How can private insurance help fund Australia’s aged care?

Private insurance in the form of long-term care could deliver higher quality aged care Australians are demanding, but there are potential drawbacks to using it

Australia’s aged care system is currently feeling the pressures of the last few years, with a combination of overworked and underpaid staff and a lack of resources. While a rise in the national minimum wage and the modern award minimum wage (to 5.2 per cent and 4.6 per cent respectively) will improve the base rate for some aged care and health care workers, there are still significant challenges ahead.

The Australian government is tasked with delivering a sustainable aged care funding model. Australian government-funded aged care services include in-home care, residential care in aged care homes, and short-term care such as respite care. But within all of these models, there is a myriad of systemic issues uncovered in the Final Report of the Royal Commission into Aged Care Quality and Safety (2021). With over 2670 reported deaths in aged care since the start of the pandemic, two-thirds of those deaths occurring in the first six months of 2022, and an estimated 50 sexual assaults occurring nationally every week in residential aged care facilities, it is clear there is a crisis in Australia’s aged care.

“The current government commits to improving aged care quality and financing, along with other government-provided services including health and childcare,” says Michael Sherris, Professor in the School of Risk and Actuarial Studies at UNSW Business School and Chief Investigator and Director of Industry Engagement at the Centre of Excellence in Population Ageing Research (CEPAR). “At the same time, it must address the massive deficit from the COVID pandemic, as well as the impact of increasing inflation and interest rates. There is no question that the current approach to aged care financing is resulting in rationing and neglect in the aged care sector,” he says.

Prof. Sherris is a leading expert in this space, appointed Head of Actuarial Studies at UNSW Sydney in 1998 to establish the program. While he officially retired in 2016, he continues to research, as well as supervise and mentor other researchers in this space. His research sits at the intersection of actuarial science and financial economics and has attracted several international and Australian best paper awards. 

According to Prof. Sherris, while the Aged Care Royal Commission made recommendations to improve the financing of aged care including an aged care levy, the increased resources will require a significant change to aged care financing in Australia. Areas like intergenerational equity will need careful consideration going forward, along with the structure of care payments and incentives to limit moral hazard. 

Put simply, additional funding for care services will be required, and one way of doing this, he says, is through the private insurance market. This could include government financing from consolidated revenue, contributions from individuals during their working lives, and means-tested co-payments from individuals for care costs. But to do this adequately, a balance between financing sources and integration with retirement income financing is needed.

“The development of private market insurance to finance individual co-payments and contribute to aged care costs such as living and accommodation during residential care will, therefore, be worth exploring,” says Prof. Sherris.

So how might Australia achieve such funding? Is private market insurance just a way for the government to offload its responsibility to ensure quality aged care options for seniors? Private insurance, which differs from Australia’s current private health insurance market, can certainly help, but there are several important considerations. Prof. Sherris explains:

Does private insurance for aged care differ from private health insurance?

Prof. Sherris: Private insurance for aged care is usually referred to as long-term care insurance. In return for a premium, it provides specified payments when an individual becomes functionally disabled and needs care. It differs from private health insurance, where, in Australia, some private health policies cover care needs after a hospital stay or in some cases palliative care.

Long-term care insurance makes payment usually when an individual has difficulties in carrying out a specified number of activities of daily living (ADLs) that relate to self-care (like eating, dressing, getting into or out of a bed or chair, taking a bath or shower, and using the toilet) or suffers cognitive decline (impacting memory, language, thinking or judgement) and requires care to function, referred to as functionally disabled.

Private long-term care insurance most often uses difficulties in ADLs, usually, two or more, or three or more, to determine when payments are made, usually certified by a physician. There is usually a maximum benefit period and a waiting period before benefits are paid. Policies can pay cash benefits, regardless of costs expended, or pay amounts based on the cost of care required, referred to as indemnity or reimbursement policies. Long-term care insurance is also often provided as riders to other insurance products such as life insurance, retirement life annuities or variable annuities.

How could private long-term care insurance benefit aged care in practice?

Prof. Sherris: In practice, individuals would first need to consider their aged care needs and the finance they have in retirement including superannuation and home ownership as well as the Australian government aged care funding. They would need to consider the means-testing for government aged care funding as well as the annual and lifetime caps on individual contributions to care costs. If they then decided they wanted to provide additional funds to pay for care, say if they were to become functionally disabled, then they would purchase long-term care insurance for either a single up-front premium or a regular monthly premium for a specified amount of regular care payment when functionally disabled.

But long-term care insurance is not for everyone. They would need to decide to purchase long-term care insurance early on in retirement, or preferably before retirement while in good health since insurance premiums increase with age and insurers usually do not offer long-term care insurance to individuals not in good health.

It could, however, be designed to fund care requirements during waiting periods for a government aged care package, pay for additional care, meet co-payments, or fund the higher level of co-payments or daily accommodation costs required for residential care.

Is long-term care insurance available in Australia?

Prof. Sherris: Currently, there are several countries where private long-term care insurance is available including the UK, USA, and France. But there is no private insurer offering long-term care insurance in Australia. The Australian government provides aged care home packages and provides funds to residential care providers to finance aged care needs based on an Aged Care Assessment. 

In Australia, the Retirement Income Covenant for Superannuation funds is placing an increased focus on risks and income needs of members in retirement. A major risk is needing aged care, and with the rationing and funding issues of the government aged care financing leading to a system of neglect and long waiting periods for home packages, there is likely to be an increased focus on aged care financing needs and how they link with superannuation and retirement income needs and risks in the future.

Given the issues with government-provided aged care highlighted by the recent Aged Care Royal Commission, additional funding through private long-term care insurance can provide cash when needed and is not available from the government aged care financing. As with all insurance, there can be significant benefits to paying premiums. For example, individuals can have more certainty about their future retirement risks and finances.

What are the cons of private market insurance for aged care?

Prof. Sherris: Long-term care insurance is most likely to be of interest to couples with significant financial resources who want to protect an inheritance. This is mostly because long-term aged care insurance is often regarded as expensive since premiums need to cover not only the insurance costs but also the loadings for the insurer to cover solvency capital costs, underwriting expenses, and claims administration. Loadings for long-term care insurance can be as high as 30 to 40 per cent. This reflects the risk from systematic trends and uncertainty in mortality and morbidity impacting the financial solvency of the insurer. But product innovations such as combined life annuities with long-term care insurance and pooled mutual long-term care insurance can reduce these costs. 

It’s also important to include inflation in benefit payments, which adds to the long-term care insurance cost. Insurers are also not always willing to provide long-term care insurance because of the risk of adverse selection. Adverse selection arises from individuals with higher risks of claiming. 

What about the aged care levy?

Prof. Sherris: An aged care levy was recommended by the Aged Care Royal Commission as a way of increasing funds available for aged care. It would be like the Medicare Levy which we pay to partly fund government health and NDIS costs. It is paid based on taxable income during working life.

If such a levy was adopted for aged care, then this is where intergenerational issues become important and also where the role of an insurance structure for financing aged care would be important to ensure the aged care levy was applied to improving aged care.

Read more: Here's how to fix the broken model for funding aged care

Is private insurance just a way for the government to offload its responsibility?

Prof. Sherris: The government funds specified amounts for home care packages as well as specified funding for residential care. The aged care royal commission has highlighted how this funding is inadequate to provide a sufficient level of quality of care, and substantial additional funding would be required. Otherwise, the current system of poor-quality residential care and long waiting time for home care packages will continue. So, government funding will always be the most significant form of financing for aged care, especially for individuals with limited resources in older age.

In other countries such as Japan, where they have an insurance-based aged care financing system, individuals contribute but government financing is important. Individuals with sufficient resources are generally willing to contribute towards their aged care especially if it improves the quality. With the government budget under pressure, additional resources from individuals will contribute to improving the system, especially as the Australian superannuation system matures and retirees will have more financial resources to support the risks of needing aged care in retirement.

Read more: The home stretch: accessing home value to fund long-term care

Can’t the government just allocate more money to aged care in the Budget?

Prof. Sherris: The government could allocate more funding to aged care in the budget. It rations then funding provided for ages care based on a ratio of people over age 75 in the Australian population. The basis they use to allocate funds is inadequate since the measure they used does not reflect the ageing population and the time when aged care will be needed. They are also under budget constraints.

The previous government aimed to keep the budget out of deficit and cut back or constrained costs to do this. Then came COVID and they had no option other than to use government budget funds to finance the impact of COVID producing the trillion dollars of debt, large amounts of money in the system and resulting in high inflation and high and volatile share markets and home prices.

The previous government did allocate more funds to age care following the Royal Commission report, but this was not enough to remove the waiting lists for aged care that existed, never mind future aged care needs. So the Labor government could allocate more funding but needs to balance this against other funding for health, and defence as well as considering the massive COVID debt that we will have to somehow finance.

No matter how you consider the financing of aged care there will be a need for more contributions from individuals if we want to meet the future expected demand and have a reasonable quality of care.

Michael Sherris is a CEPAR Chief Investigator, Director of Industry Engagement, and a part-time Professor of Actuarial Studies at UNSW Business School. His research sits at the intersection of actuarial science and financial economics and has attracted several international and Australian best paper awards. For more information, please contact Prof. Sherris directly.