THE DEFERRAL OPTION IN LONG-TERM-CARE INSURANCE

Abstract

Long-term-care (LTC) insurance contracts provide the insured with different benefits for several nursing care levels, for a limited number of benefit eligibility periods. A common assumption in pricing these LTC contracts is that the insured will exercise the right to claim benefits as soon as the eligibility conditions are satisfied. This assumption, however, may contradict the insured's optimization, as it might be worthwhile not to claim when in low care levels and, by doing so, save the option of claiming higher (more expensive) care levels in the future. We term this option of the insured as the deferral option. The consequence of the traditional pricing (i.e., of ignoring the deferral option) is unexpected losses to the insurer. The factors affecting the deferral option's value are the risk of death, the discount factor, the benefit levels of the different care levels, and the transition probabilities between the different care levels.