Financial Innovation versus
Government Employment Insurance

by Filip Palda

Forget that the Employment Insurance (EI) program is floating in money—$14 billion in surplus at last count. Its intellectual hull is ruptured and spewing economic waste. Some of the waste is evident. Nobody will have a seizure if I mention that EI creates unemployment by encouraging seasonal workers to work short spans. Street riots will not break out if I state that EI milks the Western provinces in order to suckle the eternally immature economies of the provinces east of Ontario. But I think heads would rise if I said that government EI is a poison that kills innovation in the private market for employment insurance. The private market for unemployment insurance? What is this? Institutional memories are short.

Private unemployment insurance (UI) has been around for centuries. In the 19th century, workers’ guilds and friendly societies in the UK put money into a common pool to protect their members from unemployment. Just before World War I, such private UI plans covered about 25 percent of the UK labour force. Before World War II, some private companies in the US insured their workers against unemployment. Once governments took control of UI, the demand for private sector unemployment insurance dropped out of sight. The Canadian government’s massive spending on EI ensures an enormous blackout in the minds of financial experts. Instead of turning to the problem of how to devise efficient unemployment insurance, they turn their efforts to less urgent financial pursuits, such as currency speculation.

Efficient insurance follows a simple rule: make people pay according to their risks. When people pay for their risks they try to make those risks disappear. They move away from seasonal occupations, and invest in education and training that will allow them to adapt to changes in the job market. Our government system of EI anaesthetizes us to risks by divorcing the premium we pay from the risks we face. The inefficiency lies in that the people who get the insurance do not value the benefits as much as it costs taxpayers to provide those benefits. Government forces Western taxpayers to work so that Quebec and the Maritimes can enjoy a style of life that thumbs its nose at economic reality. Instead of encouraging people to take precautions and spare resources the way private market insurance does, government EI encourages workers to live in places where their jobs are most at risk.

The trick to getting a private market in UI going is to know the risks of unemployment that workers face. Private insurance companies could buy the excellent labour market data that Statistics Canada collects or the market could collect its own data. Insurance companies maintain records on car accidents and fires. There is no reason they could not do the same with unemployment figures.

Private insurance companies have not waited for me to write this article to get moving. They are already finding ways to supplement government EI. Starting in the 1980s, firms in the UK started selling unemployment insurance that would cover the costs of your mortgage if you lost your job. French banks are also getting active in this market. On a loan of $100,000 with a 15 year maturity, mortgage unemployment insurance premiums can vary from $7 to $65. The premiums may cover part or all of the mortgage payment, and can stretch to 30 months. The beauty of these schemes is that they transfer risk from people who cannot bear it (the mortgage holders) to people who are experts at bearing risk (bankers). No unwilling taxpayers are corralled into the exchange. Another exciting form of UI on the verge of being developed would be backed by securities. Traditional UI programs force the employed to pool their money. The unemployed draw from this pool. The problem is that in times of national decline, the pool shrinks by too much to protect everyone. Financial experts are wondering how to allow workers to hedge their money in assets that would tend to increase in value in times of high national unemployment. A hedge fund would protect workers from broader risks than traditional pooled funds.

This type of innovation in insurance markets will grow as the private market gets better at identifying the risks of unemployment. It would grow much faster if Ottawa got out of the EI market.

Further reading

Michael Beenstock and Valerie Brasse, Insurance for Unemployment (London: Allen and Unwin, 1986).

C. Gourieroux and O. Scaillet, “Unemployment insurance and mortgages.” Insurance: Mathematics and Economics, (1997) 20:173-195.

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Last Modified: Wednesday, October 20, 1999.