This research will develop theoretical and computational approaches for characterizing efficient social insurance institutions. We define a social insurance institution as a compulsory government-run program that provides a set of state-contingent taxes (premiums or contributions) and transfers (benefits) that cover a well-defined set of risks. An efficient social insurance institution is one that provides a given level welfare to the individuals in the system at minimal cost. Our research will attempt to provide characterizations of efficient social insurance institutions that cover the following risks: 1) longevity, via mandatory pensions or "old age insurance", 2) disability, via disability insurance, 3) unemployment, via unemployment insurance, and 4) health care costs, via medical insurance. Another objective of social insurance is lifetime redistribution of income and/or wealth. This can be viewed as insurance for a fifth class of risks, namely insurance for individuals who have certain fixed characteristics or "types" that may lead to permanently lower lifetime employment, earnings, wealth, and welfare. Social insurance programs are large and pervasive in developed economies. In the U.S., spending on Social Security (Old Age, Disability, and Unemployment Insurance), Medicare, Medicaid amounted to 48.3% of total Federal spending and 9.8% of GDP in 2000 (U.S. Congressional Budget Office). All forecasts indicate that unless benefits are reduced, social insurance spending will grow rapidly over the coming decades as the baby boomers age and start to retire. Although there have been proposals to shift the costs of social insurance from the government to the private sector via various "privatization" schemes, a variety of moral hazard and adverse selection problems hinder the operation of private insurance markets. We take market incompleteness as the principal rationale for mandatory government provision of insurance, and as the basic point of departure for our analysis. We assume that the government can compel universal participation, but we also assume that it faces the same informational constraints as private insurance institutions would face if they existed. We deal with these fundamental informational asymmetries via two very different but related strategies: 1) a "dynamic mechanism design" (DMD) approach where we search for an efficient policy over an infinite-dimensional space of all possible policies that satisfy certain participation and incentive constraints, and 2) a "parametric mechanism design" (PMD) approach where we search for an "approximately efficient" social insurance institution in a finite-dimensional subspace of social insurance institutions and where incentive constraints are ignored.
Using these techniques we will not only be able to characterize the form of efficient social insurance institutions, we will also be able to quantify the degree of inefficiency in current social insurance institutions. We expect to be able to characterize optimal social security and disability insurance programs as part of a comprehensive, integrated analysis of social insurance in the U.S. and other developed economies. Given the large share of GDP devoted to social insurance, the potential cost savings from discovering more efficient social insurance programs provides a strong, practical rationale for this research.
