Social Insurance: Pooling Risks for a More Inclusive Singapore. Donald Low Vice President, Economic Society of Singapore

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1 Social Insurance: Pooling Risks for a More Inclusive Singapore Donald Low Vice President, Economic Society of Singapore

2 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

3 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

4 GDP growth has slowed, and become more volatile GDP Growth Rate (%) Trend GDP growth rate First oil shock Second oil shock Recession 1992 Slowdown Asian Financial Crisis SARS, Iraq war Collapse of dot.com bubble Global financial crisis

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

6 GDP per capita, US$ (2009) Inequality in Singapore is very high by rich country standards... $60,000 Norway $50,000 Switzerland United States $40,000 $30,000 Australia Sweden Germany United Kingdom Finland France Japan Italy Singapore Korea Portugal $20,000 $10,000 Hungary Poland Turkey Mexico $ Gini coefficient post-taxes and transfers Source: OECD. Gini data: mid-2000s. GDP data: 2009

7 Income growth has become more unequal Monthly Household Income from Work Among Employed Households (Inflation-adjusted) $16,000 $14,000 $13,652 $12, $ $10,000 $8,000 $6,000 $7,107 $5,272 $4,000 $2,000 $0 $3,009 $1,460 $2,180 Year HH in 2nd Decile HH in 5th decile HH in 9th decile Source: DOS Key Household Income Trends 7

8 Year The fruits of economic growth in the last decade went mostly to top-earners Share of Deciles in Total Income, 2000 & st Intercensual Differential 10th

9 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

10 Inequality matters because it reduces social mobility... The Great Gatsby Curve Intergenerational earnings elasticity United Kingdom 0.5 United States 0.4 France Sweden Germany New Zealand Japan y = 2.2x R² = Finland Norway y = 2.2x R² = 0.76 Denmark Inequality (1985 Gini Coefficient) 0.2

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

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

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

14 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

15 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).

16 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.

17 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.

18 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.

19 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

20 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.

21 Social insurance in Singapore 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 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 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.

22 Social insurance in Singapore 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.

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25 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.

26 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.

27 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 meanstesting, 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.

28 Thank you

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