The idea of unemployment insurance is unwise ("Unemployment insurance must not give false sense of security" by Ms Juliana Ang Hiok Lian; last Wednesday).

Insurance serves two important functions in an economy.

First, it is to replace income or assets if a chance loss occurs.

Second, it is to encourage people to engage in socially beneficial but risky activity that they might not undertake without insurance.

Individuals alter their behaviour after becoming eligible for insurance payments because their economic incentive is altered.

The downside of unemployment insurance is that it could cause the national unemployment rate to rise.

Without official monitoring, the unemployed may reduce the intensity of their job search and lengthen the time spent unemployed, as the insurance benefits can outweigh the gain of finding a job.

Increases in insurance benefit levels can heighten the disincentives for finding a job. Hence, policies need to strike a balance between the positive and negative effects of unemployment insurance.

This can be achieved by setting benefit levels and duration at adequate but not excessive levels.

Another important policy tool is to set clear and firm job-search requirements and to enforce them.

It is difficult to know or control how seriously and genuinely people make an effort to look for jobs.

If implemented by the Government, unemployment insurance needs to be funded from taxes, so it is important to guard against a "parasite" mentality and the urge not to rejoin the workforce.

Francis Cheng