Optimal Social Insurance and Health Inequality

This paper integrates into public economics a biologically founded, stochastic process of individual aging. The novel approach enables us to quantitatively characterize the optimal joint design of health and retirement policy behind the veil of ignorance for today and in response to future medical progress. Calibrating our model to Germany, our analysis suggests that the current social insurance policy instruments are set close to the (constrained) socially optimal levels, given proportional contribution rates for health and pension finance, the equivalence principle in the pension system, and a common statutory retirement age. Future progress in medical technology calls for a potentially drastic increase in health spending and a higher retirement age without lowering the pension contribution rate. Interestingly, from an ex ante point of view, medical progress and higher health spending are in conflict with the goal to reduce health inequality.