Question

Long-term disability (LTD) insurance policies cover workers who become disabled and can no longer perform their job functions. Workers who think they qualify as disabled can submit a claim to their employer for LTD payments to replace their lost wages.
Below is an excerpt of the abstract of a recent NBER working paper entitled “Moral
hazard and claims deterrence in private disability insurance” by David Autor, Mark Duggan, and Jonathan Gruber (2012): We provide a detailed analysis of the incidence, duration and determinants of claims made on private Long Term Disability (LTD) policies using a database of approximately 10,000 policies and 1 million workers from a major LTD insurer. ... [W]e find that a higher [wage] replacement rate and a shorter waiting time to benefits receipt ... significantly increase the likelihood that workers claim LTD.

1. Higher disability claim rates when LTD benefits are more favorable may be an instance ofmoral hazard. Any instance ofmoral hazard involves a price distortion, a behavior response, and an information asymmetry. What is the price distortion in this example?

2. What is the purported behavior response?

3. What is the nature of the information asymmetry? Explain what would happen if this information asymmetry did not exist.

4. If the higher wage replacement rate and shorter waiting time policies had been applied randomly to different workers in this sample, then the finding would be convincing evidence of moral hazard. Explain how the same result could have been found even if in fact there was no moral hazard (that is, no behavior response to the price distortion)?

Answer 1