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Lecture 06 Handout
Lecture 06 Handout
Christine Ho
Singapore Management University
Outline
Social Security
• Longevity risk
• Reasons for intervention
• Issues with intervention
1
Longevity Risk
• Uncertainty about lifespan
• Suppose that we anticipate that we will die on our 80th
birthday and thus spend all our money by the 80th birthday
• Then, if we were to actually live up to our 90th birthday,
we will have to live in poverty for the last 10 years of life
• Moral hazard
• Knowing that society will never let
anyone starve in old age, individuals
may choose to save inadequately
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Pay-As-You-Go Social Security
• A Pay-As-You-Go (PAYG)
Social Security system is one
where the current working
generation is taxed to finance the
consumption of the current
retired generation
Taxes Benefits
Working Social Retired
Generation Security Generation
Lecture 6 7
SMU Classification: Restricted
• Benefits
• Eligibility for benefits
• Worked and paid SS contributions for 40 quarters over the lifetime
• Aged 62 or older
• Amount
• Lifetime annuity based on highest 35 years of earnings
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Future Consumption
Private Savings
c
c1
1 r S
e IC0
M1
S
c0 M0 Present Consumption
10
Future Consumption
Crowding-Out
c
c1
ess
B e IC0
M1
S ss T
c0 M0 Present Consumption
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Class Exercise 1
• Suppose that Adam lives only two periods where he earns W in period
0 and is retired in period 1. He has preferences of the following form
u lnc0 ln c1
where c0 is period 0 consumption and c1 is period 1 consumption and
δ is his rate of time preference. Let r be the interest rate.
1. What is Adam's ratio of period 0 to period 1 consumption?
2. Now suppose that the government taxes Adam amount T in
period 0 and gives Adam Social Security Benefits B=(1+r)T in
period 1. What is Adam's ratio of period 0 to period 1
consumption with Social Security?
3. Is there any difference between the consumption bundles chosen
before and after the introduction of Social Security? Explain why
or why not.
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4
Social Security and Early Retirement
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15
Generation 1 SS Benefits
PAYG
PAYG
Generation N Payroll taxes
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5
Scope for Program Reform
• Benefit replacement ratio under the PAYG system
Benefits*Retirees = Tax Rate*Wage*Workers
17
Aging Population
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6
Potential Reforms within PAYG
• Raise the payroll tax
• Pros: raise revenue
• Cons: distortionary effects of taxation
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Funded
Generation 1 Payroll taxes SS Benefits
Funded
Generation 2 Payroll taxes SS Benefits
Funded
Generation 4 Payroll taxes SS Benefits
Funded
Generation N Payroll taxes SS Benefits
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7
Singapore Central Provident Fund
• Contributions
• Ordinary account: home, investment, education
• Special account: old age, retirement related financial products
• Medisave account: hospitalization expenses, medical insurance
• Employer (17%) + Employee (20%) = 37% of earnings
• Benefits
• Can withdraw savings from aged 55 or older subject to CPF
retirement sum of S$192,000+
• From age 62 will receive monthly payments from the CPF
minimum sum until exhaustion or can purchase a life annuity
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8
Disadvantages of Funded Systems
• Risk
• Investing the funds may be risky
• Administration
• The more the available portfolios and investment
opportunities, the higher the administrative costs
• Distribution
• Personal accounts typically do not lead to redistribution
from young to old or from rich to poor
26
Transition Challenges
• When switching from PAYG to a Fully Funded
system, the last generation loses
• The first generation of beneficiaries from a PAYG system
gains since they did not contribute but enjoy SS benefits
• The last generation of young workers will lose out
27
28
9
Health Insurance Markets
• Information Asymmetry
• Adverse Selection
• Moral Hazard
31
Health Insurance
• Health insurance is about providing insurance
against negative health shocks
• Uncertainty on when we are going to fall sick or get into
an accident
• Uncertainty on what type of disease or injury we will get
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10
Asymmetric Information Issues
• Health insurance suffers from adverse selection
where those who are higher risks are the most
likely to take health insurance while the lower risks
are less likely to take health insurance
• Health insurance suffers from the problem of
moral hazard when individuals are tempted to
• Engage in more risky behavior once insured
• Incur higher medical expenses once insured
34
Evidence-Based Economics 35
35
36
11
Insurance Gaps in the USA
37
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12
Free-Riding on Tax Payers
• Cost shifting
• Those without insurance often delay getting treatment thereby
leading to an increase in total costs of treatment
• Hospitals and tax payers cover the medical costs of the uninsured
• Negative financial externality on taxpayers
• In the USA,
• The uninsured pay for only 30% of the medical services they use
• They receive free care from hospitals
• Prior to Obamacare, uninsured individuals received approximately
$84.9 billion in uncompensated care
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Obamacare
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Price
Patient Side Moral Hazard
P S SMC
DWL
Insurance
Compensation
CO PMCI
Out of Pocket Medical Expenses
D SMB
QNI QI Medical Services
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Class Exercise 2
• Suppose that an individual's demand curve for doctor's visits per year
is given by P=100-25Q where Q is the number of doctor visits per
year and P is the price per visit. Suppose also that the marginal cost of
each doctor visit is $50.
1. How many visits per year would be efficient? What is the total cost of
the efficient number of visits?
2. Suppose that the individual obtains insurance. There is no deductible,
and the coinsurance rate is 50%. How many visits to the doctor will
occur now? What are the individual's out-of-pocket costs? How much
does the insurance company pay for this individual's doctors' visits?
3. What is the deadweight loss caused by this insurance policy?
4. What happens to the size of the deadweight loss if it turns out that the
marginal external benefit of visiting the doctor is $50?
Lecture 6 [RG] Chapter 9 Ex. 6 43
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• Management
• Primary care: Private practitioners (80%) and public
polyclinics (20%)
• Hospital care: Private hospitals (20%) and public
hospitals (80%)
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Health Expenditures and Life Expectancy
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Take Home
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Main Lessons
• Social security insures against the risk of living longer than expected
• Justifications for government provision
• Disincentive effects on labor supply
• Main features in USA and Singapore
• When switching from PAYG to a Fully Funded system, the
transition generations lose
• Reasons for government intervention in health insurance markets
• Adverse selection in health insurance markets
• Moral hazard in health insurance markets
• Obamacare compulsory insurance and Singapore’s funded system
Lecture 6 SMU Classification: Restricted 54
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Next
• Required Readings: [RG] Ch: 9,11
• Review, read, and write down your own notes
• Reinforce and check your understanding are important early on
• A good exercise is to draw graphs and do the mathematical derivations on your
own, and write down explanations in your own words complemented with the
required readings.
• Mid-Term Exams:
• In the next class
• Closed book 1.5 hours
• Bring stationary, non-programmable calculator…
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