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Couples’ retirement and health

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A new Ph.D. thesis shows that financial incentives are very effective at raising the age of retirement for the healthy, while those in poor health primarily experience a reduction in their income (only slight increase in labour supply). It also shows that spouses reduce their response to a financial incentive strongly (reduce labour supply) if their partner experiences a health shock. This indicates that health problems can become very costly for society, if one unhealthy person draws two persons into retirement.

Since the early 2000s, the number of people receiving pensions has increased, while the number of tax payers needed to finance these pensions has decreased. This demographic change is putting pressure on Western countries in general, and on the modern welfare state in particular. Both the increasing tax burden and the decreasing labour supply are forcing politicians to try to find ways to motivate the older working population and the less healthy either to retire at a later age, or to work more. One way of motivating people to retire later is by increasing financial incentives to keep working. However, whether that strategy will work for the less healthy population remains unknown. Knowing whether this strategy will work for the less healthy is essential for policy makers, as the demographic trend (relatively more people aged 60+) is projected to increase over the coming three to four decades.

This Ph.D. project uses data from Denmark to examine how a health shock to an individual or their partner influences the response to financial incentives (of the couple) to retire. The project uses different definitions of a health shock in order to test the robustness of the health shock parameter. One important challenge when trying to get unbiased estimates of the effect of health on retirement is the endogenous character of the relationship between health and retirement. Generally, unobserved preferences for important factors such as leisure or a healthy lifestyle are correlated with retirement and health. To circumvent this endogeneity, The project exploits a 1999 reform of the early retirement programme “Post Employment Wage” (early retirement pension, PEW) and the timing of an unexpected health shock. The PEW reform is helpful because it exogenously alters financial incentives without altering preferences or health in the short run. In addition, given that the timing of a health shock is always unexpected, it alters health without altering preferences or financial incentives in the short run.

The paper contributes to the existing literature on retirement and health in four ways. First it models the interaction between a health shock and financial incentives to retire, not only the partial effects. Second, the health level is strongly correlated with unobserved preferences for leisure and a healthy lifestyle, and the paper exploits the timing of an unexpected health shock, not only levels of health. Third, the paper uses a reform of the PEW retirement programme that changed financial incentives to retire for people aged 60 and 61, all else being equal. Fourth, the paper uses objective diagnoses from register data, which avoid the small sample problems that many surveys face when they look at health shocks instead of health levels. The objective diagnoses also avoid the justification biases that often arise in self-reported health.

The main conclusions from this paper are: Financial incentives have significant strong negative effects on retirement, and a health shock to an individual or their partner reduces the marginal response to the financial incentive significantly (about 50%). Women reduce their response to a financial incentive more than men, when the health shock hits them personally, while women and men reduce their response to a financial incentive with about the same magnitude when their spouses experience a health shock.

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