WE - Disability Insurance

Can we leave Disability Insurance to the market?

1) Independent risks = yes
2) P <1 = yes
3) P known or estimable = yes
4) no adverse selection = NO
5) no moral hazard = NO

Why do we need state intervention in Disability Insurance

1) moral hazard & adverse selection
2) Redistribution

Adverse selection and Disability insurance

asymmetric information = insurance very expensive for individual with bad health (underinsurance when good health)

Dealing with adverse selection in disability insurance

mandatory insurance

Moral hazard and Disability Insurance - Three sides

1) insured worker
2) employer
3) medical doctors

Moral Hazard DI - insured worker

may invest too little in their health, take too many risks, or try to exaggerate their impairments

Moral hazard DI - employer

may invest too little in prevention and reintegration, or try to use DI as substitute pathway into unemployment

Moral Hazard DI - medical doctors

may take into account personal condition of workers (third-party payment problem)

Disability Insurance in Practice

1) public provision
2) strong regulation
3) possibility to buy complementary insurance from a private insurer

Trade-off when designing Disability insurance

disincentives effects on labor supply
VS
providing adequate insurance against income loss

DI - disincentives effects on labor supply

price of insurance, how much does it cost to increase coverage, also in terms of labor supply

DI - providing adequate insurance against income loss

Value of insurance
depends on risk aversion and distributive preferences

Disability insurance provides coverage against

loss of earnings due to
1) professional risks
2) social risks

DI - professional risks

disability caused by work

DI - Coverage against professional risk

1) mandatory insurance
2) risks are defined rather precisely
3) provision of insurance can be private

DI - Coverage against social risks

benefit level typically related to work history

Different ways to organise DI programmes

1) Flat-rate benefits
2) Unemployment-type benefits
3) Pension-type benefits

DI - Flat-rate benefits

benefit level similar for everyone
= tax-financed

DI - Unemployment-type benefits

benefits depend on recent work history (as in unemployment insurance), replace a portion of previous earnings

DI - Pension type earnings

benefits dependent on entire work history

Residual earnings capacity (formula)

disability degree = ( Earning before MINUS earnings after ) / earning before

Insurance eligibility

often determined by threshold for earnings capacity

threshold for earnings capacity

1) either minimum percentage loss of pre-disability earnings
2) or maximum absolute level of residual earnings

Working when getting disability benefit

benefits get less, the more you work
partial benefit or reduced entitlement

Disability insurance and work incentives

1) Fixed benefit
2) Income replacement
3) wage subsidy

DI - Fixed benefit

benefits do not depend on hours/earning of the recipient (up to a threshold)

DI - rational behind Fixed benefit

fulfill basic needs + compensate for additional cost of working with disability

Effect of Fixed benefit on labor supply

Income effect = less working hours

DI Fixed benefit & budget constraint

shifts budget constraint upwards
= working becomes unattractive
= leisure becomes attractive

DI - Income replacement

benefits cover percentage of lost earnings

DI - Rationale behind Income replacement

1) maximal benefits if person unable to work
2) no benefits needed if earning do not drop

DI - Effect of Income replacement on labor supply

Substitution AND Income effect

DI - Effect of Income replacement on working hours

decreases working hours

DI - Effect of Income replacement on budget constraint

turns budget constraint upwards
same starting point but less steep now

DI - Income effect of income replacement

intersection of upwards shifting old budget constraint and higher indifference curve

DI - Substitution effect of income replacement

from intersection of old budget constraint slope and new indifference curve TO tangent point of higher indifference curve and new budget constraint

DI - Wage subsidy

Get higher benefits if work more than a given threshold

DI - Rationale behind wage subsidy

Alleviate some of the undesirable effects of the previous scheme, stimulate labor supply

DI - Wage subsidy effect on working hours

depends where the threshold is

DI - Wage subsidy effect on budget constraint

has a jump at the threshold

DI - Wage subsidy effect when threshold is above optimum (e.g. less hours than optimum)

will work less hours at higher indifference curve

DI - Wage Subsidy effect when threshold is below optimum (more hours than optimum)

more hours worked at higher indifference curve

Trade-offs for optimal coverage of DI

1) reduction in labor supply due to moral hazard or due to alleviating liquidity constraints
2) costs of disincentives vs value of insurance

Moral hazard as reason for less employment when DI is generous

people enjoy leise that is pad for by the insurance
= without DI they would work

Liquidity constraints as reason for less employment when DI is generous

DI allows people to take time for health they wouldn’t otherwise

How to determine if its moral hazard or liquidity constraints

compare incentives effects for individuals with more or less liquidity constraints

DI - Same incentives effects across individuals (with more or less liquidity constraint)

moral hazard as reason for less employment

DI - stronger effect for liquidity constraint group

liquidity constraint plays a role in less employment

Optimal coverage of DI

optimal drop in consumption = incentive effect of DI / risk aversion

Incentive effect of DI

what is the influence of the DI system on unemployment duration
= empirical question

Categories of DI reforms

1) Enhancing employer incentives
2) Stricter screening
3) Increasing work incentives

DI - Enhancing employer incentives

1) continued wage payments
2) DI experience rating

Pros - Enhancing employer incentives

1) reduces DI inflow
2) decreases DI outflow

Cons- Enhancing employer incentives

1) too much risks imposed on firms
2) adverse effects on hiring

Enhancing employer incentives - adverse effects on hiring

1) Overall effect in employment ambiguous

2) Related: more temporary hirings for disabled workers

DI - Stricter Screening pros

immediate impact on DI inflow
= less ill apply less
= higher rates of returns for workers
= spill over unto unemployment insurance

DI - Stricter Screening cons

negative effects for different groups (women)

DI - Increasing work incentives - pro

stimulating people to work can have beneficial effects

DI - Increasing work incentives con

risk of long term adverse consequences
1) deter people who actually need it
2) need to work more than is good for their health

Option to re-integrate disabled workers in the labor market

1) ALMP
2) Quota

ALMP for Disabled workers

subsidised employment

Aim of ALMP for disabled workers

1) bridge productivity gap
2) internalize positive externalities of hiring disabled workers
3) satisfy equity concerns

Quota for workers with disabilities

firms have higher share of disabled employees but partly through labelling disable workers and reallocation among firms