Dying to retire: Adverse selection and welfare in social security

Despite facing some of the same challenges as private insurance markets, little is known about the role of adverse selection in Old-Age Social Security. Using data from the Health and Retirement Study we find robust evidence that people who live longer both choose larger annuities- by delaying the age they first claim benefits- and are more costly to insure, evidence of adverse selection. To quantify welfare consequences we develop and estimate a model of claiming decisions, finding that adverse selection increases costs to the system and reduces social welfare by 1-3 percent. Our results are robust to extending the choice set to include disability insurance, observed and unobserved heterogeneity in Social Security annuity val-uations, and the endogeneity of longevity expectations. The estimates imply that increasing the pension accrual rate, by decreasing the adjustment factor for early retirement, would yield substantial costs savings and by encouraging more efficient sorting, slightly increasing social welfare. In contrast, the cost savings from in-creasing the full retirement age are accompanied by significant reductions in social welfare. A mandate eliminating the choice to claim early, while resulting in large cost reductions, is even less desirable: it would entail large social welfare losses and a 50 percent increase in the number of people claiming disability insurance