Overestimation by misspecification: revisiting the relation between the unemployment rate and disability insurance claims in the USA

Abstract

PurposeDespite numerous studies, our understanding of the determinants of disability insurance (DI) claim rates in the USA is clouded. When the unemployment (UE) rate soars during an economic downturn such as the spread of COVID-19, assuming a linear positive relationship between the two variables, as the prior literature has suggested, forewarns a large spike in DI claim rates. Yet, if the model is misspecified, it can lead to misinformed decisions such as reducing DI awards during an economic downturn when such awards are needed the most. This study aims to improve the accuracy of the DI claims' prediction.Design/methodology/approachThis study suggests that the relationship between the UE rate and DI claim rate is nonlinear and examines this hypothesis using a panel dataset of 866 state-year observations from 2002–2018.FindingsThe results provided compelling evidence in support of the proposed quadratic relationship between the UE rate and DI claim rate and revealed that compared to a quadratic model, the linear model overestimated the DI claim rate by approximately 18 percent or 172,000 claims per year.Practical implicationsGiven that DI awards represent hundreds of thousands of dollars in present value terms, the impact of increase in DI claims on the Social Security Disability Fund during an economic downturn might not be as high as some model might forecast.Originality/valueTo our knowledge, no other studies have examined a quadratic relationship between the UE rate and the DI claim rate. This study is especially relevant during the coronavirus (COVID-19) pandemic and its aftermath. In April 2020, the UE rate spiked to nearly 15 percent nationwide, with Nevada and Michigan at 28 percent and 22.7 percent, respectively. The nonlinear model used in this study suggests that, as the UE increases, DI claims increase, albeit at a decreasing rate. On the contrary, a linear relationship between the UE rate and DI claim rates implies that the increase in the DI claim rate would be constant regardless of the UE rate. This misspecification can result in misinformed decisions, such as the reduction of DI awards because of the overestimation of claims during economic downturns. This can lead to lower award rates during economic turmoil when this assistance is most needed.