Your degree: investment or insurance policy?

By Kai Liu, CERF Fellow and Professor of Economics, University of Cambridge

For decades, the ‘Mincer’ view of education has dominated our collective psyche: every additional year in the classroom is a simple transaction where you trade time today for a higher average paycheque tomorrow. We treat degrees like blue-chip stocks in a stable index fund, obsessively calculating a return on investment based on mean earnings.

But this ‘average’ view is a statistical ghost. It fails to explain why a degree feels like a life-raft for some, yet a risky, back-loaded gamble for others. Now, a massive study of career-long earnings in Norway – leveraging registry data from 1967 to 2013 – has finally confronted those models with reality. For many, education isn’t a ladder to the upper class; it is a high-stakes insurance policy against falling out of it.

Education is actually a high-value insurance policy

The study utilised a unique natural experiment: a Norwegian reform that increased compulsory schooling from 7 to 9 years between 1959 and 1974.

By tracking these individuals over their entire working lives, researchers discovered that the primary return on schooling for many isn’t a windfall salary, but the simple, vital probability of staying employed.

For the modern worker, education acts as a structural cushion.

The data is most striking when looking at the age-50 benchmark: for those affected by the reform, schooling increased mean earnings by 6.3%, but it also increased the probability of working by a full percentage point.

This effect is most transformative for those at the lower end of the ability distribution.

While high-ability individuals often find work regardless of their credentials, education provides “employment security” for those with lower initial test scores, acting as the difference between a career and chronic instability.

“Investments in education have a non-negligible insurance value, primarily by attenuating the significant employment risk that low ability workers face.”

For these workers, the graduation cap is less about the pay bump and more about the access key that keeps them in the labour market when the economy turns cold.

The steep slope problem: why college isn’t worth 21%

When we move from compulsory schooling to higher education, the maths becomes even more counter-intuitive. Traditional economic models – the ‘Certainty Equivalent’ views – promised a staggering 21% return on a college degree. Yet, when researchers applied a ‘Buffer Stock’ model that accounts for real-world uncertainty, that return plummeted to just 9%.

The discrepancy lies in the ‘Steep Slope’ of professional life. A college degree makes your income heavily back-loaded. You might be wealthy on paper because of what you’ll earn at 55, but that does little to satisfy a 25-year-old’s landlord.

• The certainty equivalent model (21%): Assumes a world of perfect foresight where you can borrow against your future 50-year-old self to buy a house today.
• The buffer stock model (9%): Accounts for prudence. Because the future is unwritten, humans are naturally risk-averse – the study calculates a coefficient of relative risk aversion of 4.65.

The ability complementarity: it’s not just what you know, but who you are

The steep slope of back-loaded earnings isn’t a universal experience; it is a burden borne primarily by the most capable. This reveals a critical bridge between the timing of our earnings and our innate traits.

The research used latent ability factors (aptitude scores) to show that education is not a one-size-fits-all benefit. It interacts with who you are in 2 distinct ways:

1. The growth multiplier (75^{th} percentile): For high-ability individuals, education is an accelerant. It increases the rate at which their earnings grow over their life cycle. For them, the return is almost entirely driven by the ladder of higher expected pay, but they face the steepest, most back-loaded climb.
2. The access key (25^{th} percentile): For low-ability individuals, the salary growth rate remains relatively flat regardless of schooling. For this group, education’s value is almost entirely its “safety net” function. It doesn’t necessarily make them much richer than their peers; it just makes them much less likely to be unemployed.

If you are highly skilled, education sharpens your tools for a long, steep climb. If you are less skilled, education builds the armour that protects you from the floor.

Conclusion: rethinking the graduation cap

To understand the true rate of return on a degree, we must look past the average salary and toward the psychological peace of mind provided by a lower risk of joblessness. We must acknowledge that many graduates are income-poor in their 20s despite being wealth-rich on paper, simply because they are too prudent to borrow against an uncertain future.

The graduation cap is a dual-purpose tool. It is a ladder for the high-ability worker, though one with a punishingly steep incline. But for a vast portion of the workforce, it is the only thing standing between them and the precariousness of the modern labour market.

Closing thought