Academic journal article Journal of Risk and Insurance

Valuing the Longevity Insurance Acquired by Delayed Claiming of Social Security

Academic journal article Journal of Risk and Insurance

Valuing the Longevity Insurance Acquired by Delayed Claiming of Social Security

Article excerpt

ABSTRACT

Individuals can claim Social Security at any age from 62 to 70, although most claim at 62. We show that expected present value calculations substantially understate both the optimal claim age and the losses resulting from early claiming because they ignore the value of the additional longevity insurance acquired because of delay. Using numerical optimization techniques, we illustrate that the optimal claim age is between 67 and 70. We calculate that the amount by which benefits payable at suboptimal ages must be increased so that a household is indifferent between claiming at those ages and the optimal combination of ages can be as high as 19.0 percent.

INTRODUCTION

In the United States, most aged workers receive retirement benefits from Social Security, paid in the form of an inflation-protected annuity. Individuals can claim benefits at any age from 62 to 70. There is no requirement that benefits be claimed immediately on retirement, although the benefits of those who continue to work between 62 and full retirement age (FRA) are subject to an earnings test. Those who postpone claiming until age 70 receive 76 percent more per month than those who claim at age 62. The increases are approximately actuarially fair, and Sass, Sun, and Webb (2007) show that the expected present value (EPV) of benefits varies little with claiming age.

But choosing a claiming age is not simply a matter of maximizing the EPV of lifetime benefits. Individuals who delay claiming also acquire additional longevity insurance. They can be thought of as returning their monthly checks to the Social Security Administration (SSA) in return for additional annuity income. Previous research (Mitchell et al., 1999) has shown that annuities have a value that is considerably in excess of their money's worth, the EPV divided by the premium paid, because they provide the purchaser with valuable insurance against the risk of outliving their wealth.

Most individuals claim benefits at age 62 or soon thereafter (Muldoon and Kopcke, 2008). We show that most households claim early as a matter of choice in the sense that they have sufficient financial wealth to delay claiming after retirement, often for substantial periods.

Using numerical optimization techniques, we calculate the optimal ages at which husbands and wives in various household types should claim benefits, taking account of the additional longevity insurance purchased because of delay. We show that the optimal age at which single individuals and married men should claim benefits is between 67 and 70, 4 to 7 years later than the current average claim age, a result that is robust to alternative assumptions regarding level of risk aversion, relative mortality risk, and rate of time preference.

We calculate Social Security equivalent income, the factor by which the Social Security benefits of a nonliquidity-constrained retired household claiming at suboptimal ages must be increased so that it is as well off in expected utility terms as it would be at the optimal combination of ages. (1) In contrast to the money's worth calculations of previous research, we show that households incur substantial losses because of early claiming. For example, assuming a coefficient of risk aversion of 5 and a 3 percent real interest rate and rate of time preference, a single-earner married couple in which the husband is 3 years younger than the wife would require a 15.9 percent increase in the benefits payable if they both claimed at age 62 to be as well off as at the optimal claim ages of 69 for the husband and 66 for the wife.

The remainder of the article is organized as follows. The "Social Security Program" section outlines relevant features of the Social Security program. The "Previous Research" section discusses previous research on the Social Security claiming and annuitization decisions. The "Modeling the Social Security Claiming Decision" section presents our model of the claiming decision. …

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