Time To Privatize Unemployment Insurance

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Besides foreclosures, one of the lasting problems of the financial crisis is the fiscal trouble many states are in. The Journal has a good story today about Neveda’s budget squeeze. And over the weekend, a study from the National Governors Association found that state economies were likely to continue to worsen.

Just one sign of how bad the finances of the states are: More than half of all state unemployment funds are now in the red. The latest entrant into the financial foul up is Massachusetts, which may have to borrow up to $1 billion from the federal government to keep paying benefits.

ProPublica has a lot of cool stats and charts following the problem. States can borrow the money they need to shore up the funds from the Feds for now. ProPublica is pointing out that the states will eventually have to pay the money back, most likely with interest (the loans are interest free for a time), and that’s going to be a continuing drain on state finances.

But there is a larger lesson to be learned here: The government is very bad at pricing insurance. It’s not just unemployment insurance. The bank insurance fund at the FDIC is out of money as well. A few months ago, I wrote a cover story for TIME on the poor performance of 401(k) plans. A number of people attacked that story saying the government would do a worse job of running retirement plans than companies. I agree, which is why that is not what I proposed. Instead, what I suggested is that individuals be mandated to buy retirement insurance from a private run insurance exchange, similar to say Lloyd’s of London or to many of the healthcare proposals at the time. Spread the cost of retirement insurance over millions of people, not just those in one company, and the cost of saving for retirement will come down and the amount each of us have in our golden years will go up.

I think the same proposal would be a good fix for unemployment insurance as well. The states are clearly not doing a good job of it. As ProPublic reports

The states, D.C., Puerto Rico and the Virgin Islands operate separate unemployment insurance systems with minimal federal oversight. They are given wide latitude to set tax rates and benefits, and while a few entered the recession with ample reserves, most had far less than the 18 months’ worth recommended by the Department of Labor. Likewise, benefit levels range from generous to bare-bones.

The problem with the government running insurance plans is that invariably, in good times, they are forced by political pressure to undercharge. In the early 2000s , the FDIC wasn’t even charging an insurance fee. And now it seems clear states weren’t charging enough for unemployment insurance either. Massachusetts entered the recession with just 5 months in reserve.

Private insurers can under price insurance and go bust, too, but they are less likely to do so than politicians. Yes, insurance companies will charge more for private unemployment insurance. But they won’t have to charge that much more. By privatizing the market and allowing insurance companies to compete across state lines, the larger pools of people are likely to bring down the cost of paying out benefits to the unemployed. Low unemployment in North Dakota could offset the cost of the growing unemployed in Michigan. It would also remove a huge budget burden for states at time when they need help the most.