REFORM

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Welfare Reform for the 21st Century

Income risks facing householdsand governmentIdeas and opinions abound about how thewelfare system should be reformed. Someideas focus on refining the existing welfaremodel, others advocate more radical reforms.There is growing political support for creating astronger contributory element to givehouseholds that contribute the most a higherlevel of support in return.But in order to create solutions that will work inpractice to deliver a fair, effective andeconomically viable model, a strong evidencebase and understanding of the problem and thechallenges involved is needed.Current welfare policy – and indeed policyover recent decades – assumes thathouseholds that would get a poor incomereplacement rate from the State will realisethis and take action to put in place a privatesafety net. The reality is that relatively fewhouseholds in this situation have put anadequate safety net in place. In part theproblem is caused by households not havinga clear and accurate understanding of howmuch income support they would be entitledto, from the State and from their employer, ifthey were to need it.The welfare system is extremely complex (andwill remain so even with the full implementationof Universal Credit) but no government hasmade any concerted effort to inform householdsabout the level of support they can expect fromthe State if they fall on hard times. The picture isconfusing even for professionals. For individualsand families, it is all but impenetrable. In addition,most people do not adequately consider thepotential risk of something preventing themfrom working, or the impacts of the loss ofemployment income on their household finances.There are powerful psychological andbehavioural factors that have a negativeinfluence on households putting in place anadequate safety net to protect themselvesagainst these risks: really bad will happen to me or my family”;present and the (uncertain) future. Greaterweight is given to the (certain) present – suchas the cost of an insurance premium – thanthe (uncertain) future benefit of income froma claim on that insurance;Emotions such as fear of loss and regret(loss aversion) often have a strongerinfluence over decisions than an objectiveassessment of costs and benefits.Even for households that decide they want toput in place a greater safety net than the Statewill provide, there are complex interactionsbetween private safety nets and State support.Policy makers must recognise that theassumptions underpinning current welfarepolicy are flawed. If further welfare reform isto achieve its objectives it must be informedby an accurate understanding of householdincome risks, as well as household behaviourin managing them. It must also ensure thatthe interaction between private, State andemployer income safety nets is easy forhouseholds to understand and producesclear, predictable and appropriate outcomes.How can insurance contribute tonew safety net solutions?This paper builds on the growing debate aboutthe role of the welfare system and the rightbalance between State and self-provision ofsafety nets. It aims to contribute to the evidencebase and the understanding of the problem, butalso to illustrate how greater use of privateinsurance based solutions can contribute tofurther welfare reform, particularly through theworkplace.Insurance based solutions can play animportant role in providing the right type andlevel of safety net that diverse modernhouseholds need, but which a taxpayer fundedState model struggles to provide. Indeed, it isdifficult to see how it is possible to both reducethe cost of the welfare budget to taxpayers and,at the same time, increase safety nets forhouseholds through a tax and NationalInsurance funded State model.Excess confidence and low accuracy in abilityto assess the probability of future events;Difficulty in judging trade-offs between the5Follow us on Twitter @BritishInsurers

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