Social insurance with risk-reducing investments

A two-sector model with sector-dependent disability risks is presented. Wor king in the low-risk sector requires skills that can be obtained by investm ents in education. Moral hazard precludes full insurance. The labour force allocation is responsive to the incentives created by a social insurance sy stem. The rationale for intervention lies in the government's power to cros s-subsidize between the sectors, and it is demonstrated how the responsiven ess of the labour force allocation limits cross-subsidization. The second-b est policy is time-inconsistent. The consistent equilibrium is explored and is argued to provide weak incentives to reduce risks.