Social security and longevity risk: An analysis of couples

Abstract

AbstractTo help manage longevity risk, Social Security pays three types of benefits to retirees: retirement benefits as a life annuity, spousal benefits until the death of the primary earner, and survivor benefits after the death of primary earner. How effective is Social Security at insuring couples against the joint longevity risks that they face? We take a public finance approach to this important question by comparing a Laissez Faire economy to a variety of different public insurance structures including the First Best, the Second Best, and US Social Security. We find that the welfare gains to couples from participating in the US Social Security system are large, and the survivor benefit feature is the key to this result while the spousal benefit provides very little efficiency gains. In fact, the optimal mixture of spousal and survivor benefits (i.e., the Second Best) improves ex ante efficiency by providing a larger payment to widows and a smaller spousal benefit than the current US system. We obtain these results using a theoretical model of couples who have full information about gender‐specific longevity risks and solve a dynamic stochastic (regime‐switching) problem to optimally hedge these risks.