Abstract
We study the impact of a fully-funded social security system in an economy with heterogeneous consumers. The unobservability of individual health conditions leads to adverse selection in the private annuity market. Introducing social security—which is immune to adverse selection—affects capital accumulation and individual welfare depending on its size and on the pension benefit rule that is adopted. If this rule incorporates some implicit or explicit redistribution from healthy to unhealthy individuals then the latter types are better off as a result of the pension system. In the absence of redistribution the public pension system makes everybody worse off in the long run. Though attractive to distant generations, privatization of social security is not generally Pareto improving to all generations.
Highlights
More than half a century ago Yaari (1965) proved convincingly that private annuities are very attractive insurance instruments when non-altruistic individuals face longevity risk
In our paper we have developed an overlapping generations model which features adverse selection in the private annuity market and endogenously determined borrowing constraints in the capital market
Consumers are assumed to be heterogeneous in two dimensions—working ability and health status—which in the absence of perfect information leads to adverse selection in the private annuity market
Summary
More than half a century ago Yaari (1965) proved convincingly that private annuities are very attractive insurance instruments when non-altruistic individuals face longevity risk. (because they are unable to go short on annuities) and the other agents receive a common yield on their annuity purchases They show that the introduction of a mandatory public pension system—though immune to adverse selection by design— leads to a reduction in steady-state welfare, an aggravation of adverse selection in the private annuity market, and a reduction in the economy-wide capital intensity. The introduction of a funded social security system reduces the capital intensity and output per efficiency unit even further, more so the larger is the system, i.e. the higher is the replacement rate it incorporates These results are consistent with Palmon and Spivak (2007) and Heijdra and Reijnders (2012). Some technical issues are dealt with in three brief appendices
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
