Optimal long-term contracts with disability insurance under limited commitment

Kyoung Jin Choi, Junkee Jeon, Ho-Seok Lee and Hsuan-Chih Lin

Insurance: Mathematics and Economics, 2022, vol. 104, issue C, 99-132

Abstract: We study an optimal long-term labor contract that provides disability insurance benefits under two frictions: the agent cannot commit to a long-term contract and the disability shock is private information. We predict that a job with a high risk of disability should provide a higher level of salary but with a lower growth rate over time. We find that the optimal contract can be implemented under a three-account trading system in which mandatory savings can be imposed to discourage a worker from falsely claiming disability. We also investigate how the nature of disability shock has an impact on the optimal contract: a larger borrowing limit should be given to a worker with a high severity of the disability shock or a low arrival intensity. Finally, our quantitative analysis shows that the cost caused by current long-term disability insurance practice can be substantial.

Keywords: Disability insurance; Limited commitment; Truth-telling; Dynamic contracting; Incentives (search for similar items in EconPapers)
JEL-codes: C61 D47 D82 D86 E21 I13 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:104:y:2022:i:c:p:99-132

DOI: 10.1016/j.insmatheco.2022.02.007

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