The provision of unemployment insurance is heavily contested amongst policy-makers around the world. Recent research by IIES Assistant Professor Arash Nekoei and Professor Peter Nilsson provides new insights into how to optimally provide unemployment insurance.

Arash Nekoei and Peter Nilsson

Unemployment insurance for all increases risk of unemployment

Insurance against the income fall experienced in case of unemployment is chronically challenging to design. When leaving the decision of taking up such insurance to every worker, the buyers will tend to be those with the highest risk of getting unemployed. Such a selection, in turn, implies that the price for such insurance is high, and a sizable group of people with lower unemployment risk will effectively not be able to obtain unemployment insurance at a price that adequately reflects their risk of unemployment. In fact, this mechanism – referred to as 'adverse selection' by economists - might lead to a full breakdown of any potential market for unemployment insurance.In light of this, many countries choose to mandate unemployment insurance for all. However, that comes with its own problems: once covered by unemployment insurance, people might decide to alter their behavior in ways that makes it more likely for them to become unemployed.

How significant are these problems, and what is the optimal way to provide unemployment insurance?

Arash Nekoei and Peter Nilsson’s work leverages the rich Swedish administrative data and several policy reforms and characteristics to answer those questions. Amongst other things, they provide a framework to think about the optimal provision of unemployment insurance and find that combination of mandatory coverage and optional, heavily subsidized top-up insurance as seen in many Scandinavian countries, including Sweden before the 2007 reforms, might be close to optimal.

The paper is co-authored with David Seim of Stockholm University (and an IIES alumnus) and Camille Landais and Johannes Spinnewijn of the London School of Economics and is forthcoming in the American Economic Review, one of the world’s most prestigious journals in economics.

Please contact Arash Nekoei and Peter Nilsson for any questions about their work. There's also an excellent summary of the paper at VoxEU.