No.637 Health Risk, Incomplete Retirement Markets, and the Value of Health and Longevity

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Health Risk, Incomplete Retirement Markets, and the Value of Health and Longevity

We calculate the value of health and longevity improvements for retirees in a calibrated life-cycle model with stochastic health risk and access to a limited menu of retirement products. In this setting, consumers optimally annuitize only a fraction of their wealth and adjust their consumption choices according to their health trajectory. These two aspects substantially affect consumers’ valuation of improvements to health and longevity. First, the ability to adjust consumption mitigates the adverse consequences of a health shock to a certain extent. Second, lower annuity holdings decrease the value of mortality reductions at old ages, as consumers tend to spend down much of their non-annuitized wealth before then—which is especially the case for consumers with poor health. In combination, these aspects substantially reduce the value consumers place on aggregate health and longevity improvements, with our estimates undercutting estimates from the literature by up to 70%. However, the reduction is smaller for preventative interventions, which conventional approaches do not distinguish from other interventions.