Optimal Partial and Full Disability Insurance with an Application to Korea

In this paper, I investigate the optimal disability insurance (DI) when partial and full disability are privately observed over the life cycle. I demonstrate that in the social optimum, partially disabled agents are induced to supply labor despite substantial government transfers unless labor supply is relatively elastic and their productivity is significantly reduced. I then apply the framework to quantitatively evaluate Korea’s DI programs, which include partial and full disability benefits. In the calibrated model, I find that welfare gains from replacing Korea’s DI programs with the corresponding optimal system amount to a 1.17% increase in consumption. Such a reform significantly raises the utility of both types of disabled agents at relatively small utility costs of able agents. Equity gains from this redistribution account for 73.4% of the total welfare gains, whereas efficiency gains from the optimal allocation account for 26.6%.