SocialInsuranceLecture

SocialInsuranceLecture - 1 Social Insurance: Outline Risk,

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Unformatted text preview: 1 Social Insurance: Outline Risk, consumption-smoothing, and the demand for insurance The theory of adverse selection Evidence of advantageous selection Government provision of insurance as a response to market failure Moral hazard; the Samaritans Dilemma 2 Life-Cycle Model $ Time School Working Life Retirement Death 3 Life-Cycle Model: Income $ Time School Working Life Retirement Death 4 Life-Cycle Model: Consumption $ Time School Working Life Retirement Death 5 Life-Cycle Model: Consumption $ Time School Working Life Retirement Death Saving Dissaving Dissaving 6 7 Life-Cycle Model As long as capital markets work well, you can smooth consumption over your life- cycle, exhausting all resources at death But there is usually uncertainty about the time of death This creates the risk that you may run out of income before your death, or save too much and leave an unintended bequest 8 Life-Cycle Model: Consumption $ Time School Working Life Retirement Death Unmet Consumption Needs 9 Life-Cycle Model: Consumption $ Time School Working Life Retirement Death Unintended Bequest 10 Life-Cycle Model How would you insure against this risk? Annuity: a financial product that pays you a fixed income per month until you die, regardless of when that happens (in exchange for an up-front payment) Is the private market for annuities likely to work efficiently? 11 Adverse Selection If buyers have more information about their longevity than do sellers, there may be market failure in the private annuities market due to adverse selection Suppose you are the manager of T. Rex Price, a financial services firm You offer annuities that pay $10/year until death to people aged 65 who have just retired; there are 2 types of retirees 12 Adverse Selection Type Fraction of the Population Pr[dying at 75] Pr[dying at 85] Expected Cost of Annuity W illingness to Pay I 0.8 0.2 $120 $140 II 0.1 0.9 $190 $210 13...
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SocialInsuranceLecture - 1 Social Insurance: Outline Risk,

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