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week 02 - Lecture 2 Social insurance 1 The economics of...

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1 Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 1 Lecture 2: Social insurance 1 The economics of actuarial insurance 2 Social insurance: unemployment insurance, sick pay, pensions 3 Long-term care: a suitable case for social insurance Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 2 1 The economics of actuarial insurance Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 3 1.1 Actuarial insurance Definitions of insurance – A device to protect individuals against risk – An actuarial mechanism Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 4 Efficiency arguments: the welfare gains from insurance Assume that high-quality long-term care costs €50,000 per year If there is no insurance, a person has to save enough to cover the maximum duration, e.g. 20 years at €50,000 per year = €1 million With insurance, a person has to save enough to cover the average duration, e.g. ½ year = €25,000 Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 5 Moral arguments: fairness behind the Veil of Ignorance Rawls argues that the rules of a just society should be made by people who do not know where they will end up in that society, i.e. behind the Veil of Ignorance Insurance is an example of solidarity behind the Veil of Ignorance, and hence has moral appeal Tax finance (e.g. income-tested poverty relief) can be interpreted as another example Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 6 How actuarial insurance works Premium = (1+ α ) pL
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2 Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 7 Conclusion Economic efficiency and morality argue in the same direction: in an efficient and humane society people should be able to insure against the need for long-term care Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 8 1.2 Technical problems on the supply side Nicholas Barr, EU456/SA4F7 Lecture 2, LT 2010 9 Conditions under which competive insurance will be efficient 1 Probabilities must be independent (individual risk, not common shock) 2 Probability must be less than one (risk, not certainty) 3 Probability must be known or estimable (risk, not uncertainty) 4
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