Boettner Center for Pensions and Retirement Research
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Working Paper

Health Expenditure Risk and Annuitization: Evidence from Medigap Coverage

Daniel W. Sacks
BWP2012-01

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Abstract — Theoretical research suggests that health expenditure risk can have an ambiguous influence on the annuitization decisions of the elderly. I provide empirical evidence on this linkage, by estimating the impact of supplemental Medicare insurance (Medigap) coverage on the annuity demand of older Americans. I use local variation in prices as an instrumental variable to address the possible endogeneity of Medigap coverage, an identification strategy motivated by the fact that Medigap policies are not medically underwritten, and Medigap insurance is required by law to be standardized, so prices reflect neither individual characteristics nor product quality. Medigap coverage has a strong impact on annuitization: the extensive margin elasticity is 0.39, the overall elasticity of private annuity income with respect to Medigap coverage is 0.56. These results are robust to controls for health, wealth, and preferences, as well as other robustness tests. They imply that medical expenditure risk has a large impact on underannuitization.