How Social Security and Medicare Affect Retirement Behavior In a World of Incomplete Markets

Abstract

This paper provides an empirical analysis of how the U.S. Social Security and Medicare insurance system affects the labor supply of older males in the presence of incomplete markets for loans, annuities, and health insurance. We estimate a dynamic programming (DP) model of the joint labor supply and Social Security acceptance decision, focusing on a sample of males in the low to middle income brackets whose only pension is Social Security. The DP model delivers a rich set of predictions about the dynamics of retirement behavior, and comparisons of actual vs. predicted behavior show that the DP model is able to account for a wide variety of phenomena observed in the data, including the pronounced peaks in the distribution of retirement ages at 62 and 65 (the ages of early and normal eligibility for Social Security benefits, respectively). We identify a significant fraction of "health insurance constrained" individuals who have no form of retiree health insurance other than Medicare, and who can only obtain fairly priced private health insurance via their employer's group health plan. The combination of significant individual risk aversion and a long tailed (Pareto) distribution of health care expenditures implies that there is a significant "security value" for these individuals to remain employed until they are eligible for Medicare coverage at age 65. Overall, our model suggests that a number of heretofore puzzling aspects of retirement behavior can be viewed as artifacts of particular details of the Social Security rules, whose incentive effects are especially strong for lower income individuals and those who do not have access to fairly priced loans, annuities, and health insurance.

Gradual Retirement: Preferences and Limitations

“…Part-time work is generally more common among older than among younger workers, but there is substantial variation across countries that remains to be analysed and explained. There is some evidence that financial incentives stimulating gradual retirement will work, but there is scope for incorporating gradual retirement in more rigorous quantitative studies based upon structural models on retirement decisions, like, e.g., Stock and Wise (1990); Gustman and Steinmeier (1986); Blau (1994), or Rust and Phelan (1997). The quantitative impact of policy measures thus remains largely to be determined.…”

Public pensions and labor supply over the life cycle

“…The main explanation for the high job exit rates between 62 and 65 is liquidity (Kahn, 1988;Rust and Phelan, 1997;Gustman and Steinmeier, 2005 Medicare provides an important retirement incentive because many individuals younger than 65 obtain group health insurance only while they continue to work. However, once individuals become eligible for Medicare at age 65, the health insurance incentive for work largely vanishes.…”

Back to Work: Expectations and Realizations of Work after Retirement

“…Even though unretirement could be optimal in a theoretical life cycle model, whether on account of uncertainty or some predictable force, many empirical analyses assume retirement is an absorbing state. Of those that relax this assumption (Berkovec and Stern 1991; Blau 1994; French 2005; Rust and Phelan 1997), only Blau (1994) and Rust and Phelan (1997) examine whether their models can predict observed re-entry rates. Although many authors have noted the existence of so-called reverse transitions in the data, rarely has unretirement been the object of direct study, perhaps because unretirement transitions were often thought to be relatively uncommon (see for example, Reimers and Honig 1993; Rust and Phelan 1997).…”