social insurance: pooling risks for a more inclusive … insurance.pdf · social insurance: pooling...

Social Insurance: Pooling Risks for a More Inclusive Singapore

Donald Low

Vice President,

Economic Society of Singapore

Outline

• A more volatile economy, a more unequal society

• Why does inequality matter?

• What is social insurance?

• Social insurance in Singapore: current programmes and future possibilities

GDP growth has slowed, and become more volatile

-2

0

2

4

6

8

10

12

14

1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

GDP Growth Rate (%)

First oil shock

1985 Recession

Asian Financial Crisis

Collapse of dot.com bubble

Global financial

crisis

1992 Slowdown

Second oil shock

Trend GDP growth rate

SARS, Iraq war

We have also become a more unequal society in the last decade

0.425

0.429

0.426

0.441

0.438

0.442

0.429

0.458

0.440 0.438

0.446

0.433

0.446 0.448

0.450 0.451

0.456 0.455

0.471

0.464

0.461

0.465

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Based on Income from work per household member after accounting for employer CPF contributions

Based in income from work per household member after accounting for Government taxes and transfers.

Ratio of average incomes of top quintile to bottom quintile of households

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Ratio 10.1 11.1 11.3 11.5 11.7 12.3 12.4 13.2 13 12.7 12.0

Inequality in Singapore is very high by rich country standards...

Source: OECD. Gini data: mid-2000s. GDP data: 2009

Finland France

Germany

Hungary

Italy Japan

Korea

Mexico

Norway

Poland

Portugal

Sweden

Switzerland

Turkey

United Kingdom

United States

Singapore Australia

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

0.2 0.25 0.3 0.35 0.4 0.45 0.5

GD

P p

er

ca

pit

a, U

S$

(2

00

9)

Gini coefficient post-taxes and transfers

7

$1,460 $2,180

$3,009

$5,272

$7,107

$13,652

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

2009 $

Year

Monthly Household Income from Work Among Employed Households (Inflation-adjusted)

HH in 2nd Decile HH in 5th decile HH in 9th decile

Source: DOS Key Household Income Trends

Income growth has become more unequal…

Share of Deciles in Total Income, 2000 & 2010

1.7

2.3

3.3

3.8

4.7

5.1

6.1

6.2

7.3

7.4

8.7

8.9

10.4

10.5

12.5

12.6

15.8

15.9

27.4

29.4

2000

2010

Ye

ar

1st 10th

Intercensual Differential

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1 2 3 4 5 6 7 8 9 10

The fruits of economic growth in the last decade went mostly to top-earners…

Outline





Denmark

Finland

France

GermanyJapan

New Zealand

Norway

Sweden

United Kingdom

United States

y = 2.2x - 0.27R² = 0.76

0.1

0.2

0.3

0.4

0.5

0.6

0.1

0.2

0.3

0.4

0.5

0.6

0.15 0.20 0.25 0.30 0.35 0.40

Inequality(1985 Gini Coefficient)

Intergenerational earnings elasticity

The Great Gatsby Curve

y = 2.2x - 0.27R² = 0.76

Inequality matters because it reduces social mobility...

Inequality matters it reduces health and social well-being...

Inequality and well-being

• Wilkinson and Pickett’s argument is a psychological and physiological one: that inequality makes people focus on their status and relative positions.

• These concerns create anxiety, distrust and social isolation, which raise psychological stress, and contribute to health and social problems (e.g. obesity, violence, etc).

The biology of stress

• Robert Frank (2007) argues that higher inequality causes people to spend more on positional goods to maintain their relative positions.

• While the rich can afford to divert more of their incomes to positional goods (as their incomes are rising faster), the middle income and the poor have to cut back spending on non-positional goods or borrow more to spend on positional goods.

• These expenditure “arms races” are wasteful because they leave people in the same relative positions as before but with more of their resources channeled to positional goods.

• Rajan (2010) argues that inequality in the US led to government policies which encouraged cheap credit and financial innovation to promote home ownership. These policies increased household borrowing in the US to unsustainable levels, and set the stage for the financial crisis.

Inequality matters because it leads to wasteful consumption, and may contribute to economic instability

Outline





What is insurance?

• Insurance is a form of risk management used to hedge against the risk of a uncertain, contingent loss. It is defined as the transfer of the risk of a loss, from one entity to another, in exchange of payment.

• An insurer is a company selling the insurance; the insured or policyholder is the entity buying the insurance policy. The amount to be charged for a certain amount of insurance coverage is called the premium.

• The insured receives a contract, called the insurance policy, which details the conditions and circumstances under which the insured will be financially compensated when the contingent event occurs.

• By pooling risks, insurance offers an efficient and cost-effective way for people to manage the risks of low probability, high impact events. The main alternative – of requiring everyone to save for these risks – is both inefficient and inequitable (or regressive).

Market failures in insurance

Adverse selection occurs when information asymmetries between buyer and seller result in bad products or customers being selected.

- A major problem in insurance markets as it leads to cherry-picking by insurers, resulting in uneven coverage.

- In the extreme, results in missing markets, e.g. unemployment insurance

Moral hazard occurs when a party that is protected from the risks or full consequences of its actions behaves differently from the way it would have behaved if it were exposed to those risks.

- May occur when consumers are fully insured and bear no costs for the loss event.

- Happens because the insurer cannot fully monitor the behaviour of the insured.

Role of Social Insurance

Because of these informational failures in insurance markets, we cannot

expect private insurance to insure us efficiently and equitably against

certain risks, e.g. in healthcare, disability, loss of income or

unemployment, retirement security.

Social insurance can mitigate many of the informational failures in private

insurance markets.

- Because participation is usually (near-) universal, social insurance solves the

adverse selection and cherry-picking problem.

- Because of public provision, the insurer’s costs of administration would also

be much lower than a private insurer. This reduces premiums.

- But moral hazard problems remain, so good policy design which pays careful

attention to incentive effects is critical.

Social insurance can strengthen norms of fairness and inclusion, while

pooling the risks of citizens promotes solidarity and social cohesion.

Alternatives to Social Insurance

Main alternatives to social insurance are:

- Individual savings

- Tax-financed transfers

Savings are an inefficient way to deal with low probability, high impact risks. They are also regressive, and do not foster a sense of shared responsibility.

In theory, tax-financing works like social insurance. But in reality, people view taxes differently from insurance premiums. Tax-financed subsidies also tend to be targeted and means-tested, and make a distinction between those entitled to benefits and those who are not.

Social insurance, on the other hand, is based on the principle of membership. Everyone contributes, so everyone is entitled to benefits.

Outline





Social insurance in Singapore

Health insurance (MediShield) - Left to market forces, health insurance will be patchy with a significant

proportion of citizens left uninsured because of cherry picking.

- MediShield was introduced in 1990 as a basic, low-cost catastrophic illness insurance scheme. Premiums paid from employees’ Medisave contributions. This reduces people’s loss aversion.

- Run on an opt-out basis. Since the scheme began, working adults have been automatically included through their (mandatory) participation in Medisave. Setting membership as the default position increases participation rates as it takes advantage of people’s status quo bias.

- To address the problem of cherry-picking by private insurers, private insurance plans that can be paid from Medisave have to be integrated with MediShield as foundation block.


Old age annuities (CPF LIFE) - CPF founded on the principle of individual savings, not on the principle of

insurance. CPF savings were designed to provide an income for older

persons till age of 85.

- But with increasing longevity, there was an increasing risk that

Singaporeans would “outlive” their CPF savings. Half of all Singaporeans

aged 65 are expected to live beyond 85.

- In 2007, PM Lee mooted the idea of longevity insurance. By pooling a part

of CPF members’ retirement savings, the insurance scheme would provide

those who live beyond 85 with a lifetime stream of income.

- But the proposed scheme faced unexpected opposition.


Old age annuities (CPF LIFE) – con’t

- Saliency bias: Some Singaporeans found it hard to imagine living past 65, and

saw the proposed insurance scheme as a “raid” on their savings.

- Framing: “Longevity insurance” seemed to undermine the public’s

understanding of what the scheme was intended to achieve. The scheme was

eventually named CPF LIFE.

- Equity bias: Income tends to be positively related with life expectancy. The

proposed scheme was seen as regressive, i.e. that it benefits the rich more

than the poor.

- Loss aversion: Others focused on the loss of their CPF savings if they were to

pass away before 85, rather than on the certainty of a lifelong stream of

income if they did. The eventual scheme offered “refundable” options.

- Choice paralysis and use of defaults: Originally, twelve plans were proposed.

Four were eventually implemented with one of the plans set as the default.

This will be further streamlined to two from next year.

Other Possibilities for Social insurance in Singapore

Wage loss insurance - In the context of increased economic volatility and frequent economic

restructuring, workers are subject to more turbulence and uncertainty.

- Traditional unemployment insurance suffers from moral hazard.

- Wage loss insurance, on the other hand, can facilitate economic restructuring

by making it easier for people to move from one sector to another, thereby

promoting labour mobility.

- Moral hazard can be limited by capping the insurance payout to a certain

percentage (say 50%) of the wage loss for a limited period (say one year).

- It is also an efficient way of subsidising job-specific skills training, and may be

superior to the current system of providing generous subsidies for generic

skills training not tied to a specific job.

- Does not cost employees/employers a lot, while state needs only to pay the

premiums of the low-income.

Other Possibilities for Social insurance in Singapore

Long-term care insurance - With an ageing population, more Singaporeans will require long-term care.

But the current scheme, ElderShield, is inadequate. Payouts are relatively low,

they’re not inflation-indexed, and they leave the members exposed to the

risks of catastrophic costs.

- ElderShield needs to be expanded and may have to be restructured. Instead of

providing a fixed payout and requiring citizens to pay for costs in excess of this

amount, it could be structured as a scheme that provides protection for costs

over a certain amount.

- The main risk of such restructuring is moral hazard. Physicians or care homes,

knowing that patients are insured, may prescribe more expensive or even

unnecessary care.

- How to check against such practices leading to spiraling long-term care costs?

Patient co-payment (without fixed limits) would probably be necessary.

Conclusions

The last decade or so has been characterised by increased economic volatility and higher levels of inequality.

Left unchecked, these trends could erode our social cohesion, reduce social mobility, and undermine our socio-political fabric.

Our social compact is built on the principle of individual savings. Although appropriate for an earlier context, it is no longer sufficient to deal with today’s realities of ageing, inequality and volatility.

Relying primarily on individual savings passes too much risks to citizens, while relying on tax financing means strict targeting of benefits and means-testing, which can be divisive and stigmatising.

We need a new social compact that makes wider use of social insurance. Pooling our risks can also strengthen norms of inclusion and fairness.

Thank you

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