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

Abstract

This paper studies the role of social security in providing annuity insurance when there is adverse selection in the annuity market. I calculate the welfare gain from mandatory annuitization in the current U.S. social security system 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. The main findings of the paper are the following: 1) the overall welfare gain from having mandatory annuitization through the current U.S. social security system is 0.27 percent of consumption; 2) social security has a large effect on price of annuities because it crowds out the demand for annuities by people who have low survival expectations. This price effect has negative welfare impact of 0.29 percent of consumption. On one hand, individuals with high mortality (who will die soon and do not have demand for longevity insurance) incur large welfare losses from mandatory participation. On the other hand the effect on prices limits the benefit to the low mortality individuals. These two effects results to the overall small ex ante welfare gain.

What Do We Know About Annuitization Decisions?

“…Theoretical + Having symmetrically distributed retirement income from social security increases couples' welfare compared to the scenario where all preretirement wealth is held in liquid funds Hosseini (2015) Theoretical, empirical + Small welfare gain; but about the same fraction of annuitized wealth as without social security empirical studies report the fraction of individuals or households in the sample who possess annuities, instead of the amount of wealth invested in annuities, which may lead to an overestimation of annuitization rates in terms of wealth. Furthermore, the results also depend on the characteristics of the underlying data set, such as peculiarities of legislation, 9 group or individual insurance, hypothetical or actual annuity possession, and occupation and other characteristics of the respondents.…”

Fair Retirement Under Risky Lifetime*

“…At the old age, 6 Utilitarianism also prevails in optimal retirement age studies in a dynamic setting (see Crettez and Le Maitre, 2002;Michel and Pestieau, 2002;Lacomba and Lagos, 2006). 7 Those recent articles pay particular attention to the design of an optimal pension system in a second-best environment, because of a limited set of policy instruments (Shourideh and Troshkin, 2012;Golosov et al, 2013) or because of adverse selection (Hosseini, 2014). agents can still work some subperiod, of length z, and are retired over the remaining subperiod of length 1 − z.…”

“…Those recent articles pay particular attention to the design of an optimal pension system in a second‐best environment, because of a limited set of policy instruments (Shourideh and Troshkin, ; Golosov et al., ) or because of adverse selection (Hosseini, ).…”

Retirement Financing: An Optimal Reform Approach

“…Hubbard and Judd (1987), İmrohoroǧlu et al (1995) and Hong and Ríos-Rull (2007) and Hosseini (2015) (among many other) have examined the welfare enhancing role of providing annuity income through social security when there is imperfections in the private annuity insurance market. Caliendo et al (2014) point out that because social security does affect individual's inter-temporal trade-offs, its welfare enhancing role in providing annuitization is limited.…”