Optimal Disability Insurance and Unemployment Insurance With Cyclical Fluctuations

Hsuan-Chih Lin

No 16-A003, IEAS Working Paper : academic research from Institute of Economics, Academia Sinica, Taipei, Taiwan

Abstract: This paper studies the optimal joint design of disability insurance and unemployment insurance in an environment with moral hazard, when an individual’s health status is private information, taking into account cyclical fluctuations. I first show how disability benefits and unemployment benefits vary with aggregate economic conditions in an optimal contract that resolves this information problem. I then consider a calibrated version of the model and study the quantitative implications of changing from the current system to the optimal one. Last, in a special case, I demonstrate that the optimal joint insurance system can be implemented using a relatively simple model. In the optimal system, disability benefits are designed such that the system punishes workers who stay unemployed for a long time, reducing the unemployment rate by roughly 40 percent and incurring substantial cost savings from resolving incentive problems. Using the model to implement the optimal system, I am able to analyze in details the driving forces behind the differences between the current system and the optimal system. Under the optimal joint design of these insurance programs, disability insurance serves as an additional tool for the government to provide incentives for the job search. JEL Classification: D8, H5, J6

Keywords: Disability insurance; Unemployment insurance; Business cycles; Optimal policy (search for similar items in EconPapers)
Pages: 36 pages
Date: 2016-03, Revised 2016-10
New Economics Papers: this item is included in nep-dge and nep-ias
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