An empirical analysis of income risk and social insurance policy in the United Kingdom

This thesis examines the level of income risk in conjunction with private and social insurance mechanisms in the United Kingdom. In particular, I focus on the evolution of income risk and insurance mechanisms during the last decade. This thesis emphasises the importance of measuring the heterogeneity of risk and the nature of two insurance mechanisms (i) marriage and (ii) social insurance generated through welfare policies. I complement these findings with a discussion on how adverse income shocks affect welfare. The first chapter sets the scene by offering a theoretical review of the background of income risk and its developments in the United Kingdom over the past four decades. At the same time it also offers information on the data set and the methodological approach of the thesis. The chapter presents the data set used in this work, from Understanding Society: the United Kingdom Household Longitudinal Study (UKHLS) with information of individuals and households in the United Kingdom from 2009 to 2018. This chapter also introduces the model of income dynamics, which comprises a transitory and a permanent component following Friedman's Permanent Income Hypothesis (PIH). The second chapter of the thesis measures the distribution of individual gross and net income risk in the United Kingdom. Whenever realised income differs from expected future income, individuals encounter an income risk. These risks are not uniformly distributed across individuals, which might result in losses of welfare. The current literature lacks an in-depth analysis of the potential heterogeneity of income risks. Therefore, this chapter examines the heterogeneity of individual income risk, based on social and demographic factors in the United Kingdom. Women face more than double the permanent income shock variance than for men. Further, individuals from Non-White ethnic backgrounds face slightly higher levels of permanent income shocks than White individuals. Government policies such as taxes and benefits do not mitigate the income risk distribution. Consequently, the chapter exposes evidence of income risk heterogeneity in the United Kingdom. The third chapter quantifies the insurance opportunities arising from marriage in the United Kingdom. Marriage can reduce individual net income risk through income risk pooling with a partner. However, if one partner faces higher income volatility related to certain socioeconomic characteristics, marriage can lead to an increase in net income risk for one of the partners. Firstly, I find that marriage generates a form of income risk insurance as single individuals face considerably higher levels of net income risk than those who are married. Secondly, the results indicate that the degree of marriage insurance depends on marital choice. Sharing the same socioeconomic background with a spouse is found to reduce levels of net income risk, compared to couples from different socioeconomic backgrounds. In addition, assortative couples face a lower probability of encountering permanent income shock. To test the robustness of these fidings, a counterfactual exercise was created in the form of a synthetic dataset in which I randomise the couples based on their original marital choice. This controls for any endogeneity, for example, responses of labour supply. The test further supports my main finding. The fourth chapter compares the impact of British welfare policies on net income risk for welfare receiving households. A major role of the welfare policy is to mitigate the impact of adverse income shocks through financial support such as benefits. This is particularly relevant as the British welfare system is currently undergoing a major reform. The new system, Universal Credit, provides considerably lower benefis to programme recipients for their daily expenses than the former Legacy System . I use a natural policy experiment to quantify the effects of a change in the welfare system on net income risk for programme receiving households., The main finding is that net income risk increases for households under Universal Credit compared to households under the Legacy System, as there is reduced social insurance for households under the new policy scheme. The lower cost to taxpayers associated with Universal Credit has reduced the effectiveness of the social insurance provided. The policy suggestions indicate the need for welfare policy design that focus on support that takes account of income risk