, Volume 160, Issue 3, pp 311-337,
Open Access This content is freely available online to anyone, anywhere at any time.
Date: 28 Apr 2012

Adverse Selection in Private Annuity Markets and the Role of Mandatory Social Annuitization

Abstract

We study the effects on the macroeconomic equilibrium, the wealth distribution, and welfare of adverse selection in private annuity markets in a closed economy inhabited by overlapping generations of heterogeneous agents who are distinguished by their health status. If an agent’s health type is private information there will be a pooling equilibrium in the private annuity market. We also study the implications for the macro-economy and welfare of a social security system with mandatory contributions that are constant across health types. These social annuities are immune to adverse selection and therefore offer a higher rate of return than private annuities do. However, they have a negative effect on the steady-state capital intensity and welfare. The positive effect of a fair pooled rate of return on a fixed part of savings and a higher return on capital in equilibrium is outweighed by the negative consequences of increased adverse selection in the private annuity market and a lower wage rate.

A previous version of this paper formed part of the second author’s bachelor thesis which was awarded the 2011 Netspar Bachelor Thesis Award. It was also joint winner of the 2011 Grote Financiën Scriptieprijs, a thesis prize established by the Dutch Ministry of Finance.