Life Expectancy and Claiming Behavior in a Flexible Pension System

• Published date: 01 October 2018
• Date: 01 October 2018
• DOI: http://doi.org/10.1111/sjoe.12271

Scand. J. of Economics 120(4), 979–1010, 2018

DOI: 10.1111/sjoe.12271

Life Expectancy and Claiming Behavior in a

Flexible Pension System*

Christian N. Brinch

BI Norwegian Business School, NO-0442 Oslo, Norway

christian.brinch@bi.no

Dennis Fredriksen

Statistics Norway,NO-0177 Oslo, Norway

dff@ssb.no

Ola L. Vestad

Statistics Norway,NO-0177 Oslo, Norway

olv@ssb.no

Abstract

Westudy the relationship between early claiming of pensions and incentives in the highly flexible

Norwegian public pension system, measuring incentives to claim based on an estimated model

for expected longevity.Despite a strong cor relation betweenincentives and claiming decisions,

the additional costs to public budgets arising from this selection turn out to be modest. Based

on analyses exploiting only variation in expected pensions generated by variation in parental

longevities and only claiming of pensions not in conjunction with retirement, we conclude that

part of the selection is active: some individuals claim pensions early because they gain from

doing so.

Keywords: Annuity; pension benefits; retirement; social security

JEL classification:H55; J14; J26

I. Introduction

The design of old-age pension systems is an issue that is currently

of considerable interest, as most OECD countries are facing challenges

as a result of a combination of aging populations and strained public

finances. In addition to the fiscal challenges, a key challenge is how to

design systems that minimize labor supply distortions and, at the same

time, provide sufficient insurance against productivity shocks occurring at

*We are grateful for valuable comments from Giovanni Mastrobuoni, Josef Zweim¨uller,

numerous seminar participants, and anonymous referees. The project received financial support

from the Norwegian Ministry of Labour and Social Affairs, and from the Norwegian Research

Council, projects 227020 and 220746.

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The editors of The Scandinavian Journal of Economics 2017.

980 Life expectancy and claiming behavior

late stages of careers. The Norwegian old-age pension system offers one

promising solution to this challenge, in decoupling the claiming of old-

age pensions and the decision to retire from the labor force: individuals

can decide to claim old-age pensions at any age between 62 and 75;

benefits are not earnings tested; and annual benefits are subject to actuarial

adjustments based on longevity measures specific to each birth cohort.

Hence, the system provides no disincentives to work in terms of implicit

taxes on continued work past the pension-eligible age (Gruber and Wise,

1999). This is an important feature in light of the substantial behavioral

responses to earnings testing, as documented by recent studies (e.g.,

Song and Manchester,2007;Haider and Loughran,2008;Gelber et al.,

2013;Hernæs et al.,2016;Brinch et al.,2017).

The main purpose of this paper is to provide an answer to the following

question. How, and to what extent, is early claiming of public pensions

associated with short expected longevity? We approach this question in

two steps. First, we measure the overall association between claiming

at age 62 and expected longevity in the Norwegian pension system.

Any association between expected longevity and pension claiming might

affect both the distribution of individual pension entitlements and the

total outlays of pension systems, both of which would be important

components in assessments of the performance and effects of old-age

pension systems. Second, we study the extent to which individuals claim

pensions early in part because they act on information about their expected

longevity. When faced with a pension system with flexible claiming and

without earnings testing, potential claimants might take into account that

their expected longevities might differ from the average in their birth

cohort, and they might exploit this difference to increase expected pension

payouts, compared to claiming pensions in conjunction with retirement

from the labor force. Such behavior would be an example of adverse

selection.

A delay in claiming is equivalent to buying an annuity: current pension

benefits are given up in return for a higher future income stream from old-

age pensions. Empirical evidence of adverse selection in private markets for

annuities is provided by Finkelstein and Poterba (2002,2004). Although

the universal coverage provided by the pension system and the absence

of endogenous pricing exclude any concern for missing markets, there

are reasons to suspect that adverse selection takes place also in the

context of public pension claiming behavior. However, recently it has

been shown that the usual assumption of fully optimizing individuals

might not hold in the context of complex tax and benefit systems (see,

e.g., Chetty et al.,2009;Brinch et al.,2017). Another strand of literature

studies to what extent financial literacy affects individual behavior (e.g.,

Lusardi and Mitchell,2007). Whether and to what extent individuals are

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The editors of The Scandinavian Journal of Economics 2017.

C. N. Brinch, D. Fredriksen, and O. L.Vestad 981

taking longevity expectations into account when deciding when to start

claiming pensions are of direct relevance to both these strands of literature.

Knowledge about the extent to which individuals act on information about

their expected longevity in claiming behavior might also be useful for

predicting behavior under different potential social security schemes.

Our paper is closely related to the body of literature on claiming

behavior and life expectancy in the US. Empirical analyses of mortality and

pension claiming date back to Wolfe (1983), who finds that those who claim

their social security pension at age 62 have higher mortality than those who

claim at age 65. Coile et al. (2002) show that it would be beneficial for

many to delay claiming but that few actually do. Hurd et al. (2004) study

the effects of subjective survival on retirement and social security claiming,

and find that those with very low subjective probabilities of survival both

retired earlier and claimed earlier than others. Hurd and Panis (2006)find

no evidence of adverse selection associated with cash-out of pension rights

in the event of job separation or retirement.

Also related to our paper are some studies of annuitization decisions

(e.g., Brown,2001;Hagen,2015) and of labor supply effects of removing

earnings testing. Engelhardt and Kumar (2009) and Disney and Smith

(2002) study the repeal of earnings tests with a deferral mechanism (in the

US and in the UK, respectively), and both find that labor supply responses

are concentrated mostly in groups of individuals who are likely to find the

earnings test particularly disadvantageous; those with high mortality risks

and those facing liquidity constraints.

Unlike earlier studies of claiming behavior, our paper addresses the

relationship between expected longevity and claiming behavior in a system

in which claiming and retirement decisions are largely decoupled. We study

the first birth cohort to enter the recently reformed Norwegian pension

system at age 62. We simulate expected longevities and expected present

values of pensions conditional on claiming at age 62 (i.e., the minimum

pensionable age) and at age 67 (i.e., the normal retirement age). We then

construct the relative money’s worth of the two annuities characterized

by claiming pensions at age 62 and age 67, respectively, defined as the

ratio of the expected present value of the two benefit streams. We find

that a 1 percent increase in the relative money’s worth is associated

with a 4 percentage points (12 percent) reduction in claiming at age

62. Although the measured selection amounts to as much as one-third of

the full potential for our expected longevity measure, the costs to public

funds are rather moderate. Compared to a situation in which there is no

difference between early and late claimers in terms of expected longevity,

the observed selection in early claiming increases the expected present

value of the outlays of public pensions for early claimers by a modest

0.8 percent.

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The editors of The Scandinavian Journal of Economics 2017.