Who values the Social Security Annuity?

March 10, 2008 in Public Policy, Social Security | Permalink

If you were offered an actuarially fair lump-sum payment, would you give up half of your Social Security benefits? This is the question asked by Brown, Casey and Mitchell in their 2008 NBER working paper.

Overall, about 60% of respondents from the HRS data set preferred the lump-sum payment. The authors find the following individuals are more likely to prefer a lump-sum payment over the annuity:

  • those with shorter expected longevity or who are in poor health,
  • those with more education,
  • those with less financial sophistication conditional on education,
  • those who believe Social Security benefits will be cut.

Predictably, individuals who think they live longer will choose the annuity since they will get paid over a longer period of time. We also see that those who believe that there is significant political risk (i.e., Social Security benefits will be cut) are more likely to choose the lump-sum benefits.

Men aged between 63 and 67 have only 5% of their assets in private annuities. People have claimed that this was due to one of the following reasons:

  • Adverse selection leads to high load factors on annuities, making them a poor value.
  • Because they are made up of a fixed payment, Annuities are subject to inflation risk.
  • Social Security may be a substitute for private insurance annuities.

The study finds evidence to contradict all three of these hypotheses. Social security benefits are actuarially fair, and inflation-adjusted. If people really benefited from Social Security annuities, than they should be hesitant to give up this stream of payments. Yet three of five people still would prefer a lump sum payment over the Social Security annuity, a type of annuity that offers significant advantages over those offered in the private market.

Maybe Social Security isn’t as valuable as once thought.

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  1. structured settlements’s avatar

    structured settlements on May 27, 2008 at 2:57 pm

    Great article. “Maybe Social Security isn’t as valuable as once thought” – I think this may be a huge understatement…

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