Evaluating the role of Social Security in providing annuity insurance

In this dissertation I study the usefulness of social security in providing annuity insurance when there is adverse selection in the annuity market. In Chapter 1 I study a two period economy where altruistic consumers have uncertain lifetime and are privately informed about their survival probabilities. Consumers buy insurance by participating in insurance pools. In this environment competitive equilibrium with life and annuity insurance exists despite the presence of adverse selection. This environment has three key features: (1) In any equilibrium there is at most one insurance market where trade occurs. (2) Increase in social security tax and benefits leads to increase in price of annuity and crowds out trade activities in annuity market. (3) In this environment efficient allocations are independent of private information and can be optimally implemented using simple tax-transfer instruments. Under optimal policy both annuity and life insurance markets are endogenously closed. I extend the model to a multi-period dynamic environment in Chapter 2. 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 0.12 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.

Economics

20010