HOW SOCIAL-SECURITY AND MEDICARE AFFECT RETIREMENT BEHAVIOR IN A WORLD OF INCOMPLETE MARKETS

This paper provides an empirical analysis of how the U.S. Social Secur ity and Medicare insurance system affects the labor supply of older ma les in the presence of incomplete markets for loans, annuities, and he alth insurance. We estimate a dynamic programming (DP) model of the jo int labor supply and Social Security acceptance decision, focusing on a sample of males in the low to middle income brackets whose only pens ion is Social Security. The DP model delivers a rich set of prediction s about the dynamics of retirement behavior, and comparisons of actual vs. predicted behavior show that the DP model is able to account for a wide variety of phenomena observed in the data, including the pronou nced peaks in the distribution of retirement ages at 62 and 65 (the ag es of early and normal eligibility for Social Security benefits, respe ctively). We identify a significant fraction of ''health insurance con strained'' individuals who have no form of retiree health insurance ot her than Medicare, and who can only obtain fairly priced private healt h insurance via their employer's group health plan. The combination of significant individual risk aversion and a long tailed (Pareto) distr ibution of health care expenditures implies that there is a significan t ''security value'' for these individuals to remain employed until th ey are eligible for Medicare coverage at age 65. Overall, our model su ggests that a number of heretofore puzzling aspects of retirement beha vior can be viewed as artifacts of particular details of the Social Se curity rules, whose incentive effects are especially strong for lower income individuals and those who do not have access to fairly priced l oans, annuities, and health insurance.