Disability Insurance and the Dynamics of the Incentive-Insurance Tradeo¤

We provide a lifecycle framework for comparing the insurance value and the incentive cost of disability bene…ts. We estimate the risks that individuals face and the parameters governing the disability insurance program using longitudinal US data on consumption, health, disability insurance, and wages. We characterize the economic e¤ects of disability insurance and study how policy reforms impact behavior and household welfare. Disability insurance is characterised by high rejections rates of disabled applicants; acceptances of healthy applicants is less widespread. Welfare increases as: (1) the program becomes less strict, reducing rejection rates among the disabled, despite the worsening of incentives; (2) generosity is reduced or reassessments increased because false applications decline; (3) the generosity of unconditional means-tested bene…ts is increased. JEL Codes: D91, H53, H55, J26