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To Borrow or Insure? Long Term Care Costs and the Impact of Housing

Pension finances

Adam W. Shao, Hua Chen and Michael Sherris

We consider the impact of housing and the availability of reverse mortgages and long-term care insurance on a retiree's optimal portfolio choice and consumption decisions. Individuals decide how much to borrow against their home equity and how much to insure health care costs with long-term care insurance. We build a multi-period life cycle model that takes into consideration longevity risk, health shocks and house price risk.

We use an endogenous grid method along with a regression based approach to improve computational efficiency and avoid the curse of dimensionality. Our results show that borrowing against home equity dominates long-term care insurance reflecting higher consumption in earlier years and inclusion of longevity insurance. Long-term care insurance transfers wealth from healthy states to disabled states but reduces earlier consumption because of the payment of upfront insurance premiums.