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Social Insurance with Competitive Insurance Markets and Risk Misperception

Author

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  • Cremer, Helmuth

    (Toulouse School of Economics)

  • Roeder, Kerstin

    (University of Augsburg)

Abstract

This paper considers an economy where individuals differ in productivity and in risk. Rochet (1991) has shown that when private insurance markets offer full coverage at fair rates, social insurance is desirable if and only if risk and productivity are negatively correlated. This condition is usually shown to be satisfied for many health risks, but it appears to be violated for the old age dependency risk (mainly because longevity in turn is positively correlated with productivity). We examine the role of uniform and nonuniform social insurance to supplement a general income tax when neither public nor private insurers can observe individual risk and when it is positively correlated with wages. Consequently, a Rothschild and Stiglitz (1971) equilibrium emerges in the private insurance market and low-wage/low-risk individuals are not fully insured. We show that even when social insurance provided to the poor has a negative incentive effect, it also increases their otherwise insufficient insurance coverage. Social insurance to the rich produces exactly the opposite effects. Whichever of these effects dominates, some social insurance is always desirable. Finally, we introduce risk misperception which exacerbates the failure of private markets. The insurance term now reflects the combined failure brought about by adverse selection and misperception. Now the low-risk individuals are not only underinsured, but also pay a higher than fair rate. However, and rather surprisingly, it turns out that this does not necessarily strengthen the case for public insurance.

Suggested Citation

  • Cremer, Helmuth & Roeder, Kerstin, 2016. "Social Insurance with Competitive Insurance Markets and Risk Misperception," IZA Discussion Papers 9651, Institute of Labor Economics (IZA).
  • Handle: RePEc:iza:izadps:dp9651
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    References listed on IDEAS

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    Cited by:

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    2. Claire Borsenberger & Helmuth Cremer & Denis Joram & Jean-Marie Lozachmeur & Estelle Malavolti, 2024. "The Design of Insurance Contracts for Home versus Nursing Home Long-Term Care," CESifo Working Paper Series 11112, CESifo.
    3. Thomas Aronsson & Luca Micheletto, 2021. "Optimal Redistributive Income Taxation and Efficiency Wages," Scandinavian Journal of Economics, Wiley Blackwell, vol. 123(1), pages 3-32, January.
    4. Thomas Aronsson & Luca Micheletto, 2017. "Optimal Redistributive Income Taxation and Efficiency Wages," Working Papers 107, "Carlo F. Dondena" Centre for Research on Social Dynamics (DONDENA), Università Commerciale Luigi Bocconi.
    5. Simon Fan & Yu Pang & Pierre Pestieau, 2022. "Investment in children, social security, and intragenerational risk sharing," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 29(2), pages 286-315, April.
    6. Aronsson, Thomas & Micheletto, Luca, 2017. "Optimal Redistributive Income Taxation and Efficiency Wages," Umeå Economic Studies 953, Umeå University, Department of Economics.
    7. Spencer Bastani & Tomer Blumkin & Luca Micheletto, 2019. "The Welfare-Enhancing Role of Parental Leave Mandates," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 35(1), pages 77-126.

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    More about this item

    Keywords

    social insurance; optimal taxation; adverse selection; overconfidence; long-term care;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H51 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Health
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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