Protecting the Vulnerable: the Tradeoff between Risk Reduction and Public Insurance

In a risky world should governments provide public goods thatreduce risk or compensate the victims of bad outcomes throughsocial insurance? This article examines a basic question indesigning social protection policies: how should a governmentallocate a fixed budget between these two activities? In thepresence of income and risk heterogeneities a simple publicinsurance scheme that pays a fixed benefit to all householdsthat suffer a negative shock is an effective redistributionalinstrument of public policy. This is true even when a well functioningprivate insurance market exists, and so the role of public insuranceis not to correct a market failure. In fact, the existence ofa private insurance market means that the public system hasdesirable targeting properties—all but the poor and high-risktake up private insurance. The provision of public goods thatreduce risk for all should therefore be complemented with publicinsurance that (automatically) benefits those who are especiallyvulnerable.