How to fix broken social insurance programs

Last month, Carmen Pages and I launched our book Social Insurance, Informality and Labor Markets at the InterAmerican Dialog. The book covers new approaches and policies to expand the coverage of social insurance programs such as pensions, health and unemployment benefits. It also looks at how to make these programs more equitable and reform the rules that compromise the creation of formal sector jobs – either because employers cannot afford to offer formal contracts or workers prefer not to take them.


See the infographci in high resolution here.

The book identifies three main problems:

1. Bismarkian systems have reached their limit because it is difficult to expand their coverage to all workers. These systems - where employers and employees make contributions to social security to finance benefits - were designed for workers in medium or large firms. But the majority of workers do not now have these jobs. They are farmers, own-account workers, or wage employees in small firms that often have productivity levels below the cost of labor. 
    
2. Most social insurance programs redistribute income among plan members, but the way it is done is not transparent and is unlikely to benefit the most vulnerable workers and their families. In many of the programs, contributions are not linked to benefits. Indeed, some individuals pay more than what they get, while others pay less. But it is difficult to assess ex-ante who benefits from the redistribution. Often the transfers are from low- to high-income workers. 
    
3. The programs create a tax-wedge that can penalize formal jobs, in part because workers do not value all the benefits they are mandated to pay for. The tax-wedge is the difference between the total costs of labor and: a) take home pay; and b) how much workers value the benefits associated with the contribution they make. When contributions are higher than the expected benefits, the tax-wedge increases. But even if the contributions are linked to benefits there can be a wedge if workers do not value the benefits they are mandated to pay for. Unfortunately, social insurance programs offer the same health plan to all regardless of age or family size. They also offer the same unemployment benefits regardless of how likely the person is to be unemployed. And the same pension regardless of the level of income or other assets the person might have.

These are some general - and simple - recommendations to design better social insurance programs:

• Have an integrated social insurance system that treats all workers equally regardless of where they work – wage employees, farmers, or own account workers.
• Enroll all workers in the system, overnight, and have proper identification systems and open social insurance accounts for all. This can be done, in fact, as soon as people are born.
• Give more information and choice to individuals regarding the type and level of benefits they want to get, be it for health insurance, pensions, or unemployment benefits. For instance, young, single workers might want to have cheaper health insurance plans.
• In all cases, link the contributions that workers make (and their employer when there is one) to the benefits they expect to receive.
• Motivate workers to save more or buy more insurance by providing information, financial incentives or nudges. Text messages, for instance, seem to be effective in increasing savings rates.
• Finally, have explicit, transparent, and integrated redistributive arrangements to ensure that low income workers are able to obtain a basic level of benefits. Explicit and transparent means that you know who are the beneficiaries of subsidies, how much these cost, and how they are paid. Integrated means that you don't have a parallel contributory program for informal sector workers. Subsidies should be allocated based on means, not on the type of job that workers have.