Moral hazard and claims deterrence in private disability insurance.
Through its Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI) programs, the U.S. government provided nearly 12 million disabled individuals with annual benefits totaling $150 billion in 2010. The public Medicare and Medicaid programs provided roughly the same amount of health insurance benefits to these individuals. Nonetheless, the acceptance rates for these programs are low (about half of applicants) and their replacement of pre-disability earnings averages about 50 percent after taxes, with lower replacement rates for higher income workers.
Because of the limitations of these public disability programs, many private employers offer supplemental long-term disability (LTD) insurance. In Moral Hazard and Claims Deterrence in Private Disability insurance (NBER Working Paper No. 18172), David Autor, mark Duggan, and Jonathan Gruber provide a detailed analysis of the incidence, duration, and determinants of claims made on private LTD policies. Using a database of approximately 10,000 policies and one million workers from a major long-term disability insurer covering the years 2000 to 2006, they determine that private LTD claims rates are much lower than claims rates on SSDI, and that private LTD policies have a much higher return-to-work rate among initial claimants.
Their analysis also suggests that the impact of moral hazard on LTD claims is substantial. Based on within-firm, over-time variation in plan characteristics, the researchers find that a higher replacement rate and a shorter waiting time to receive benefits--known as the elimination period--significantly increase the likelihood that workers claim LTD. About 60 percent of the effect of a longer elimination period comes from the censoring of shorter claims, while the remainder is due to the fact that workers facing a longer elimination period are less likely to claim benefits for impairments that would lead to only a brief period of receiving disability payments. This effect is equally large among high- and low-income workers, suggesting that moral hazard rather than liquidity underlies the behavioral response. Consistent with this interpretation, the response of LTD claims to plan parameters is driven primarily by the behavior of the healthiest disabled, those who would return to work after receiving disability benefits.