The NY Times reports the (economically) obvious: there’s no private market for unemployment insurance. The problem, of course, is adverse selection: Individuals know much more than insurers about their risk of being laid off, and only those at high risk will seek coverage.

PS. A terrific read here is Martin Feldstein’s presidential address to the American Economic Association in 2005. (It’s also published in the AER, March 2005.)

Today I will discuss how the major forms of social insurance could be improved by shifting to a system that combines government insurance with individual investment-based accounts: Unemployment Insurance Savings Accounts backed up by a government line of credit, Personal Retirement Accounts that supplement ordinary pay-as-you-go Social Security benefits, and Personal Retirement Health Accounts that finance a range of Medicare choices.

Of these, the Unemployment Insurance Savings Accounts seems to me to be the most clear-cut.

Although unemployment insurance is a relatively small program with total federal and state outlays in 2003 of $39 billion, it is particularly important because of its impact on macroeconomic performance. It is also significant as an illustration of how reforms have been able to reduce distortion while retaining protection for those who need it. Moreover, it is a form of social insurance where further reforms through investment-based accounts could achieve substantial economic gains…

A third possibility is to require everyone to have an Unemployment Insurance Saving Account earmarked to pay benefits if unemployment occurs. Dan Altman and I (Feldstein and Altman, 1998) explored a variety of such possible plans. In a typical plan, each individual would be required to accumulate funds in an Unemployment Insurance Saving Account until the balance was enough to
pay benefits for two spells of six months at 50 percent of the individual’s current wage. These funds would be invested and would earn a market rate of return. After a transition period to accumulate account balances, anyone who would be eligible for unemployment benefits under today’s UI rules would instead be able to withdraw the same amount from his Unemployment Insurance Saving Account. If a balance remains in the account when the individual reaches retirement age, the funds would be available for the individual to take and spend. An individual who dies before retirement bequeaths the account balance. In short, individuals would regard the funds in the UISA as their own money. For someone who expects to have a positive balance in his account until retirement, the UISA plan would provide the same income protection as the current UI system but without any distortion.

What about individuals who experience so much unemployment that they use up the funds in their UISA? Such individuals would be able to borrow from a government UI fund to receive the same benefits that they would withdraw if they had a positive account balance. After they return to work, they would again save to repay the loan with interest and to rebuild their UISA balance. If they expect their account to accumulate a positive balance in the future, the dollars that they borrow would be a very real obligation and the incentives to return to work would not be distorted by the government loan. They would have full protection and no distortion while unemployed and would accumulate personal wealth after they returned to work.

It is only those who expect that they will have a negative balance in their account when they retire for whom this plan would represent no improvement over current law. For them the protection and distortion would be the same as it is with the current UI rules.

I find this to be pretty impeccable logic. Too bad President George W Bush instead headed straight into a disastrous attempt on Social Security.