Private insurance 'not a painless solution to welfare pressures', warns report

Based on an analysis of costs in areas where private welfare insurance is already being marketed, the study concludes that public social security schemes may offer better value for money than is commonly supposed.

It also warns policy makers against assuming that private insurance offers a painless way out of the dilemma created by rising demand for welfare services and constraints on taxation and spending. The state could still face a rising bill for supporting 'high risk' individuals and many others unable to pay the private sector's premiums, while losing tax contributions from those who opt out.

Tania Burchardt and John Hills of the London School of Economics used data from 10,000 adults to examine private insurance in three different areas - to cover mortgage payments in case of unemployment or reduced earnings; to replace income during long-term sickness; and to meet the costs of care in old age.

They found that:

• The costs of private insurance were substantial. To cover himself in just these three areas - a small part of welfare protection - a 45-year old married man with average earnings might typically pay £900 a year - equivalent to 6p in the pound on his income tax.
• Switching from social security to private insurance generally increased costs for those on average to low incomes - and for others, if they were rated 'high risk' by insurance companies.
• Mortgage payment protection policies covering unemployment offered poor value for money compared with other insurance products. For example, the amount companies would pay out in claims as a proportion of the premiums taken was well below that for motor insurance.
• Private insurance against long-term sickness was appropriate for niche markets, such as the higher income self-employed. However, a comparison between private premiums and claims for state Invalidity Benefit by typical younger employees suggested that commercial polices were expensive for the cover provided.
• The value of long-term care policies was almost impossible to assess given the inevitable uncertainty regarding future care costs and needs. To cope with this, insurers set high premiums and restrictions on the circumstances in which they would pay out - including stringent tests of disability under which many existing residents of care homes might be excluded.

Effect on incomes

Looking at the effects of switching mortgage payment protection from tax-funded social security to private insurance, the analysis shows that people on higher incomes and non mortgage-holders would gain, while home-buyers with average to low incomes would lose out. A move away from flat-rate premiums in the insurance industry to rates based on an assessment of personal risk would mean even greater costs for lower income owners.

Commercial permanent health insurance policies would cost more than the equivalent state sickness benefit for people with low incomes, for women and for those classed as high risk, such as individuals with a history of poor health.

Illustrative calculations of the consequences of moving from state provision to private long-term care insurance suggested it would be equivalent to switching tens of thousands of pounds - over an individual's lifetime - from those at the bottom of the income distribution to those at the top. Women would lose out more than men because of their greater need for long-term care.

Tania Burchardt said: "If these case studies are typical of the kinds of risks that private insurance would be expected to cover, then policy makers should consider their options very carefully indeed before advocating any major shift from public to private welfare protection.

"Reliance on private insurance to cover long-term care looks an especially dubious proposition, since the state would still have to pay for uninsured individuals and for those who failed the stringent disability tests set by insurers. The considerable costs of premiums would, meanwhile, add to the pressures on government to hold down spending and taxation."

Policy options

The report urges policy makers to decide how a balance should be struck between public and private welfare insurance on a case by case basis. It identifies a spectrum of options ranging from no state involvement to protection financed entirely out of tax. These include:

• Safety net protection - state-funded provision for excluded groups and others unable to afford private premiums.
• Regulation - such as rules obliging private insurers to accept all applicants and to hold down premiums for policyholders on low incomes.
• Compulsion - spreading risk and reducing costs by compelling consumers to take out private policies, as with motor insurance.
• Arms-length provision - passing the administration of a compulsory national insurance fund to private or non-profit sector managers. (This was the model recommended last year by the Joseph Rowntree Foundation Inquiry into Meeting the Costs of Continuing Care).
• Earmarked taxes - where state provision remains the fairest, most cost-effective solution, it might be appropriate to restrict insurance contributions to potential claimants (e.g. mortgage insurance funded by further cuts in mortgage interest tax relief).

John Hills said: "Given the tax and public spending constraints on government, it is tempting to see private replacements of welfare provision as a straightforward way to reduce revenue requirements. This study shows there could be major difficulties in implementing such a strategy.

"Private alternatives will, in some cases, cost the average family more while serving to make the rich richer and the poor poorer. But publicly-funded and provided provision is not the only alternative: there is a range of possible solutions - such as the hybrid National Care Insurance scheme suggested in a recent JRF report - that may be appropriate."