This week, it has been reported that the UK government is proposing to increase National Insurance by 1 percentage point, in order to fund social care, along with introducing a cap on the total contribution that an individual would need to make of between £60,000 and £80,000. However, why is this cap on contributions necessary, and why does this require an increase in taxation to fund it?
By Dr Steven Proud.
Plans to reform the funding of social care have sat in the manifestos of political parties of all colours for many years, with plans for funding social care including many unpopular policies, including unpopular taxes such as one whereby assets would be sold after an individual dies to pay for their cost of care.
Social care is an umbrella term for a range of services, which provide care and protection for individuals who may not be able to care for themselves. Most commonly, when people discuss social care, they think about care for older people (e.g. in a care home, providing support for dementia), but social care also encompasses care for young people, and for individuals with learning and physical disability. In this post, I focus on care for older people.
Care takes a number of different forms. Typically, the form of this care ranges from carers visiting the service-user’s home to provide care within the home (domiciliary care), to at an extreme, residential care, provided with nursing support. Unlike health care, there is no universal funding for social care and what funding there is, is means-tested, based on the wealth of the individual. In England, individuals with wealth greater than £23,250 currently are required to pay for their entire cost of care.
Typically, for an older person living alone who owns their own home, the value of the home will be included within the calculation of their wealth. Since the average house price in England is £271,434 (Source: Gov.UK), this means that if an older person is a home-owner, and they need social care, then they will be liable for the full cost of that care. With the annual costs of nursing home places between £35,000 and £55,000 (Laing and Buisson), this means that individuals with complex, and long-term care needs could face almost unlimited liability for their care.
Even though individuals run the risk of almost unlimited liability, only a small proportion of the population will ever need the highest level of social care, and so this is a risky activity. In a well-functioning market, individuals could purchase insurance products to protect against unexpected costs (e.g. against crashing their car), yet for social care in the UK, there are no insurance products available which fully protect an individual against the risk of requiring social care. Without insurance, people who are unlucky enough to require social care may need to sell off their assets (such as their home, if they are homeowners) in order to pay for the cost of their care.
Why doesn’t an insurance product exist?
In 2015, Amy Finkelstein wrote that ‘Long-term care represents one of the largest uninsured financial risks facing the elderly in the United States,’ and the UK is little different. But why is there no market for long-term care insurance?
To illustrate this, let’s begin by illustrating how insurance products work. Essentially, an insurance policy is a way of “pooling risk.” In the population, it might be the case that one out of every 50 people is likely to face significant social care costs (e.g. £600,000). For simplicity, let’s assume that the other 49 out of 50 people face zero risk (and won’t require social care). However, no individual knows for sure whether they will need social care or not.
If everyone in the population takes out an insurance policy, then the insurer can charge a premium, so that the cost of care is split equally between everyone in the population. This would mean that to cover a cost of £600,000 affecting one person out of every 50, they would have to charge a premium of at least £12,000.
This simple model of insurance raises several issues. If, within the population, there are some individuals who are much lower risk than others of needing long-term care, they may choose not to purchase insurance, meaning that the premium the insurance company needs to charge to avoid making a loss would need to be increased. This could then price higher-risk individuals out of the market as well, leading to no one purchasing insurance!
Secondly, there is an aspect of mismatched liabilities for individuals with moderate levels of assets. Consider an individual with assets of £30,000, and (unbeknownst to them) faces lifetime social care costs of £600,000. Without insurance, initially, they would be liable for the full cost of their care, but once their assets had been depleted to £23,250, the state would step in to provide support. This would mean that their total liability would only be approximately £20,000.
Now consider the same example, but in this case, they have taken out an insurance policy, protecting their wealth against the need for social care. If the insurance company covers the full cost of care, then their assets will never be depleted to pay for the care. As such, they will never be eligible for state support for their care, and the insurance company would need to continue to pay the full cost of care (up to, in this example, £600,000). As such, we can think of the insurance company facing almost unlimited liability, whilst service users would only face limited liability, due to implicit insurance from the state. Because of this implicit insurance from the state, they might decide not to purchase an insurance policy, and run the risk that she needs to pay for the (relatively lower cost) of social care.
In 2011, the Commission on Funding of Care and Support, led by Andrew Dilnot published proposals to reform the funding of social care. The headline proposal was to introduce a cap of approximately £35,000 to the lifetime amount that any individual was liable to pay for social care, and for the state to step in and pay for all costs beyond this cap.
By introducing a cap, the funding of social care would act a little like a social insurance policy; depending on where the cap is set, only those with the highest care needs would ever exceed the cap, but the cap itself would act as a limit on the liability that any one individual would face. In most insurance policies, there is an excess which policyholders need to pay in the result of a claim; the cap on social care costs would act a little like the excess on an insurance policy; before the insurer (the government) steps in, you need to pay a minimum amount yourself, up to the cap, and then the insurer (the government) pays the remaining costs.
By limiting individuals’ liability explicitly, there may be several advantages. Firstly, in the absence of private insurance, it lowers the risk of any individual having to deplete most of their assets to pay for care; in 2018, 52% of households headed by over 65s lived in households with wealth greater than £500,000 (source: ONS). As such, this would mean that, for the majority of individuals, even if they faced the highest care needs, they would not need to dispose of the majority of their assets.
Secondly, as a spillover, limiting individuals’ liability might increase the likelihood of private insurance companies stepping into the market to provide insurance products to cover the costs up to the cap. By limiting the costs to any one individual, the market failure created by the potential unlimited liability (above) may be reduced.
Based on 2011 data, the Dilnot commission estimated that introducing a cap of £35,000, along with other reforms, would cost the state an additional £1.7billion per year. With increases in the overall cost of care (and inflation), and with an aging population, this cost to the state will have increased over time.
Whilst a cap on overall costs would lower the risks of individuals facing almost unlimited liabilities, it would still leave the median older person needing to dispose of a large proportion of their assets to pay for social care. This raises the question of whether, like the NHS, social care should be provided for free at the point of use.
The impact of providing universal social care for all would be a significant increase in costs for the Government. Whilst it is true that, even with a cap of £35,000, only a small minority of individuals would ever receive support from the government for care costs, a large proportion of older people will have some need for social care at some point in their life. There are 5.7 million people aged 75 or over in the UK (up from 4.8 million in 2009) and expected to grow to 8.9 million in 2039. Even with relatively low care needs, a universal, free social care policy would require significant additional government funding, to go alongside the increased cost of state pensions (and hence a significant increase in taxation).
Impact of a National Insurance increase
National insurance is effectively a tax that is used to determine eligibility for state pension benefits later in life. In effect, national insurance, plus income tax gives the level of total tax burden an individual faces (based on income alone). By increasing the national insurance contributions by one percentage point, basic rate taxpayers would increase their tax from 32% to 33%, higher rate from 42% to 43%, and top-rate from 52% to 53%. This would mean that the average worker would pay approximately £200 extra in taxation each year.
When national insurance contributions from employees are increased, this is often paired with an increase in national insurance contributions from the employer. Whilst these are not directly paid by the worker, this makes employing a worker more expensive, and could lead to downward pressure on wages, or at the margin, a reduction in employment.
It is important to remember that national insurance is only payable on earnings from employment (or self-employment), and is not paid after the state pension age. This means that, whilst older people pay taxes on earnings from pensions, they do not pay national insurance contributions. As such, the policy of increasing national insurance contributions would act as a transfer from younger people, to protect the assets of older people.
An increase in taxation, provided it is hypothecated towards funding social care could provide a new source of revenue, and if allied to a cap in care costs could lower the fear and risks associated with potentially needing high levels of care in old age.
However, the use of national insurance is likely to be seen as unfair, particularly from those workers with lower incomes, who will have an increased tax burden to protect the assets of older pensioners.
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