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.
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