Overlooked in Discussion on Social Security: Social Security is “Insurance”

Overlooked in Discussion on Social Security: Social Security is “Insurance”

The Japanese social security system, saddled with issues such as missing pension records, the healthcare system for the latter-stage elderly, and the role of the Social Insurance Agency, has been scrutinized recently by the media and Diet. Ahead of every election, the ruling and opposition parties debate the merits of the “taxation method” compared to the “insurance premium method,” or how to view the unification of the systems. Newspapers and so on discuss the choices from the viewpoint of fiscal sustainability, insurance premium rates, consumption tax, individual burden, and who will benefit and lose. Often overlooked in the evaluation of these systems, however, is the perspective that “social security is insurance.” The use of the expression “insured person” in the context of much of the social security system, including public pension, draws on the principle of insurance.

Whether private or a public institution such as the government, the insurer collects premiums, establishes a fund, and pays out to the insured from this fund only in the event of certain accidents. Premiums (and the burden borne by the state in the case of Japan) and insurance benefits are decided by predicting the probability of accidents. Though there is no guarantee that the calculated rate will be consistent with the actual rate, with many insured the difference in the value (rate) is expected to be marginal using the law of numbers.

Under the principle of insurance, insurance (pension) is paid out only when an accident occurs. The majority of people not involved in driving accidents or fires therefore do not receive insurance payments from private insurers; similarly, insurance (pension) is not paid out in the absence of an accident covered by the social security system. In other words, unlike normal savings, one cannot necessarily get back the amount put in.

In this sense, it is natural to conclude after-the-fact that normal savings are the better choice for married couples with healthy lifestyles and average life spans – in other words, the “model cases.” Conversely, for those who are widowed, disabled, in need of long-term nursing care, or involved in unfortunate accidents – in other words, those leading abnormal lifestyles – the expected rate of return from the social security system is higher than normal savings from an ex-post facto perspective.

It is therefore misleading to evaluate the systems based on whether they return more money than the average person puts in, or whether they are more beneficial than regular savings. Insurance is by nature a system that prepares for the unusual situation. If calculations are to be made, they should be to first determine the probability of disability, mortality rate, and incidence of disease, and then to estimate the corresponding changes in income. The probability distribution and resulting changes from the social security system should also be calculated. Reduction of the calculated risk (diversification) is the social merit of the public pension system.

On the other hand, the social security system generates social costs. The first cost is behavioral changes resulting from the collection of premiums. A major example is part-time workers intentionally keeping their income below a certain level (for example, 1.3 million yen) to avoid paying premiums. The resulting reduction of labor supply is a social cost.

Another cost is behavior that changes the probability of accidents when insurance benefits (pension) are paid out. This is because complete monitoring of behavior is impossible. For example, public pension designates a weakened capability to earn income as a covered accident. Excluding situations such as death, however, it is extremely difficult for a third party to objectively determine whether an individual’s capability to earn has decreased. Old age, disability, and death are therefore designated as three covered accidents, and whether an accident has occurred is determined with actual income as a factor. This gives elderly people an incentive to create a covered accident by intentionally retiring early and keeping income low. This phenomenon is a moral hazard, and generates the social cost of reduced labor.

Despite a succession of recent social security system “reforms”, the public remains dissatisfied. One reason for the lack of a real solution is the choices (menu) for the system based on individual incentives – the merits of concentrating on fiscal response and hedging risks through the system, and costs resulting from behavioral changes – were not clearly presented to voters.

Until now, fiscal and macroeconomic perspectives have been emphasized in the discussion on the social security system, while microeconomic incentives have been largely discounted. While fiscally-unsound policy is unlikely, the balancing of the budget is itself a constraint for the social security system, and is not the final goal. Discussion that simply focuses on whether the paid amount becomes a social burden and received amount becomes a social benefit can mislead on essence of the social security system.

The perspective offered in this paper is not unique among researchers, but has yet to gain currency, perhaps because it is too specialized. Creating a basis and forum for discussion based on this perspective should lead to a solution beyond political motivations; mass media and think tanks will be increasingly called on to provide such forums in the future.