Crowd Out in Insurance Markets

In doing my homework for the Public Econ class, I got to thinking about measuring crowd out with publicly provided insurance and making inferences about what it means.  Maybe there’s a flaw in my logic, but I got to thinking in the context of unemployment insurance (UI).  People probably want UI, but the adverse selection/moral hazard issues are probably too great for a large private UI market to develop – hence a need for government intervention.  That much is pretty standard.  However, when people measure how much $1 in UI increases spending, they tend to get estimates around $0.30 – so there’s 70% crowd out.  They use this as justification that there’s an overprovision of UI because a lot of people are just substituting away from other private forms of insurance (spouse working more/returning to work, borrowing from relatives, spending down savings, etc.).  My thought was that everyone has informal insurance mechanisms that they can tap in the event of an emergency (losing a job, getting sick) whether they have insurance or not.  If they buy insurance, this coverage will automatically crowd out some of the spending the informal mechanisms would have allowed, but this crowd out is not necessarily enough to say the insurance itself would not have been utility increasing.  It is really only considered crowd out if it is provided by the government.  If someone chose to increase their health insurance coverage, you could get a measure of the crowd out that caused, but it’s not considered the same as if government had done the same thing for them.

I guess my general thought was that just finding a value for crowd-out may not really be enough to make a statement about welfare improvements (or losses) due to a program since in private provision of the same benefit could have had similar crowd out.   I guess the problem becomes, who would have wanted to buy the service (such as UI) if it were offered privately (maybe with perfect information) and has a crowd out that is not welfare decreasing, and who wouldn’t have bought the service absent government provision (and the provision of the service to these individuals is welfare decreasing).