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1. PowerPoint Slidesfor Professors Spring 2010 Version This file as well as all other PowerPoint files for the book, “Risk Management and Insurance: Perspectives in a Global Economy” authored by Skipper and Kwon and published by Blackwell (2007), has been created solely for classes where the book is used as a text. Use or reproduction of the file for any other purposes, known or to be known, is prohibited without prior written permission by the authors. Visit the following site for updates: http://facpub.stjohns.edu/~kwonw/Blackwell.html. To change the slide design/background, [View]  [Slide Master] W. Jean Kwon, Ph.D., CPCUSchool of Risk Management, St. John’s University101 Murray StreetNew York, NY 10007, USA Phone: +1 (212) 277-5196E-mail: Kwonw@stjohns.edu

2. Risk Management and Insurance: Perspectives in a Global Economy 9. Public-Sector Economic Security

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3. Study Points Why private markets fail to provide some financial services Selected public-based economic security services The future of social insurance
4. Market Failure Market failure stemming from Financial intermediaries refusing to offer an otherwise demanded service Prices being so high that no or only a modest market evolves Causes of the failure Financial intermediaries cannot adequately address the information problems. Positive externalities accompany the purchase. Buyers have insufficient income. Risk aversion is insufficient to motivate individuals to pay high loadings.
5. Cause – Information Problems Also discussed in Chapters 2, 8 and 19. Financial markets characterized by Adverse selection problems and Moral hazard problems Where the usual techniques for dealing with these information problems do not work well or at all, the private sector offers no solutions or offers them only at very high prices.
6. Cause – Fails to Capture Positive Externalities If society receives positive spillovers from some members having acquired additional security, the price becomes too high because It reflects only private producers’ marginal costs of production and It fails to credit against those costs the marginal societal benefits. Individuals then consume too little (in society’s view) if they must pay the full private cost. Examples The market for terrorism insurance (figure 9.1) Social insurance (figure 9.2)
7. Market for Terrorism Insurance (Figure 9.1)
8. Social Insurance (Figure 9.2)
9. Cause – Insufficient Buyer Income Many individuals have income that are insufficient to pay for life’s necessities (immediate utility) and for financial security services (future utility). The interest rate necessary to induce a poor person to forego current consumption for future consumption is exceptionally high, maybe even infinite. In the absence of positive externalities, insufficient income provides no economic justification for government becoming a provider of financial security services. But, Some economic security services do carry positive externalities. Societies often choose to provide security services for non-economic reasons (e.g., concerns about fairness).
10. Cause – Insufficient Buyer Risk Aversion Intermediaries incur expense and other cost loadings, which may be viewed high for several reasons Illustration using insurance Low-severity or high-frequency exposures Correlated exposures Exposure ambiguity
11. Public-based Economic Security Services The remaining part of the chapter discusses mainly social insurance. The other two discussed in page 228. Social insurance The most important government-provided economic security services in most countries Mandatory savings programs Economic-needs-tested programs
12. Social Insurance
13. Fundamentals Social insurance provides income security for individuals It is also an important public policy instrument Government-sponsored economic security programs possesses three characteristics: Economic security is provided for well-defined loss exposures. Participation is compulsory for the target population. Contributions usually are not adjusted for probability of loss.
14. Social Security Programs Worldwide (Table 9.1)
15. Comparison of Programs by Region (Table 9.2)
16. Funding Social Insurance Programs Table 9.3 Three main sources Taxes paid by participant workers Taxes paid by employers Government contributions Required contributions are closely related to worker earnings. The government’s contribution may be derived from general revenues or, less frequently, from special earmarked or excise taxes Social insurance programs are often financed in a manner that redistributes income from one generation to another or from one income group to another or both.
17. Funding Social Insurance Programs Fully funded approach Most private pension systems are fully funded. Pay-as-you-go (paygo) approach Benefits for current recipients paid from the contributions by the currently working population Politically, the easier of the two funding approaches to implement Most OECD states have paygo retirement income security plans. If the worker-retiree distribution remains roughly constant, the paygo system does not necessarily result in a transfer of income between generations. If otherwise, the system may result in intergenerational transfers.
18. Public Pension Liabilities – NPV (Figure 9.3)
19. Social Insurance Benefits Retirement income Survivor benefits Health insurance Unemployment insurance
20. 1. Social Insurance – Retirement Support for the elderly is a prime focus of social insurance. Logical assumptions Individuals may not have the information needed to prepare adequately for retirement. There are economies of scale in funding retirement benefits. The elderly’s consumption is likely to have external benefits to society.
21. 1. Social Insurance – Retirement Originally for government (and military) employees in many countries Gradually extended first to private-sector workers in urban areas and then to virtually all wage earners and salaried employees Initially excluded were (1) agricultural workers and the self-employed due mainly to administrative difficulty as well as (2) family workers, domestics and day workers The trend is to cover these groups under separate funds or to bring them under the general system. Even the non-employed may now be covered.
22. 1. Social Insurance – Retirement Plan design and reform objectives Provide economic security against destitution in old age Smooth the distribution of consumption spending over a lifetime Provide for life’s requirements for those with exceptional longevity Three distinct tiers The first tier – provides poverty relief, normally in a public system funded on a paygo basis participation with mandatory The second tier – provides for consumption smoothing over each person’s lifetime The third tier – private, funded and voluntary
23. 1. Social Insurance – Retirement IMF’s proposals for plan design and reform All pension systems require strong and effective government. The choice between government paygo and (private or public) funded schemes is of secondary importance To the government’s ability to manage the economy effectively To promote adequate output growth, and To sustain a stable foundation for whatever pension system is adopted. Within the limits of national economic and government capacity, countries have a wide range of choice over pension design. No one approach will prove superior.
24. 1. Social Insurance – Retirement Benefit qualification – eligibility requirement Attainment of a specified age and Completion of a specified period of contributions or covered employment Many programs have the same pensionable age for women as for men. Nature of benefits Benefits are commonly wage-related and based also on formulas. For example, A basic rate (e.g., 30%) of average earnings, plus an increment of 2% of earnings for each year of service in excess of a minimum number of years for qualification
25. 2. Social Insurance – Survivor Benefits Most social insurance programs provide for some type of payment to dependents Spouse and dependent children under a certain age Patterned closely after their counterpart retirement income benefit programs Funding for survivor benefits ordinarily follows that for retirement income benefits. Eligibility The deceased worker was a pensioner at death or have completed a minimum period of covered employment or contribution. Again, certain additional conditions apply (e.g., age requirement)
26. 2. Social Insurance – Survivor Benefits Periodic benefits are provided under most systems, although a few pay lump-sum benefits only. Survivor benefits are paid to some categories of widows under nearly all programs. The age limits for children’s benefits are often the same as for children’s allowances through retirement income or disability income benefit programs. Benefits are payable under a number of programs to certain widowers of insured workers or pensioners.
27. 3. Social Insurance – Health Benefits The healthcare delivery and financing systems reflect the cultural, economic and political character of the nation. Most industrialized countries place great value on equal access to healthcare across individuals, and provide basic universal coverage to all. It is not the case in the U.S., which does not have a national healthcare program. The culture in the U.S. places relatively less value on social equity and relatively greater value on private-market solutions to financing healthcare. Several attempts to introduce universal healthcaremade, including the Obama plan
28. Healthcare Expenditures (Figure 9.4)
29. Economics of Healthcare – Market Imperfections Difficulty in measuring marginal benefit of additional medical service on health Buyers cannot purchase health per se but consume medical services to improve or maintain health. Presence of information asymmetries, including adverse selection Information asymmetry exists between buyers and sellers. Information asymmetries exist with respect to the price of medical services. Information asymmetries exist between insureds and insurers.
30. Economics of Healthcare – Market Imperfections Problems of moral hazard Third-party payment for healthcare services not only reduces incentives for consumers to seek price information, but also increases the potential for moral hazard. Consumer behavior may change since insureds do not bear the full cost of medical care. Demand for services induced by suppliers The provider of medical services not only supplies medical services to consumers, but also advises them on what to demand. Barriers to market entry Healthcare markets have barriers to entry.
31. Economics of Healthcare – Market Imperfections Other considerations Cultural beliefs Growth of medical technology Medical malpractice costs
32. Healthcare Systems Trends Developed countries have modern healthcare services available to most of the population. Developing countries tend to provide a higher level of medical service to urban residents. Delivery systems (Figure 9.5) Direct, voluntary out-of-pocket payment Compulsory public insurance General revenue tax model Social insurance model Voluntary private insurance
33. Healthcare Systems (Figure 9.5)
34. Healthcare System Reform Initiatives Increased use of the public contractual model Greater use of third-party payers Greater independence of hospital management Enhanced use of managed care and cost sharing
35. Healthcare Spending and Health Outcomes The prime determinant of differences in national spending for healthcare is national per capita income. The variation in general health of populations is also explained primarily by differences in income level. Nations with higher per capita incomes have longer life expectancy and lower infant mortality rates. Exceptions exist.
36. 3.1 Social Insurance – Disability Benefits In most programs, participants in the retirement income plan also participate in the disability income plan. Funding ordinarily follows that of retirement income benefit funding. Benefit eligibility requirements Loss of productive capacity and Fulfillment of a minimum period of work or contributions
37. 3.1 Social Insurance – Disability Benefits Additional features The qualifying period usually shorter than for an old age, retirement income benefit. Provisions for persons who are permanently disabled due to non-occupational causes are similar to those for retirement. A relatively short waiting period (e.g., 2~7 days) is imposed. For example, workers ordinarily may receive short-term benefits for up to 26 weeks.
38. 3.2 Social Insurance – Occupational Injury Benefits Workers’ (workmen’s) compensation programs are the oldest and most widespread type of social insurance. Program structures Social insurance systems utilizing a public fund Various forms of private or semiprivate arrangements required by law Most countries maintain the programs that do not share a direct link with other social security programs. In some other countries, the benefits are available under special provisions of the country’s social security programs.
39. 3.2 Social Insurance – Occupational Injury Benefits Economic Condition and Occupational Injury Claims Table 9.6 Medical benefits: two variations All “necessary” medical services – unless specifically excluded in the law A list of covered medical services Income replacement benefits A percentage of the (average) wage prior to disability, a stated monetary ceiling, or both Most programs not offer full indemnification Compensation varies according to the degree of disability: Temporary disability Permanent total disability Permanent partial disability
40. 3.2 Social Insurance – Occupational Injury Benefits Survivor benefits Customarily payable to a widow, regardless of her age, until her death or remarriage; to a disabled widower; and to dependent children below specified ages Industrialization and occupational injury Employment shifted from the manufacturing to the service sector Claims associated with industrial injury and illness decreased Growth in the number of recognized occupational diseases due to a greater understanding of the origins of certain diseases
41. 4. Social Insurance – Unemployment Benefits Table 9.7 Objectives Provide periodic cash income to workers during temporary periods of involuntary unemployment Help stabilize the economy during recessionary periods Encourage employers to stabilize employment Help the unemployed find jobs The programs exist mainly in industrialized countries. About one-half of the compulsory unemployment programs cover the majority of employed persons, regardless of industry.
42. 4. Social Insurance – Unemployment Benefits Program structuring Most are compulsory and fairly broad in scope. Some countries with voluntary programs with no government mandate. Some unemployment programs economic-needs tested. Some offer scheduled payments of benefits, and others provide lump-sum grants. Contribution solely by employers is the typical method governments use to finance unemployment insurance. The contribution usually as a fixed percentage of the covered payroll
43. 4. Social Insurance – Unemployment Benefits Benefit eligibility Completion of a minimum period of service in a covered employment Involuntary unemployment Nearly all unemployment insurance programs require that applicants be capable of and available for work. Benefits A percentage of the average wage during a recent period Payable only after a waiting period Several countries maintain unemployment assistance or similar means-tested programs supplementing regular unemployment insurance.
44. Mandatory Savings ProgramsEconomic-needs-tested Programs
45. Mandatory Savings Programs Table 9.8 Also known as provident funds Features Employees’ contribution toward their own personal retirement savings programs Substitute for or complement paygo types of social insurance systems The account holder often may purchase separate disability and survivors’ insurance coverages. Little or no income redistribution among participants These programs do not meet our definition of social insurance.
46. Economic-needs-tested Programs Benchmarks each applicant’s resources to formula-based standards for subsistence need estimation and offers benefits only to applicants who satisfy the test Different countries have different tests, but they commonly take into consideration The net wealth and current income of the applicant and the family Health condition and age of the breadwinner Family size Place of living If the program does not require contributions by the beneficiary, it is a social assistance (welfare) program intended to alleviate poverty. It is not insurance.
47. The Future of Social Insurance Selected factors affecting the insurance Rising healthcare costs Low birth rates Increasing life expectancy Paygo public pension systems preservation of economic security through equitable financing approaches Social and political environments Macroeconomic performance Transition into fully funded programs Privatization of social insurance programs Chile Japan
48. Discussion Questions
49. Discussion Question 1 Does flood insurance qualify as a social insurance program? Justify your answer.
50. Discussion Question 2 In the section on “Low-Severity or High-Frequency Exposures,” the authors discussed several types of loss exposures for which private insurance is unsuitable. What are the characteristics of exposures that insurers are willing to cover? You may refer to Chapter 19 for a related discussion.
51. Discussion Question 3 Provide a rationale for instituting a paygo social insurance program.
52. Discussion Question 4 Discuss the implications of a successful social insurance program on a country’s finances.
53. Discussion Question 5 Compare public and private programs for providing retirement income. Who benefits under each type of program?