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Summary  The efficient organisation of social insurance is an important problem for modern societies. The paper discusses evidence that shocks in labour income have largely persistent effects and analyses the implications of this observation for the optimal design of institutions for wage contracting, social security, and pensions. In an optimal contract, wages reflect variations in individual productivity for incentives reasons. However, the optimal contract insures workers against firm specific shocks. These can better be born by shareholders who can diversify risks on capital markets. Progressive income taxation provides further insurance. On top of that there is scope for additional insurance based on ‘verifiable’ information on unemployment and health conditions. As final form of ‘insurance’, the paper analyzes the role of self-insurance. Income shocks can be absorbed partially by precautionary saving. The individual’s saving plans for retirement and for precaution are, therefore, related issues. In an institutional setting with mandatory saving for retirement, an integration of disability and unemployment insurance on the one hand and the pension system on the other hand in a lifetime savings account allows for this interrelation. The paper analyzes how to deal with the uncertainty in the return on savings in the framework of a lifetime saving account.

How to Share Our Risks Efficiently? Principles for Optimal Social Insurance and Pension Provision