IDEAS home Printed from https://ideas.repec.org/p/red/sed008/264.html
   My bibliography  Save this paper

Adverse Selection in the Annuity Market and the Role for Social Security

Author

Listed:
  • Roozbeh Hosseini

    (Univeristy of Minnesota)

Abstract

This paper studies the role of social security in providing annuity insurance. I calculate the welfare cost of adverse selection in the annuity market using a life cycle model in which individuals have private information about their mortality. I calibrate the model to the current U.S. social security replacement ratio, fraction of annuitized wealth and mortality heterogeneity in the Health and Retirement Study. My findings are as follows. First, in the absence of social security, individuals (on average) maintain about the same fraction of annuitized wealth as they do in the presence of social security, despite the fact that prices in the market are actuarially unfair. As a result, the welfare loss of abolishing social security is only 0.15 percent (in terms of consumption). Second, there is an ex ante gain of 0.51 percent from implementing the ex ante efficient allocations, which comes from redistributing resources from high mortality types to low mortality types. Individuals with high mortality (who will die soon and do not have demand for longevity insurance) incur large welfare losses from mandatory participation. These losses offset the benefits of providing insurance to low mortality types, leaving the overall ex ante welfare gain small.

Suggested Citation

  • Roozbeh Hosseini, 2008. "Adverse Selection in the Annuity Market and the Role for Social Security," 2008 Meeting Papers 264, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:264
    as

    Download full text from publisher

    File URL: https://economicdynamics.org/meetpapers/2008/paper_264.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Kotlikoff, Laurence J & Spivak, Avia, 1981. "The Family as an Incomplete Annuities Market," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 372-391, April.
    2. Abel, Andrew B & Warshawsky, Mark, 1988. "Specification of the Joy of Giving: Insights from Altruism," The Review of Economics and Statistics, MIT Press, pages 145-149.
    3. Walliser, Jan, 2000. " Adverse Selection in the Annuities Market and the Impact of Privatizing Social Security," Scandinavian Journal of Economics, Wiley Blackwell, pages 373-393.
    4. Hansen, G D, 1993. "The Cyclical and Secular Behaviour of the Labour Input: Comparing Efficiency Units and Hours Worked," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(1), pages 71-80, Jan.-Marc.
    5. Li Gan & Michael D. Hurd & Daniel L. McFadden, 2005. "Individual Subjective Survival Curves," NBER Chapters,in: Analyses in the Economics of Aging, pages 377-412 National Bureau of Economic Research, Inc.
    6. Kenneth Manton & Eric Stallard & James Vaupel, 1981. "Methods For Comparing The Mortality Experience of Heterogeneous Populations," Demography, Springer;Population Association of America (PAA), vol. 18(3), pages 389-410, August.
    7. Svetlana Pashchenko, 2010. "Accounting for non-annuitization," 2010 Meeting Papers 563, Society for Economic Dynamics.
    8. Harald Uhlig, 1996. "A law of large numbers for large economies (*)," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 41-50.
    9. V. Kerry Smith & Donald H. Taylor & Frank A. Sloan, 2001. "Longevity Expectations and Death: Can People Predict Their Own Demise?," American Economic Review, American Economic Association, pages 1126-1134.
    10. Liran Einav & Amy Finkelstein & Paul Schrimpf, 2010. "Optimal Mandates and the Welfare Cost of Asymmetric Information: Evidence From the U.K. Annuity Market," Econometrica, Econometric Society, vol. 78(3), pages 1031-1092, May.
    11. Cristia, Julian P., 2009. "Rising mortality and life expectancy differentials by lifetime earnings in the United States," Journal of Health Economics, Elsevier, vol. 28(5), pages 984-995, September.
    12. Pashchenko, Svetlana, 2013. "Accounting for non-annuitization," Journal of Public Economics, Elsevier, pages 53-67.
    13. Eichenbaum, Martin S & Peled, Dan, 1987. "Capital Accumulation and Annuities in an Adverse Selection Economy," Journal of Political Economy, University of Chicago Press, vol. 95(2), pages 334-354, April.
    14. Burman, Leonard E. & Coe, Norma B. & Gale, William G., 1999. "Lump Sum Distributions From Pension Plans: Recent Evidence and Issues for Policy and Research," National Tax Journal, National Tax Association, pages 553-562.
    15. Mikhail Golosov & Aleh Tsyvinski, 2007. "Optimal Taxation with Endogenous Insurance Markets," The Quarterly Journal of Economics, Oxford University Press, pages 487-534.
    16. Barbara A. Butrica & Gordon B.T. Mermin, 2006. "Annuitized Wealth and Consumption at Older Ages," Working Papers, Center for Retirement Research at Boston College wp2006-26, Center for Retirement Research, revised Dec 2006.
    17. Hurd, Michael & Panis, Constantijn, 2006. "The choice to cash out pension rights at job change or retirement," Journal of Public Economics, Elsevier, pages 2213-2227.
    18. Bisin, Alberto & Gottardi, Piero, 1999. "Competitive Equilibria with Asymmetric Information," Journal of Economic Theory, Elsevier, pages 1-48.
    19. Thomas Davidoff & Jeffrey R. Brown & Peter A. Diamond, 2005. "Annuities and Individual Welfare," American Economic Review, American Economic Association, pages 1573-1590.
    20. Bisin, Alberto & Gottardi, P. & Guaitoli, D., 1998. "A Note on the Convergence to Competitive Equilibria in Economies with Moral Hazard," Working Papers 98-41, C.V. Starr Center for Applied Economics, New York University.
    21. Benjamin M. Friedman & Mark J. Warshawsky, 1990. "The Cost of Annuities: Implications for Saving Behavior and Bequests," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 135-154.
    22. Pashchenko, Svetlana, 2013. "Accounting for non-annuitization," Journal of Public Economics, Elsevier, pages 53-67.
    23. Krueger, Dirk & Perri, Fabrizio, 2011. "Public versus private risk sharing," Journal of Economic Theory, Elsevier, vol. 146(3), pages 920-956, May.
    24. Diamond, P. A., 1977. "A framework for social security analysis," Journal of Public Economics, Elsevier, pages 275-298.
    25. Cannon, Edmund & Tonks, Ian, 2008. "Annuity Markets," OUP Catalogue, Oxford University Press, number 9780199216994.
    26. Jeremy Greenwood & Boyan Jovanovic, 1999. "The IT Revolution and the Stock Market," NBER Working Papers 6931, National Bureau of Economic Research, Inc.
    27. Amy Finkelstein & James Poterba, 2002. "Selection Effects in the United Kingdom Individual Annuities Market," Economic Journal, Royal Economic Society, vol. 112(476), pages 28-50, January.
    28. Burman, Leonard E. & Coe, Norma B. & Gale, William G., 1999. "Lump Sum Distributions from Pension Plans: Recent Evidence and Issues for Policy and Research," National Tax Journal, National Tax Association, vol. 52(n. 3), pages 553-62, September.
    29. Michael D. Hurd & Kathleen McGarry, 1995. "Evaluation of the Subjective Probabilities of Survival in the Health and Retirement Study," Journal of Human Resources, University of Wisconsin Press, vol. 30, pages s268-s292.
    30. Butt, Zoltan & Haberman, Steven, 2004. "Application of Frailty-Based Mortality Models Using Generalized Linear Models," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 34(01), pages 175-197, May.
    31. P. Dubey & J. Geanakoplos, 2001. "Insurance Contracts Designed by Competitive Pooling," Department of Economics Working Papers 01-09, Stony Brook University, Department of Economics.
    32. Hubbard, R Glenn & Judd, Kenneth L, 1987. "Social Security and Individual Welfare: Precautionary Saving, Borrowing Constraints, and the Payroll Tax," American Economic Review, American Economic Association, pages 630-646.
    33. Cristia, Julian P., 2009. "Rising mortality and life expectancy differentials by lifetime earnings in the United States," Journal of Health Economics, Elsevier, vol. 28(5), pages 984-995, September.
    34. Eckstein, Zvi & Eichenbaum, Martin & Peled, Dan, 1985. "Uncertain lifetimes and the welfare enhancing properties of annuity markets and social security," Journal of Public Economics, Elsevier, pages 303-326.
    35. David McCarthy & Olivia S. Mitchell, 2003. "International Adverse Selection in Life Insurance and Annuities," NBER Working Papers 9975, National Bureau of Economic Research, Inc.
    36. G. Dionne & N. Doherty & N. Fombaron, 2000. "Adverse Selection in Insurance Markets," THEMA Working Papers 2000-21, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    37. Alberto Bisin & Piero Gottardi & Danilo Guaitoli, 1998. "A note on the convergence to competitive equilibria in economies with moral hazard," Economics Working Papers 381, Department of Economics and Business, Universitat Pompeu Fabra.
    38. James Vaupel & Kenneth Manton & Eric Stallard, 1979. "The impact of heterogeneity in individual frailty on the dynamics of mortality," Demography, Springer;Population Association of America (PAA), vol. 16(3), pages 439-454, August.
    39. Lee Lockwood, 2012. "Bequest Motives and the Annuity Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 226-243, April.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dennis Fredriksen & Christian N. Brinch & Ola L. Vestad, 2017. "Life expectancy and claiming behavior in a flexible pension system," Discussion Papers 859, Statistics Norway, Research Department.
    2. Maik T. Schneider & Ralph Winkler, 2010. "Growth and Welfare under Endogenous Lifetime," Diskussionsschriften dp1013, Universitaet Bern, Departement Volkswirtschaft.
    3. Sita Slavov & Devon Gorry & Aspen Gorry & Frank N. Caliendo, 2017. "Social Security and Saving: An Update," NBER Working Papers 23506, National Bureau of Economic Research, Inc.
    4. Caliendo, Frank N. & Guo, Nick L., 2014. "Roosevelt And Prescott Come To An Agreement," Macroeconomic Dynamics, Cambridge University Press, pages 1383-1402.
    5. Hosseini, Roozbeh & Shourideh, Ali, 2016. "Retirement Financing: An Optimal Reform Approach," MPRA Paper 71613, University Library of Munich, Germany, revised 19 Jan 2016.
    6. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
    7. Pashchenko, Svetlana, 2013. "Accounting for non-annuitization," Journal of Public Economics, Elsevier, pages 53-67.
    8. Frank N. Caliendo & Aspen Gorry & Sita Slavov, 2017. "Survival Ambiguity and Welfare," NBER Working Papers 23648, National Bureau of Economic Research, Inc.
    9. repec:spr:jopoec:v:31:y:2018:i:1:d:10.1007_s00148-017-0654-z is not listed on IDEAS
    10. Frank Caliendo & Nick Guo & Roozbeh Hosseini, 2014. "Social Security is NOT a Substitute for Annuity Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(4), pages 739-755, October.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed008:264. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.