The Cost of Pension Insurance - Essay Example

The Cost of Pension Insurance When one takes a historical tour on the provision of ‘public goods’, one will be able to see that the so-called public goods had originally been provided by private entrepreneurs and are still currently provided in one country or another. The postal service, for example, was once private everywhere. Mass transportation vehicles such as ships and trains were originally provided by the private sector. Police forces, detectives, and arbitrators were formerly provided by private entities. Even the caring for the sick, the poor, the elderly, orphans and widows has been traditionally the concern of private charity organizations1. However, public goods theorists argue today that public goods, such as security and community welfare, cannot be produced privately, but instead require state intervention. This is in conjunction with the theory of the welfare state. According to the welfare state theory, all citizens are entitled to receive decent and adequate social benefits such as food, medical care, education and income from the public thru the national government. This concept stems from several elements. Foremost of these elements is the notion that citizens have inalienable rights. These rights include the right to life, liberty and happiness. For these rights to be exercised, the citizen should have the necessary facilities and resources. It follows then that life, liberty and happiness can only be obtained by a person who is clothed, fed, sheltered and educated. These being the case, does it follow then that the state should provide insurance for its constituents? Or, should the state delegate this responsibility to the individual? That is, should this be left alone for the private business sector? We will try to address these questions in this paper. Chapter 1: Assessment of Insurance Benefits The provision of insurance is seen by the government as necessary for efficiency reasons. The reason behind this is that not doing so will cost the government- and ultimately the taxpayers- more than if it has done so. Consider a person who was left to acquire insurance for himself. If that person did not do so, it would then fall upon the government to take care of him if he has been injured, hospitalized or senile. The case only considers a single person. One can imagine the magnitude of expenses that the government incurs if this happens to even a fraction of the population. The propensity of an individual to acquire for himself insurance is basically a function of income – the lower the income, the less probable to acquire one. The basic principle is that when the decision is left on the individual, he may or may not opt acquire insurance for himself. Even if he did avail of a private insurance, it might be insufficient to cover his needs. And who then will carry the burden of taking care of these individuals? It is none other than the government and more importantly, the taxpayers. Another issue that insurance provision faces is equity or whether it is sustainable or not. The risks are great for this kind of business as people are getting more and more unscrupulous. This is why before the insurer pays the insurance money, a rigorous investigation is undertaken. With regards to public provision of insurance, the problem becomes complex as the government operates as a welfare state. That is, the government usually offers rates that are not aimed not to make profits but to provide social services. This type of mechanism is problematic because of the clamor to lower taxes which basically translates to fewer revenues and consequently fewer funds for the insurance service. Where then would the government get the funds for the increasing cost of insurance provision? The problem is further compounded by the fact that the difference between payments to acquire insurance is much less than what the insurance pays to the beneficiary. As a rule, insurance is most effective when losses are common enough to be of concern but not frequent enough to be routine. The problem is that old age care is becoming more of a routine as medical advances prolong life but not necessarily heal them. The cost of medical care is also on the rise as medication and medical procedures are becoming more effective but more complex and costlier. Provision of unemployment insurance also offers great risks as the beneficiary may prolong his unemployment and industries are currently threatening or have already size down its number of employee to reduce labor costs. It becomes apparent that there is now a clash between equity and efficiency. Insurance provision may be efficient but it is not equitable. However, the probability of equitability may be increased by providing mechanism to minimize lay-off and this includes a sound economic management. This mechanism along with sound financial projections can minimize the problem of insufficient funds2. Chapter 2: The Wisdom of Public Insurance The private sector is marked by financial management excellence and competitive packages which is a good factor when talking about insurance provisions. Does this mean that it would be more beneficial to avail of insurance from the private sector? One important reason why public insurance should be availed of is due to the fact that it is more secure. This is because the government has a taxation system which provides a rather steady supply of resources as compared to private insurers who rely on the success of their insurance funded investments (the private sector is still prone to business failure). If the investments fail, where can the insurer source funds for insurance payments? By filing for bankruptcy, the private insurer can easily absolve himself of responsibilities leaving the expectant clients hapless and miserable3. With the public insurance as compulsory and publicly organized, the government is assured of steady revenue to finance the insurance operations. The public servant is not offered the convenience of turning his back on his state welfare duties although he may do so at the expense of condemnation and inclusion in history books as an infamous personage. As we already have discussed earlier, it would be more efficient for the government to do so. Another reason why an individual should avail of public insurance is because private insurance may not offer what he requires. Private market supplies are dictated by the demand. This implies that those insurance which receives minimum request can be phased out. In the case of unemployment, the probability of acquiring insurance is minimal because people tend not to think that they will be unemployed- especially for those in the higher income strata who are usually in relatively stable employment. They would rather insure for sickness and disability because of the severity of the repercussions of being in such a condition4. It must be remembered that the prerogative of private firms is to produce profits which may lead them to adapt policies that places the client at the losing end. For example, an insurer may install a policy of releasing payments only after 120 days. They may overprice insurance payments when all along they knew that the probability of occurrence is very low. They may point out legal technicalities such that the client becomes unqualified for insurance payments. The government is more apt to consider social profits rather than financial gain and is more considerate in dealing with cases5. Suffice it to say, it is the government which will be more dependable compared to the private sector. Chapter 3: The Issue of Unemployment Insurance Insurance is defined as a form of risk management primarily used to secure against risk that would entail gross financial loss. It is the equitable transfer of the risk of a potential loss in exchange for a premium. Insurance is basically a safety net which a person can resort to in times of financial troubles6. Based for this definition, can we consider unemployment insurance as insurance per se? The problem that comes to mind with regards to the unemployment insurance is that it tends to make the beneficiary dependent on the insurance itself especially when the differential amount between the insurance and work salary is minimum – thus the “unemployment trap”. Instead of providing a means of reinstating the individual into an employed status, it creates a favorable environment to stay unemployed. In other forms of insurance such as those for sickness and disability, the received amount provides temporary relief for the individual by providing him with money to secure his needs. But, it does not create dependency tendencies because health conditions are verifiable and usually temporary. In the unemployment scenario, an individual can always claim or forward reasons to justify his unemployment making the insurer virtually helpless to force the person to find employment 7. But does this problem makes unemployment insurance unqualified to be considered as a form of insurance? The answer is no. Unemployment insurance can still be called as insurance precisely because it suffices the criterion that insurance serves as a safety net for predicaments such as loss of income and destruction of property. The ‘unemployment trap’ although theoretically possible receives little empirical evidence. Even if dependency does develop, one must remember that car and health insurance also tend to promote dependency although for a short period of time only. Chapter 4: Long Term Care for Old Age Given that the volume of individuals requiring long term care in old age is becoming significant, it becomes necessary to consider whether this type of insurance should be mandatory and, if this is the case, determine whether it is the public or the private who should provide the insurance. Mandatory insurance is necessary for the reason that it lessens the burden passed on to the next generation. Considering that more people are entering the retirement stage as compared to the number of people entering the workforce, it can be seen that if insurance is not made this way, the incoming generation would be supporting a large number of old dependent people. Since the government cannot just ignore this segment of society due to moral, equity and efficient reasons, one can expect a tremendous increase in tax imposed in the future to finance the welfare state8,9. One of the reasons why it is more preferable to have the government provide lifetime insurance is due to the difficulty to estimate future developments in medical care and uncertainty in medical prices due mainly to the fluidity of technological and epidemiological dynamics. The government is in a better position to respond to these systemic risks due to its power of taxation. As an example, consider the situation wherein medical technology has enabled the prolonging of lifespan of an individual (although not actually curing him). If for example, the company study projected its insurance requirements over a 10 year period but the technology raised the old age care to 15 years. This would then force the company to pay for the additional 5 years which was not paid by the claimant. Considering the volume of claimants and the span of additional period, the monetary figures can be very large. This places the company and the claimant in a precarious position because the company will be lacking in funds while the claimants may not receive any more benefits during the last stage of their life. The government is more apt to respond to these changes because they have the financial foundation- taxation – which they can easily adjust to remediate such developments10. Another important factor explaining why the government should provide this insurance is that it is easier to hold down total health expenditure as compared to the private insurance (usually subsidized through a tax system). The reason for this is because the government can avail of cheaper health care as compared to privately procured services. This benefit has been proven by the OECD countries which registered only an average of 0.6% increase in health care spending between 1980 and 1990 amounting to only 0.6% of gross product. The United States which extensively relied on private insurance experienced an increase in health expenditure from 9.3% to 12.6% of Gross Domestic Product in the same time frame as that of the OECD example. This represents a 3.3% increase as compared to the 0.6% of the OECD. Switzerland, which also delegates insurance to the private sector, experienced an increase in health spending by 3% of GDP from 1980-8211. Conclusion At the end of the day, public provision of insurance is more preferable as compared to private provision primarily because optimal conditions can be achieved if the government takes on the role as an insurer. Unemployment insurance, although theoretically troublesome, is also a form of insurance because it suffices the basic requirement that insurance provides a safety net for sudden financial loss. References: Bernheim, B. Douglas, Lorenzo Forni, Jagadeesh Gokhale, and Laurence J. Kotlikoff (1999) “The Adequacy of Life Insurance: Evidence from the Health and Retirement Study”, NBER Working paper No. 7372, October 1999. Boyce, Steven, and Richard A. Ippolito (2002) “The Cost of Pension Insurance”, Journal of Risk and Insurance, 69 (2), 2002, 121-170. Brown, Jeffrey, and Amy Finkelstein (2003) “Why Don’t People Purchase Long-Term Care Insurance”, mimeo, NBER, 2003. Cutler, David (1996) “Why Don’t Markets Insure Long-Term Risk?”, mimeo, Harvard University, 1996. Cutler, David and Zeckhauser (2003).Extending the Theory to Meet the Practice of Insurance. Harvard University and NBER Merrian Webster (2006) Definition of Insurance. 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