Social Insurance

Study guides: Exam 6C, Exam GH-201C, Exam RET-101

Social Insurance is a compulsory, government-administered insurance program covering a risk the private market serves badly or not at all — Employment Insurance, Health Care Insurance, Workers Compensation Insurance, public pensions. Participation is universal or near-universal, contributions are usually a function of earnings rather than of individual risk, and benefits are set by statute.

• The five features that distinguish social insurance from private insurance: compulsory participation; benefits prescribed by legislation rather than contract; contributions not fully risk-based, so cross-subsidy is intentional; a social adequacy objective alongside individual equity; and financing that may be pay-as-you-go rather than fully funded.
• The economic justification is Adverse Selection: a voluntary program covering unemployment, or health care for the sick, attracts only the high risks and collapses. Compulsion eliminates selection, which is what makes universal coverage affordable.
• Individual equity versus social adequacy is the trade-off to be able to state on demand. Private insurance aims for equity — each pays their own expected cost. Social insurance deliberately sacrifices some of it so that benefits are adequate for those who need them, and accepts the resulting Moral Hazard and cross-subsidy as the price.
• Evaluation criteria the syllabus asks candidates to apply to any government program: does it meet its stated objective; is it financially sustainable (solvency and funding); is it efficient (administrative cost, incentive effects); is it equitable; and how does it interact with the private market — does it crowd it out, complement it, or leave a gap?
• Funding is the recurring weakness. Pay-as-you-go financing works while demographics are favourable and fails when they are not, and benefits set politically tend to be increased in good times faster than contributions are.
• The private market is not absent: it often provides the top-up layer above the social floor — supplementary health, disability and life coverage — so program design determines the size of the private market beside it.

Evaluating a Government Program A province proposes a compulsory public earthquake insurance program funded by a flat levy on every property, replacing private earthquake coverage. Apply the standard evaluation framework.

Answer Objective. Universal coverage against a catastrophic peril with very low take-up privately (earthquake take-up in high-risk Canadian regions is well below the level required to avoid a solvency crisis after a major event). Compulsion solves the Adverse Selection and under-insurance problems at once. So far the case is strong.

Sustainability. Weak as designed. Earthquake is the archetypal low-frequency, extreme-severity peril: the program will accumulate a fund for decades and then face a claim far exceeding it. Without reinsurance, a capital markets facility or an explicit government backstop, "the fund" is a promise the treasury will honour later — and that should be stated in the proposal rather than discovered after the event.

Efficiency. A flat levy is administratively cheap but destroys the price signal. Building in a high-hazard zone costs no more than building on bedrock, which discourages mitigation and encourages exposure growth exactly where it is most dangerous — Moral Hazard at the land-use level, and the same criticism made of disaster assistance.

Equity. A flat levy transfers from low-hazard to high-hazard property owners. Whether that is fair is a policy judgement; that it is a subsidy is not, and the actuary should quantify its size.

Interaction with the private market. Replacing private earthquake coverage removes the insurers who currently price, model and reinsure this risk, and with them the expertise and the global reinsurance capacity. A layered design — public coverage above a private layer, or public reinsurance behind private policies — usually dominates full replacement.

Recommendation. The coverage gap is real, but risk-based levies with a mitigation credit, and retention of private participation, address it at lower cost. That structure keeps the price signal while still achieving universality.