Question

Suppose that the disability insurance (DI) program was changed so that individuals who want to receive DI must first go 10 months without working to demonstrate that they are truly disabled instead of the current 5 months.

1. How would this change affect the moral hazard costs of DI?

2. A critic of this change does some research and finds out that the acceptance rate (the share of those applying who are accepted into the program) of the DI program increased as a result of the change. He says that this is evidence that the change in the program has increased the moral hazard costs associated with DI. What do you think?

Answer 1

a. It should reduce the moral hazard costs, since an individual who wants to show themselves as disabled when in reality they are not, will first need to go without earnings for 10 months, which is a far longer period than the earlier stipulation which was for 5 months only. Since this longer period without earnings means bigger pain, the moral hazard costs of the program would come down, as fewer people who are not really disabled would falsely claim disability insurance

b. The critic seems to be misinterepreting the increase in acceptance rate to claim that the moral hazard cost has gone up. In fact, the acceptance rate must have gone up since there would be far fewer false disability insurance claimants and hence the acceptance rate woudl be higher now