Should State Long-Term Care Insurance Funds Invest In Stocks?

California’s evolving effort to build a public long-term care insurance program includes an important, and potentially far-reaching, feature: The insurance fund would be allowed to invest some assets in stocks.

This would be a dramatic change for both social insurance and long-term care insurance. For example, Social Security is allowed to invest only in Treasury bonds. Regulators require private long-term care insurance companies to invest their premiums only in super-safe bonds.

A California state task force is mulling several alternative public long-term care insurance models. They vary by size, structure of benefits, and cost. The group is scheduled to release final recommendations by the end of the year.

Balanced Portfolios

But, perhaps surprisingly in deep blue California, 60% of the 15-member panel wants to see taxes used to fund the program (or contributions, if you prefer) invested in a diversified portfolio including bonds and stocks. Only 30% favored a portfolio of bonds only.

In Washington State, the task force that designed its public long-term care insurance program also recommended broadening investment guidelines to include equities. Washington State will begin collecting taxes to fund its program next month and will start paying benefits in a few years.

In both states, allowing equity investments would require no less than a constitutional amendment. But it may be time to consider such a move.

For private long-term care insurance, regulators limited investment options because they worried carriers might not be able to pay promised benefits during a steep stock market downturn. That forced insurers to accept lower returns in return for market stability. And it is one of the reasons why premiums have risen so steeply in recent years.

Trading A Bit More Risk For Lower Taxes

Just as the price for lower investment returns is higher premiums for private insurance, the price is higher taxes for a public program. And to keep taxes low, most members of the California commission seem willing to accept the increased risk of some equity investments.

The comparison is not perfect, but typically corporate pension funds invest about one-third of their assets in publicly-traded stocks, about half in bonds (including corporate debt), and the rest in a mix of real estate, private equity and other alternative investments, according to the consulting firm wtw.

Public pensions have invested even more in stocks, about 47% in 2019, according to the Pew Charitable Trusts.

Higher Returns

Stocks are attractive because over the long run investment returns are far higher than for bonds. For example, over the past half century, stocks have generated an average annual return of about 11.73% while Treasury bonds have returned about only 6.59%.

Bonds generally are less volatile than stocks and overall carry less risk. But as we have seen over the past year, when interest rates rise, older bonds that pay relatively low rates of interest can lose a lot of their value. Over the long run, a well-balanced portfolio of stock and bonds can outperform bonds with relatively little additional risk.

The last time the idea of investing social insurance in equities got any airing was in 2005, when President George W. Bush proposed allowing younger workers to invest some of their Social Security taxes in personal retirement accounts. While the Social Security Trust fund itself would not have invested in equities, eligible workers would have had the flexibility to invest their own accounts in many different assets. But Democrats attacked the idea as privatization of the sacrosanct retirement program, most congressional Republicans were unwilling to support it, and the idea died a quick death.

Guardrails

No prudent investor would put long-term funds in any single asset class. Every responsible investment adviser preaches diversification, especially over the long run. And remember, social insurance programs begin collecting taxes/contributions as soon as people start to work (say, age 20). And participants in a public long-term care insurance program typically would not begin to claim benefits until they reach their 80s. A 60-year time horizon is a very long time to hold a portfolio of only debt.

Of course, whatever the asset allocation, any public trust fund needs appropriate investment guardrails and oversight. The system must make sure that managers avoid chasing high returns at the price of excessive risk (a mistake college endowments are notorious for making).

But as the California task force and some political leaders in Washington State are coming to realize, limiting investments for long-term care insurance comes with a price that may not be worth paying.