many people may perceive the risk of its not providing services 

many years into the future as less than that of private insurance. A drawback to Medicaid coverage, however, is 

that its benefits could be reduced if budgets are strained.

Finally, the consequences of adverse selection may also 

discourage people from purchasing private insurance. 

Many people who buy private LTC policies in today’s 

market do so because they expect to use LTC insurance 

someday, and policies’ premiums might reflect that probability. If premiums are higher because of adverse selection, they could dissuade individuals who expect to have 

relatively good health in the future from purchasing coverage, even though those individuals may wish to do so.

 Zero to

$49,999

$50,000 to

 $99,999

$100,000 to

 $249,999

$250,000 to

 $499,999

$500,000 to

 $999,999

$1 million

 or more

0

5

10

15

20

25

30

35

40
SUMMARY xiii

Policy Approaches to Long-Term Care 

Financing

Policy approaches are available that could address the 

structure of LTC financing in the face of expected demographic trends and alter incentives that negatively affect 

the market for private LTC insurance. Alternatives include restricting growth in spending for long-term care 

by federal programs and improving the functioning of the 

market for private insurance. Although those policies 

would affect the future distribution of expenditures for 

long-term care, including federal spending, they are not 

likely to significantly affect the total resources, both private and public, that are devoted to LTC services. Some 

modest savings in total expenditures might be achieved 

by improving the efficiency with which services are provided, and many such efforts have been made in publicsector programs. Those efficiencies, however, are likely to 

be overshadowed by future demographic changes.2

Restrict Growth in Long-Term Care Spending

by Medicaid and Medicare

Growth in future LTC expenditures by the major federal 

health financing programs could be constrained by placing additional limits on eligibility for Medicaid coverage 

and restricting the services covered under Medicare’s 

home health care benefit. Restricting growth in those 

programs’ LTC expenditures would address both the fiscal strain on government budgets brought about by the 

population’s aging and the low levels of participation in 

the private LTC insurance market. As people’s expectations about federal assistance changed, they might purchase private LTC insurance or set aside additional savings to prepare for the possibility of future long-term care 

needs. The adjustments in the program’s benefits could 

be phased in over an extended period to allow people 

time to appropriately adjust their long-range financial 

plans.

Restricting growth in Medicaid and Medicare spending 

would shift some costs from the public to the private sector, although such constraints would probably not have 

more than a marginal effect on total spending for LTCservices. If people either had to wait longer to qualify for 

Medicaid than they would under current law or could 

not get coverage from either Medicaid or Medicare for 

the cost of their care, they would probably monitor the 

cost of their services more closely and limit the number 

and kinds that they purchased. Reducing the amount of 

public assistance might also shift some of the cost of care 

to LTC providers, primarily nursing homes, in the form 

of charity care and bad-debt expense, and perhaps to 

friends and relatives, who would either have to pay for 

the care themselves or provide it informally.

Improve the Functioning of the Market for

Private Long-Term Care Insurance

Improving the private market’s functioning could offer 

better alternatives for financing possible long-term care 

needs as people prepared for old age. Private insurance 

could be made more attractive to consumers by standardizing insurance policies to allow competing policies to be 

more easily compared and by taking steps to remove or 

lessen what is sometimes termed Medicaid crowd-out—

the dampening effect that the availability of Medicaid’s 

LTC benefits has on sales of private LTC insurance policies.

State insurance regulations do not require insurance carriers to offer policies that conform to particular design 

standards, except to the extent that the policies must 

comply with certain consumer protection requirements. 

Moreover, insurance companies offer a variety of policies 

with differing features so that consumers frequently find 

it difficult to compare the premiums of one carrier with 

those of any other. On the one hand, requiring carriers to 

offer policies that met a set of standard designs to enable 

consumers to compare them could stimulate price competition among insurers and help keep premiums lower 

than they would otherwise be. On the other hand, imposing standard policy designs on the private LTC insurance market could backfire if it hampered carriers’ flexibility in adapting to changes both in the provision of 

long-term care and in the varying preferences of consumers who are considering buying coverage.

One method for reducing Medicaid’s impact on sales of 

private LTC insurance would be to allow consumers to 

purchase a policy that supplemented Medicaid coverage 

and thus obtain the advantages of both private and public 

financing. The Partnership for Long-Term Care, which 

currently operates in four states does just that. In those 

states, consumers may purchase private insurance policies 

2. Specific initiatives aimed at improving the efficiency of LTC services financed through federal programs are not a major focus of 

this paper, although they are described in Appendix B.
xiv FINANCING LONG-TERM CARE FOR THE ELDERLY

to cover the first one to three years of LTC benefits. 

When their private coverage expires, they apply for Medicaid coverage—just as they would have if they had had 

no coverage—but they do not have to spend down their 

assets except to the extent that the assets exceed the value 

of their LTC insurance benefits.

Supplemental coverage would enable purchasers to improve the quality of their LTC coverage without having to 

surrender their Medicaid benefits. However, private insurance that supplemented Medicaid coverage would not 

be likely to reduce the federal government’s expenditures 

and might instead increase them.
1

The Current Context of Long-Term Care Financing

With the aging of the baby-boom generation, 

the United States’ elderly population is expected to grow 

rapidly over the next several decades, more than doubling 

by 2040 while the population as a whole grows by about 

one-third. As people age, the likelihood increases—dramatically so for people aged 65 and older—that their 

ability to carry out certain basic physical functions will 

become impaired. (Impairment is measured on the basis 

of such activities; see Box 1-1.) The surge in the population of seniors is thus expected to increase the number of 

impaired people and in turn the demand for long-term 

care (LTC) services. Long-term care is the personal assistance that enables impaired people to perform daily routines such as eating, bathing, and dressing. Such services 

may be provided at home by family and friends, through 

home and community-based services such as home health 

care, personal care, and adult day care; or in institutional 

settings, such as nursing or residential care facilities (see 

Appendix A for more details).

The need for long-term care is already substantial, even 

without the coming demographic wave of elderly people. 

(Nonelderly people may also require such services; however, this report focuses on LTC services for seniors.) 

About 19 percent of seniors experience some degree of 

chronic physical impairment. Among the very old, those 

aged 85 or older, the proportion of people who are impaired is 55 percent.

Expenditures for LTC services are substantial as well: the 

Congressional Budget Office (CBO) estimates that 

spending on long-term care for the elderly in 2004 will 

total about $135 billion—or approximately $15,000 per 

impaired senior. Those funds come from two broad 

sources of financing: personal resources (consisting of 

out-of-pocket spending and private LTC insurance) and 

government programs—primarily Medicare and Medicaid.1 Another significant source of financing is donated, 

or informal, care—significant, because most impaired seniors rely solely on services donated by family and friends 

and not on purchased services. If only services in which 

dollars change hands are taken into account, Medicaid 

and Medicare together are responsible for the majority of 

LTC expenditures (see Figure 1-1). If the total includes 

the dollar value of donated care, then personal resources 

are the main source of seniors’ LTC financing.

That financing framework will experience pressures in 

coming years not only as a result of the rising number of 

impaired seniors but also because of other demographic 

trends—such as declining numbers of informal caregivers 

willing to donate their services. The current mix of LTC 

financing—and in particular the rules governing public 

programs—include incentives that both discourage people from making their own financial preparations for 

long-term care and encourage them to rely on that public 

LTC coverage. If left unchanged, those incentives will 

bring even more fiscal pressure to bear at a time when 

government programs for retirees are already facing potentially overwhelming forces.

This Congressional Budget Office paper summarizes the 

current sources of financing for long-term care and identifies some of the issues that arise under the current financing structure, in particular the factors that discourage people from securing private LTC insurance coverage. 

It also considers policy alternatives that address the mix 

CHAPTER

1. For a brief review of the history of federal policy for financing 

long-term care, see Richard Price, Carol O’Shaughnessy, and Bob 

Lyke, Long-Term Care for the Elderly: Themes of Financing Reform,

CRS Report for Congress RL30062 (Congressional Research Service, January 15, 1999), pp. 4-6.
2 FINANCING LONG-TERM CARE FOR THE ELDERLY

of private and governmental sources of financing for LTC 

costs.

Personal Resources

Most long-term care is provided through the personal resources of the impaired person who receives it. Many elderly people receive long-term care without exchanging 

formal payment for those services—that is, through care 

donated by family and friends. They also pay for a substantial amount of care out of pocket—such spending accounts for about one-third of total LTC payments.2 Private insurance accounts for a very small share of spending 

today, but with the growing number of policies being 

purchased, that source of financing is likely to account 

for a larger proportion of expenditures in the future. 

Informal Care

Most functionally impaired seniors who reside in the 

community, including those who are severely impaired 

(unable to perform at least four activities of daily living, 

or ADLs), rely entirely on donated care from friends and 

family (see Table 1-1). And even many people who do 

pay for care in their home rely on some informal services 

as well. Donated care is most common among lowerincome groups and among seniors who live close to people willing to provide it, such as family members.

As mentioned earlier, the economic value of informal care 

is significant, although—as the following ranges imply—

estimates of it are highly uncertain. In 1998, the Department of Health and Human Services estimated that replacing donated LTC services for seniors with professional care would cost between $50 billion and $103 

billion.3

 Another recent analysis estimated the value of 

informal care for impaired people of all ages in 1997—

measuring it as the forgone wages of caregivers—at 

Box 1-1.

Activities of Daily Living and Instrumental Activities of Daily Living

The activities of daily living (ADLs) and the instrumental activities of daily living (IADLs) describe a 

broad array of physical functions that is used to determine whether a person can live without assistance. 

ADLs represent basic physical abilities—eating, getting in and out of bed, getting around inside the 

home, dressing, bathing, and using the toilet. IADLs 

represent functions necessary for living independently; they include doing heavy housework and 

laundry, preparing meals, shopping for groceries, 

getting around outside, getting to places that require 

either driving or taking public transportation, managing money, using the telephone, and taking medications.

State Medicaid programs, private long-term care insurers, and other programs that provide long-term 

care benefits typically use ADLs and IADLs to define 

losses in ability that may qualify an enrollee or policyholder for benefits. Usually, if people are unable to 

perform three or more ADLs, they qualify for benefits. Losses in the abilities measured by IADLs are 

part of the general clinical picture of whether people 

can function on their own but by themselves are not 

used to trigger benefits. IADLs indirectly measure 

cognition; however, they are not generally used to 

gauge cognitive impairment. Instead, insurers commonly pay benefits when an individual’s cognitive 

impairment is so severe that supervision is required 

to protect the person’s health and safety.

2. By comparison, out-of-pocket spending for acute, or general, 

health care for the elderly—such as hospital care and physicians’ 

visits—makes up a much smaller share of those total costs (about 

13 percent). For more information, see Joel W. Cohen and others, 

Health Care Expenses in the United States, 1996, Research Findings 

12, AHRQ Pub. No. 01-0009 (Rockville, Md.: Agency for 

Healthcare Research and Quality, 2000). The data on which that 

publication draws are for the civilian noninstitutionalized population only and exclude dental expenses.

3. Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, Administration on 

Aging, Informal Caregiving: Compassion in Action (June 1998). 

CBO has updated the department’s figures to 2004 dollars.
CHAPTER ONE THE CURRENT CONTEXT OF LONG-TERM CARE FINANCING 3

Figure 1-1.

Estimated Percentage Shares of Spending on Long-Term Care for the Elderly, 2004

Source: Congressional Budget Office.

a. Values are calculated on the basis of how much such care would cost if it were provided through formal means. Estimates are from 

Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, Administration on Aging, Informal Caregiving: Compassion in Action (June 1998), inflated to 2004 dollars.

$196 billion.4 Those forgone wages are the “opportunity 

cost” of informal care—the value of the caregivers’ time 

that could have been used for other activities, such as 

working more, doing household chores, or enjoying leisure activities.

Out-of-Pocket Spending

Out-of-pocket spending in 2004 will account for about 

one-third of total LTC expenditures, CBO estimates, or 

roughly $5,000 per impaired senior. The federal government reduces the cost of some long-term care through the 

tax code’s advantageous treatment of certain LTC expenses. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) allows a taxpayer (or his or 

her dependent) who incurs such expenses and has a specified degree of physical or cognitive impairment to deduct 

them from taxable income along with other medical and 

dental costs. Qualifying expenses include expenditures 

for nursing home care; home-based care; medical equipment and supplies, such as oxygen; and alterations to a 

home, such as grab bars in the bathroom. (However, only 

the portion of the alterations that does not add to the 

market value of the home is eligible for the deduction.)

Private Long-Term Care Insurance

Private insurance for long-term care is a relatively recent 

development and pays for only a small amount of care at 

present. Few elderly people currently maintain privatecoverage.5 However, that source of financing is growing—although the precise extent of the growth is difficult 

to measure accurately. The data on private LTC insurance 

generally capture payments that insurers make directly to 

providers but do not always pick up insurers’ reimburse-

 Medicaid

 (35%)

Medicare

 (25%)

 Private

 Insurance

 (4%)

 Out-of-

 Pocket

Payments

 (33%)

 Other

 (3%)

 Medicaid

 (22%)

Medicare

 (16%)

 Private

 Insurance

 Out-of-Pocket (3%)

 Payments

 (21%)

 Other

 (2%)

Informal

 Care

 (36%)

Without Informal Care With Informal Care a

4. Peter S. Arno, Carol Levine, and Margaret M. Memmott, “The 

Economic Value of Informal Caregiving,” Health Affairs, vol. 18, 

no. 2 (1999), pp. 182-188.

5. In 2001, William J. Scanlon, Director of Health Care Issues for 

the General Accounting Office, noted that less than 10 percent of 

seniors had such coverage. For more details, see his statement 

before the Senate Committee on Finance, published as General 

Accounting Office, Long-Term Care: Baby Boom Generation 

Increases Challenge of Financing Needed Services, GAO-01-563T 

(March 27, 2001), p. 12.
4 FINANCING LONG-TERM CARE FOR THE ELDERLY

Table 1-1.

Impaired Elderly People, by Level of Impairment

and Sources of Assistance, 1994

Source: Congressional Budget Office based on K. Liu, K.G. Manton, and C. Aragon, “Changes in Home Care Use by Disabled Elderly Persons: 

1982-1994,” Journal of Gerontology, vol. 55B, no. 4 (2000), pp. S245-S253.

Note: The instrumental activities of daily living (IADLs) and the activities of daily living (ADLs) describe a broad array of physical functions 

used to determine whether a person can live without assistance. ADLs represent basic physical abilities—eating, getting in and out of 

bed, getting around inside the home, dressing, bathing, and using the toilet. IADLs represent functions necessary for living independently—for example, preparing meals, shopping for groceries, and getting around outside.

ments to policyholders for covered services that policyholders initially pay for out of pocket. Thus, estimates of 

LTC insurance payments—and of out-of-pocket spending—should be interpreted with caution because the 

former may be underestimated and the latter overestimated.

In 1995, private insurance paid about $700 million for 

LTC services for seniors, or 0.8 percent of all such expenditures. In 2004, such spending will be about $6 billion, 

CBO estimates, or about 4 percent of total expenditures 

(see Table 1-2). The number of policies written yearly increased from about 300,000 in 1988 to more than 

700,000 in 2001. According to America’s Health Insurance Plans (formerly the Health Insurance Association of 

America), about 8.3 million policies were sold from 1987 

through 2001; about 70 percent of them are still in force 

(see Figure 1-2).

Benefits. A typical LTC insurance policy pays the cost of 

nursing home care and home and community-based care 

but specifies a maximum daily benefit (such as $100 or 

$150) and may impose other limits. Policies with socalled inflation protection increase the dollar value of 

their benefits by a contractually specified percentage each 

year, usually 5 percent. Although some policies offer coverage for an unlimited period, most commonly cover services for a shorter time, such as four years, or until benefit 

payments for a policyholder reach a preestablished maximum lifetime amount. Policyholders typically become eligible to collect benefits when they reach a specific minimum level of impairment, usually defined as being 

unable to perform two or three ADLs or being cognitively impaired to a degree that warrants substantial supervision (see Box 1-1 on page 2).

Premiums. Premiums for LTC insurance reflect the cost 

of services and the risk that a policyholder will require 

long-term care as he or she ages. In 2002, the average annual premium for a typical policy was $2,014 if the policy was purchased at age 65; the premium more than 

doubled if the policy was purchased at age 75 (see Table 

1-3 on page 8). The lower premiums offered to younger 

people reflect the lower risk of their requiring LTC services at younger ages and the expectation that younger 

policyholders will pay premiums over a longer period 

than will people who purchase coverage when they are 

older. Thus, the average annual premium for the same 

policy purchased by a 30-year-old would be only $622 

and for a 50-year-old, $925.

In fact, fixed premiums are a key feature of LTC insurance policies—that is, the premiums do not increase as 

the policyholder grows older or as his or her health deteri1,488 9.5 78.3 12.2

1,114 10.7 64.9 24.4

745 7.3 62.8 30.0

443 5.4 57.4 37.2

434 2.6 51.1 46.2

512 3.3 41.4 55.3 

Total 4,737 7.8 64.3 28.0

Three ADLs

Four ADLs

Five ADLs

Impairment Level

IADL Only

One ADL

Two ADLs

Number of Impaired 

People (Thousands)

Percentage of Impaired People with

Both Paid and 

Informal Helpers

Informal 

Paid Helpers Only Helpers Only
CHAPTER ONE THE CURRENT CONTEXT OF LONG-TERM CARE FINANCING 5

Table 1-2.

Long-Term Care Expenditures for the 

Elderly, by Source of Payment, 2004

(Billions of dollars)

Source: Congressional Budget Office.

orates, even though the risk of requiring services rises. Instead, insurers calculate premiums to ensure that the premiums’ total, paid over the life of a policy, plus the interest that accrues from investing them will be sufficient to 

cover both the claims of the policyholder and an insurer’s 

profit and overhead costs. However, insurers reserve the 

right to increase premiums for a specific group, or rating 

class, of policyholders—such as all policyholders in a 

state—if new data indicate that expected claims will exceed the class’s accumulated premiums and their associated investment returns. 

Some premiums for private LTC insurance are taxdeductible; any policy purchased before HIPAA was enacted qualifies for such a deduction, but policies purchased afterward must conform to the law’s requirements 

for their premiums to be tax-deductible. The tax benefit 

is limited to people who itemize their deductions and 

whose total medical and dental expenditures exceed 7.5 

percent of their adjusted gross income. The President in 

his 2005 budget has proposed creating an “above-theline” tax deduction (the amount is deducted from gross 

income) for qualified LTC insurance premiums.

Public Long-Term Care 

Insurance Programs

Medicaid is the biggest public source of payment for 

long-term care, covering costs for services provided to 

beneficiaries who are institutionalized as well as those 

who remain in the community. Medicare covers care provided in skilled nursing facilities (SNFs) and at home; its 

benefits are designed primarily to help beneficiaries recover from acute episodes of illness rather than to provide 

care for long-term impairment. The stays in nursing facilities that Medicare covers are only for skilled care, not the 

more custodial nursing home care typically covered by 

Medicaid, and stays in SNFs tend to be relatively short. 

But Medicare’s home health benefit, originally conceived 

to finance short-term rehabilitation, has evolved into 

what some observers have described as a de facto LTC 

benefit. As a result, Medicare’s spending for both kinds of 

care is generally included in estimates of LTC expenditures.

Medicaid

Medicaid is a means-tested program, jointly funded by 

the federal and state governments, that pays for medical 

care for certain groups of people, including impaired seniors who have low income or whose expenses are high 

enough that they allow those seniors to meet Medicaid’s 

criteria for financial eligibility (see Box 1-2). Within 

broad national guidelines that the federal government 

provides, each of the states establishes its own eligibility 

standards; determines the type, amount, duration, and 

scope of services; sets the rate of payment for services; and 

administers its own program. The share of each state’s 

Medicaid expenditures that is paid by the federal government is determined by a statutory formula; the average 

share is about 56 percent.

Figure 1-2.

Long-Term Care Insurance Policies 

Sold, 1988 to 2001

(Thousands)

Source: Congressional Budget Office based on data from America’s Health Insurance Plans (formerly, the Health Insurance Association of America).

Payment Source

36.5 10.8 47.3

15.9 17.7 33.6

2.4 3.3 5.6

35.7 8.3 44.0

2.0 2.5 4.4 ___ ___ ____

Total 92.4 42.5 134.9

Institutional

Care Home Care Total

Other

Medicaid

Medicare

Private Insurance

Out of Pocket

1988 1990 1992 1994 1996 1998 2000

0

100

200

300

400

500

600

700

800
6 FINANCING LONG-TERM CARE FOR THE ELDERLY

Box 1-2.

Financial Eligibility Requirements for Medicaid Coverage

The high cost of institutional care ($66,000 per year 

in 2003 for a private room) leads many seniors to try 

to qualify for public coverage of long-term care 

(LTC) costs through Medicaid. As a means-tested 

program, Medicaid is governed by financial eligibility rules that restrict its benefits to applicants whose 

income and assets do not exceed certain “ceilings,” 

which are established by the states subject to federal 

guidelines. Separate ceilings apply to income and assets; an applicant must meet both to qualify for benefits. To become eligible for Medicaid’s long-term 

care coverage, applicants must also meet certain 

state-set criteria involving the degree of their impairment. Seniors with very low income who become 

impaired may meet the program’s financial eligibility 

requirements almost immediately, but others may 

eventually qualify—even people with fairly substantial assets and income—by exhausting, or “spending 

down,” those funds to pay medical expenses.

The Income Standard

States have several options for setting an income 

standard for Medicaid coverage. In most states, seniors who are eligible for Supplemental Security Income (SSI) under the Social Security Act are automatically eligible for Medicaid.1 To receive SSI 

benefits in 2004, individuals may have no more than 

$564 per month in so-called countable income; couples are limited to $846 per month. States may also 

extend Medicaid coverage to elderly and disabled individuals whose income exceeds the SSI limits; the 

rules allow states to qualify people who have income 

as high as 100 percent of the federal poverty level 

($9,310 for a single person and $12,490 for a couple 

in 2004). States establish their own limits within that 

range. Florida’s eligibility criterion, for example, is 

income that is less than or equal to 90 percent of the 

poverty level.

Medicaid’s eligibility rules also give states two options, not mutually exclusive, under which people 

who have excessive health care costs and income 

above the usual Medicaid limit may nevertheless 

qualify for coverage. Under the first alternative, 

known as the “medically needy” option, seniors may 

qualify for Medicaid coverage if what remains of 

their income after subtracting their medical costs 

falls below a set amount. (Again, states establish that 

limit.) Once elderly people qualify, all of their income except a small allowance to cover nonmedical 

costs must be applied to their medical expenses.2 In 

2002, 35 states and the District of Columbia used 

the medically needy rule.

The second option that states may use to qualify 

people whose income exceeds the state-specified ceiling is known as the special income, or “300 percent,” 

rule. That approach is only for people who need 

long-term care; applicants must meet the physical 

criteria for receiving Medicaid-covered nursing home

1. Policymakers have allowed some states, known as 209(b) 

states, to apply more-restrictive criteria for income, assets, 

and disability than those that apply for SSI eligibility. However, policymakers have also required those states to give 

people options for spending down their assets to become eligible.

2. The allowance may be as low as $30 per month for nursing 

home residents. It may be much higher—as much as three 

times the SSI income standard—for people who receive 

long-term care in the community.
CHAPTER ONE THE CURRENT CONTEXT OF LONG-TERM CARE FINANCING 7

Box 1-2.

Continued

care, and once they are enrolled, Medicaid pays for 

their medical care in addition to their long-term 

care. As is the case with the medically needy rule, 

people who qualify for coverage under the special income rule must use all of their income to pay for 

care, except for the small allowance noted above.

Under the special income option, the state sets an income cap of no more than 300 percent of the federal 

SSI benefit level. Regardless of their medical expenses, people in states that use this rule (38 in 

2002) must have income below the state-set level for 

qualifying for Medicaid. However, applicants who 

have income that exceeds the cap may place the excess portion in special trusts to reduce their countable income and so become eligible. Under federal 

law, the money set aside in those so-called Miller 

Trusts must be used to pay for the beneficiary’s care. 

When the beneficiary dies, the state Medicaid program is entitled to any residual funds in the trust to 

pay for costs it incurred in providing the person’s 

care.1

The Asset Standard

The states also limit, subject to federal law, the 

amount of countable assets a person may hold and 

still qualify for Medicaid coverage. In that count, all 

states exempt the value of certain items such as a person’s primary residence and a car (of limited value). 

All other assets, or “countable resources”—such as 

cash, bonds, and stock—must be depleted until the 

person’s assets meet the standard. Most states choose 

a standard for assets that equals the current SSI asset 

standard of $2,000 for a single person and $3,000 

for couples. (The standard is generally the same for 

someone applying for nursing home residency or for 

home and community-based care.)

Income and Asset Rules for

Married Couples

Special rules for Medicaid eligibility, set by federal 

law, apply to married couples when one spouse is institutionalized and the other remains in the community. All income of the so-called community spouse 

remains with that person and is not counted in determining the institutionalized spouse’s eligibility for 

benefits. In addition, federal law requires states to allow the community spouse to retain enough of the 

institutionalized spouse’s income to make up a 

monthly allowance for minimum living costs. The 

allowance is set by the state according to federal 

guidelines—in 2004, no less than $1,515 per month 

and no more than $2,319. 

The community spouse also has rights with regard to 

the couple’s assets. The community spouse is allowed 

to retain either an amount equal to one-half of the 

couple’s resources at the time that his or her spouse 

enters the institution, up to a federally specified 

maximum ($92,760 in 2004) or the state standard—

whichever is greater. Federal law requires that the 

state standard be no lower than a specified amount

—$18,552 in 2004. (Such maximum and minimum 

resource allowances are adjusted annually for inflation.) If the community spouse’s half of the couple’s 

combined resources is less than the state standard, 

the institutionalized spouse may transfer up to that 

amount of his or her resources to the community 

spouse.

1. The state also uses the funds to reimburse the federal government for its share of the expenditures for the beneficiary’s 

care.
8 FINANCING LONG-TERM CARE FOR THE ELDERLY

Table 1-3.

Average Annual Premiums for Private Long-Term Care Insurance, 2002

(Dollars)

Source: Congressional Budget Office based on Weiss Ratings, Inc., Weiss Ratings' Consumer Guide to Long-Term Care Insurance (Palm 

Beach Gardens, Fla.: Weiss Ratings, Inc., 2003).

Note: The table reflects policies offering comprehensive benefits (nursing home care, in-home care (including respite care), and communitybased care (for example, hospice or adult day care) with a $100 daily benefit for a three- to six-year period, a 30- to 100-day elimination period, and a pool-of-money contract.

Medicaid generally pays for services provided both in 

nursing facilities and in the home, although the specific 

benefits that the program provides differ from state to 

state, as do patterns of practice, the needs and preferences 

of beneficiaries, and the prices of services. That variation 

produces substantial differences in states’ Medicaid 

spending (see Figure 1-3). In total, however, Medicaid’s 

expenditures for long-term care for elderly people since 

1992 have grown at an average annual rate of about 5 

percent (see Figure 1-4). CBO estimates that in 2004, 

Medicaid’s payments for institutional care for seniors, including both state and federal expenditures, will total 

$36.5 billion, or about 77 percent of all Medicaid LTC 

spending. Accounting for about 40 percent of total expenditures on nursing facilities, those payments will cover 

the care of more than half of all elderly nursing home residents.6

Medicaid’s expenditures for home and community-based 

services (HCBS), which include home health care, personal care services, and spending under HCBS waiver 

programs, are much smaller than its spending for nursing 

homes—HCBS expenditures constitute only about 

23 percent of total Medicaid LTC spending. (Under the 

waiver programs, which are discussed in more detail in 

Appendix B, states have the option of providing impaired 

people with enhanced community support services not 

otherwise authorized by the federal statutes.)

Since 1992, spending for home-based care has grown 

faster than spending for nursing home care, rising by 

about 11 percent annually on average compared with 

about 3 percent growth for care in nursing facilities. Potential causes of the higher rate include the growth of 

HCBS waiver programs and a 1999 decision by the 

If Policy Is Purchased 

at Age

30 284 622 437 1,016

35 299 667 467 1,089

40 336 743 515 1,171

45 375 822 592 1,319

50 427 925 687 1,499

55 537 1,140 874 1,839

60 740 1,474 1,170 2,345

65 1,086 2,014 1,675 3,160

70 1,771 2,987 2,700 4,647

75 3,015 4,607 4,461 7,029

80 4,822 6,791 7,077 10,378

85 6,528 7,718 10,700 13,869

Policies with Terms

Averaging Three to Six Years Policy with Lifetime Term

No Inflation Inflation Protection of 

Protection 5 Percent Compounded

Inflation Protection of

 5 Percent Compounded

No Inflation 

Protection

6. See Celia S. Gabrel, Characteristics of Elderly Nursing Home Current Residents and Discharges: Data from the 1997 National Nursing 

Home Survey, Advance Data no. 312 (Centers for Disease Control 

and Prevention, National Center for Health Statistics, April 25, 

2000). The disparity between Medicaid’s share of total spending 

on nursing facilities (40 percent) and the proportion of patients 

covered by Medicaid (56 percent) may result from one or more 

factors: Medicaid’s low average reimbursement rates; differences 

between the severity of Medicaid enrollees’ conditions and the 

conditions of patients using other sources of payment; or enrollees’ cost sharing, which counts as out-of-pocket spending.
CHAPTER ONE THE CURRENT CONTEXT OF LONG-TERM CARE FINANCING 9

Figure 1-3.

Average Medicaid Payments for Long-Term Care, Selected States, Fiscal Year 2000

(Thousands of dollars)

Source: Congressional Budget Office based on unpublished data from the Centers for Medicare and Medicaid Services, Office of Research, 

Development, and Information.

a. Beneficiaries aged 65 and older only.

Okla. Ark. La. Ariz. Tenn. U.S. Del. Hawaii D.C. R.I. Alaska

0

10

20

30

40

50

60

Lowest-Spending States

Highest-Spending States

Okla. Ohio Hawaii Ala. W.V. U.S. Wis. Colo. Tenn. Mass. Md.

0

2

4

6

8

10

12

14

16

18

20

Lowest-Spending States

Highest-Spending States

a

a

Nursing Facility Payments per Beneficiary

Home Health Care Payments per Beneficiary
10 FINANCING LONG-TERM CARE FOR THE ELDERLY

Figure 1-4.

Medicaid’s Expenditures on Long-Term 

Care for Elderly Beneficiaries, Fiscal 

Years 1992 to 2004

(Billions of dollars)

Sources: Congressional Budget Office and personal communication 

from Brian K. Bruen, Research Associate, Urban Institute.

Note: Expenditures for 2004 are projected.

Supreme Court requiring states, where possible, to provide community-based care to disabled Medicaid beneficiaries.7

Medicaid’s involvement in LTC financing is consistent 

with the correlation between functional impairment and 

impoverishment. Lower-income groups—at any age—

have higher rates of impairment than do higher-income 

groups, so people who are more likely to be impaired are 

also more likely to be eligible for assistance. But not all 

people who obtain Medicaid coverage for long-term care 

come from low-income households. Middle-income people may qualify for Medicaid if the cost of impairment 

drains their financial resources (see Box 1-2).

Many impaired people who are not eligible for Medicaid 

while they live in the community become so immediately 

or shortly after being admitted to a nursing facility because of the high cost of institutional care. (As noted earlier, nursing home costs in 2003 averaged $66,000 for a 

private room.) According to a 1996 study, about onethird of discharged nursing home patients who had been 

admitted as private-pay residents became eligible for 

Medicaid after exhausting their personal finances; nearly 

one-half of current residents had similarly qualified for 

coverage.8

 Medicaid coverage is especially common 

among nursing home patients who have been institutionalized for long periods because they are likely to have used 

up whatever Medicare benefits were available as well as 

any assets they might have had.

Medicare

Medicare finances a substantial share of LTC services for 

elderly people in skilled nursing facilities and at home. To 

be eligible for reimbursement, services must be provided 

by a licensed professional, such as a registered nurse or 

physical therapist. A further requirement is that the SNF 

care be preceded by a recent, related hospitalization lasting at least three days. In the case of coverage for home 

health care, services need not be related to a prior hospitalization. One study based on 1994 data observed that 

only about a quarter of home health visits followed the 

beneficiary’s hospitalization sometime in the previous 

60 days.9

By CBO’s estimates, Medicare’s LTC spending for seniors 

in 2004 will total about $16 billion for care in skilled 

nursing facilities and $17 billion for home health care. 

Although the program’s outlays for those categories grew 

rapidly from the late 1980s to the mid-1990s, expenditures actually declined near the end of the past decade 

(see Figure 1-5). A combination of factors was responsible, including changes in reimbursement methods imposed by the Balanced Budget Act of 1997, increased federal activities to counter providers’ fraud and abuse of the 

7. Olmstead v. Georgia, 527 U.S. 581 (1999). For details, see Nancy 

Lee Jones, The Americans with Disabilities Act (ADA): Supreme 

Court Decisions, CRS Report for Congress RL31401 (Congressional Research Service, June 19, 2002), p. 6. The growth attributable to that decision may be primarily among younger Medicaid 

beneficiaries rather than among seniors.

1992 1994 1996 1998 2000 2002 2004

0

5

10

15

20

25

30

35

40

Skilled Nursing Facilities

Home Health Care Services

8. Joshua M. Wiener, Catherine M. Sullivan, and Jason Skaggs, 

Spending Down to Medicaid: New Data on the Role of Medicaid in 

Paying for Nursing Home Care (Washington, D.C.: AARP Public 

Policy Institute, June 1996). Those proportions differ because discharged residents include people who were institutionalized for 

only a short time and the sample of current residents will include 

more people who stay for extended periods.

9. General Accounting Office, Long-Term Care, March 27, 2001.
CHAPTER ONE THE CURRENT CONTEXT OF LONG-TERM CARE FINANCING 11

Figure 1-5.

Medicare’s Expenditures on LongTerm Care for Elderly Beneficiaries, 

Fiscal Years 1992 to 2004

(Billions of dollars)

Source: Congressional Budget Office.

Note: Expenditures for 2004 are projected.

program’s payment systems, and delays in processing 

claims. CBO projects steady growth in spending for SNF 

and home health care over the 2005-2014 period, averaging approximately 5 percent annually. Although benefits 

are similar from state to state, Medicare spending, like 

spending for Medicaid, differs among the states and for 

many of the same reasons, such as variations in practice 

patterns and prices for services (see Figure 1-6).

Recent Reforms

Changes to Medicaid and Medicare LTC programs over 

the years have attempted to reduce costs, make service delivery more efficient, and improve the quality of LTC 

care. For example, to help control the growth of costs, 

Medicare recently switched from cost-based reimbursement to prospective payment systems for SNF stays and 

home health care. Prospective payment systems base reimbursement on the average costs of all providers—rather 

than on the costs only of the provider being reimbursed 

—and bundle those costs into a single payment for a 

specified unit of service. (In the case of SNFs, the unit is a 

day; for home health care, the unit is 60 days of visits.) 

The system thus rewards efficient providers who produce 

services at lower-than-average costs.

The HCBS waiver programs that most states now operate 

generally provide a more attractive living situation for 

beneficiaries because they enable Medicaid enrollees 

whose condition qualifies them for nursing home residency to remain in their homes. Moreover, for a few 

states, the waiver programs may have helped reduce their 

Medicaid costs. In addition, Medicare and Medicaid have 

initiated other policies to integrate acute and long-term 

care and better coordinate benefits for people enrolled in 

both programs. (Those initiatives, together with other reforms, are discussed in more detail in Appendix B.)

Nevertheless, despite the improvements in quality of care 

or efficiency that such changes may have elicited, there is 

little evidence to suggest that the new policies by themselves can rein in the projected surge in LTC spending 

that is likely to result from the demographic changes expected in the next several decades. How that spending is 

distributed among the various sources of LTC financing 

will depend in part on whether certain incentives present 

in the current financing structure remain in place. 

1992 1994 1996 1998 2000 2002 2004

0

2

4

6

8

10

12

14

16

18

20

Skilled Nursing Facilities

Home Health Care Services
12 FINANCING LONG-TERM CARE FOR THE ELDERLY

Figure 1-6.

Average Medicare Payments for Long-Term Care, Selected States,

Fiscal Year 2001

(Dollars)

Source: Congressional Budget Office based on unpublished data from the Centers for Medicare and Medicaid Services, Office of Research, 

Development, and Information.

Note: Medicare’s home health benefit—though originally meant to cover only short-term rehabilitation—has evolved into what some 

observers describe as a de facto long-term care benefit. Consequently, the program’s spending for both skilled nursing facility and 

home health care is generally included in estimates of long-term care expenditures.

a. Beneficiaries aged 65 and older only.

Home Health Care Payments per Beneficiarya

Hawaii Minn. S. Dak. Wis. Ariz. U.S. Conn. Miss. Vt. Mass. La.

0

100

200

300

400

500

600

Lowest-Spending States

Highest-Spending States

Skilled Nursing Facility Payments per Beneficiary a

Alaska Hawaii N. Mex. Ariz. Ark. U.S. N.J. N.Y. R.I. Mass. Conn.

0

100

200

300

400

500

600

700

800

Lowest-Spending States

Highest-Spending States
2

Major Issues in the Financing of Long-Term Care

The current financing structure of long-term care, if 

carried forward into the coming decades, could add to 

the expected pressures that the federal budget is likely to 

experience with the aging of the baby-boom generation. 

As the proportion of older people in the population 

grows, the demand for long-term care will rise at the same 

time that other demographic forces (such as increased life 

expectancy and changes in the structure of families) are 

tending to reduce the availability of informal care. Contributing to the strains that public LTC programs will 

probably face is a series of factors that create incentives 

that in turn diminish the attractiveness of private insurance as a means for seniors to finance their care. Changes 

in those incentives could facilitate growth in the market 

for private LTC insurance. 

Demographic Trends

Affecting the Demand for

Long-Term Care Insurance

The oldest members of the baby-boom generation become eligible for early retirement under Social Security in 

2008, and their overall numbers drive the demographic 

trends that will affect the demand for long-term care services over the coming decades. According to estimates by 

the Bureau of the Census, the number of elderly people 

in the United States will double between 2000 and 2030; 

by 2050, the share of the population comprising people 

aged 65 or older will be 21.5 percent, up from 12.4 percent in 2000 and 8.1 percent in 1950 (see Figure 2-1). 

The most significant growth will be among the oldest seniors, those aged 85 or older—the people who have the 

greatest probability of using long-term care. Their share 

of the population will reach about 5.2 percent by 2050, 

more than triple the 1.5 percent share they claimed in 

2000. By comparison, the proportion of the population 

accounted for by working-age people (aged 20 to 64)—

who will in large part be paying the taxes that support 

public programs for retirees, including LTC programs—

will grow by about 35 percent by 2050.1

Although the growth in the aged population may have 

the most powerful demographic effect on future demand 

for long-term care and in turn on LTC spending, other 

trends could also play a role. For example, a decline in the 

prevalence of functional impairment among elderly people (the percentage of people in the aged population who 

are impaired as measured by losses in the activities of 

daily living and the instrumental activities of daily living) 

could help slow the growth of LTC spending. Impairment among seniors appears to have waned significantly 

during the 20th century. From 1910 to the early 1990s, 

prevalence fell by about 6 percent per decade.2 And some 

researchers found that in the early 1980s, it began to drop 

by just over 1 percent per year, primarily because of reCHAPTER

1. See Bureau of the Census, Population Division, 1980 Census of 

Population, PC80-1-B1 (May 1983), and U.S. Interim Projections by Age, Sex, Race, and Hispanic Origin, Table 2a. “Projected Population of the United States, by Age and Sex: 2000 to 

2050” (March 2004), available at www.census.gov/ipc/www/

usinterimproj/natprojtab02a.pdf.

2. Note that the decline in prevalence is a percentage drop, not a percentage-point drop. Of impairments among men at the beginning 

of the 20th century, difficulties in bending were the most prevalent at 50 percent. By the mid-1990s, the prevalence of such difficulties had fallen to 16 percent, a drop of 34 percentage points 

over eight decades, or a little more than 4 percentage points for 

each 10 years. Prevalence rates at the beginning of the last century 

for other types of impairment began at much lower levels and had 

very small percentage-point declines—but they still had relatively 

large percentage drops.
14 FINANCING LONG-TERM CARE FOR THE ELDERLY

Figure 2-1.

People Aged 65 and Older as a Share of the U.S. Population,

Selected Years, 1900 to 2050

(Percent)

Source: Congressional Budget Office based on Bureau of the Census, U.S.. Interim Projections by Age, Sex, Race, and Hispanic Origin, Table 

2a, “Projected Population of the United States, by Age and Sex: 2000 to 2050” (March 2004), available at www.census.gov/ipc/

www/usinterimproj/natprojtab02a.pdf.

duced impairment as measured by the instrumental activities of daily living.3 (The Congressional Budget Office 

has projected that trend to 2040 in Figure 2-2.)

Not all measures show seniors’ impairment rates as declining, however. Losses of functioning in the activities of 

daily living for which people require assistance only with 

equipment—such as walking canes—have been rising at a 

rate of about 4 percent per year since 1984 (although the 

prevalence of such impairment is still only about 3 percent of all seniors).4 Impairment in general among people 

under age 65 may also be increasing, which could lead 

not only to higher current costs but also to higher future 

rates of impairment among seniors (see Box 2-1). In fact, 

one recent study projects that the currently declining 

trend in the prevalence of impairment among seniors will 

reverse in the future, leading to greater rates of institutionalization than those that prevail today.5 As those conflicting trends suggest, projecting the prevalence of impairment in future years and basing estimates of spending 

on those projections are both difficult and subject to a 

high degree of uncertainty.

Yet despite that uncertainty, the expected increase in the 

number of seniors as the baby boomers age is so great that 

spending on long-term care is likely to rise over time because the number of impaired seniors will grow even if 

the prevalence of impairment declines. Moreover, life expectancy continues to grow—a trend that may increase 

the likelihood that a senior will use long-term care because, as noted earlier, the probability of being impaired 

1900 1950 1980 1990 2000 2010 2020 2030 2040 2050

0

5

10

15

20

25

65 to 74

75 to 84

85 and Older

65 and Older

Actual Projected

3. See Dora L. Costa, “Long-Term Declines in Disability Among 

Older Men: Medical Care, Public Health, and Occupational 

Change” (paper presented at the annual meeting of the American 

Economic Association, Boston, Mass., January 7-9, 2000); and 

Kenneth G. Manton, Larry Corder, and Eric Stallard, “Chronic 

Disability Trends in Elderly United States Populations: 1982-

1994,” Proceedings of the National Academy of Sciences, vol. 94,

no. 6 (March 18, 1997), pp. 2593-2598.

4. Brenda C. Spillman, Changes in Elderly Disability Rates and the 

Implications for Health Care Utilization and Cost (report prepared 

for the Department of Health and Human Services, Office of 

Aging and Long-Term Care Policy, 2002).

5. Darius Lakdawalla and others, “Forecasting the Nursing Home 

Population,” Medical Care, vol. 41, no. 1 (2003), pp. 8-20.
CHAPTER TWO MAJOR ISSUES IN THE FINANCING OF LONG-TERM CARE 15

Figure 2-2.

CBO’s Projections of Impaired Seniors 

as a Share of the Elderly Population, 

2000 to 2040

(Percent)

Source: Congressional Budget Office.

rises with age. Thus, the cohort of people turning 65 in 

2020 may be more likely than the cohort turning 65 in 

2000 to require nursing home care at some time before 

they die because that younger cohort will live longer (see 

Table 2-1).

In part because of the substantial opportunity costs of informal caregiving—as well as other factors, such as 

smaller families, lower fertility rates, and increasing divorce rates—donated LTC services may become less common in the future. The size of the average family has declined, reducing the number of adult children available to 

care for their elderly parents. Family size fell from 3.8 

members in 1940 to 3.1 members in 2000; if current 

trends continue, it is likely to decline further, to 2.8 people by 2040 (see Figure 2-3 on page 18). At the same 

time, the rate at which women participate in the labor 

force will probably continue to grow, at least until 2010.6

Women are more likely than men to provide LTC services 

for impaired people, and several studies have demonstrated that increases in the hours worked at paid emTable 2-1.

Probability of Nursing Home Use by 

Elderly People Over Their Remaining 

Lifetime

(Percent)

Source: Congressional Budget Office using data from Brenda C. 

Spillman and James Lubitz, “New Estimates of Lifetime 

Nursing Home Use: Have Patterns of Use Changed?” Medical Care, vol. 40, no. 10 (2002).

ployment reduce the number of hours spent in caregiving.7 Those family-related trends, in sum, could further 

stimulate the demand for formal, paid services.

The increased demand for long-term care that is expected 

to emerge with the baby boomers’ aging implies that if 

current patterns persist, public programs that finance 

such care—like all government programs serving large 

numbers of elderly people—will consume a growing 

share of the federal budget and of the national economy. 

In 1999, CBO projected that total LTC expenditures for 

seniors (including government and private spending but 

not the value of donated care) would rise from about 

$123 billion in 2000 (1.3 percent of GDP) to $346 bil2000 2010 2020 2030 2040

0

5

10

15

20

25

30

6. According to the Bureau of Labor Statistics, the female civilian 

labor force participation rate will increase from 51.5 percent in 

1980 to approximately 62.2 percent in 2010. However, the pace 

of that growth has been declining in recent years, shrinking from 

6.0 percent during the 1980s to 2.7 percent during the 1990s. 

The rate of increase is projected to decline further, to 2.0 percent, 

over the 2000-2010 period. See Howard N. Fullerton Jr. and 

Mitra Toossi, “Labor Force Projections to 2010: Steady Growth 

and Changing Composition,” Monthly Labor Review Online, vol. 

124, no. 11 (November 2001), Table 3.

7. Richard W. Johnson and Anthony T. Lo Sasso, The Trade-Off 

Between Hours of Paid Employment and Time Assistance to Elderly 

Parents at Midlife (Washington, D.C.: Urban Institute, February 7, 2000). See also Rachel F. Boaz and Charlotte F. Muller, 

“Paid Work and Unpaid Help by Caregivers of the Disabled and 

Frail Elders,” Medical Care, vol. 30, no. 2 (1992), pp. 149-158.

Any Use 44 45 46

Three Months or Longer 32 33 34

One Year or Longer 23 24 25

Five Years or Longer 8 9 9

2000 2010 2020

People Turning 65 in
16 FINANCING LONG-TERM CARE FOR THE ELDERLY

lion (in 2000 dollars) by 2040, or 1.5 percent of GDP.8

That estimate of a relatively modest increase in spending 

incorporated the assumption that the prevalence of impairment would decline at a rate of about 1.1 percent per 

year. If impairment levels instead remain about the same 

as they are today, expenditures will rise faster, to $484 billion by 2040, or about 2.0 percent of GDP. Spending 

could be even higher if, as some researchers believe, the 

prevalence of impairment actually increases in the future. 

Another factor that could translate into higher spending 

levels is that the cost of LTC care is likely to increase at a 

faster rate than that of general price inflation since historically, the growth of health care costs has outpaced that of 

the economy in general.

Factors Affecting the Demand for

Private Insurance

If the current framework of long-term care financing remained unchanged, the proportion of LTC spending that 

private insurance pays would rise to about 17 percent in 

2020, by CBO’s estimates, but that share of expenditures 

would still be smaller than those of Medicaid, Medicare, 

Box 2-1.

Long-Term Care Expenditures for Nonelderly People

Approximately one-third of the expenditures on 

long-term care in the United States go to pay for services for nonelderly people (see the table to the 

right). In 1994, about 3.3 million adults aged 18 to 

64 and 400,000 children below the age of 18 used 

long-term care (LTC) services.1 The majority of 

those people lived in the community—only about 

100,000 nonelderly people lived in nursing homes.

In general, people who are younger than 65 use longterm care for different reasons than do people who 

are over 65. Impaired seniors who require long-term 

care generally suffer from physical problems, such as 

arthritis and coronary heart disease; younger adults 

are more likely to be impaired as a result of conditions such as mental retardation and mental illness 

(although they may also suffer the kinds of physical 

problems that older people experience). Common 

causes of impairment among children are respiratory 

problems and mental or neurological conditions.

Medicaid is by far the biggest funder of long-term 

care for impaired people under the age of 65, and the 

program’s spending for that group has grown significantly over the past two decades. Taken together, 

Medicaid’s payments to nursing homes, home health 

care providers, and Medicaid-run intermediate-care 

facilities for the mentally retarded (ICF/MRs) grew 

on average by about 4.8 percent annually between 

1992 and today. However, examining the growth 

rate for each category of services separately reveals a 

shift over the period from institutional care to home 

and community-based services. Medicaid’s expenditures for home health care grew at an average annual 

rate of more than 15 percent during the 1992-2004 

1. The information in this box is drawn from the following 

sources: Judith Feder, Harriet Komisar, and Marlene Niefeld, “Long-Term Care in the United States: An Overview,” 

Health Affairs, vol. 19, no. 3 (2000), pp. 40-56; General 

Accounting Office, Long-Term Care: Diverse, Growing Population Includes Millions of Americans of All Ages, GAO/

HEHS-95-26 (November 1994); Darius Lakdawalla, Jay 

Bhattacharya, and Dana Goldman, Are the Young Becoming 

More Disabled? Working Paper No. 8247 (Cambridge, 

Mass.: National Bureau of Economic Research, April 2001); 

Paul W. Newacheck and Neal Halfon, “Prevalence, Impact, 

and Trends in Childhood Disability Due to Asthma,” 

Archives of Pediatric Adolescent Medicine, vol. 154 (March 

2000), pp. 287-293; and William D. Spector and others, 

The Characteristics of Long-Term Care Users, AHRQ Pub.

no. 00-0049 (Department of Health and Human Services, 

Agency for Healthcare Policy and Quality, 1998).

8. Congressional Budget Office, Projections of Expenditures for LongTerm Care Services for the Elderly (March 1999). Long-range estimates are particularly prone to error and should be interpreted 

with caution.
CHAPTER TWO MAJOR ISSUES IN THE FINANCING OF LONG-TERM CARE 17

and out-of-pocket spending.9 A number of factors underlie the limited rise that CBO projects for the use of private insurance. Some factors are related to the unique 

characteris-tics of long-term care—the interaction of private insurance and Medicaid and the inability to insure 

against certain kinds of risk. Other factors are common to 

most insurance markets but particularly to new ones—

they include issues related to administrative costs, premium stability, and adverse selection.

The Availability of Medicaid

Although Medicaid in general serves people with very low 

income and assets, it also provides assistance to impaired 

people who exhaust all other sources of financing for 

their long-term care. As discussed in Chapter 1, even people who have set aside significant savings may eventually 

become eligible for Medicaid assistance. In that way, 

Medicaid serves as an alternative form of insurance for 

people who do not have private coverage and who are impaired for a significant period. Indeed, Medicaid’s impoverishment requirement may discourage people from saving because the less they have, the quicker they will 

qualify for coverage. It also creates an incentive for people 

Box 2-1.

Continued

Expenditures on Long-Term Care for Nonelderly People, 1998

(Billions of dollars)

Source: Congressional Budget Office.

period, whereas its spending on institutional care 

grew by less than 5 percent.1

Although the percentage of elderly people who are 

impaired appears to be decreasing, the corresponding 

percentage of nonelderly individuals may be increasing. Several factors might explain that rise. For example, because of advances in medical technology, children who are born prematurely or who have severe 

disabilities that previously were fatal are now more 

likely to survive, but they may still have impairments 

that require some form of long-term care. In addition, the prevalence of certain potentially disabling 

diseases is increasing. Asthma is becoming more 

common, and respiratory disorders in general, including asthma, are a significant cause of disability 

among children. The prevalence of diabetes among 

the young is growing as well, perhaps because of an 

upswing in obesity. (If diabetes is untreated or poorly 

managed, it can eventually limit a person’s mobility.)

Source Amount

Third-Party Payers

Medicaid 24.4

Private insurance 5.1

Medicare 2.1

Out-of-Pocket Spending 3.2

Other 5.6

Total 40.4

1. That analysis of spending growth is based on Congressional 

Budget Office data and a personal communication from 

Brian K. Bruen, Research Associate, Urban Institute.

9. Ibid.
18 FINANCING LONG-TERM CARE FOR THE ELDERLY

Figure 2-3.

Average Family Size, 1940 to 2040

(Number of people)

Sources: Congressional Budget Office (projections for 2015 to 2040) and Bureau of the Census (data for 1940 to 2010, which are available at 

www.census.gov/population/www/socdemo/hh-fam.html).

to hide their assets so that they can qualify for Medicaid 

and still preserve their personal wealth.

Medicaid is not a perfect substitute for private LTC insurance, however. As a means-tested program, it requires eligible applicants to rely on out-of-pocket spending until 

they use up all of their savings. In addition, because Medicaid generally pays lower fees for services than those paid 

by private payers, beneficiaries may not receive the same 

quality of care that private policyholders receive. In some 

states, moreover, Medicaid might not be as flexible in the 

types of services it covers as private insurance would be; 

an impaired person with private coverage would probably 

have a broader choice of providers and types of care than 

a Medicaid beneficiary would have.

Those drawbacks to Medicaid’s coverage are balanced by 

features that some people might consider advantageous. 

Medicaid is free (except for the taxes that people pay regardless of whether they ever qualify for the program’s 

coverage), and it pays for most kinds of LTC services. In 

addition, Medicaid has a defined-benefit structure—that 

is, it covers a particular set of services. As a result, it may 

be more attractive than private insurance to people planning for their long-term care needs, because private insurance ensures that a policyholder will have a specified 

monetary benefit to pay for care but does not guarantee 

that the money will be sufficient to pay for that care if 

prices rise faster than the value of the benefit.

The availability of coverage through Medicaid after people “spend down” (exhaust) their own resources has several effects on the LTC financing structure. Although 

Medicaid’s coverage is not a perfect substitute for that of 

private insurance, it may nevertheless reduce the demand 

for private policies. Indeed, one recent study found that it 

constitutes a substantial deterrent to the purchase of private insurance for people at various income levels.10

1940 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Actual Projected

10. Jeffrey R. Brown and Amy Finkelstein, “The Interaction of Public 

and Private Insurance: Medicaid and the Long-Term Care Insurance Market” (unpublished working paper, University of Illinois 

at Urbana-Champaign, April 2004).
CHAPTER TWO MAJOR ISSUES IN THE FINANCING OF LONG-TERM CARE 19

Medicaid’s rules for financial eligibility affect people’s decisions to purchase private LTC insurance as well as how 

much insurance they buy because the rules offer a lowcost alternative (by allowing people to qualify for the program’s benefits) to making personal financial preparations 

for long-term care. People who buy private insurance or 

set aside savings for long-term care substantially reduce 

the probability that they will ever qualify for Medicaid 

benefits. In that sense, as people prepare financially for 

long-term care needs, they forgo the value of the Medicaid benefits that they might otherwise have obtained—

which raises the relative cost of purchasing private insurance or of saving. That increase is small for relatively 

wealthy people who have little likelihood of ever qualifying for Medicaid coverage, but it may be more substantial 

for people of relatively modest means.

The Inability to Insure Against Certain Risks

Private LTC insurance may be unattractive to some consumers because it does not, in general, insure against the 

risk of significant price increases for long-term care. 

(Some types of so-called continuing-care retirement communities guarantee care for life, but that type of coverage 

is relatively uncommon.) Most policies guarantee to provide contractually specified cash benefits in the event that 

the policyholder becomes impaired. To protect themselves against inflation in the price of LTC services, consumers can purchase a rider to their policy under which 

the policy’s benefits grow at a specified rate each year 

(usually 5 percent); however, such riders offer no protection against additional costs if prices rise at a faster pace. 

Concerns about price increases of that kind are not unjustified: Medicaid’s average reimbursement rates for 

nursing facilities grew at an average annual rate of 6.7 

percent from 1979 to 2001.11 Over a 20-year period, a 

nursing facility benefit of $100 per day in today’s dollars 

would grow to $265 per day with an annual inflation 

protection rider of 5 percent. But the benefit would need 

to grow to $366 per day to keep up with a 6.7 percent annual growth rate—should costs continue to grow that fast 

in the future.

Another risk not covered by private LTC policies is the 

possibility that the insurer will go bankrupt and not be 

able to pay policyholders’ claims. LTC insurance is a relatively new product, which makes it difficult for insurers 

to accurately predict the volume of claims that they will 

have to satisfy. Amplifying that difficulty is uncertainty 

about trends in, for example, impairment (see the earlier 

discussion). In some cases, LTC policyholders have seen 

their premiums increase substantially because an insurer 

underestimated its future claims costs.12

An additional risk is the possibility that the policy might 

become obsolete at some point in the future. LTC services, and the private insurance policies that cover such 

care, are steadily evolving as the LTC insurance market 

matures. That fluidity may give some consumers pause, 

and indeed, one prominent insurance rating agency recommended in 2000 that people purchase LTC coverage 

no earlier than age 60 to avoid the problem of obsolescent coverage.13 Some consumers might also be reluctant 

to purchase LTC insurance if they believed that changes 

in public policy at some point could render their coverage 

obsolete.

At least one of those risks, that of insurer insolvency, is 

being addressed. The recently implemented LTC insurance program for federal employees and annuitants, for 

example, includes safeguards against the possibility that 

insurers will become insolvent.14 (The government’s Office of Personnel Management promises to continue an 

enrollee’s coverage in the event that the group policy 

ceases to exist.)15 Holders of policies not purchased 

through the federal program may have some protection as 

well. Each state has a life and health insurance guaranty 

association that provides coverage, up to certain statutory 

limits, for holders of policies issued by insolvent insurers. 

11. CBO based its calculations of increases in Medicaid’s reimbursement rates on data from James H. Swan and others, “Medicaid 

Nursing Facility Reimbursement Methods: 1979-1997,” Medical 

Care Research and Review, vol. 57, no. 3 (2000), pp. 361-378, and 

on a personal communication to CBO from James Swan.

12. Ann Davis, “Shaky Policy: Unexpected Rate Rises Jolt Elders 

Insured for Long-Term Care,” Wall Street Journal, June 22, 2000, 

p. A1.

13. See Weiss Ratings, Inc., Long-Term Care Policies Vary Drastically in 

Cost to Consumers (Palm Beach Gardens, Fla.: Weiss Ratings, Inc., 

April 5, 2000). Weiss Ratings evaluates the financial condition of 

insurers (including companies that sell life, health, property and 

casualty, and LTC insurance) and banks and savings and loan 

institutions.

14. The federal program was created with the passage of Public Law 

106-265 in September 2000. Under that legislation, federal 

employees and their families have access to employer-sponsored 

LTC coverage, although like most employees of private firms that 

offer such coverage, they must pay the full premium.

15. Federal Long-Term Care Insurance Program, “Continuation of 

Coverage,” available at http://www.ltcfeds.com/the_federal_

program/Continuation_Of_Coverage.html, updated June 28, 

2002.
20 FINANCING LONG-TERM CARE FOR THE ELDERLY

Although the private LTC insurance market is too new to 

have encountered problems with such insurers, the insolvency protection of state guaranty associations is believed 

to extend to those policyholders.16 In addition, most 

states require LTC insurance carriers to adhere to certain 

standards that are intended to prevent their future insolvency. For those reasons, and because insurers will gradually become more adept at predicting the claims costs of 

their policyholders, these concerns are likely to be less of 

an impediment to consumer demand in the future.

Administrative Costs

Administrative costs contribute a substantial amount to 

LTC insurance premiums because most policies are sold 

individually rather than as group (employer-sponsored) 

policies.17 The costs of marketing to and enrolling individuals are much higher than—in fact, about double—

those for groups, for which economies of scale may apply. 

On average, administrative costs in the future are likely to 

fall as group policies make up a larger share of the private 

LTC insurance market. In 2001, group policies constituted about 25 percent of new LTC policy sales. (By comparison, nearly 90 percent of people with private health 

care insurance hold group coverage.) But group policies 

are accounting for an increasing share of the LTC insurance market, a trend that is likely to continue if more employers offer LTC coverage as an employee benefit. If employers offered such a benefit, the part of the premium 

for their employees’ LTC coverage that they paid, like 

their contributions for regular health insurance, would 

not be included in employees’ taxable income. As more 

people became interested in having LTC coverage as part 

of their compensation package, they might be willing to 

accept lower wages or slower growth in the taxable portion of their compensation in exchange.

Premium Instability

Although LTC insurers typically offer premiums that do 

not automatically increase as the policyholder grows older 

or experiences deteriorating health, state insurance regulators allow them to increase premiums for all holders of a 

given type of policy in a state (known as a rating class) if 

they find that they have miscalculated the expected cost 

of their claims. Some insurers have boosted premiums 

several times for that reason, leading many policyholders 

to cancel their coverage and in all likelihood deterring 

some potential purchasers from acquiring LTC coverage. 

However, premiums may be stabilizing: a survey of topselling LTC insurance carriers by the Health Insurance 

Association of America observed fairly steady premium 

levels from 1997 to 2001 after a sustained decline in average premiums from 1990 to 1996.18

Policyholders can obtain some protection against large 

jumps in premiums by purchasing nonforfeiture benefits 

with their policy. That feature enables policyholders who 

cancel their coverage to recoup from the insurer as much 

as all of the premiums they have paid. Nevertheless, although policyholders might get a proportion of their premiums back, they do not receive the associated returns on 

the investment of that money.

Adverse Selection

The relative newness of the market for LTC insurance 

and the still fairly small number of policies being sold 

suggest that the market may be affected by adverse selection. According to that theory, people who purchase LTC 

insurance have greater expectations than nonpurchasers 

of using services in the future, and those greater expectations are not captured in the information that insurers 

collect as they enroll purchasers of their policies. If insurers believed that adverse selection was occurring, it might 

lead them to set premiums higher than a policyholder’s 

health status would suggest so as to incorporate the 

greater likelihood that that policyholder would use the 

insurance. In turn, the higher premiums might deter people who would purchase coverage if the premiums reflected their relatively lower expectations of using LTC 

services. 

Recent research suggests, however, that although adverse 

selection does exist in LTC insurance markets, it may not 

16. Personal communication to the Congressional Budget Office from 

Joni Forsythe, National Organization of Life and Health Insurance Guaranty Associations, November 26, 2003.

17. Statistics in the remainder of this section are drawn from the following sources: personal communications to the Congressional 

Budget Office by Frank Dino of the Florida Department of Insurance and Jonathan Shreve of Milliman & Robertson (an actuarial 

consulting firm), May 23, 2000; Susan A. Coronel, Long-Term 

Care Insurance in 2000-2001 (Washington, D.C.: Health Insurance Association of America, January 2003), p. 16; and Robert J. 

Mills, Health Insurance Coverage: 2000, Current Population 

Reports, Series P60-215 (Bureau of the Census, September 2001). 18. Coronel, Long-Term Care Insurance in 2000-2001.
CHAPTER TWO MAJOR ISSUES IN THE FINANCING OF LONG-TERM CARE 21

be producing higher overall claims costs.19 According to 

that study, the higher costs of policyholders with higherthan-average expectations of using services in the future 

are offset by the costs of people who purchase LTC insurance because they are averse to risk and whose probability 

of using services in the future is actually lower than the 

average for the population at large. Because of the market’s youth, there are no clear data to resolve the question 

of adverse selection, but the phenomenon appears unlikely to be a problem over the long run. 

19. Amy Finkelstein and Kathleen McGarry, Private Information and 

its Effect on Market Equilibrium, Working Paper no. 9957 (Cambridge, Mass.: National Bureau of Economic Research, September 

2003).

3

Policy Approaches to Long-Term Care Financing

Two sets of broad policy approaches might be used 

to alter the incentives described in Chapter 2 and shift 

the mix of sources of long-term care financing. The first 

set entails tightening eligibility for Medicaid and limiting 

Medicare’s home health care benefit. The second set examines policies to alter the incentives that encourage people to substitute Medicaid for private LTC insurance (but 

without restricting eligibility) and to increase price competition among insurance carriers. Those approaches include standardizing private policies and allowing consumers to purchase private policies that supplement 

Medicaid’s coverage.

A third set of alternatives would expand publicly financed 

LTC insurance programs. Although part of the total 

range of available options, that general approach would 

run counter to efforts to alleviate the federal fiscal pressures anticipated with the aging of the baby-boom generation and could further undermine the development of 

the private market for LTC insurance. Box 3-1 briefly 

summarizes some of those alternatives.

Restrict Growth in Long-Term Care 

Spending by Medicaid and Medicare

The fiscal strains that are expected to emerge with the 

baby boomers’ aging could be somewhat constrained by 

limiting the rise in spending for long-term care by Medicaid and Medicare that is likely to occur under current law. 

Limits on the growth of public LTC spending could be 

phased in over an extended period to allow people who 

faced new restrictions on eligibility and benefits ample 

time to make other financial arrangements. Rather than 

rely on public programs, they could seek private solutions 

to their future LTC financing needs by setting aside savings or purchasing private long-term care insurance.

Reduce the Number of People

Eligible for Medicaid Coverage

Medicaid’s spending for long-term care could be constrained by making it more difficult for middle-income 

people to qualify for coverage by spending down their resources. One approach would tighten existing limits on 

income and assets, which would delay some applicants’ 

entry into the Medicaid program and discourage others 

from applying at all. Another approach would eliminate 

some of the mechanisms that people currently use to 

spend down their income, which might significantly reduce the number of individuals who became eligible for 

coverage.

Place New Limits on Income and Assets. Medicaid’s current rules already restrict applicants from keeping more 

than a nominal amount of assets. Yet despite such restrictions, many applicants manage to protect a significant 

portion of their assets and still qualify for Medicaid coverage by taking advantage of certain rules regarding the 

disposition of assets. That practice, which is referred to as 

Medicaid estate planning, comprises several methods, 

some of the more common of which are discussed below.

Asset Conversion. Medicaid applicants can convert socalled countable resources (assets), such as savings and investments, into uncountable—or protected—resources 

by using them to purchase, for example, home improvements, an automobile, or appliances. In addition, applicants may place their assets in certain types of trusts or 

purchase annuities to convert assets into income.1

CHAPTER

1. Applicants can purchase annuities to convert jointly held assets 

into a stream of income for a spouse who remains in the community.
24 FINANCING LONG-TERM CARE FOR THE ELDERLY

Timing of Illegal Asset Transfers. Because of the way Medicaid applies penalties for illegal asset transfers, applicants 

may be able to protect as much as half of all their assets 

and still become eligible for Medicaid. For the purpose of 

simplicity, the following discussion uses an asset transfer 

amount of one-half, but depending on an individual’s situation, it could be less.

An applicant who is applying this strategy transfers about 

half of his or her assets to another party. (The transfer can 

be made as late as the day that the applicant enters the 

nursing home.) The applicant then spends the remaining 

portion of the assets on long-term care—typically, nursing home services. Once those remaining assets have been 

used, the person applies for Medicaid benefits.

Box 3-1.

Expanding Public Programs That Finance Long-Term Care

A policy to expand publicly financed long-term care 

(LTC) insurance could increase the number of people with LTC coverage, but the drawbacks of such a 

policy are likely to outweigh its benefits. Increasing 

spending by public programs—for example, by relaxing Medicaid’s financial eligibility requirements, 

expanding Medicare’s benefits for long-term care, or 

offering tax credits to people who become functionally impaired—would probably worsen the fiscal difficulties that future demographic changes are expected to bring if current law remains unchanged. 

Such a policy could shift spending for long-term care 

from private sources to the federal programs as well 

as diminish incentives for people to purchase private 

insurance. 

Expand Medicaid Eligibility

The federal government and the states could 

broaden coverage under Medicaid by raising the current limits on income and assets so that more people 

met the program’s criteria for financial eligibility. 

Such an option would, of course, bring a rise in 

costs—for states in particular, unless the federal government agreed to cover a larger fraction of Medicaid’s expenditures than it does now. (That model is 

followed in the State Children’s Health Insurance 

Program.) The costs that both the federal and state 

governments would incur by permitting beneficiaries 

to retain a larger amount of their assets could be 

somewhat constrained by establishing stricter standards for transferring assets to prevent people with 

significant resources from qualifying for Medicaid 

coverage.

Just as reducing the number of people eligible for 

Medicaid coverage is likely to stimulate additional 

sales of private LTC insurance (see the discussion in 

Chapter 2), increasing it is likely to further depress 

sales of private coverage by strengthening Medicaid’s 

distortionary impact in that market. The effect 

might not be large, however, unless the new asset 

standards for Medicaid eligibility were significantly 

higher than they were before. Another issue is that 

many of the individuals who qualified under the new 

criteria would otherwise have had to spend down 

more of their assets. Consequently, much of the increase in Medicaid’s expenditures would probably 

represent a shift from out-of-pocket spending.

Expand Benefits Under Medicare

Medicare could provide more-comprehensive LTC 

coverage than it currently does by expanding its benefits for skilled nursing facility and home health care 

or by covering other types of LTC-related services. 

Policymakers could enhance skilled nursing care coverage by dropping the requirement of a three-day 

prior hospitalization, by increasing the 100-day limit 

on coverage (making it more of a true “long-term” 

benefit), or by reducing the cost sharing that the 

benefit requires. They could also broaden the eligibility criteria for home health care services so that a 

greater number of impaired beneficiaries qualified 

for coverage. 

A more modest expansion might entail covering respite care, under which an impaired beneficiary living in the community is entitled to one to two 
CHAPTER THREE POLICY APPROACHES TO LONG-TERM CARE FINANCING 25

Asset transfers are illegal if they take place within 36 

months of a person’s application for benefits, and thus the 

Medicaid program’s rules require caseworkers to “look 

back” 36 months to see if the person transferred assets 

during that time. (Caseworkers are required to check 

back 60 months for transfers from certain types of trusts.) 

The applicant is penalized for having made an illegal asset 

transfer during the look-back period—the penalty is that 

his or her eligibility is delayed by the amount of services 

that could have been purchased with the transferred assets. However, the penalty begins on the date that the assets were transferred. Since half of them were transferred, 

the penalty ends on the date that the person uses up the 

other half of the assets and is otherwise eligible for MedBox 3-1.

Continued

weeks’ stay in a nursing home each year. The benefit 

is intended not so much for the impaired senior as 

for caregivers providing informal care. A break from 

what may be a heavy burden of care might help those 

caregivers sustain their efforts over a longer period—

thus preventing the elderly person from entering a 

nursing home permanently and possibly becoming 

dependent on Medicaid.

An expansion of Medicare might not affect consumers’ buying decisions in quite the same way that an 

expansion of Medicaid would, for two reasons. First, 

unlike Medicaid, Medicare is not means-tested—it 

has no income or asset limits that must be met before 

people are eligible for benefits. As a result, it does not 

discourage people from saving money (so they can 

purchase LTC services when they need them) or 

from buying private LTC insurance coverage. Second, private LTC insurance generally does not cover 

services that are covered by Medicare—in that sense, 

it supplements Medicare. If Medicare’s benefits were 

expanded, consumers might not desire as much private coverage as they otherwise would buy because 

some of their LTC needs would be covered by Medicare.

Establish Tax Credits for Impaired 

People

An alternative to direct public funding of long-term 

care would be to offer tax credits to taxpayers who 

are functionally impaired or who have a functionally 

impaired dependent. (The Bush Administration has 

proposed that an additional personal exemption be 

allowed for people who care for impaired relatives 

living in their homes. An exemption operates as a deduction from taxable income, whereas a credit directly reduces tax liability.) A tax credit program 

would depart significantly from traditional public 

LTC financing in the sense that it would provide a 

defined contribution—a cash subsidy of a specified 

amount—rather than a defined benefit. Beneficiaries 

would be able to exercise a greater degree of choice 

about the type of care they purchased and the providers from whom they purchased it. In fact, if they 

preferred, they could spend the money on goods and 

services not directly related to long-term care.

A tax credit might be more attractive to potential 

beneficiaries than a traditional program would be—

because of the unrestricted nature of a cash benefit—

but it could also have some substantial drawbacks, 

including its cost to the federal budget. Because cash 

has value to people whether or not they are impaired, 

a tax credit might offer a greater incentive relative to 

a more standard LTC benefit for people to exaggerate their impairments to qualify for the credit. In addition, the substantial discounts that public programs can often obtain from providers would 

probably not be available to recipients of cash assistance. 
26 FINANCING LONG-TERM CARE FOR THE ELDERLY

icaid. Thus, the applicant has effectively protected half of 

his or her assets—the half that was originally transferred 

to another party.2

Refusal of Support. In cases in which the spouse of a nursing home resident lives in the community, assets may be 

protected if the community spouse is willing to refuse to 

support the institutionalized spouse. Under that approach, the resident transfers all assets to the community 

spouse, who then refuses to make them available to pay 

for LTC services. (Box 1-2 on page 6 explains the rights 

of community-dwelling spouses under Medicaid’s rules.) 

This strategy takes advantage of a Medicaid policy that 

supports nursing home residents who have been abandoned by relatives.

The use of Medicaid estate planning inflates the program’s spending for long-term care by allowing people to 

qualify for Medicaid more quickly than they otherwise 

would have and without having to expend all of their 

own savings and other assets first. Little evidence exists 

regarding the extent of Medicaid estate planning, however. Anecdotal evidence suggests that it may be prevalent 

in only a few states—in particular, New York, New Jersey, 

and Massachusetts, whose Medicaid programs offer relatively generous benefits. Yet some analysts believe that it 

is becoming more common.3 Strengthening the rules to 

reduce the use of such strategies would delay the point at 

which some people became eligible for benefits and 

would prevent others from qualifying. It could also discourage some people from going through the application 

process. 

Eliminate Mechanisms for Spending Down Assets and 

Income. Under current law, states allow people with 

moderate income and assets to exhaust those funds and 

become eligible for Medicaid benefits under the medically needy option or the special income rule combined 

with the use of Miller Trusts (see Box 1-2 on page 6 for 

details). The number of people covered under Medicaid 

could be reduced by:

B Eliminating the medically needy option for spending 

down income and assets;

B Requiring all states to adopt the special income rule, 

whereby people must have income below a specified 

ceiling to qualify for Medicaid coverage; and

B Eliminating Miller Trusts as a method for reducing 

countable income below the ceiling. 

Together, those actions could significantly reduce the 

number of people who became eligible for Medicaid. In 

effect, people with income above a specified level—even 

if that level was less than the cost of living in a nursing 

home and they had no other assets—would be unable to 

meet the financial requirements to qualify for Medicaid 

coverage.

Tightening eligibility for Medicaid would shift the 

sources of financing of long-term care and might modestly improve efficiency. As people came to understand 

that their likelihood of being eligible for Medicaid was 

significantly lower than under current law, they would be 

more likely to make their own preparations for impairment in old age—by setting aside savings (if they chose to 

self-insure) or by purchasing private insurance. And if 

they did become impaired and were unable to obtain assistance from Medicaid, they would be more likely to 

shop for lower-cost providers and to use fewer services in 

order to conserve their resources.

Another potential effect from a tightening of Medicaid 

eligibility is that people who did not make their own 

preparations might find it more difficult to obtain care. 

One alternative would be to seek help from friends and 

family in the form of informal care or cash assistance (to 

purchase services). Limits on Medicaid eligibility might 

also affect providers of LTC services, especially nursing 

homes, who would probably see their expenditures for 

charity care and bad-debt expense rise as public financing 

declined. Some local governments might also increase 

spending.

2. The Congress included a provision in the Balanced Budget Act of 

1997 that made it a crime to accept fees for advising Medicaid 

applicants about making illegal asset transfers. The provision’s 

constitutionality came into question, however, and the Attorney 

General notified the Congress on March 11, 1998, that the 

Department of Justice would not enforce that part of the law.

3. See Joshua M. Wiener, David G. Stevenson, and Jessica Kasten, 

State Cost Containment Initiatives for Long-Term Care Services for 

Older People, CRS Report for Congress RL30752 (Congressional 

Research Service, May 8, 2000).
CHAPTER THREE POLICY APPROACHES TO LONG-TERM CARE FINANCING 27

Limit Services under Medicare’s 

Home Health Benefit

Medicare’s spending for long-term care could be constrained by altering coverage under the program’s home 

health care benefit. Compared with the skilled nursing facility benefit, which provides only modest coverage after 

the first 20 days of care and must be preceded by a hospitalization, the home health care benefit is relatively generous. Once a person meets the physical qualifications for 

coverage, there are no copayments or other coinsurance 

requirements. A modest cost-sharing requirement for 

beneficiaries could decrease the program’s LTC expenditures because beneficiaries would probably reduce the 

amount of care they used in response to that kind of financial incentive. Its overall impact on LTC spending, 

however, would likely be a modest one.

Improve the Functioning of the Market 

for Private Long-Term Care Insurance

Approaches that might improve the market for private 

long-term care insurance include standardizing private 

policies and allowing consumers to supplement Medicaid 

benefits with private coverage. Each of those approaches 

could provide a more attractive set of choices for people 

who wished to protect themselves against the financial 

costs of impairment, and each approach would improve 

the functioning of the private LTC insurance market. 

Nevertheless, each approach also has drawbacks. For example, although the standardization of policies could increase competition among insurers based on prices and 

lead to lower average premiums, it might also limit insurers’ ability to respond to changes in the long-term care 

marketplace and could restrict the variety of insurance 

options available to consumers.

Standardize Long-Term Care Insurance Policies

A policy to standardize the variety of LTC insurance policies now being sold would make it easier for consumers to 

compare premiums, might lead to more competition 

among insurers, and could make policies generally more 

understandable. Furthermore, benefit packages that conformed to governmental standards might not only boost 

consumers’ confidence in LTC insurance but also reduce 

the potential for favorable selection by preventing insurers from tailoring their products to appeal only to healthier purchasers.

The Health Insurance Portability and Accountability Act 

of 1996 already provides some standards that LTC policies must meet to qualify for tax-exempt status, such as 

benefit “triggers”—in the form of levels of impairment—

and provisions for consumer protections. In addition, 

most states have adopted at least some aspects of the 

model legislation on LTC policies recommended by the 

National Association of Insurance Commissioners. But 

the model legislation is primarily concerned with protecting consumers and not with standardizing policies. Moreover, states’ acceptance of any portion of the legislation is 

voluntary, and thus adoption has been piecemeal in nature. To limit the current variation in benefits and 

strengthen consumer protections might require federal 

intervention.

A major downside of standardization is that such an approach might dampen the demand for LTC coverage and 

thus block the objective it was meant to achieve. A required minimum set of benefits and consumer protections might be so comprehensive that insurers would 

have to charge higher average premiums, which would inevitably deter some potential purchasers. In addition, 

standardization might constrain insurers’ innovations in 

response to changes in LTC services or in the market for 

those services. A further disadvantage of standardization 

is that it could prevent insurers from offering a variety of 

products to meet consumers’ diverse needs.

Allow Consumers to Supplement Medicaid

Coverage with Private Policies

Permitting consumers to purchase private policies that 

supplemented Medicaid coverage could remove a significant impediment to the efficient functioning of the market for private LTC insurance. In general, Medicaid’s 

rules for financial eligibility do not allow enrollees to hold 

supplemental private insurance. Applicants for Medicaid 

must exhaust all other sources of LTC financing—including benefits offered by any private insurance they might 

carry. Being able to supplement Medicaid with private insurance coverage would make such policies a more realistic option for people who have a modest amount of income and assets that they would like to protect—that is, 

people with enough resources to desire some form of insurance coverage but not enough to justify the premiums 

they would have to pay for the several years of benefits 

they would need to effectively protect those resources under current law. 
28 FINANCING LONG-TERM CARE FOR THE ELDERLY

Box 3-2.

Comparing the Financial Impacts of a Partnership Policy

and Other Insurance Options

The Partnership for Long-Term Care offers people 

with modest income and savings a potential advantage by allowing them to protect more of those funds 

than they could under a conventional long-term care 

policy. The following example considers a man who 

purchases a policy at age 55 and becomes impaired at 

age 75, and whose income is less than the income 

ceiling for Medicaid eligibility.1

 The example compares the financial effects under a policy that provides one year of payments and a policy that provides 

two years’ worth. In the case of the one-year policy, 

the man is assumed to have $100,000 in savings at 

the time he becomes impaired; for the two-year policy, the assumption is that he has savings of 

$200,000. A third option is also examined—that the 

man has no insurance. In that case, the assumption is 

that he saves the money that he would have spent on 

premiums, investing it at an annual rate of return of 

8 percent.

In this example, the premium for a policy purchased 

at age 55 and covering approximately one year of 

care at a maximum of $100 per day (total benefit of 

$36,500) would be $47 per month. For two years of 

care (total benefit of $73,000), the premium would 

be $65 per month.2 The policies would both be adjusted for inflation of 5 percent per year. Thus, at age 

75, the one-year policy would pay a total of about 

$97,000 ($265 per day), and the two-year policy 

would pay about $199,000 ($265 per day in the first 

year and $278 per day in the second year). The example assumes that the policy’s benefit amount covers all necessary expenses.

The table to the right compares the financial impact 

that the man would experience with a three-year and 

five-year period of impairment under a partnership 

policy, a conventional policy, or no insurance. If the 

man had a one-year policy, his coverage would run 

out at age 76. At that point, the man would have to 

pay out of pocket for his care until he became eligible for Medicaid coverage. If he had a partnership 

policy, about $97,000 (the value of his policy’s benefit, as noted above) of the $100,000 in savings he 

had accumulated by age 75 would not be included in 

determining his eligibility for Medicaid. 

1. Based on average 2001 premiums for partnership policies in 

California. Such policies specify coverage limits by expenditures, not time. But the policies’ dollar value generally conforms to the yearly increments found in the policies offered 

in other states. For example, a policy that provides a daily 

maximum benefit of $100 is packaged as a total payout of 

$36,500 for one year of coverage, $73,000 for two years, and 

$109,500 for three years.

2. Premiums for partnership policies and conventional coverage are the same because the coverage itself does not differ 

between the two policy types. What differs is that the partnership policy allows some of the policyholder’s savings to be 

designated as uncountable assets for purposes of determining eligibility for Medicaid.
CHAPTER THREE POLICY APPROACHES TO LONG-TERM CARE FINANCING 29

Box 3-2.

Continued

The Financial Impact of Three Insurance Options

(Thousands of dollars)

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Under a conventional policy, the man’s savings 

would be depleted when he reached 77 years and two 

months of age. If he was uninsured, he would have 

about $30,000 more in savings at age 75 than if he 

had carried insurance (because he would have paid 

no premiums), but he would have to use the money 

to pay for his long-term care before he could qualify 

for Medicaid. Those savings would last until he was 

aged 76 years and four months; at age 78, he would 

have no savings left other than the minimal amount 

of assets allowed under California’s rules for Medicaid eligibility.

The outcome for the two-year policy would be similar. The partnership policy would leave the policyholder with nearly $200,000 in savings (the value of 

the policy benefit) at age 78 (and at age 80 as well). 

Conventional coverage would enable the policyholder to preserve some of his savings if the period of 

impairment lasted three years. But if it lasted five 

years, all of those savings would be exhausted. If the 

person was uninsured, he would run out of funds at 

77 years and eight months of age.

Partnership

Conventional

Private Insurance No Insurance

One-Year Policy

Savings at age 75 100 100 130

Savings at age 78 97 0 0

Savings at age 80 97 0 0

Age at which insurance expires 76 years 76 years n.a.

Age at which savings are used up Never 77 years, 2 months 76 years, 4 months

Two-Year Policy

Savings at age 75 200 200 240

Savings at age 78 199 13 0

Savings at age 80 199 0 0

Age at which insurance expires 77 years 77 years n.a.

Age at which savings are used up Never 79 years, 3 months 77 years, 8 months
30 FINANCING LONG-TERM CARE FOR THE ELDERLY

One example of how to structure supplemental LTC insurance is provided by the Partnership for Long-Term 

Care, which currently operates in California, Connecticut, Indiana, and New York.4 Originally sponsored by the 

Robert Wood Johnson Foundation, the program joins 

with state Medicaid programs to provide long-term care 

for beneficiaries who purchase partnership coverage. In 

essence, partnership policies are intended to allow middle-income people to purchase less-expensive, shorterterm LTC coverage and protect some or all of their assets.

Partnership policies resemble typical private LTC insurance policies in every respect except that they offer additional protection of assets. Policyholders who become impaired for an extended period and exhaust all of their 

LTC insurance benefits can apply for Medicaid coverage; 

the value of their assets up to the amount of their exhausted LTC benefits is not included in determining 

their eligibility. (New York and Indiana offer policies that 

protect all of a policyholder’s assets.) A substantial number of one- and two-year policies have been sold in California, Connecticut, and Indiana; New York requires 

three-year coverage. (See Box 3-2 on page 28 for an example of how a partnership policy works.)

Despite the potential advantages that the partnership 

program offers to its policyholders, the program is relatively small. One reason is probably that the average partnership policy has historically been somewhat more expensive—about 15 percent higher in 1995 and 1996—

than the average conventional policy because the partnership coverage had to include consumer provisions, such 

as inflation protection, that until HIPAA had not been 

required of conventional LTC insurance policies. Perhaps 

because of the price differential, partnership policyholdTable 3-1.

Average Annual Premiums for

Policies of the Partnership for

Long-Term Care, 2004

(Dollars)

Source: Congressional Budget Office using data from Connecticut's Office of Policy and Management, February 2004.

Note: The table reflects policies offering a benefit of $200 per day 

for both nursing home and home care, a 90- to 100-day 

elimination period, and automatically compounded inflation 

protection of 5 percent.

ers in 1996 actually had higher income and more assets 

than holders of conventional LTC insurance policies, 

rather than the lower income and fewer assets that the 

program’s originators envisaged would be the case.5

Another likely reason that the partnership program remained small in the late 1990s was that many insurers 

were reluctant to sell such policies because of the time 

and effort required to develop them and get them approved by the participating states. (Also dampening insurers’ enthusiasm were the data-reporting and other requirements established by the states.) The fact that the 

policies were not portable—a partnership policyholder in 

Indiana could only expect that state’s Medicaid program 

to honor the enhanced eligibility advantages of a partnership policy—was another feature that diminished sales. 

Indiana and Connecticut have since passed legislation 

that would allow for portability of the Medicaid assetprotection benefit that their policies include.

Today, the prices of partnership and conventional policies 

are similar, and many more policies are being sold to the 

more modest-income segments of the market that the 

partnership program was originally intended to target. 

HIPAA’s requirements for qualifying as a tax-advantaged 

policy have narrowed the gap in prices since 1996. In 

4. In 1993, the Congress effectively limited the partnership program 

to the original states by stipulating that policyholders in other 

states wanting to participate in the program would be subject to 

estate recovery. In other words, the states would be required to 

recover at least some of the assets of policyholders after they died, 

up to the value of Medicaid’s expenditures on their behalf. Thus, 

the value of a partnership policy was limited to preserving policyholders’ assets while they were alive. The President’s proposed 

budget for 2005 would eliminate the estate recovery requirement 

and so allow other states to establish programs under the same 

provisions that apply to the original four.

5. See Marc Cohen, “The Partnership for Long-Term Care: The 

Road Ahead,” in Nelda McCall, ed., Who Will Pay for Long Term 

Care? (Chicago: Health Administration Press, 2001).

If Policy Is Purchased 

at Age One Year Two Years Three Years

55 1,487 2,026 2,505

60 1,775 2,433 3,098

65 2,358 3,264 4,083

70 3,355 4,662 5,872

75 5,098 7,097 8,954

Premium for a Policy with a Term of
CHAPTER THREE POLICY APPROACHES TO LONG-TERM CARE FINANCING 31

fact, from 1996, when HIPAA was enacted, until the end 

of 2000, the total number of applications for partnership 

policies grew from 28,000 to 120,000. Over the same period, total sales of all LTC insurance policies grew from 

about 5 million to 7.5 million. If the acceptance rate of 

applications remained relatively constant over that period, then partnership sales grew at a much faster rate 

than did sales of all types of LTC policies. One of the major factors stimulating significant increases in sales of 

partnership policies was the changes in the program that 

were made to keep pace with innovations in conventional 

policies. According to one study, sales grew from 300 percent to 500 percent over the one-year periods following 

the policy redesigns.6

Another problem that has contributed to the relatively 

low rate of participation in partnership programs is that 

short-term partnership policies have not been proportionally less expensive than policies with longer terms. 

For example, in Connecticut, the average premium for a 

partnership policy providing benefits for one year is 

about 72 percent of the average premium for a policy offering two years of benefits and about 58 percent of the 

average premium for a three-year policy (see Table 3-1). 

The policies with the most extensive coverage—those offering inexhaustible lifetime benefits—cost about 60 percent more than policies that pay benefits for four years, 

according to Weiss Ratings.7

 Nevertheless, short-term 

policies are at least somewhat less expensive than conventional policies, and thus their sales offer less incentive to 

insurance agents, whose sales commissions are tied to the 

size of a policy’s premium.

An additional potential drawback to partnership policies 

is that they might increase Medicaid’s spending for longterm care. Without question, partnership policyholders 

would generate more Medicaid LTC expenditures than 

would holders of conventional policies because partnership coverage would allow policyholders to qualify for 

Medicaid without first exhausting all of their assets. And 

Medicaid expenditures would increase for those people 

purchasing partnership coverage who would have purchased conventional coverage if partnership coverage had 

not been available.

What is not as clear is how Medicaid expenditures might 

be affected by people who would otherwise not have purchased insurance at all. On the one hand, partnership 

policyholders might qualify for Medicaid more quickly 

than if they had never purchased LTC insurance. People 

with insurance do not pay the full price of long-term 

care; most of it is paid by their insurance coverage. As a 

result, they use more care—and qualify for Medicaid—

more quickly than if they had had to pay for all of their 

care out of pocket. On the other hand, people without 

insurance might qualify for Medicaid faster than they 

would if they had held a partnership policy. People without insurance have a diminished incentive to preserve 

their finances because by exhausting their resources 

quickly, they qualify for Medicaid that much faster. They 

also have a strong incentive to try to protect some of their 

assets using Medicaid estate planning. One reason that 

New York originally chose to require partnership policyholders to purchase 36 months of coverage was that that 

period exceeded the average time (30 months) during 

which a New York resident was penalized by having to 

pay for long-term care if he or she had previously transferred assets to become eligible for Medicaid. 

6. Mark R. Meiners, Hunter L. McKay, and Kevin J. Mahoney, 

“Partnership Insurance: An Innovation to Meet Long-Term Care 

Financing Needs in an Era of Federal Minimalism,” in Francis G. 

Caro and Robert Morris, eds., Devolution and Aging Policy (Binghamton, N.Y.: Haworth Press, Inc., 2002).

7. Congressional Budget Office calculations using data from 

Table 1-3.

A

An Overview of Long-Term Care Services

Long-term care services are generally categorized as 

either institutional or based in the home and community. 

Institutional care is provided primarily in nursing facilities, or nursing homes. Home and community-based services (HCBS) may be provided in people’s homes or in 

various facilities in the community, such as assisted living 

facilities (ALFs), board-and-care homes, and congregate 

housing. Some common types of home and communitybased services are home health care, personal care services, and adult day care.1

Nursing Facilities

Nursing facilities typically provide skilled nursing care for 

people who are recovering from acute episodes of illness 

involving a recent stay in the hospital; they also offer custodial care for people who are functionally impaired and 

unable to live independently. People who require skilled 

nursing care tend to remain in a facility for a relatively 

brief period, and their stays are likely to be covered by 

their health insurance—the same insurance that covers 

their hospital stays and office visits to physicians. (Medicare covers much of that type of care.) In contrast, functionally impaired residents of nursing facilities may remain there for extended periods—depending on their 

longevity, in some cases for many years. Their costs may 

be paid by Medicaid, or they may rely on their own resources if they do not qualify for public coverage.

The number of people in nursing homes has declined in 

recent years as a result of several factors, including the increasing use of home-based care and assisted living facilities and a decline in the prevalence of functional disability. From 1973 to 1985, about 50 of every 1,000 persons 

over age 65 resided in nursing homes.2 In 1997, that 

number had fallen to 43 per 1,000.3 About 56 percent of 

those residents were covered by Medicaid. (See Tables

A-1, A-2, and A-3 for additional data.)

Assisted Living Facilities

These facilities can be an attractive residential alternative 

for people who require some assistance but do not need 

the intensity of care provided at a nursing facility. And 

they may have special appeal for middle-income seniors 

because they tend to be less expensive than nursing 

homes and in many cases offer more attractive physical 

surroundings. ALFs range in size from very small operations to large-scale developments with 600 to 800 residents. Although they are not licensed as medical facilities 

(and most states do not license them to provide care to 

residents who are bedridden), ALFs may offer a wide 

APPENDIX

1. For more information on types of long-term care services, see the 

Web site of the Office of the Assistant Secretary for Planning and 

Evaluation of the Department of Health and Human Services 

(http://aspe.hhs.gov/daltcp/diction.shtml).

2. Based on an analysis by Genevieve W. Strahan, An Overview of 

Nursing Homes and Their Current Residents: Data from the 1995 

National Nursing Home Survey, Advance Data no. 280 (Centers 

for Disease Control and Prevention, National Center for Health 

Statistics, April 25, 2000); and on population data from the 

Bureau of the Census, available at http://eire.census.gov/popest/

archives/national/nation2/intfile2-1.txt.

3. Calculated from data in Celia S. Gabrel, Characteristics of Elderly 

Nursing Home Current Residents and Discharges: Data from the 

1997 National Nursing Home Survey, Advance Data no. 312 (Centers for Disease Control and Prevention, National Center for 

Health Statistics, April 25, 2000); and population data from the 

Bureau of the Census, available at http://eire.census.gov/popest/

archives/national/nation2/intfile2-1.txt.
34 FINANCING LONG-TERM CARE FOR THE ELDERLY

Table A-1.

Elderly Nursing Home Residents, by Age and Sex, 1997

Source: Congressional Budget Office based on Celia S. Gabrel, Characteristics of Elderly Nursing Home Current Residents and Discharges: 

Data from the 1997 National Nursing Home Survey, Advance Data no. 312 (Centers for Disease Control and Prevention, National 

Center for Health Statistics, April 25, 2000).

range of personal care and health-related services that appeal to people with functional impairments. In addition 

to room and board, ALFs provide 24-hour emergency 

monitoring, supervision and dispensing of medications, 

opportunities for socializing, and assistance with one or 

more activities of daily living. Home and communitybased services provided in ALFs may be covered under 

Medicaid HCBS waiver programs, but room-and-board 

costs cannot be covered.4 As a result, some states, such as 

Oregon, use ALFs extensively in their Medicaid programs 

because they are less expensive than nursing facilities yet 

offer many of the same services.

Board-and-Care Homes

Also called an adult care home or group home, a boardand-care home offers housing and personal care services 

to between three and 16 residents. Services such as meals, 

supervision, and transportation are usually provided by 

the home’s owner or manager. A board-and-care home 

may be a single-family dwelling; it is licensed as either an 

adult family or adult group home.

Congregate Housing

Congregate housing describes facilities with individual 

apartments plus shared dining and other common areas 

in which residents may receive some services, such as a 

daily meal, with other tenants. (Additional options may 

include housekeeping, transportation, and individual 

meal preparation but not personal care and protective supervision.) Typically, residents pay for congregate housing 

with their personal resources, but some people may obtain federal housing grants to pay for these living arrangements.

Adult Day Care

Adult day care is a community-based program for functionally impaired adults that provides a variety of health, 

social, and related support services in a protective setting.

Table A-2.

Average Length of Stay of Current

Elderly Nursing Home Residents,

by Age and Sex, 1997

(Days)

Source: Congressional Budget Office based on Celia S. Gabrel, 

Characteristics of Elderly Nursing Home Current Residents and Discharges: Data from the 1997 National Nursing Home Survey, Advance Data no. 312 (Centers for 

Disease Control and Prevention, National Center for 

Health Statistics, April 25, 2000).

Age Group

198.4 13.5 80.8 21.7 117.7 10.8

528.3 36.1 159.3 42.8 368.9 33.8

738.3 50.4 132.0 35.5 606.3 55.5 

Total 1,465.0 100.0 372.1 100.0 1,092.9 100.0

65 to 74 Years

75 to 84 Years

85 Years and Older

 Both Sexes Males

Number

(Thousands) Percent

Females

Number

(Thousands) Percent

Number

(Thousands) Percent

4. Under the waiver programs (which are discussed in more detail in 

Appendix B), states have the option of providing impaired people 

with enhanced community support services that are not otherwise 

authorized by the federal statutes governing Medicaid. 

Age Group

857 823 881

789 759 801

932 725 977

Average, All Groups 870 761 907

Males Females

Both 

65 to 74 Years

75 to 84 Years

85 Years and Older

Sexes
APPENDIX A AN OVERVIEW OF LONG-TERM CARE SERVICES 35

Table A-3.

Average Length of Stay of Discharged Elderly Nursing Home Residents,

October 1996 to September 1997

Source: Congressional Budget Office based on Celia S. Gabrel, Characteristics of Elderly Nursing Home Current Residents and Discharges: 

Data from the 1997 National Nursing Home Survey, Advance Data no. 312 (Centers for Disease Control and Prevention, National 

Center for Health Statistics, April 25, 2000).

Adult day care centers are often the locus of treatment for 

programs such as PACE (Program of All-Inclusive Care 

for the Elderly), which serves impaired seniors who wish 

to remain in the community. Typically, the functionally 

impaired person spends the day at the center and the 

night at home. Some state Medicaid programs cover that 

form of care; the Medicare fee-for-service program does 

not, although some alternative Medicare financing programs may. (Appendix B discusses PACE in more detail.) 

Table A-4.

Average Duration of Care of Elderly 

Home Health Care Patients, 1996

(Days)

Source: Congressional Budget Office based on Martha Little Munson, Characteristics of Elderly Home Health Care Users: 

Data from the 1996 National Home and Hospice Care Survey, Advance Data no. 309 (Centers for Disease Control 

and Prevention, National Center for Health Statistics,

April 25, 2000).

Home Health Care

Home health care provides medically oriented services for 

acute or chronic illness in the patient’s home; it often follows a hospital stay for an acute medical condition or a 

discharge from another type of medical facility. Most insurers, including Medicaid, Medicare, and private insurance, provide at least limited coverage for home health 

care. (Tables A-4 and A-5 provide demographic information on elderly home health care patients.)

Personal Care

For people who need assistance in performing activities of 

daily living, Medicare covers some personal care services—known as home health aide visits—under its 

home health care benefit. Beneficiaries must be receiving 

home health care services to qualify for such visits. State 

Medicaid programs have the option of offering personal 

care but vary in their coverage of such services. Many of 

them cover personal care as part of a Medicaid HCBS 

waiver program. However, the most common source of 

personal care is the donated care of family members and 

friends.

Reason for Discharge

60 10.2

55 19.0

729 27.1

392 28.3

126 7.5

78 7.6

Average, All Discharged Residents 341 100.0

All Discharged Residents

Length of Stay

 (Days)

Percentage of 

Admitted to Another Nursing Home

Other

Recovered

Stabilized

Deceased

Admitted to Hospital

Both

 Sexes Males Females

Discharged Patients 107 104 109

Current Patients 336 331 338
36 FINANCING LONG-TERM CARE FOR THE ELDERLY

Table A-5.

Elderly Home Health Care Patients, by Age and Sex, 1996

Source: Congressional Budget Office based on Martha Little Munson, Characteristics of Elderly Home Health Care Users: Data from the 1996 

National Home and Hospice Care Survey, Advance Data no. 309 (Centers for Disease Control and Prevention, National Center for 

Health Statistics, April 25, 2000).

527.9 30.1 180.4 34.2 347.5 28.4

820.5 46.8 253.5 48.0 566.8 46.3

404.9 23.1 94.4 17.9 310.6 25.4 

Total 1,753.4 100.0 528.3 100.0 1,224.8 100.0

Number

(Thousands) Percent

Males

 (Thousands)

Number

Percent

 Both Sexes

(Thousands)

Number

Percent

Females

65 to 74 Years

75 to 84 Years

85 Years and Older

Age Group
B

Recent Policy Initiatives Affecting

Long-Term Care Financing

The federal government has undertaken several initiatives to control how much publicly financed programs 

spend on long-term care (LTC) and to increase the efficiency of LTC services. Additional objectives of those initiatives include improving the quality of care provided to 

people who are impaired and better coordinating Medicare and Medicaid benefits for people who are eligible for 

both programs. The initiatives have reduced costs modestly and improved efficiency to some degree, but evaluations of the programs have generally concluded that those 

outcomes were largely achieved through so-called favorable selection of participants (participants were healthier 

than average) or by the shifting of costs to other programs. Indeed, some new programs’ expenditures have 

actually been higher than costs for the fee-for-service programs that they were designed to replace.

The rest of this appendix reviews some of the government’s major initiatives regarding publicly financed LTC 

programs. The first two sections, those dealing with 

home and community-based services (HCBS) programs 

and the so-called Cash and Counseling Demonstration 

fall under the “consumer-directed” rubric (which implies 

greater participation of the beneficiaries in planning their 

care) and are two of the most prominent such programs. 

The remaining discussion describes some representative 

attetmps to integrate state and federal financing for longterm care.

Home and Community-Based

Services Programs

In 1981, the Omnibus Budget Reconciliation Act gave 

states the option of setting up HCBS waiver programs 

under Medicaid to serve impaired people—both seniors 

and individuals under age 65—in the community rather 

than solely in nursing homes. Established under section 

1915(c) of the Social Security Act, the waiver programs 

allowed states to provide enhanced community support 

services (such as respite care, home modifications, and 

nonmedical transportation) that are not otherwise authorized by the federal Medicaid statutes. The programs held 

out the promise of reducing states’ Medicaid spending by 

caring for qualified HCBS patients in the community 

rather than in nursing homes—not only to save money 

but also to help patients retain some sense of independence. As of 2001, 49 states and the District of Columbia 

had established some type of HCBS waiver program. (Arizona provides home and community-based services under a separate demonstration program, as discussed 

later.)1

In general, Medicaid’s spending per patient for HCBS 

programs is much lower than its spending for nursing 

home care: Medicaid’s average costs per HCBS recipient 

were $3,135 in 2000, compared with about $20,220 for 

the average nursing home resident.2

 But those savings 

may be illusory because of the so-called woodwork effect 

and because of cost shifting.

APPENDIX

1. Demonstrations are programs in which one or more regulations 

are relaxed to test different ways of managing a particular program.

2. The average cost of $20,220 includes nursing home patients who 

were institutionalized for the entire year as well as patients who 

had much shorter nursing home stays.
38 FINANCING LONG-TERM CARE FOR THE ELDERLY

As evaluators of HCBS programs discovered, the increased availability of home-based care brought new patients “out of the woodwork”—patients who were eligible 

for care in a nursing home but who would not have entered one in the absence of the HCBS program.3

 Of 

course, the increased spending implied by such an effect 

is not necessarily inappropriate or unwelcome, since the 

people who benefit are eligible for the new program and 

presumably were meant to receive its services. But the 

woodwork effect boosts the number of recipients beyond 

what it would have been if only nursing home care had 

been available. As a result, it increases Medicaid’s costs for 

providing long-term care, even though home and community-based services cost less per patient than institutional care does. To encourage states to more aggressively 

move institutionalized Medicaid beneficiaries back into 

the community, the President, in his 2005 budget, has 

proposed that the federal government pay all HCBS costs 

for those beneficiaries for the first year after they leave the 

facility.

Some programs may have succeeded in saving money, 

however. Evaluations of a few state programs concluded 

that they might have reduced spending below what it 

would have been without the HCBS waiver—by aggressively screening applicants, exploiting other sources of financing, and carefully controlling spending for homebased services, among other approaches. The authors 

caution, however, that the results’ validity is limited by 

the lack of an appropriate control group.4

Another reason that the savings attributed to home-based 

care may be exaggerated is that a portion of them represents not actual economies but a shift in costs to payers 

other than Medicaid. When a Medicaid enrollee who is 

eligible for nursing home care lives at home rather than in 

a nursing facility, room and board are his or her responsibility.5 (However, enrollees living at home are also allowed to keep more of their income than they could if 

they were institutionalized at Medicaid’s expense.) In addition, some spending on home-based services shifts from 

Medicaid to the Medicare program under its home health 

care benefit. Thus, substituting HCBS for institutional 

care might be desirable to the impaired person and could 

reduce both Medicaid and overall LTC expenses. However, it would not necessarily reflect a more efficient use 

of resources.

The Cash and Counseling

Demonstration

Three states—Arkansas, Florida, and New Jersey—are 

participating in this program, which allows impaired 

Medicaid beneficiaries who reside in the community to 

use the program’s funds to purchase services on their own 

rather than rely on Medicaid-provided care. The program 

is intended to give beneficiaries more choices among 

types and sources of services and a stronger incentive to 

search for lower prices to get the most care for their 

money.6

 (Typical Medicaid coverage provides less of a financial incentive to use services efficiently because beneficiaries experience no direct benefit from doing so.) The 

President has proposed to further strengthen that incentive by allowing beneficiaries enrolled in the demonstrations to accumulate savings and still maintain their eligibility for Medicaid and Supplemental Security Income 

coverage.

Preliminary evaluation results from Arkansas, the first 

state to implement the demonstration, showed that participants in the cash and counseling program were more 

satisfied with the quality of the care they received, had 

more access to paid care, and had fewer unmet needs for 

services relative to participants in the traditional Medic- 3. See Steven Lutzky and others, Review of the Medicaid 1915(c) 

Home and Community Based Services Waiver Program Literature 

and Program Data (prepared by the Lewin Group for the Department of Health and Human Services, Health Care Financing 

Administration, June 2000).

4. See Lisa Maria B. Alecxih and others, Estimated Cost Savings from 

the Use of Home and Community-Based Alternatives to Nursing 

Facility Care in Three States, Pub. no. 9618 (Washington, D.C.: 

AARP Public Policy Institute, November 1996); and General 

Accounting Office, Medicaid Long-Term Care: Successful State 

Efforts to Expand Home Services While Limiting Costs, GAO/

HEHS-94-167 (August 1994).

5. States that use assisted living facilities (ALFs) in their Medicaid 

programs save money because residents pay the room-and-board 

charges. (ALFs offer a wide range of personal care and healthrelated services but not the intense care provided in a nursing 

facility.)

6. More information is available at www.cashandcounseling.org. See 

also Kevin J. Mahoney and Lori Simon-Rusinowitz, “Cash and 

Counseling Demonstration and Evaluation: Start-Up Activities,” 

Journal of Case Management, vol. 6, no. 1 (Spring 1997), pp. 25-

30.
APPENDIX B RECENT POLICY INITIATIVES AFFECTING LONG-TERM CARE FINANCING 39

aid program.7 The evaluators noted, however, that the results also suggested that the program could lead to paid 

care’s replacing unpaid care and a rise in total Medicaid 

spending.

Moreover, the program could have an even larger woodwork effect than that observed in the Medicaid-sponsored 

HCBS programs. Impaired people who met Medicaid’s 

eligibility criteria but had not previously accepted government coverage might choose to claim benefits under the 

new program if they had greater flexibility in using Medicaid assistance. In turn, their participation could push up 

spending, although that might not be an undesirable outcome if those expenditures served impaired people who 

otherwise might have gone without care or obtained it 

only through hardship imposed on family and friends. In 

addition to spending prompted by a woodwork effect, 

the program might see some inappropriate expenditures 

if some people exaggerated their physical infirmities to 

qualify for benefits.

Demonstrations That Integrate

Acute and Long-Term Care

Health maintenance organizations and some other providers of acute care accept some financial risk in serving 

their patients because they receive a fixed payment for 

each enrollee regardless of the amount of care he or she 

may use. That system encourages providers to reduce 

costs by eliminating unnecessary treatment—which can 

increase efficiency—but it gives them no incentive to 

provide services that might eliminate or lessen the need 

for long-term care and no encouragement to coordinate 

acute and long-term care to both save money and benefit 

the patient.8

 Assigning financial responsibility for both 

kinds of care to a single organizational entity could create 

that incentive and make service delivery more efficient. 

For example, directing more resources toward rehabilitating a patient after a stroke might increase spending on 

acute care, but it could also lead to overall savings and a 

better outcome for the patient if rehabilitation restored 

functions lost through the stroke and thereby prevented 

or delayed years of long-term care.

Since the early 1980s, the Centers for Medicare and Medicaid Services, or CMS (formerly the Health Care Financing Administration), has authorized several demonstrations in which providers receive capitation payments that 

cover the entire spectrum of care—from acute to long 

term.9

 The demonstrations described in this section include social health maintenance organizations, or 

S/HMOs; the Program of All-Inclusive Care for the Elderly (PACE); and related variants initiated by the states.10

Social HMOs

These entities are similar to Medicare Advantage (formerly, Medicare+Choice) health plans:11 they receive a 

monthly capitation payment from Medicare and accept 

full financial risk for the cost of all medical benefits to 

which their enrollees are entitled. But the payments that 

S/HMOs receive are somewhat higher than the payments 

made to Medicare Advantage plans to allow S/HMOs to 

provide a modest array of LTC benefits in addition to the 

services typically covered by the Medicare plans. Social 

HMOs enroll both healthy and impaired seniors, although the majority of enrollees are not impaired. The 

programs are funded almost exclusively by Medicare and 

by enrollees’ premiums. (S/HMOs may receive Medicaid 

funding for their enrollees who are eligible for that program, but most S/HMO enrollees are not so eligible.)

Four S/HMO sites were established in the project’s first 

phase, in 1984. Three are still operating and as of January 

2004 enrolled just over 70,000 Medicare beneficiaries.12

The Congress authorized a second round of sites in 1990; 

7. Stacy Dale and others, “The Effects of Cash and Counseling

on Personal Care Services and Medicaid Costs in Arkansas,” 

Health Affairs Web Exclusive, November 19, 2003, available at 

www.healthaffairs.org.

8. Acute health care comprises such services as hospital care and physicians’ visits. 

9. Capitation is a payment method whereby a contracting provider 

of care receives a flat monthly fee to provide services to an enrollee 

over that period. Typically, the payment does not vary, regardless 

of how many services are provided.

10. For more details, see Edward Alan Miller, Federal and State Initiatives to Integrate Acute and Long-Term Care: Issues and Profiles, CRS 

Report for Congress RL30813 (Congressional Research Service, 

January 22, 2001).

11. The change in name will take effect in 2006, but the Congressional Budget Office, like many organizations, has begun to use 

the plans’ new name.

12. The operating sites are Elderplan, Inc., in Brooklyn, New York; 

SCAN Health Plan in Long Beach, California; and Senior Advantage II, part of Kaiser Permanente of the Northwest, in Portland, 

Oregon.
40 FINANCING LONG-TERM CARE FOR THE ELDERLY

one phase II S/HMO is now operating in Las Vegas, with 

roughly 50,000 members.13 Compared with the sites set 

up in the first phase of the project, the Las Vegas plan is 

designed to provide more specialized geriatric care. It also 

features expanded case management to better coordinate 

care and thus address some of the problems with coordination that had been identified among the phase I sites.

The LTC benefits offered by S/HMOs typically include 

community-based services—such as help with homemaking activities and household chores, personal care, 

transportation to medical appointments, adult day care, 

respite care, and case management—as well as limited 

nursing home services.14 Spending for LTC services offered by S/HMOs is subject to ceilings that differ by the 

type of benefit (home and community-based care or 

nursing home care) and period (monthly, annual, or lifetime). The annual maximum benefit ranges from $7,800 

to $9,600 per enrollee. In general, the S/HMO may provide LTC services only to enrollees who are impaired 

enough to qualify for admission to a nursing home.

For each enrollee of plans established during the project’s 

first phase, the S/HMO base payment is 105.3 percent of 

the county rate for Medicare Advantage plans. That payment is adjusted on the basis of the enrollee’s age and sex 

as well as several other factors, including whether the enrollee is a nursing home resident, is enrolled in Medicaid, 

is working, or has end-stage renal disease. In addition to 

the slightly higher base payment, phase I S/HMO payments differ from those of Medicare Advantage plans in 

that they are higher for community-dwelling enrollees 

who meet the state’s eligibility criteria for admission to a 

nursing home.15 Payments to Medicare Advantage plans 

are not adjusted in that fashion. As a result of those payment differences, phase I S/HMO plans receive payments 

that average about 15 percent to 30 percent more than 

those of their Medicare Advantage counterparts.

The payment method for phase II sites is completely different from the phase I approach. The payment for each 

enrollee is based on an analysis of data from the Medicare 

Current Beneficiary Survey and depends on the enrollee’s 

sex, the presence or absence of certain chronic diseases, 

the ability to perform the activities of daily living, selfreported health, and the ability to walk a quarter mile. 

Each year, the payments are updated, in part through surveys that gather new data on each enrollee’s health status. 

Under this new method, payments for the phase II S/

HMO plan and for Medicare Advantage plans in the 

same county differ by only about 5 percent.

Like Medicare Advantage plans, S/HMO plans are in the 

midst of a transition to a new risk adjustment mechanism 

called the CMS-Hierarchical Conditions Category 

(CMS-HCC) model. Under that new method, the base 

payment is adjusted according to the enrollee’s frailty as 

measured by the CMS-HCC model. The shift to the new 

payment methodology began this year and will continue 

for several years. In 2005, Medicare Advantage plans will 

be paid half on the basis of the CMS-HCC model and 

half on the basis of the system in place in 2003. S/HMO 

plans will be paid 30 percent on the basis of the CMSHCC model and 70 percent on the basis of the 2003 

system.

Research on the S/HMO demonstrations suggests that 

they may not provide better health outcomes than those 

provided by typical Medicare (and Medicaid) fee-for-service coverage of post-acute care. Indeed, analyses show 

that impaired S/HMO enrollees have had somewhat 

higher mortality rates than fee-for-service beneficiaries 

have had.16 Enrollees’ satisfaction with the program appears to vary by their functional status. Assessments of 

the phase I demonstrations indicated that in general,

S/HMO enrollees who were not impaired were more 

satisfied with the care they received than were Medicare 

fee-for-service beneficiaries, whereas impaired S/HMO 

enrollees were less satisfied. The data on customer satis13. Personal communication to the Congressional Budget Office by 

Thomas Theis, Project Officer, Centers for Medicare and Medicaid Services, February 17, 2004.

14. See Appendix A for a description of adult day care. Nursing home 

services are not intended to cover long stays. For example, the 

SCAN Health Plan in southern California offers a “short-term 

institutional stay” benefit for respite care or to help frail patients 

rest for up to two weeks after a hospital stay. The benefit has a 

maximum lifetime cap of $15,000 on expenditures.

15. That so-called frailty adjustment is intended to reflect the historically higher amount that the Medicare fee-for-service program 

spends on health care for institutionalized beneficiaries.

16. That finding is documented in Miller, Federal and State Initiatives 

to Integrate Acute and Long-Term Care; and Kenneth Manton and 

others, “Social/Health Maintenance Organization and Fee-forService Health Outcomes Over Time,” Health Care Financing 

Review, vol. 15, no. 2 (1993), pp. 173-202.
APPENDIX B RECENT POLICY INITIATIVES AFFECTING LONG-TERM CARE FINANCING 41

faction, however, are from the late 1980s and may not be 

representative of the experience of today’s enrollees.17

A study that compared enrollees in the S/HMO demonstrations with Medicare Advantage enrollees in the same 

counties showed many of the same results as in the feefor-service comparison and found no justification for the 

higher payments that S/HMOs receive. For example, 

evaluators found no evidence that enrollees in the 

phase II S/HMO obtained better health outcomes than 

their Medicare Advantage counterparts, and enrollees in 

phase I S/HMOs were no more satisfied with the quality 

of their care or their health insurance coverage. Moreover, 

except for the Kaiser S/HMO, there was no measurable 

difference in health status or functioning between Medicare Advantage and phase I S/HMO enrollees, although 

the S/HMO enrollees were older. Evaluators also discovered that despite significantly higher payments for their 

enrollees, phase I S/HMOs—with the exception of the 

Kaiser site—did not spend all of the extra revenue on 

long-term care benefits.18

PACE (Program of All-Inclusive Care

for the Elderly)

PACE began as a demonstration authorized under the 

Omnibus Budget Reconciliation Act of 1986, but the 

Balanced Budget Act of 1997 established the PACE 

model as a permanently recognized provider type under 

both the Medicare and Medicaid programs. Today, 32 

PACE organizations provide preventive, acute, and LTC 

services to approximately 9,000 enrollees.19

PACE enrolls Medicare beneficiaries who are frail enough 

to be eligible for nursing home care but who want to continue living at home. Although not a requirement, nearly 

all PACE enrollees are also eligible for Medicaid. People 

who are not eligible for Medicaid may enroll in PACE, 

but they are required to pay a monthly premium similar 

to the state’s payment for people who are eligible. The 

premiums have deterred many people who are not eligible for Medicaid from enrolling in PACE.

In PACE’s model of service delivery, the main locus of 

care is the adult day care center, where enrollees receive 

the bulk of their care from multidisciplinary teams of 

providers that include physicians, nurses, and case managers. Typically, the providers are PACE employees, drawing a salary rather than charging fees for each service they 

provide.

PACE plans receive monthly capitation payments from 

both Medicare and Medicaid to cover their enrollees’ 

costs for acute and long-term care. Before January 1, 

2004, Medicare calculated its PACE payment in the same 

way that it calculated a Medicare Advantage payment but 

then multiplied the payment by a frailty adjustment of 

2.39. Beginning on January 1, 2004, the Medicare payment for PACE began a transition to a risk-adjustment 

approach using the CMS-HCC model (the approach also 

being used to adjust payments for Medicare Advantage 

and S/HMO plans). Under that method, the base payment will be adjusted by each enrollee’s frailty score as 

measured by the CMS-HCC model as well as by a frailty 

score for the particular PACE organization to which the 

enrollee belongs.

Medicaid’s payment for PACE enrollees is a rate negotiated between the state and the PACE organization that, 

in theory, is less than would otherwise have been paid for 

a comparable population. The state must establish an upper payment limit based on a comparable population, a 

limit that includes weighted costs from both the home 

and community-based population and the nursing home 

population. Typically, rates are set at a percentage of that 

upper payment limit, which varies by state.

Evaluations of PACE have shown less nursing home use, 

lower mortality rates, lower rates of inpatient utilization 

(hospital days), and higher satisfaction for enrollees than 

for their Medicare fee-for-service counterparts. However, 

PACE’s ability to delay or prevent the need for nursing 

home care may result in part from favorable selection: although PACE enrollees are significantly impaired when 

they enter the program, they appear to be less impaired 

than nursing home residents. That finding suggests that if 

they had not joined PACE, they would still not have required care in a nursing home and their associated Medi17. See Office of Research and Demonstrations, Health Care Financing Administration, Status Report on the Implementation and Evaluation of the Social Health Maintenance Organization Demonstration (1996).

18. See Judith Wooldridge and others, Social Health Maintenance 

Organizations: Transition into Medicare+Choice (report submitted 

by Mathematica Policy Research, Inc., to the Health Care Financing Administration, January 5, 2001).

19. Personal communication to the Congressional Budget Office by 

Tonya Moore, Project Officer, Centers for Medicare and Medicaid 

Services, March 2004.
42 FINANCING LONG-TERM CARE FOR THE ELDERLY

care costs might have been much lower than Medicare’s 

capitation payment to PACE sites.

An evaluation published in 2000 found that care delivered through PACE costs a little more than care from the 

Medicare and Medicaid fee-for-service programs.20 The 

analysis compared PACE’s capitation payments with 

what Medicare and Medicaid would have spent, on a feefor-service basis, for PACE enrollees during their first 

year in the program. Overall, the two programs’ payments to the PACE plans exceeded what they would have 

spent if the PACE enrollees had remained under fee-forservice arrangements. Yet those results should be interpreted with caution because the study looked only at the 

first year of enrollment in PACE and the authors did not 

have a good comparison group. Currently, the potential 

impact of PACE on national LTC spending is limited by 

the small number of people who actually join the program. However, an expansion of the program’s enrollment would probably increase rather than decrease Medicare’s and Medicaid’s LTC spending.

The Arizona Long-Term Care System

The Arizona Long-Term Care System (ALTCS) is the 

first capitated LTC Medicaid program in the nation to 

operate statewide. ALTCS provides both acute and longterm care for its enrollees and is their sole source of 

Medicaid-funded LTC services. The program serves severely impaired people both older and younger than age 

65; clients must be so impaired that their condition qualifies them for a stay of at least 90 days in a nursing home 

(although they need not actually be institutionalized to 

qualify for coverage under ALTCS). Patients who require 

stays of less than 90 days may receive such care in Arizona’s regular acute care Medicaid program if they otherwise meet the state’s eligibility requirements for enrollment.

ALTCS controls costs by aggressively screening potential 

beneficiaries, which helps constrain possible woodwork 

effects. One study estimated that 97 percent of ALTCS 

enrollees needed help with toileting and eating compared 

with 65 percent of nursing home residents nationwide.21

ALTCS also helps restrain spending by designing financial incentives to encourage the utilization of lower-cost 

care.

Health plans that participate in the Arizona program may 

be privately owned or operated by a county. The state 

pays the plans a capitation amount, which does not vary 

according to an enrollee’s institutional status, to encourage them to provide services economically. To develop the 

payment for each plan, the state estimates the proportion 

of people who could be served through home and community-based services rather than in nursing homes in 

the coming year. It then sets the capitation rate to cover 

what the plan would have to spend on the basis of that assumption. If the actual proportion of enrollees served by 

home and community-based services is larger than had 

been estimated, the plan retains 70 percent to 100 percent of the savings depending on their magnitude; if the 

proportion is smaller, the state reimburses the plan for 

only zero to 30 percent of its resulting losses (again, depending on the extent of the savings).22 Participating 

plans thus have a powerful incentive to use home and 

community-based services rather than nursing homes.

According to a CMS-funded evaluation of the ALTCS 

demonstration, the capitated system saved 16 percent of 

the costs that would have been incurred for nursing home 

care if Arizona’s program had been a more traditional 

Medicaid program.23 Another study, which compared 

ALTCS data with Medicaid data from other states, estimated that ALTCS produced savings equal to about 

35 percent of the nursing home costs that would have 

been incurred without it.24 The reasons for the Arizona 

program’s success—which were identified in both studies—were the careful screening process (in one analysis, 

20. Abt Associates, Inc., Evaluation of the Program of All-Inclusive Care 

for the Elderly Demonstration: A Comparison of the PACE Capitation Rates to Projected Costs in the First Year of Enrollment (report 

prepared for the Health Care Financing Administration, October 

27, 2000).

21. See William G. Weissert and others, “Cost Savings from Home 

and Community-Based Services: Arizona’s Capitated Medicaid 

Long-Term Care Program,” Journal of Health Politics, Policy, and 

Law, vol. 22, no. 6 (1997), pp. 1329-1357.

22. See Michael S. Sparer, “Health Policy for Low-Income People in 

Arizona,” in Assessing the New Federalism, Occasional Paper no. 32 

(Washington, D.C.: Urban Institute, 1999).

23. See Nelda C. McCall and others, Evaluation of Arizona’s Health 

Care Cost Containment System Demonstration: Final Report (prepared for the Health Care Financing Administration by Laguna 

Research Associates, San Francisco, February 1996).

24. Weissert and others, “Cost Savings from Home and CommunityBased Services.”
APPENDIX B RECENT POLICY INITIATIVES AFFECTING LONG-TERM CARE FINANCING 43

nearly 75 percent of the ALTCS clients were deemed to 

be at high risk of nursing home placement) and the aggressive use of home and community-based services 

rather than institutionalization. But the savings that 

ALTCS produced may be exaggerated if some of the clients who were at high risk of institutionalization would 

not, in fact, have chosen to enter a nursing home if home 

and community-based services had not been available. 

Another consideration in weighing the value of the demonstration is that the stricter eligibility criteria employed 

by ALTCS may mean that many of the people who failed 

to qualify are still significantly impaired and must either 

purchase long-term care or obtain it informally from a 

family member or friend. (In another state, those people 

might have qualified for LTC services under a more traditionally run Medicaid program.) Such individuals may 

also use greater amounts of acute care than they would 

have if they had been accepted into the ALTCS program.

Other Long-Term Care Programs for Elderly People

A number of states participate in the Medicare/Medicaid 

Integration Program, an effort sponsored by the Robert 

Wood Johnson Foundation that seeks to better coordinate financing, case management, and the delivery of services for people who are eligible for coverage under both 

of those public programs. The current roster of states receiving funding comprises Colorado, Connecticut, Florida, Maine, Massachusetts, Minnesota, New Hampshire, 

New York, Oregon, Rhode Island, Texas, Vermont, 

Washington, and Wisconsin. For the purposes of illustration, the following discussion highlights three of those 

programs. 

Minnesota Senior Health Options, the Wisconsin Partnership Program, and Massachusetts Senior Care Options 

are demonstrations that are working to delay institutionalization (by expanding home and community-based services), control costs, and reduce administrative complexity. Wisconsin’s program enrolls only people whose 

impairments are severe enough to qualify them for nursing home care; the Minnesota and Massachusetts programs enroll both healthy and impaired seniors.

In general, these demonstration programs receive 

monthly capitation payments from Medicare and from 

their respective state Medicaid programs. For each impaired enrollee (a Medicare beneficiary), the demonstration programs, like PACE plans, receive funding from 

Medicare that is 2.39 times the county payment rate for 

Medicare Advantage plans. (The programs’ payments for 

healthy enrollees are essentially the same as those to the 

Medicaid Advantage plans.) And, like the S/HMOs and 

PACE plans, these state demonstration programs are 

shifting to the CMS-HCC risk-adjustment approach. 

The transition began this year: programs were paid 90 

percent on the basis of the old method and 10 percent on 

the basis of the CMS-HCC model. In 2005, the plans 

will be paid 30 percent on the basis of the CMS-HCC 

method and 70 percent on the basis of the system in place 

in 2003.

The states’ Medicaid payments are also capitated and adjusted to cover the costs of an impaired population. In 

the Minnesota program, for example, the Medicaid payment for impaired seniors equals the average monthly 

payment for home and community-based services less 5 

percent. For enrollees who are admitted to nursing 

homes, the demonstration programs pay all costs for the 

first six months. After that, the state is responsible for 

paying the nursing home’s basic per diem rate, and the 

programs must pay all remaining expenses.

Conclusion

In general, demonstrations integrating acute and longterm care do not by themselves offer much promise of 

substantially lowering future LTC spending, although the 

model they represent may be beneficial for their enrollees. 

Programs that rely on voluntary enrollment—even 

though they may provide cost-effective, high-quality 

care—have not attracted large numbers of people. In addition, because most of the programs are available only to 

people who are eligible for Medicaid, the pool of potential participants includes just a fraction of the people who 

need LTC services. Indeed, for many of the programs, an 

important objective has been to better coordinate funding from Medicare and Medicaid because elderly impaired people and their caregivers are often overwhelmed 

by the administrative complexity involved in receiving 

benefits from both programs.

Enrollees in S/HMOs need not be eligible for Medicaid, 

and therefore those programs could have a larger enrollment than is possible for some of the other integrated 

programs. The distinction is moot, though, since few 

managed care plans have been willing to participate, and 

the LTC benefits may be inadequate for people with significant long-term care needs.