Reinsurance Of National Unemployment Benefit Schemes
Reinsurance of NationalUnemployment Benefit SchemesMiroslav Beblavý, Daniel Gros, Ilaria MaselliNo. 401 / January 2015AbstractThis study is a contribution to the debate around the creation of an unemployment insurancescheme for the EU/euro area by proposing an alternative mechanism to the Europeanisationof national insurance schemes. The authors make the case for a reinsurance mechanism andshow that such a system delivers, for a small average contribution, large shock-absorptioncapacities. At the same time, due to a threshold issue, it is not suitable for EU-levelabsorption of small national shocks. It is rather meant to deliver a large punch onceactivated, which should occur only in case of MAJOR events for the labour market. Had sucha scheme been in place in the EU during the period 2000-2012, it would have been triggered40 times.This study has been prepared at the request of the European Commission,Employment, Social Affairs and Inclusion DG. VT/2013/133CEPS Working Documents are intended to give an indication of work being conductedwithin CEPS’ research programmes and to stimulate reactions from other experts in thefield. The opinions expressed in this document are the sole responsibility of theauthors and do not necessarily represent the official position of the EuropeanCommission or of CEPS.ISBN 978-94-6138-438-6Available for free downloading from the CEPS website (http://www.ceps.eu) CEPS 2015
Contents1.Introduction . 12.The Swiss and US models . 12.1 The Swiss system . 22.2 The US system . 42.3 Lessons from the two (con)federations. 73.A fiscal shock absorber for the eurozone? Lessons from the economics of insurance . 83.1 Insurance and convexity . 93.2 Insurance with deductible first best . 93.3 An illustration: Normally distributed shocks. 103.4 Conclusions . 124.The reinsurance in practice . 124.1 The trigger . 134.2 The claim. 154.3 The deductible. 164.4 The pay-out . 174.5 The pay-in . 184.6 The EUI balance for the EU and for selected countries . 204.7 The stabilisation impact of the reinsurance . 235.Summary of results and recommendations . 27References . 30List of Boxes, Figures and TablesBox 1. Short-term vs. total unemployment rate . 15Box 2. Technical aspects of the simulation . 19Box 3. Review of the literature on the multiplier effect of unemployment benefits . 24Figure 1. Ratio of people registered as unemployed to canton population, December 2010 . 3Figure 2. Yearly unemployment benefit payments as a percentage of canton GDP,average 2008-11. 4Figure 3. Correlation by state between unemployment rates and unemployment paymentsas a percentage of state GDP, average 2000-13. 6Figure 4. Total unemployment insurance benefits paid by month and type of programmein the United States, 2007-10 . 7Figure 5. Welfare loss with a (partial) shock absorber vs. insurance with deductible . 10Figure 6. Difference between social losses with a proportional shock absorber andan insurance mechanism with a deductible . 11Figure 7. Number of cases had the reinsurance been in place since 2000 . 14Figure 8. Correlation between the number of cases and unemployment rates andstandard deviation . 14Figure 9. Maximum duration of unemployment benefits in Europe . 17Figure 10. Cumulative payout, 2008-12. 18Figure 11. Average annual pay-in as a percentage of GDP, 2000-10. 19Figure 12. Fund yearly balance. 20Figure 13. Fund cumulative balance . 21Figure 14. Fund balance in selected countries for ‘stormy days’ (SD 1). 22Table 1. Example of stabilisation effect of the reinsurance during the Great Recessionin selected countries (percentage of GDP) . 25Table 2. Comparison of actual GDP evolution and GDP growth with EUI . 26
Reinsurance of NationalUnemployment Benefit SchemesMiroslav Beblavý, Daniel Gros and Ilaria Maselli*CEPS Working Document No. 401 / January 20151.IntroductionThis short study analyses theoretical and practical aspects of introducing an EU-widereinsurance scheme for national unemployment insurance systems. The objective of thestudy is to elaborate on the welfare gains of such a setup, and to flesh out what such ascheme could look like from a practical point of view and thus provide policy-makers andthe wider public with a ‘tangible’ example they can examine.The study has four sections in addition to this brief introduction.In Section 2, we review existing reinsurance schemes in the United States and Switzerland.Although both schemes are very different from our proposal for Europe, they provideinspiration for particular aspects of the proposal.In Section 3, we assess reinsurance schemes from a theoretical point of view, outlining therationale for such schemes, in principle, and their welfare benefits.In Section 4, we discuss possible key characteristics of the scheme, namely contributions(including their macroeconomic impact and the possibility to differentiate rates/premiumsaccording to country risks), pay-outs (with or without earmarking) and the size of thescheme, issues regarding the potential triggering of the pay-out and possible thresholdeffects, and stabilisation effects. We do this by presenting a detailed scheme design as well asa simple retrospective simulation of how the scheme would have operated in the period2000-12, had it been in existence.In Section 5, we summarise our findings in an accessible and clear way.2.The Swiss and US modelsWe start this study by looking for inspiration in two (con)federations: the United States andSwitzerland. Despite their different sizes, the two case studies shed light on how federalstates manage unemployment insurance (UI) schemes and their estimation of the best levelat which to organise such schemes. The decision to centralise UI at the highest level has notonly produced different systems but also seems to have been determined by different needs.For each of the two cases, we sketch answers to the following questions: How is unemployment insurance organised?What do the data say?Why is the case interesting?Miroslav Beblavý is a Member of the Slovak Parliament (since 2010) and a Senior Research Fellow atCEPS. Daniel Gros is Director of CEPS. Ilaria Maselli is a researcher in the Economics and SocialWelfare Policies unit at CEPS. The authors are grateful to Amin Bahrami for his diligent researchassistance.* 1
2 BEBLAVÝ, GROS & MASELLI2.1 The Swiss systemHow does it work?For wages up to 10,500 Swiss francs ( 8,588) per month, the replacement rate ofunemployment insurance in the Swiss system is 70% of the worker’s average wage over thelast six to twelve months of his/her employment. The rate goes up to 80% for workers withdependent children. The unemployment allowance is granted on a daily basis (fiveallowances a week). The maximum duration of the allowance is 260 daily allowances if theinsured person can demonstrate a contribution period of 12 months in total, and 400 dailyallowances if the insured person proves a contribution period of 18 months in total.The main organisation responsible for unemployment benefits is the State Secretariat forEconomic Affairs (SECO), but cantons and communes play a very important role in theadministration of the process, especially in light of the very close link established by theSwiss system between active and passive labour market policies. The unemployment schemein Switzerland is rather generous, but it is conditional on the participation of theunemployed person in the active labour market programmes, under the supervision of theregional unemployment office, as stipulated by the federal law.Battaglini and Giraud (2003) argue that different cantons use different “policy styles” in theirapproach to labour market policies: some cantons primarily use ALMP instruments aimed atimproving the reintegration of unemployed persons into the labour market, while others aremore intent on preventing unemployment benefit abuse. The authors argue that “policystyles influenced by interventionist traditions and more leftist political forces are more proneto use job-seeker reintegration instruments. On the contrary, policy styles influenced bymore liberal traditions and conservative political forces give preference to controlinstruments or the simultaneous use of both types of instruments”. According to Battagliniand Giraud, another factor that explains how the same federal law is applied locally indifferent ways is the regional diversity that results from language or religious segmentations.Unemployment insurance is compulsory for all non-self-employed employees and isfinanced both by employers and employees. Contributions are collected along with othersocial insurance schemes and are split equally between the employer and employee. Thecontribution rate is set at 2.2% (i.e. 1.1% each for the employer and employee) of insuredearnings, up to a maximum gross salary of 126,000 francs ( 103,051) per year. Workersearning higher wages pay an additional solidarity contribution.1Both the Confederation and the cantons support the financing of the unemploymentinsurance. The Confederation contributes to the costs of the employment service and of theactive labour market programmes at the rate of 0.159% of the total amount of salaries subjectto contributions, while the share of the cantons is 0.053%. The payments from all overSwitzerland are gathered in a single fund at the federal level and the unemployment benefitsare paid out of this same fund. This Unemployment Insurance Compensation Fund alsoderives revenue from returns on its assets. In case the means described above are notsufficient to cover the costs of insurance, the federal government grants short-term cashloans according to market conditions. To ensure long-term stability of the fund, the FederalCouncil can, at the end of the year, raise or lower the contribution rate.Solidarity of 1% (employee: 0.5%; employer: 0.5%) is levied on pay bands between 126,000 francs( 103,051) and 315,000 francs ( 257,627).1
REINSURANCE OF NATIONAL UNEMPLOYMENT BENEFIT SCHEMES 3Some dataThe performance of the Swiss labour market is the envy of many advanced economies.According to data provided by the Swiss Federal Office of Statistics, the average rate ofunemployment of Swiss nationals over the decade 2003-13 was 3%.2 Despite the low levels,however, there are relatively strong disparities between cantons. For instance, theunemployment ratio observed in Geneva in December 2010 was more than six times largerthan that observed in Obwald in the same month (Figure 1).Figure 1. Ratio of people registered as unemployed to canton population, December ppenzell Rh.-Ext.GrisonsUriNidwaldObwaldAppenzell Rh.-Int.43.532.521.510.50Source: Office fédéral de la statistique, Switzerland.According to a study carried out by the Swiss State Secretariat for Economic Affairs(Flückiger et al., 2006), cantonal differences are sensitive to the business cycle in such a waythat they increase during upswings and decrease during downturns. When the situationdeteriorates, all cantons are affected by the decrease in economic activity that results in anincrease in unemployment inflows proportional to the size of the labour force. However,when the economy improves, the rate of unemployment falls more in some cantons thanothers, which show more pronounced exit rates from unemployment. One could infer thatthe divergence in recovery patterns is due to structural differences between the smallentities. As a result, different cantons spend different shares of their GDP on incomeprotection measures (Figure 2).The Swiss Federal Office of Statistics also calculates a separate rate for foreigners. The average overthe same period is 8.1%, but they constitute a small share of the population.2
4 BEBLAVÝ, GROS & MASELLIFigure 2. Yearly unemployment benefit payments as a percentage of canton GDP, average NidwaldBâle-VilleAppenzell St-GallBâle-CampagneGlarisArgovieAppenzell sJuraVaudNeuchâtelTotal0.00%Source: Office fédéral de la statistique, Switzerland.Why is the Swiss case interesting?The Swiss Confederation gives large powers to its 26 cantons and 2,396 communes in theorganisation of policies. Yet, unemployment insurance (as well as disability and ageinginsurance) is organised at the federal level. The question is therefore: Why is incomeprotection against unemployment a federal rather than a local policy, despite thedivergences observed among the local labour markets?A review of the literature and official reports suggest two main reasons. The first is a‘solidarity element’; the second is dictated by the ‘law of large numbers’. For the fund to bebalanced, a large number of contributors is needed. Given the small size of the cantons andof the country itself, the optimal level to organise an unemployment insurance scheme cantherefore only be the federal one.2.2 The US systemHow does it work?The US federal unemployment compensation (UC) programme provides income support toworkers who lose their jobs for up to a maximum of 26 weeks in most states. Approximately130 million jobs are covered by the programme. As at the end of the week of 17 August 2013,2.9 million unemployed workers were receiving unemployment compensation with anaverage weekly compensation of 307. Estimated expenditure on regular unemploymentbenefits in 2014 amounts to 40.5 billion (Whittaker and Isaacs, 2013).In case of severe recessions and consequent high unemployment in a state, extended benefitscan be launched, funded 50% by the state and 50% by the federal government (andexceptionally, 100% by the federal government in the 2009 stimulus package).The US system constitutes an obvious point of comparison for the potential Europeansystem, given that the UC programme centralises part of the organisation but still allowseach state the possibility to tailor certain features and requirements.UC in the United States in fact is administered by a joint federal-state programme financedby federal taxes under the Federal Unemployment Tax Act (FUTA) and by state payroll taxes
REINSURANCE OF NATIONAL UNEMPLOYMENT BENEFIT SCHEMES 5under the State Unemployment Tax Acts (SUTA). The FUTA tax rate for employers is 6% oflabour costs, but a credit of 5.4% is granted for employers in states that have a nationalsystem in place, which is the case today for all US states. The provision served in the past asan incentive for all states to create an insurance scheme, as it constituted a minimum floor foremployers in every state.Most businesses are subject to state and federal unemployment taxes. An estimated 6.7billion in federal unemployment taxes (FUTA) and 44.47 billion in state unemploymenttaxes (SUTA) should have been collected in the financial year 2011-12 (Whittaker and Isaacs,2011). Part of the former is used by each state to cover the administrative costs of its system,and the latter part finances the extended benefits when needed.Unlike in most European countries, the US version of an unemployment insurance scheme isfully financed by employers. The mechanism is based on the principle that those that firemore also need to contribute more to the fund. For the firms’ side of the labour market, thesystem is organised as insurance: companies need to insure themselves against the risk offiring a certain number of workers. The same is not true for employees, who do notcontribute to the fund. From their point of view, therefore, the benefits qualify instead associal assistance in the form of income protection.3The system is administered by the US Department of Labor (DOL). Federal law sets broadrules that the state programmes must follow, including the broad categories of workers thatmust be covered by the programme, the method for triggering the Extended Benefit (EB) andEmergency Unemployment Compensation 2008 programmes, the highest stateunemployment tax rate to be imposed on employers (5.4%), and how the states will repayUnemployment Trust Fund (UTF) loans. If the states do not follow these rules, theiremployers may lose a portion of their state unemployment tax credit when their federalincome tax is calculated. The federal tax pays for both federal and state administrative costs,the federal share of the EB programme, loans to insolvent state UC accounts, and stateemployment services (Whittaker and Isaacs, 2011).Maximum benefit levels vary enormously, from 133 per week in Puerto Rico to 625 inMassachusetts.4 States can obtain loans from the Federal Unemployment Account shouldthey run low on funds, but the deficit needs to be cleared in the long run.Some dataA certain level of dispersion around the average national unemployment rate also exists inthe United States. For example, at the height of the financial crisis in 2009-10, the rate ofunemployment in Michigan was three times higher than that of North Dakota. According tothe long-term average, unemployment in California is more than two times higher than inNorth or South Dakota. As shown in Figure 3, States with higher unemployment rates spenda higher portion of their budgets on unemployment benefits.This is due to the fact that it is not the workers that insure themselves against the risk ofunemployment, since the contribution is paid by employers. Workers simply receive the benefit incase of job loss.342011 data.
6 BEBLAVÝ, GROS & MASELLIFigure 3. Correlation by state between unemployment rates and unemployment payments as apercentage of state GDP, average 2000-13Average Yearly FUTA reciepts as percentage of YND0.06%HIIANENHSD0.04%MTWV NYMEWINMCOAR INMNKSMD ALUTOK DEWACTLAMOTXMIAK RINVOHGASC 7.0%8.0%9.0%Average Unemployment Rate 2000-2013Source: Bureau of Labor Statistics, US Department of Labor.Why is the US case interesting?The US case is worth studying not only due to the size of the labour market, which iscomparable to the European one, but also for three additional reasons: the reason why the UC system was brought in at the federal level – i.e. to avoid socialdumping;the experience rating at state level; andthe additionality in case of severe recessions.The origin of the system dates back to the mid-1930s. The Great Depression had made it clearthat an income support mechanism was necessary, and a number of states started toinvestigate and make proposals in this direction. The main obstacle, however, remainedemployers’ fears of losing competitiveness vis-à-vis neighbouring states. This madeintervention at the federal level necessary. Witte (1936) explains:Throughout the history of the unemployment compensation provisions of the SocialSecurity Act, there was general agreement regarding the necessity for federallegislation. It was recognized by everyone who believed in the desirability ofunemployment insurance that little headway could be made unless employers in allstates would be subject to the same (or substantially the same) costs, whether theirrespective states enacted unemployment insurance laws or not.As a result, the creation of a common minimum standard was not expressed in terms of thelevel of protection, but in terms of employers’ contributions necessary in order to finance thepolicy.
REINSURANCE OF NATIONAL UNEMPLOYMENT BENEFIT SCHEMES 7The experience rating at state levelIn case of a lack of liquidity, a state can borrow from federal funds, with interest charged onloans that are not repaid by the end of the fiscal year in which they were obtained. Statesfacing troubles in financing their own insurance can therefore ask for help from the federalfund, but only in the form of a loan that needs to be repaid based on an agreement with theUS Secretary of Labor. If the state fails to restore the balance between revenues andexpenditure of national funds in the medium run, the federal authority raises the firms’contribution.5A less remarked upon, but interesting aspect of the US system is its capacity to strike abalance vis-à-vis individual states over the cycle. Each state can indeed borrow from thefederal cash pot in hard times, but these remain loans and as such need to be returned. Thisin principle ensures that the objective of stabilising income when most needed is not missed,but at the same time avoids free-riding. If a state is unable to repay the loan, the employers’contribution is raised by the federal authority, as happened recently in California, forexample, where the fund currently runs a deficit of almost 10 billion (EmploymentDevelopment Department, 2013).Additionality in case of severe recessionsOne of the added values of the federal system lies in the possibility to extend benefits inexceptional cases of severe recessions in one or more states, i.e. when the stabilisation tool ismost needed. This takes place via the extended and emergency benefits, with the formerpartially and the latter completely financed at the federal level. Extended benefits are thegeographically redistributive part of the system.Figure 4. Total unemployment insurance benefits paid by month and type of programme in the UnitedStates, 2007-10Source: Boushey and Eizenga (2011).2.3 Lessons from the two (con)federationsThis section raises two main questions:“For calendar year 2013, employers in 13 states and the Virgin Islands face an increased net federalunemployment tax (FUTA) because the state UC program had borrowed funds from the federal UTFloan account for two consecutive years” (Whittaker and Isaacs, 2014).5
8 BEBLAVÝ, GROS & MASELLIWhat are the reasons behind the decision to make income stabilisation viaunemployment benefits a federal policy in the United States and in Switzerland?Can the EU learn anything from the way in which the two (con)federations organisedtheir policy? In response to the first question, according to our review, the reasons behind the twocountries’ decisions are:a solidarity principle;a problem with the size of the federal entities in Switzerland; andthe need to create an income stabilisation tool in case of recession, without generating acompetitive disadvantage for national firms, which is able to absorb even severe blows. The extent of solidary is essentially a political issue. Most EU member countries are at leastas big as Switzerland, so the size issue is not very relevant. Therefore, the key issue is theneed to create an income stabilisation tool in case of recession.On the one hand, unlike in the United States in the 1930s, national unemployment benefitssystems have been in place in European countries for approximately a century, albeit withdifferent levels of generosity and taxation. However, different systems in Europe clearlyhave very different stabilisation capacities.6 The experience of the recent years has alsoshown that severe recessions can overcome the ability of some national systems to cope andcan lead to pro-cyclical policies.The US case also offers inspiration in two ways. One is additionality at the highest level – incase of a severe recession, unemployment benefits can be extended, paid by the federalbudget. The possibility to top up national systems whenever there is no sign of recovery inthe economy is certainly an interesting feature. Such decisions, however, can be taken in theUnited States relatively quickly. For additionality to be implemented in the EU, automateddecision-making would be necessary given the intrinsic slow nature of decision-making atthe European level. The experience rating is also an element worth examining. Each US statecan receive funds from the federal pot, but the deficit needs to be cleared in the long run.These two principles will factor in our proposal for how to organise a EuropeanUnemployment Insurance (EUI).3.A fiscal shock absorber for the eurozone? Lessons from the economicsof insuranceEven before the euro crisis started, it had been widely argued that the eurozone needed amechanism to help countries overcome idiosyncratic shocks. The experience of the crisisitself seemed to make an overwhelming case for this argument, and throughout the EUinstitutions it is now taken for granted that the eurozone needs a system of fiscal shockabsorbers. For example, a 2012 Report of the President of the European Council calls for:“Stage 3 (post-2014): establish a well-defined and limited fiscal capacity to improve shockabsorption capacities, through an insurance system set up at the central level ” (VanRompuy, 2012, p. 5).Following this line of thought, a number of shock-absorber mechanisms have been proposedrecently. These mechanisms usually stipulate that a certain percentage of each upswing ordownturn in the economy should be offset by payments to a central fund (e.g. Dullien, 2013;Enderlein et al., 2013). But this approach neglects a key insight from the economics ofinsurance.6For a discussion, see Dolls et al. (2012).
REINSURANCE OF NATIONAL UNEMPLOYMENT BENEFIT SCHEMES 93.1 Insurance and convexityInsurance is particularly useful when the cost of unpredictable events is convex, i.e. when ashock of twice the magnitude of another one causes more than twice as much damage,because if this is the case the expected value of the cost of being hit by a shock is not simply alinear function of the disturbance. The standard case for insurance at the microeconomiclevel is simply that utility functions are assumed to be concave (and hence the cost of losingincome is also convex). In macroeconomic terms, this means that the political and economiccost of a recession with an increase of unemployment by 4 percentage points is not simplytwice that of a recession which is half as strong in terms of unemployment (i.e. with a 2percentage point increase). The euro crisis has vividly illustrated that the costs of largeshocks can be disproportionately large, especially when the shock impairs access to financialmarkets. In this case, consumption smoothing is no longer possible, or is very expensive. Thecase of Greece has also shown that the social cost of very large, ‘catastrophic’ shocks can beextremely severe, because a shock that leads to insolvency creates other problems, includingwidespread bankruptcy costs. By contrast, the small shocks that were prevalent during theGreat Moderation did not involve large costs, as temporary shocks to output or income canbe smoothed at a low cost via savings or borrowing in capital markets.7There ar
Reinsurance of National Unemployment Benefit Schemes Miroslav Beblavý, Daniel Gros, Ilaria Maselli No. 401 / January 2015 Abstract This study is a contribution to th
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