Household Self-Insurance and the Value of Disability Insurance in the United States

Abstract

While the U.S. Disability Insurance (DI) system is large in terms of fiscal costs and beneficiary rolls, its interactions with household self-insurance mechanisms are not well-understood. In addition to crowding out the insurance value of DI, household self-insurance may drive negative selection into DI by reducing the implicit costs that stem from its lengthy application process. Allowing for such interactions in a rich life cycle model, this paper finds that revenue-neutral expansionary DI reforms do not necessarily improve welfare, as benefits often accrue to negatively-selected individuals with stronger self-insurance capacity. However, an asset test can reduce negative selection on the basis of household self-insurance capacity, so much so that expansionary reforms become welfare-improving. Finally while household self-insurance crowds out the value of different kinds of DI expansions, abstracting away from insurance value can still lead to erroneous conclusions regarding their overall and relative welfare effects.

Keywords: Disability insurance, welfare value, negative selection, household self-insurance, asset tests

JEL Classification: D15, I38, J14, H55, J22