Dynamic Inefficiencies in Insurance Markets: Evidence from Long-Term Care Insurance

Most analyses of insurance market failures have been implemented in a one-period (static) setting, with considerably less attention devoted to problems arising in a multi-period (dynamic) context. In a dynamic framework, risk-averse individuals benefit not only from period-by-period "event" insurance, but also from insurance against becoming a bad risk and begin reclassified into a higher-risk group with a concomitant increase in premiums. We refer to this latter possibility as "reclassification risk." This article examines the private market for long-term care insurance in the US and present empirical evidence suggesting that it does not provide full insurance against reclassification risk.