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Social insurance

Updated by Sven Nef on 10.06.2015

Social insurance – like all forms of insurance – is a mechanism for (financial) risk pooling. It represents one of the most important  instruments through which social security schemes operate, as it has done since the outset of national systems of social security, the earliest being the system introduced by Chancellor Bismarck in Germany in the 1880s.

The insurance principle operates on the basis that a group of individuals (or perhaps their families), who are vulnerable to a specific risk (for example, disabling injury, or sickness) pay contributions into a pool or fund, which is then used to pay benefits according to specified rules so as to indemnify those participants who suffer the occurrence of the relevant risk. Those who are lucky enough not to experience such an occurrence should not in general expect any return from the fund. The insurance arrangement usually works over a fixed period of time, typically one year, and is then renewed, although life insurance or assurance schemes work over longer periods, often for the lifetime of the participants.



What is distinctive about social insurance is that the basis of calculation on which each participant’s contribution to the pool (the payment of which is typically shared between the individual and her/his employer) is one of social “fairness”. Often, this is determined as a certain “flat” percentage of her/his periodical earnings. In technical terms, this is described as risk-pooling on the principle of solidarity, and in this regard, social insurance differs in a well-defined technical sense from other forms of insurance, including nearly all of the familiar, “commercial” insurance arrangements.

In the latter type of arrangement, each individual pays a contribution (called in this case a premium) which is calculated according to the assessed level of relative risk which the participant brings to the pool. So, for example, in a scheme of disablement insurance organised on a risk-premium basis, a worker in a dangerous occupation such a mining would be required to contribute proportionately more to the pool than a worker in a sedentary, office-based occupation.

It is, fairly obviously, necessary that the amount of money collected for the pool must be sufficient to make all of the promised payments to those participants who have valid claims. This balance can, particularly in so-called “long-term” insurances such as life assurance, be established over a period of several years, rather than one year alone, but the general principle is that of ensuring actuarial balance; the statistical estimations needed to calculate the contributions or premiums are made by a specialist in financial statistics called an actuary.

In general, it is important to ensure that the largest possible “target” group of participants are included in any insurance arrangement or scheme; one reason for this is that the statistical variance relating to the risk of occurrence of the insured event is minimised. However, in the case of social insurance, full participation is of especial importance; otherwise, it may be impossible to assure the statistical basis of the risk pooling needed to maintain the actuarial balance. Hence it is usual that social insurance schemes require that membership, for the target population group, should  be on a compulsory basis. In any case, such schemes generally have the objective, set at the level of national policy, of covering the entire workforce of a country (or at least, say, a province).

Social insurance schemes have the advantage that, in general, the contribution basis facilitates the inclusion of the maximum number of participants. Even so, it is likely that the poorest workers, especially in less developed countries, will find the burden of contributions too onerous. It is fairly common that (national) schemes allow such members  to participate on a concessionary basis, and subsidise their contributions to the insurance fund. This represents, strictly, a departure from the “pure” insurance principle, and such schemes are better described as operating on a “mixed” basis (of insurance together with a proportion of tax-based financing); nevertheless, they are often presented as “insurance” schemes.

 

 


Main Resources

 

Introduction to social security,
ILO, 1984