Estimating the Moral Hazard Cost of Private Disability Insurance and its Welfare Consequences

Although one-third of workers in the USA and Germany contract supplementary private disability insurance (DI), most studies on the design of public DI systems abstract from private DI. Using unique and comprehensive contract data from a major German insurance company and representative survey data, I add novel insights on the interaction between private and public DI by estimating a rich dynamic life-cycle model with private insurance choices. I find that the welfare-improving public DI schedule is less generous in the presence of supplementary private DI. This is a consequence of the additional moral hazard private DI take-up imposes on the public system. I show that while having a private DI market is welfare-improving under the current public DI schedule in Germany, private DI markets can be welfare-reducing for more generous public DI systems as observed in other countries