Study Claims ‘Perverse’ Incentives Causing U.S. Disability Costs to Soar

The number of workers receiving disability in the U.S. is growing so rapidly that these benefits are now the fastest rising component of Social Security spending — growing at nearly twice the rate of retirement benefits, according to a new analysis from a private sector think tank.

The National Center for Policy Analysis concluded that the disability system has been growing so fast in part because of what it terms “perverse” incentives. For example:

According to the Social Security Trustees, the number of disabled beneficiaries more than doubled, from 3.9 million in 1985 to 8.4 million in 2006, whereas people receiving retirement benefits grew less than 25 percent over the same period. Annual disability expenditures grew five fold, while retirement benefits grew less than three-fold.

If workers claim early retirement benefits from Social Security, the amount they receive for retirement is reduced. By contrast, a 62- year-old worker can claim disability and receive monthly benefits that are about 30 percent higher than early retirement benefits. This creates an incentive to claim disability. And, disability benefits stop if the beneficiary returns to work, therefore discouraging productive labor.

Although less than 40 percent of disability applicants are initially
approved, about 60 percent are approved after appeals. Since appeals are only made by the applicant, not Social Security, the number can only go up, never down, during the appeals process.

In a separate study, the NCPA says Chile’s disability system costs less than half of the U.S. system — 1.8 percent of payroll in the U.S. versus 0.7 percent of payroll in Chile — and provides more generous benefits.

“Older workers often have an incentive to use disability as a form of early retirement,” said NCPA President John Goodman. “In Chile, the incentive is to keep working.”

Chile replaced its traditional social security system 25 years ago with a system of personal retirement accounts. Workers now put 10 percent of their wages into personal retirement accounts in pension funds of their choice and pay an additional 2.4 percent for survivors’ and disability insurance and administrative fees.

Depending on the number of years they have participated and the degree of their disability, Chilean workers are guaranteed to receive as much as 70 percent of their wages — a higher percentage than disabled workers in the U.S. Although workers have a lifetime to save for retirement, they can become disabled at any age. If a disabled worker’s retirement account balance is insufficient to purchase an annuity that replaces a guaranteed percentage of his wages, he receives the rest from a group insurance policy purchased by the worker’s pension fund. On the average, workers’ own savings are projected to cover about 50 percent of the cost of their disability benefits; insurance covers the rest. Due to this reform, Chile’s disability system will cost only a fourth of what it otherwise would have been, in the long run.

According to the NCPA’s study, several features of Chile’s disability system reduce costs and provide workers with incentives to continue working. For example:

Part of the benefit is financed by the worker’s retirement account and investment earnings on the annuity premium.

Since disabled workers draw on their own retirement accounts to fund their benefits, workers have less of an incentive to claim disability as a form of early retirement.

Pension funds in Chile participate in the disability assessment procedure and can challenge disability determinations made by
independent medical boards.

Once workers in Chile are approved for permanent disability, they are
still permitted to work.

“The experience of Chile suggests disability costs can be contained in a way that benefits both workers and the economy,” said former World Bank economist Estelle James, author of the NCPA study. “It is a model worth considering.”

The NCPA is a nonprofit, nonpartisan research institute with offices in Dallas and Washington, D. C. that advocates private solutions to public policy problems. It is supported by contributions of individuals, corporations and foundations. The NCPA accepts no government grants.

Source: National Center for Policy Analysis
www.ncpa.org