This article studies how firms’ screening incentives in the labour market affect the optimal design of social insurance programs and quantitatively assesses the U.S. disability policies accounting for firms’ screening of the disabled. We develop an equilibrium search model where workers with different productivities have heterogeneous preferences over non-wage benefits and firms cannot offer an employment contract that explicitly depends on worker types. In this environment, firms may use contracts to screen out a certain type of workers, distorting employment rates and contracts in equilibrium. Therefore, the optimal structure of social insurance policies depends on firms’ screening incentives. We extend and structurally estimate this framework to quantitatively understand the inefficiencies arising from firms’ incentives to screen out disabled workers and examine the optimal joint design of disability insurance (DI) and various forms of firm subsidies. We find that hiring subsidies mitigate screening distortions; at the same time, they interact with DI by reducing the labour supply disincentives it generates. The optimal policy structure leads to a considerable welfare gain by simultaneously making firm subsidies and DI benefits more generous.

This article quantitatively evaluates the trade-off between the provision of health-related social insurance and the incentives to maintain good health through costly investments. To do so, we construct and estimate a dynamic model of health investments and health insurance in which the cross-sectional health distribution evolves endogenously and is shaped by labour market and health insurance policies. A no wage discrimination law in the labour market limits the extent to which wages can depend on the health status of a worker, and a no prior conditions law outlaws higher insurance premia for individuals with worse health status. In the model, the static gains from better insurance against poor health induced by these policies are traded off against their adverse dynamic incentive effects on household efforts to lead a healthy life. In our quantitative analysis, we find that it is optimal to insure 80% of labour market-related income risk (70% if a no prior conditions law is also present). Providing full insurance is strongly suboptimal, however, since at high levels of consumption insurance, the negative dynamic incentive effects on health effort and thus the population health distribution in the long run start to dominate the short-run consumption insurance gains.