Department Seminar: Johannes SPINNEWIJN (LSE)
Joint work with C. Landais, A. Nekoei, P. Nilsson and D. Seim
Despite the large existing literature on unemployment insurance (UI), the fundamental question why it is mandated, with no coverage choice available, remains unanswered. While risk-based selection has long been recognized as hindering efficient market function, to date no direct evidence exists for adverse selection in UI and thus its role in rationalizing the mandatory nature of UI policy. Building on the unique institutional setting of Sweden, where workers can buy supplemental UI coverage above a minimum mandate, we provide the first direct evidence for risk-based selection in UI and of its implication for the design of social insurance against unemployment risk. First, we document substantial correlation between unemployment risk and the choice of buying supplemental coverage (with semi-elasticities around 1), even after controlling for a rich set of observables. Second, exploiting unique individual level variation in risk, we bound the part of this correlation that is driven by moral hazard. Third, using unique variation in the price of UI, we document that the average cost of UI increases with the price of UI. Despite the substantial adverse selection, we find that the offered choice welfare-dominates mandating the supplemental coverage. Our estimates indicate that the minimum coverage and the subsidy for supplemental coverage are complementary policy instruments, but the subsidy is set too high given the minimum mandate in place.