Transcript Relational Data Base Fundamentals

Social Insurance Arises, In Part, Because
of Asymmetric Information
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Assume there are 2 groups, each with 100 people.
The first group has 5% chance of getting injured,
and the second group has a 0.5% chance.
The payout is $30,000 when injured.
Table 2 shows how information affects the
insurance market in this context.
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It illustrates the principle of adverse selection in the presence
of asymmetric information.
The insured individuals know more about their risk level
than does the insurer.
Table 2
With fullItinformation,
the insurance
therefore charges
separateThe
prices
insurance company collects
The
premium
to
the
accident
prone of
Insurance
pricing
with
separate
groups
companytocan
tell group;
the high
risks from forces
each
competition
$1500it x 100
from the accident
is therefore 5% x $30,000. For the
low risks.
tothe
charge
an actuarially fair prone,
price. and $150 x 100 from the
consumers
careful, it is 0.5% x $30,000.
careful. Total premiums of $165,000
Now imagine
the insurance
Premium
per:
equal expected costs.
company
cannot
tell
people
apart.
continue
to charge separate
Information
Pricing It could
Careless
Careful
Total
Total
Net profits to
This
is
a
case
with
asymmetric
approach premiums
benefits
paid
insurers
to the
different premiums
groups,
(100
(100
The
In this
insurance
case,
the
company
company
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loses
The
accident
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have
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paid
people)
people)word that
taking
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they
$150
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so itfrom
willout
not
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are $1,500
either
careful
or accident
prone.
Full
Separate Another
$150
$165,000
0
The
average
cost$165,000
for
Again,
the
population
themarket
loses
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Thus,
and
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the
xcompany
100
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the
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potential
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With
this
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payprice
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(100
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ascompany
a whole would
so
be
itnot
$165,000
willbe
not
offer
in
insurance.
Thus,
will
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able
to
obtain
ofthe
$30,000
the optimal
are
the insurance
careful
buy
policy.
The
much understands
if they
revealpeople
truthfully
about
+ 200
100
xpeople,
claims
divided by
the
market
fails
or
again
with ax pooling
$135,000
amount
less
than
of
insurance.
expected
costs.
it cannot tell
consumers
apart.
company
collects
$825
100
their
status.
$150)
$825 per
person.
equilibrium.
Thus, it charges a uniform
premium
people, but
pays $1,500 x 100
Asymmetric
Separate
$1,500for all customers.
$150
$30,000 people
$165,000
-$135,000
in benefits.
(0 x $1,500
+ 200 x
$150)
Asymmetric
Average
$825
$825
$82,500
(100 x $825
+ 0 x $825)
$150,000
-$67,500
Does Asymmetric Information Necessarily Lead to
Market Failure?
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Will adverse selection always lead to market failure?
Not if:
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Most individuals are fairly risk averse, such that they will
buy an actuarially unfair policy.
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When risk averse people purchase insurance that is not actuarially
fair, we say that the policy entails a risk premium: the amount
that risk-averse individuals will pay for insurance above and
beyond the actuarially fair price.
This leads to a pooling equilibrium, which is a market
equilibrium in which all types buy full insurance even though it is
not fairly priced to all individuals.
Does Asymmetric Information Necessarily Lead to
Market Failure? Separating Equilibrium…
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In addition, the insurance company might offer separate
products at separate prices that, in some cases, would cause
consumers to reveal their true types (careless or careful).
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This leads to a separating equilibrium, which is a market
equilibrium in which different types buy different kinds of
insurance products.
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The separating equilibrium still represents a market failure.
Insurers can force the low risks to make a choice between full
insurance at a high price, or partial insurance at a lower price.
Although insurance is offered to both groups in this case, the
low risk group does not get full insurance, which is
suboptimal.
How Does The Government Address
Adverse Selection?
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The government can help correct this kind
of market failure. It could:
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Impose an individual mandate that everyone buy
insurance at $825 per policy from the private
company, forcing all to pool their risks.
It could offer the insurance directly, which would
have similar effects.
Both policies would lead to low-risk types
subsidizing the high-risk types.
OTHER REASONS FOR
GOVERNMENT INTERVENTION IN
INSURANCE MARKETS
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Although adverse selection is an important
motivation for government intervention in
insurance markets, there are also motivations related
to:
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Externalities (early, preventive health coverage).
Administrative costs (economies of scale).
Redistribution (fairness – is it right to charge people
differently because of accidents at birth?)
Paternalism (society deems that people should behave in
particular ways).
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“Samaritan’s Dilemma”
Institutional Features of Unemployment
Insurance
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Unemployment Insurance (UI) is a federally mandated,
state-run program. Payroll taxes are used to pay benefits to
workers laid off by companies for economic reasons.
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Although UI is federally-mandated, each state sets its own
parameters on the program.
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This payroll tax averages 2.5%.
This creates a great deal of variation across states, which many
economists use as a “laboratory” for empirical work.
UI is partially experience-rated.
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The tax that finances the UI program rises as firms have more
layoffs, but not on a one-for-one basis.
Institutional Features of Unemployment
Insurance
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There are eligibility requirements for UI:
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First, individuals must have earned a minimum annual amount.
Second, the unemployment spell must be a result of a layoff,
rather than from quitting or getting fired.
Third, the individual must be actively seeking work and willing to
accept a job comparable to the one lost.
These eligibility requirements mean that not all of the
unemployed collect benefits (44% of unemployed collect).
Even among eligibles, participation is not full.
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Roughly 66% of eligibles take up the UI benefit. Nonparticipation (among eligibles) results from lack of information
about eligibility, stigma from collecting a government handout, or
from transaction costs.
The unemployment benefit schedule in Michigan
Figure 1
Unemployment Benefits in Michigan
$400
$350
$300
Weekly Benefit
$250 in Michigan
Benefits
initially rise, and are then
$200
capped at a maximum.
$150
$100
$50
$0
$0
$50 $100 $150 $200 $250 $300 $350 $400 $450 $500 $550 $600 $650 $700 $750
Weekly Wage in Highest Quarter of Past Year
Institutional Features of Unemployment
Insurance
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The replacement rate is the amount of previous earnings that is
replaced by the UI system.
Replacement rates vary from 35% to 55% of earnings, and UI
is treated as taxable income.
In addition to benefits, the duration of UI can vary. In
general, an individual can collect UI for 26 weeks. This varies:
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For those with sporadic work, for a state that has a “supplemental”
UI program, or if there is a federal extension, as in 2003.
The time pattern of benefits must balance the trade-off
between three considerations:
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Consumption smoothing implies rising benefits
Work disincentives from moral hazard
Targeting
Figure 2
Net Replacement Rates Over a Five-Year Period
For a One-Earner Couple With Two Children
Net replacement rate (%)
100
Sweden
80
Other countries tend to
have higher replacement
rates than the U.S.
60
Belgium
Spain
40
Especially for extended
spells of unemployment.
20
Hungary
USA
0
4
8
12 16 20 24 28 32 36 40 44 48 52 56 60
Length of Unemployment (months)
Institutional Features of Disability
Insurance
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Disability Insurance (DI) is a federal program in
which a portion of the Social Security payroll tax is
used to pay benefits to workers who have suffered a
medical impairment that leaves them unable to
work.
Current expenditures are roughly $71 billion per
year.
Benefits are federally uniform, but the initial
decision on qualification is made at the state level.
Institutional Features of Disability
Insurance
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Unlike many other programs, there is a waiting period of 5
months before an individual can collect DI.
The initial acceptance rate for DI is roughly 33%; after
appeals to higher levels, the acceptance rate is roughly 50%.
The benefits equal the primary insurance amount from Social
Security, computed as if the applicant were age 65.
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The applicant qualifies for Medicare after two years on DI.
Detecting “true” disability is challenging.
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Parsons (1991) reported on a study in which a set of disability
claims was initially reviewed by a state panel, and then one year later
resubmitted as anonymous new claims.
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22% of those who had initially qualified were rejected, and 22% of
those initially rejected were qualified!
Institutional Features of Workers’
Compensation
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Workers’ Compensation (WC) is state-mandated
insurance, which firms generally buy from private
insurers, that pays for medical costs and lost wages
associated with an on-the-job injury.
The cash payment from WC is designed to replace
two-thirds of workers’ wages. Unlike UI, these
payments are untaxed, leading to a considerably
higher replacement that can approach 90%.
As with UI, there is substantial state variation in the
program parameters.
Unlike UI, however, the insurance premiums are
more tightly experience rated.
Table 1
WC across states for permanent and temporary injuries in 2003
Maximum Indemnity Benefits Paid to Selected
Types of Work Injuries, 2003
Type of permanent impairment
State
Arm
Workers’
Yet therecompensation
are dramatic
differences
payments are
in generosity
larger for
permanent
across states.
injuries.
California
Hand
Index
finger
Leg
Foot
Temporary
Injury
(10 weeks)
$108,445
$64,056
$4,440
$118,795
$49,256
$6,020
Hawaii
180,960
141,520
26,800
167,040
118,900
5,800
Illinois
301,323
190,838
40,176
276,213
155,684
10,044
86,500
62,500
10,400
74,500
50,500
5,880
175,657
140,395
24,814
140,395
105,786
6,530
78,908
59,521
15,305
70,405
52,719
6,493
New Jersey
154,440
92,365
8,500
147,420
78,200
6,380
New York
124,800
97,600
18,400
115,200
82,000
4,000
Indiana
Michigan
Missouri
Institutional Features of Workers’
Compensation
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A key feature of WC is that it provides no-fault
insurance.
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No-fault insurance–when there is a qualifying injury, the
WC benefits paid out by the insurer regardless of
whether the injury was the worker’s or the firm’s fault.
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In the early 20th century, workers could sue their
employers, but the system was viewed as unfair
because low-income workers may not have had the
resources to bring suit against firms.
CONSUMPTION-SMOOTHING BENEFITS
OF SOCIAL INSURANCE PROGRAMS
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More generous UI crowds-out other sources of income
support:
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Recent empirical work finds for UI that:
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Households save less
Spouses are less likely to work
It mitigates the negative effects on consumption from
unemployment.
Every $1 of UI reduces the drop in consumption by 30¢.
There is no parallel evidence on consumption smoothing for
Disability Insurance or Workers’ Compensation, however.
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DI and WC probably play a stronger consumption smoothing role
than UI: disability is usually unexpected and permanent, so
individuals are less able to use their own savings to smooth
consumption.
Exit Rate from Unemployment
Figure 3
Moral hazard in UI: are unemployment exits slower when UI benefits are
higher?
0.165
But towards the end
of benefits eligibility,
the hazard rate spikes
upward.
The exits from
unemployment0.100
are
fairly steady for most
of the benefits period.
0.050
0.035
1
5
10
15
20
Weeks Out of Work
26
Moral Hazard Effects of
Unemployment Insurance
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In the 26th week of unemployment, precisely the time when
benefits run out, the exit rate from unemployment jumps up.
Empirical work suggests a benefit elasticity of +0.8–each
10% rise in unemployment benefits leads to an 8% rise in
unemployment durations.
Is this moral hazard good or bad?
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If the unemployed individual is simply using the benefits to
subsidize leisure consumption (e.g., watching television, etc.), then
the increase in duration is inefficient.
If the individual finds a better job match, society as a whole may
gain. Job match quality is the marginal product associated with
the match of a particular worker with a particular job.
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There is little evidence (using wages) that UI improves match quality.
Moral Hazard in Disability Insurance
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Moral hazard in DI is thought to manifest itself in
higher DI application rates and lower labor supply.
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If an applicant was “truly disabled,” then use of the DI
program and work behavior should be unaffected by the
benefit levels.
International evidence (where there is cross-sectional and
over-time variation in DI generosity) suggests the implied
elasticity of labor supply with respect to DI benefits is -0.3.
In the U.S., applications for DI rise during recessions, even
though it is unlikely that true disability changes. Applicants
find it a less costly “gamble” to go through the process when
their labor market opportunities are smaller.
Moral Hazard in Workers’
Compensation
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Moral hazard in WC is thought to manifest itself in reported
injuries, injury durations, and types of injuries reported.
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Krueger (1990) finds that for every 10% in benefits generosity, the
rate of reported injury rises by 7%.
He finds that for every 10% in benefits generosity, the duration of
injury rises by 17%.
Moral hazard will be worse for injuries that are hard to observe or
verify, such as sprains or strains, and less of a problem for other
types, such as lacerations or broken or missing limbs. He found
larger elasticities for difficult-to-verify injuries.
Finally, there appears to be a “Monday effect” to WC claims.
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By examining claims by day of the week, there is a large rise in sprains and
strains relative to lacerations on Mondays.
This suggests some weekend injuries unrelated to the job are being passed on to
the employer.
Figure 7
PartialWhen
experience
the schedule rating in UI
When the schedule
is above the 45
degree line, firms
pay more than
employees get out.
is below the 45
degree line, firms
pay less than
employees get out.
5.4
The payroll tax is at
The 45 degree line
first very steep, then
would be a fully
flattens out completely.
experience-rated
schedule.
10% means that UI
benefits equal 10%
of a firm’s payroll
ratio is
over the The
past benefit
4
yearstotal UI benefits
divided by payroll.
The Effects of Partial Experience Rating
in UI on Layoffs
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Relative to a full system of experience rating, partial
experience rating subsidizes firms with high layoff
rates.
How is this a “subsidy”?
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Firms and workers may make a joint decision whether to
place the worker on temporary layoff, with a promise of
being hired back later.
UI system acts to make such behavior a partially paid
vacation.
With partial experience rating, the cost to the firm of
doing this is less than the benefits to the workers.
The “Benefits” of Partial Experience
Rating
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Why is partial experience rating so common in UI programs if
it leads to more layoffs? The benefit that offset this moral
hazard cost is consumption smoothing.
Fully experience rated UI would “hit firms while they are
down.” Yet, by having a partially experience rated system, it
sustains inefficient firms that perhaps should be driven out of
business.
Empirical studies have examined state systems with different
degrees of experience rating.
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They find that partial experience rating increases the rate of
temporary layoffs.
Partial experience rating alone can account for as much as one-third
of all temporary layoffs in the U.S.
Workers’ Compensation and Firms
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Similar issues arise in WC. If the system is not fully
experience rated, firms and workers can get together to
increase “injuries” and thus the payouts from insurance.
Moreover, firms have less incentive to invest in safety,
because the insurance is no-fault.
Krueger (1991) examined injury durations at firms that selfinsure and at firms that buy insurance in the partially
experience rated market.
By definition, self-insurance is full experience rating. The
injury durations were shorter at these firms, and less
sensitive to benefit increases.
TAX-BENEFITS LINKAGES AND THE
FINANCING OF SOCIAL INSURANCE
PROGRAMS
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Tax-benefit linkages are direct ties between taxes paid
and benefits received.
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Summers (1989) shows that such linkages can affect the equity
and efficiency of a tax. The link between payroll taxes and
social insurance benefits can lead the incidence to fall more fully
on workers than might be presumed.
The key point of Summers’ analysis is that with taxes alone, only
the labor demand curve shifts, but with tax-benefit linkages, the
labor supply curve shifts as well.
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That is, workers are willing to work the same amount of hours at a lower
wage, because they get some other benefit as well, such as workers’
compensation or health insurance.
Figure 10
Tax-Benefit Linkages
Wage (W)
Wage (W)
C
Creating
smaller DWL.
S1
S1
Mandated
benefits
A shift
also
the supply
curve.
E
W1
W1
A
F
W
W
B
2
B
S2
2
W
D1
D
3
D1
D2
L2
L1
D2
Labor (L)
L2
L3
L1
Labor (L)
Wages adjust by more with the tax-benefit linkage, employment falls by less, and deadweight loss is smaller
than with a pure tax.
Tax-benefits linkages and the financing of
social insurance programs: The model
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With full valuation, the cost of the program is fully shifted
onto workers in the form of lower wages, and there is no
deadweight loss or employment reduction.
This raises some issues with tax-benefit linkages, especially
with respect to employer mandates.
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If there is no inefficiency, why doesn’t the employer simply provide
the benefit without government intervention?
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Market failures, such as adverse selection, may be present. The employer that
provides a benefit such as workers’ compensation or health insurance may end
up with high risks.
When are there tax-benefit linkages?
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They are strongest when the taxes paid are linked directly to a
specific benefit that workers can receive.