Risk-based Selection in Unemploymen t Insurance: Evidence and Implications (with C Landais, A Nekoei, P Nilsson and D Seim)
Abstract:
De
spite the large existing literature on unemployment insurance (UI), the fun
damental question why it is mandated, with no coverage choice available, re
mains unanswered. While adverse selection has long been recognized as hinde
ring efficient market function, to date no direct evidence exists in the UI
context and the desirability of a UI mandate is untested. 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 f
or risk-based selection in UI and of its implication for the design of soci
al insurance against unemployment risk. First, we document a strong correla
tion between unemployment risk and the choice of buying supplemental covera
ge (with semi-elasticities around 1), even after controlling for a rich set
of observables. Second, exploiting unique individual level variation in ri
sk, we provide evidence for substantial risk-based selection, controlling f
or moral hazard. Third, using unique variation in the price of UI, we docum
ent that the average cost of UI increases with the price of UI. Despite the
severe adverse selection, we find that the offered choice welfare-dominate
s mandating the supplemental coverage. We cannot reject that the subsidy fo
r supplemental coverage is set optimally. We also explore the complementari
ty between the subsidy and mandating a minimum coverage level.