WORKERS' COMPENSATION AS INCOME INSURANCE

This paper focuses on the role of workers' compensation as income insurance. One fundamental problem in the provision of disability insurance such as workers' compensation is the difficulty of monitoring the true loss of earning capacity due to injury. The workers' compensation program cope with this problem by using two different kinds of indirect indicator of the economic losses due to injury; the actual earnings losses and a measure of physical impairment. In contrast to social security disability insurance, which is based on actual earnings losses as well as physical impairment and pays benefits for total disability only, workers' compensation allows benefits for partial disability.;I compare first the alternative benefit schemes based on actual earnings loss measures including 'Total only' payment schemes and linear 'Partial' payment schemes. Analytical results suggest that type of injury, the distribution of health damage, the degree of risk-averseness, and the individual's labor response to the system are major factors determining which benefit scheme is better. A simulation comparing benefit distortions, labor distortions, and expected utilities under the two schemes reveals that the linear 'Partial' payment scheme is a better approximation to the optimum.;Next I compare the 'impairment' based insurance program with the 'actual earnings loss' based program. Analytical results suggest that the less risk-averse the worker and the more response to the system is his labor supply, the more appropriate the benefit scheme based on the physical impairment. Simulation results reveal that, as the size of government subsidy to the worker in the social insurance program increases, the relative efficiency of the 'impairment' payment scheme to the 'actual earnings loss' payment scheme increases as well. The 'impairment' payment scheme is also relatively more advantageous when the insurer is more concerned about labor distortions than about benefit distortions.;Taking into account this informational problem, this work develops a theoretical model of disability insurance and provides the optimal benefit schemes under differing informational conditions. Important aspects of the performances of alternative schemes under imperfect information are compared with specific focus on the benefit distortions and labor distortions induced by these alternative mechanisms.