A merican workers have been retiring from I L their jobs and receiving Social Security retirement benefits at younger and younger ages in recent decades.' Motivated by concern over this trend, studies of the retirement decision have followed two distinct lines: some have found poor reported health to be associated with earlier retirement, while others have analyzed the effects of retirement program parameters on life-cycle employment plans.2 There is, however, a connection between these causal factors which is not widely recognized: under the Social Security system, the financial attractiveness of early, actuariallyreduced benefits can be shown to be directly related to the remaining length of time that one expects to live. This is the hypothesis that I propose in this paper. The Social Security system, at its inception, provided retirement benefits only to insured workers who had attained age 65. More recently (since 1956 for women and since 1961 for men), however, reduced benefits have been available beginning at age 62. The reduction is applied to all future benefits, is scaled according to the number of months before age 65 that benefits are first received, and is roughly fair: the reduction is calculated to provide roughly the same present discounted value of lifetime benefits, regardless of the age at which benefits are first taken.3 Superficially, then, the early retirement option appears to be formulated in such a way as to minimize behavioral distortions by providing no financial advantage, relative to taking benefits at 65. Actuarial fairness also makes the option seem costless to the Social Security trust funds. In fact, however, the actuarial reduction equates expected present values of early and normal retirement benefit streams only for those with typical life expectancy. Prospective retirees with atypically low survival probabilities can maximize the expected present value of their benefits by choosing early benefit entitlement,4 while those with high probability of survival wan receive greater lifetime benefits through age 65 entitlement. Adverse selection can thereby increase the average expected present value of benefits for the population as a whole. The paper begins by demonstrating that early entitlement provides the greatest discounted lifetime benefit stream if and only if one dies before a specific borderline age. It is then straightforward to incorporate this actuarial insight into a more conventional analysis of the labor-leisure choice made by 62-year-olds. I then test the hypothesis that age at entitlement is positively related to longevity by using Social Security's Continuous Work History Sample (CWHS). The empirical approach is to measure how well entitlement decisions predict mortality. By taking this approach, I am able to obtain an estimated equation with which age at entitlement can be used to predict actual mortality. Thus, mortality rates can be generated for those claiming benefits at different ages, and by using these it is possible to estimate the gains to beneficiaries (and cost to the Social Security system) due to adverse selection. Received for publication May 3, 1982. Revision accepted for publication January 31, 1983. * Michigan State University. I would like to thank Joseph Applebaum, Paul Cullinan, Robert Dalrymple, Daniel Hamermesh, Kathy Ruffing, Frank Sammartino, and two anonymous referees for advice and comments on earlier drafts. I have also benefited from ideas expressed by Francisco Bayo and Steven Goss of the Office of the Actuary of the Social Security Administration. All errors and omissions are my own, however. Anne Rader provided extremely able research assistance. l Between 1971 and 1976 the proportion of retired workers' benefits awarded to 62-year-olds rose from 29% to 37%. See Social Security Administration (1971-76). In this paper the Old Age and Survivors Insurance (OASI) program will be referred to as the Social Security Retirement Program. 2 Boskin (1977) has highlighted this dichotomy in the literature. 3Monthly benefit amounts are reduced by 5/9% for each month before age 65 that they are taken. Thus, a monthly benefit claimed at age 62 is equal to 80% of the benefit available to the same worker at age 65 (if potential benefits are unchanged by any further covered earnings between ages 62 and 65). An increase of much lesser magnitude (1/4%) is applied to the benefits of those who delay their claims beyond age 65. This increase is far less than actuarially fair. 4 Entitlement denotes the receipt of benefits. Initial entitlement need not be coincident with retirement, except in the sense that entitlement requires that a beneficiary be earning little enough that the earnings test does not reduce benefits to zero.
Read full abstract
Oct 1, 2017
Anna Castañer Garriga + 2
Open Access
