Absenteeism is a cause of substantial loss of working time worldwide. In some OECD countries nearly 10 percent of annual working days are lost because of sickness absence. The costs are considerable for employers, co-workers, and health and benefit systems. Among cash benefits, sickness insurance – which compensates workers for their earnings losses – is one of the most important social protection schemes in Europe.
While sickness insurance is important to mitigate income shocks of truly ill individuals, very generous systems create a moral hazard problem as people might prefer to stay at home and live off the insurance benefits. In that respect, the key policy parameter is the replacement rate – the ratio of sickness insurance benefits to past earnings. Policymakers face the difficult task to set the optimal replacement rate so that work incentives and the “right to be sick” are balanced.
In a new IZA Discussion Paper, Petri Böckerman, Ohto Kanninen and Ilpo Suoniemi analyze how people in Finland respond to different replacement rates. The authors use a special feature of the Finnish sickness insurance system, which is that the replacement rate is not the same for everyone but depends on past earnings.
The authors find strong behavioral responses to changes in the replacement rate: a one percent increase in the replacement rate raises sickness absence by 1.4 percent. Policymakers should be aware of this sizeable effect when designing sickness insurance schemes that might induce some to stay home longer than medically necessary.