Asymmetric Information and Countermeasures in Early Twentieth-Century American Short-Term Disability Microinsurance

ABSTRACT American workers and employers a century ago formed microinsurance funds to provide sick pay to temporarily disabled workers. This article analyzes a 1908 survey of several hundred such microinsurers. Theoretically, a single cross-section may yield evidence of asymmetric information, but cannot enable the separation of moral hazard and adverse selection effects. However, microinsurance fund managers and outside observers believed they did see separate such effects and so microinsurers created separate countermeasures to mitigate these problems. This article finds prima facie evidence of asymmetric information and suggestive evidence of the separability of informational asymmetries and the effectiveness of such countermeasures. INTRODUCTION Formation and management of microinsurance funds by ordinary workers who were not insurance professionals was the rule rather than the exception for much of the history of health and disability insurance. Early twentieth-century American workers operated hundreds of such sickness funds, in every region and in a variety of industries. These funds recognized the potential for sick pay to induce a moral hazard in their members that led to additional claims and paid days off, as well as the potential for adverse selection when membership was voluntary. In addition to such ex post strategies as close monitoring of claimants, disability microinsurers employed particular ex ante methods to limit claims that have not been carefully examined. This article examines ex ante efforts to discourage opportunistic behavior by structuring insurance contracts so as to mitigate inherent incentives toward moral hazard and adverse selection. Workers had operated microinsurance funds for centuries. Many guilds had provided sickness benefits to members since the Middle Ages. By the turn of the twentieth century, friendly societies in Britain provided wage replacement benefits to perhaps two-thirds of workingmen (Riley, 1997). In the United States skilled workers organized the first sickness benefit societies in the eighteenth century, and after the Civil War the idea of mutual sickness insurance had spread to industries such as cotton textiles and ferrous metals (Murray, 2007a, pp. 73-77). Nor does this organizational form belong exclusively to the past. The legal setting for Voluntary Employee Beneficiary Associations, recently adopted by American automakers and unions, was based on laws regarding mutual sickness benefit societies (Murray, 2007b). West Africans tired of waiting for government programs to appear have begun their own mutual sickness societies that cover over 200,000 people (Lacey, 2005). The notion of mutual microinsurance against the costs of ill health is not a peculiarly American idea, then, but it is one that Americans built upon to create the largest extragovernmental network of health insurance in the world. The beginnings of that network can be traced back to the sickness funds of the early twentieth century. DISABILITY MICROINSURANCE FUNDS In Democracy in America Alexis de Tocqueville observed that Americans were constantly forming associations to deal with collective problems (Volume II, Part 2, Chapter 5). Recognizing the feasibility and efficiency of mutual sickness microinsurance societies, Americans organized groups to finance and operate them. By 1920 or so, these microinsurance funds covered a third of the industrial labor force--a share that grew from the late nineteenth century as the labor force itself grew absolutely by some 27 million (Murray, 2007a, p. 91). As shown by Emery and Emery (1999), Emery (1996), Beito (2000), and Murray (2007a), mutual sickness funds, sponsored by fraternal societies, employers, and labor unions, provided most short-term wage disability insurance in the United States until the mid to late 1930s, and did so effectively. A typical microinsurance fund could count its membership in the dozens. …