The effects of health insurance and self-insurance on retirement behavior

Using an estimable dynamic programming model of retirement behavior, this paper assesses the relative importance of Medicare and Social Security in determining job exit rates at age 65. Of central importance is whether individuals value health insurance benefits not just for the reduction in average medical expenses, but also for the reduction in the volatility of medical expenses. To address this problem the model accounts explicitly for the effects of health cost volatility and health insurance on retirement behavior. By including a savings decision within the model, we allow for the possibility that individuals can self-insure against health cost shocks. Self-insurance potentially reduces an individual's valuation of health insurance. Using data from the Health and Retirement Survey, we find that the reduction in expected medical expenses explains 75% of a typical individual's valuation of health insurance, with the reduction in volatility explaining the remaining 25%. We find that shifting the Medicare eligibility age to 67 will delay age of retirement. However, shifting the Social Security normal retirement age to 67 will cause a larger retirement delay than shifting the Medicare eligibility age to 67.