How generous should disability benefits be to provide adequate insurance for individuals with health limitations, without discouraging them from working? Economists refer to this dilemma as the incentive-insurance trade-off. Designing public insurance systems requires policymakers to weigh both cost-effectiveness and welfare implications. In the case of disability insurance (DI), two key parameters are central: eligibility criteria and benefit generosity. Eligibility criteria determine who can receive benefits, while benefit generosity defines the level of payments provided to eligible recipients.
This study examines the impact of benefit generosity on recipients’ employment outcomes and mortality. Typically, isolating the role of benefit levels is challenging because payments often depend on the prior employment history. To overcome this, we use a policy reform in Germany from 2014, which increased benefits for new DI recipients but left payments unchanged for existing beneficiaries. Crucially, the reform altered only benefit amounts without changing eligibility rules, allowing us to study the effect of a benefit generosity in isolation from other policy components.
Our results show that, unlike findings from other countries, the increase in benefit generosity did not reduce recipients’ likelihood of working while receiving benefits. This is a notable result, given that roughly 25% of full-disability beneficiaries in Germany engage in some form of employment. However, we do find that higher benefits increased the likelihood that temporary recipients extend their benefit period beyond the initial three-year entitlement period commonly granted under the German DI system. This outcome is significant from both fiscal and welfare perspectives, as around 95% of DI recipients ultimately remain on benefits until retirement, despite the system’s default design of temporary support.
Unlike similar studies in the U.S., we also find that the benefit increase had no effect on mortality. However, we do estimate a significant reduction in poverty rates among those who received the higher benefits.
Overall, our findings offer valuable insights for policymakers. The 2014 benefit increase appears to have improved recipient welfare with modest behavioral side effects. These results suggest that, at least in the German context, increasing DI benefit generosity can enhance economic security without undermining work incentives.
This study is published as a working paper in the IZA Discussion Paper Series:
Becker, S., Gehlen, A., Geyer, J., & Haan, P. (2024). Income effects of disability benefits (No. 17298). IZA Discussion Papers.
