Social Insurance

When market failures are so severe that the private market cannot provide adequate coverage, there may be a role for social insurance, which is mandatory insurance provided by the government .. In these circumstances, the government may choose to step in and provide broad and universal coverage. The taxing and regulatory powers of government, plus the ability to prevent adverse selection through universal coverage, can make government insurance a welfare- improving measure. One important example of social insurance is employment insurance.

This is an example of a private market that cannot function because so many of the requirements for private insurance are violated. Insurance companies do not provide unemployment insurance because the moral hazard is so high (people may decide to become unemployed if benefits are generous), because of severe adverse selection (those who often lose jobs are more likely to participate), and because spells of unemployment are not independent (they tend to occur together during business-cycle recessions). At the same time, some countries feel that people should have a safety net under them should they lose their job. As a result, governments often step in to provide unemployment insurance.

The government cannot remove the problem of moral hazard, but adverse selection is avoided by universal Another important example of cases where governments step in is health insurance for the elderly. We noted above the problems of adverse selection that arise when healthy people decline coverage and leave insurers to cover only high-cost individuals. Adverse selection is particularly serious for the aged because inedical costs in the last year of life are almost 20 percent of all health-care costs. Today, to amid adverse selection, the U.S. government offers Medicare, universal health coverage for the elderly, which is paid for through premiums and through taxes on active worken.

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