Adverse selection in the annuities market and the impact of privatizing social security

The observation that few Americans purchase life annuities has often been a ttributed to adverse selection. A still unanswered question is whether obse rvable price increases caused by adverse selection can be generated endogen ously in a life cycle model. This paper calibrates a pure life cycle model for a characteristic US cohort and reproduces three stylized facts. Adverse selection increases annuity prices by 7-10 percent; the cost of adverse se lection rises with the age of the annuitant; and the cost is smaller for fe males than for males. Social security privatization could reduce annuity pr ices by between 2 and 3 percent.