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Savings and Risks Over the Lifecycle: Theory and Evidence

Final Report Summary - SAVINGS AND RISKS (Savings and Risks Over the Lifecycle: Theory and Evidence)

The project "Savings and Risks" studied the effects of means-tested programmes on the savings of single retirees and their medical expenses, the determinants of the savings of couples and singles over their life cycle and the determinants of the labour supply of married and single people during their working period, and the difference in wealth accumulation between the healthy and the unhealthy.

As for the first theme, our work shows that Medicaid, a means-tested health insurance program, benefits both high- and low-income retirees, but that the return for each dollar spent on Medicaid payments is actually higher for the high-income retirees, who would like an even more generous Medicaid program to reduce the risk that they will drastically have to cut their consumption in case they get very old and experience very expensive medical conditions. We also find that the Medicaid program has the largest effects on the saving, medical expenses, and welfare of the high-income retirees because they have the longest life expectancy and might face very expensive medical conditions when very old. Thus, they have the most to gain from a Medicaid expansion.

Our work on couples before and after retirement has shown that the level of medical expenses by age is lower for married than for single people and that, in the United States, the current structure of marriage-based taxes and social security benefits decreases the savings of couples, the labour participation of married and single women, and increases the labour participation of married men. It thus shows that incentives to work and save that are related to marital status have large effects.

Regarding the difference in wealth accumulation between the healthy and the unhealthy, I have, with Svetlana Pashchenko and Ponponje Porapakkarm developed and estimated a rich model of how health affects labor supply and retirement savings. The paper allows us to disentangle and measure multiple pathways by which health affects labour market and retirement outcomes. In this paper we find that starting life with a given health type, which could come from genetics or lifestyle, is more important that luck in determining the probability that one recovers from sickness. We also find that, in contrast, the probability of becoming sick depends on bad luck and one’s health status over the previous two years. Importantly, we find that to a large extent, the huge differences in savings that we observe between the healthy and the unhealthy is due to a pre-existing health type that is already formed at age 25, and that patience has to be correlated with this health type to explain the observed health-wealth outcomes. More specifically, since the wealth of the healthy at retirement is approximately a factor of twice as much as the wealth of the unhealthy at the same time, to reproduce this large inequality by health status we need that people in bad health are also, on average, less patient. We find, in fact, that we can explain approximately half of the wealth gap between the healthy and unhealthy at retirement if we do not have patience to be correlated with health type.