Social Insurance: What it is, How it Works

What Is Social Insurance?

Social insurance might be an unfamiliar term, but most people are familiar with its programs. Citizen-funded, government-administered programs that support the community in times of financial instability, whether due to financial hardship, disability, or age, are considered social insurance.

Social insurance programs are funded by the people who use them. Look at an average paycheck and you'll see deductions for Social Security, Medicare, and unemployment. Those deductions feed the pool of benefits that create a safety net for retirement or in case of hardship or illness.

Most people don't think of Social Security payments, unemployment benefits, or workers' compensation as insurance, but that's precisely what they are: a system that provides a cushion to shield participants from financial harm.

Examples of federal social insurance programs include:

1. Social Security provides a basic income to those in their later years.
2. Unemployment insurance offers income replacement after a job loss.
3. Medicare provides low-cost health insurance to those over the age of 65.
4. Workers' compensation replaces lost wages after an employee has been injured on the job and funds vocational rehabilitation.
5. Social Security Disability insurance provides income for those unable to work because of illnesses, injuries, pregnancy, or childbirth.

The History of Social Insurance

Although the social insurance programs we know are a relatively new institution, public assistance for people whose incomes are below the federal poverty threshold has a long history, stemming from colonial times in North America. The colonies modeled their own assistance programs on the 17th-century Elizabethan Poor Laws. The shift from almshouses to programs that encouraged independent living happened in the 19th century.

Formal social insurance programs were first introduced by the German Chancellor Otto von Bismarck in 1883, starting with state-offered health insurance and rounding out their benefits with workers' compensation and retirement benefits. Other European nations quickly followed Germany's lead.

The social insurance programs most Americans would recognize today were introduced in the United States in 1935 when President Franklin D. Roosevelt signed the Social Security Act into law. A social insurance program of this kind was needed, Roosevelt stated, as communities grew in size and family support became harder to find. Roosevelt wanted to provide citizens who had worked hard with the opportunity to rest in their golden years or in times of physical illness.

In 1965, President Lyndon B. Johnson signed the Medicare bill into law, providing low-cost healthcare for seniors. Disability benefits followed in the 1980s.

Differences Between Social Insurance and Public Assistance

When it comes to government-administered benefit programs, one of the key differences between public assistance programs such as the Supplemental Nutrition Assistance Program (SNAP) or Temporary Assistance to Needy Families (TANF) and social insurance programs is funding.

Social insurance programs are universally funded through payroll deductions or taxes and are available to anyone who has paid into the system. These payroll taxes are earmarked for these specific programs, not general taxation.

Public assistance programs are based on financial need and have no premiums, so to speak. Instead, public assistance programs are paid for from the federal budget: $4.6 trillion in 2020, which was 21.8% of U.S. GDP that year. Many programs, such as Medicare, Children's Health Insurance Program (CHIP), and SNAP also receive funding from state budgets.

For example, when a family is considered under or near the poverty line, they are entitled to assistance with food and shelter costs through programs like SNAP or TANF. They are not required to pay into those programs. Instead, they must qualify based on their average income as determined by the Internal Revenue Service.

By contrast, the amount of a citizen's Social Security benefits is based on how much they earned during their 35 most lucrative working years. Similarly, unemployment benefits are based on the length of time and the salary that an employee has paid into the unemployment system under a single employer.

Many social insurance programs are subsidized by employers as well. Employees pay half of the established tax percentage and their employer pays the rest. For self-employed individuals, contributions to social insurance programs are paid for via self-employment taxes.

Many social insurance institutions have private insurance counterparts, such as private disability insurance, retirement accounts, or private health insurance. All of these services require additional premiums or contributions paid out of pocket. However, payments into social insurance programs from every citizen ensure that premiums and taxes are kept low and the pool of resources kept stable for those that need assistance.

Government Oversight of Social Insurance

Since social insurance programs are all administered by either the federal or state government, they can occasionally be altered to increase the benefits beyond what is funded by individual citizens. One such example was the introduction of unemployment benefits for contract workers as provided by the CARES Act of 2020. The Social Security Administration also regularly reassesses payments based on the cost of living, ensuring that benefit amounts keep pace with common expenses.

The Bottom Line

The need for societies to provide financial assistance for people whose incomes are below the federal poverty threshold, older adults, and the disabled is not new. The colonies created assistance programs modeled on the British Elizabethan Poor Laws of the early 17th century. The United States established a more formal system, recognizable to most people today, when President Franklin D. Roosevelt signed the Social Security Act of 1935, establishing a federal safety net for elderly, unemployed, and disabled Americans. Since then, the country has added to social insurance programs for the needs of various populations, such as healthcare for children and assistance for injured workers. The beneficiaries of social insurance programs have already paid into the funding sources, one factor that distinguishes them from public assistance.