How do Subjective Longevity Expectations Influence Retirement Plans? M. R. Kahn, M.S. Rutledge, A.Y. Wu July, 2014 Comments: Deb Dwyer DEBRA SABATINI DWYER TECHNOLOGY AND SOCIETY 16th Annual Meeting of the Retirement Research Consortium “Social Security and the Retirement Income System” National Press Club, Washington, DC

RRC 2014 – Slide 3 Aims to contribute to the literature related to:  Retirement Planning and Social Security Policy  Rational Expectations and Retirement Decisions BY:  Examining how individuals incorporate Subjective Life Expectancy (levels and changes) into the planning process  How this translates into Actual Retirement POTENTIAL CONTRIBUTION

RRC 2014, Slide 4 Large literature on factors influencing retirement  Relevance to policies aimed at addressing solvency and sustainability of SS Programs  Little focus on SLEs  Literature does motivate focus on SLEs  Relationship exists but not studied for identification of isolated role  Time Horizon: Important and uncertain resource  Important to understand behavior to set policy to incentivize work (or other goals)  If decision-makers account for longevity in retirement planning they may be more responsive to policies – like extending early and normal age of retirement given rising LE MERIT OF THE CONTRIBUTION

RRC 2014, Slide 5 “Information is the resolution of uncertainty.“Information is the resolution of uncertainty.” Claude Shannon Relevance for policy: Analysts have been acknowledging the importance of accounting for uncertainty in modeling when it comes to retirement -We learn from actual revealed preferences -Understanding the complexities of how those outcomes came about, what influences them, is critical  Theories are ambiguous - This work contributes not only to our understanding of the role of an important resource for retirement (years of life), but the fact that this resource is uncertain. MERIT OF THE CONTRIBUTION

RRC, 2014, Slide 6 Increasing Life Expectancy has been the basis for discussions of raising eligibility ages for SS OASI benefit take-up Theory predicts a positive relationship between work life and longevity (as authors acknowledge) because:  Longer life means greater consumption needs  Wealth Effect: More time available for work and leisure Empirical Work is Required to Examine the magnitude of these effects  Depends on preferences (utility weights) over work and leisure as individuals age BACKGROUND

RRC, Slide 7 Cartoon Upfront: Endogenous Wealth Effect of Life Years: -Retiring earlier can increase actual/expected life years -Still does not predict a negative relationship between time horizon and work life necessarily unless… -Strong preferences for a longer time horizon might pose an investment incentive in the form of retirement -Could explain mixed findings in the literature -Important consideration for interpretation of findings IS IT UNAMBIGUOUS THEORY?

RRC, 2014, Slide 8 Mixed Findings on role of SLE on Retirement:  Hamermesh (1984)  Two Surveys – neither directly ask SLE  Rely on national trends, parent mortality  These indicators do not show a strong relationship with individual behavior  Cannot identify if it is a measurement error issue  Even if accurately measured, it is a different cohort Clearly motivates analysis of SLE on Retirement Behavior as it relates to overall planning for future consumption - FIT IN LITERATURE

RRC, 2014, Slide 9 Mixed Findings on role of SLE on Retirement: Evidence on Diminishing Marginal Returns -Hurd et al (2004) findings consistent with DMR theory  The value of an additional year is greater to those who have less for US HRS population – dominating substitution effect of leisure for work  Also may retire earlier to gain some years (endogenous wealth effect) -O’Donnell et al (2008) findings consistent with Wealth Effect Theory  Those with less can afford less retirement (fewer years to spend on both) in England -Bloom et al (2006) offsetting effects – in US FIT IN LITERATURE

RRC, 2014, Slide 10 Expectation Formation and Rational Expectations  Hamermesh (1985, Expectation, Life Expectancy and Economic Behavior in QJE)  Experimental survey data to capture SLE and how it is formed  Skewed toward subjective inputs rather than actual statistics available – despite the fact that they are aware of the facts  Go on to use SLEs to study their role in behavior and utility over work and leisure  Use Findings to Comment on Need for Social Assistance: “Shortfalls in utility in old age because of skewed or imperfect forecasting of survival probabilities were found to be relatively small. This implies that large subsidies to retirees under today's Social Security system cannot be justified as compensation for an unexpectedly long retirement for which they failed to save.” - FIT IN LITERATURE

RRC, Slide 11 2 studies that examine expected retirement Van Solinge and Henkins (2009) Dutch workerss Szinovacz et all (2014) HRS – focus on Macroeconomic indicators not SLE - Neither control for measurement error and endogeneity FIT IN LITERATURE

RRC, Slide 12 Benitez-Silva et al (2008, Expectations in Micro Data: Rationality Revisited, Empirical Economics) -Supports Rational Expectation Theory in the formation of SLE and Expected Retirement -Unlike Hamermesh, after controlling for measurement error bias, model mis-specification, and endogeneity, find individuals on average use information available to predict well -HRS SLEs are a good indicator of information used in retirement planning -Use as an instrument for Expected Retirement -Find strong positive relationship between SLE and Expected Retirement (an additional year of life - delay year) -Account for selection in responding to SLE questions Earlier cohort and focus of work is not on sLE FIT IN THE LITERATURE CONTINUED

RRC, Slide 13 -More waves – Thorough and careful analysis -Compare SLE to Objective LE (OLE) -Account for endogenous SLE in expected retirement model -Acknowledge classic measurement error in individual responses and control for it -Examine CHANGES in SLE to understand how the evolution of Retirement Planning*** -Studies Actual Retirement Behavior to be able to Compare to Literature -Allow for differences in effects by gender -Sensitivity Checks SUCCESS IN MAKING CONTRIBUTION

RRC, Slide 14 Sample Selection -Authors do examine this concern for non response in Expected Retirement -Non-response in indicators of SLE could be a concern (Benitez-Silva et al, 2008)  Sicker, more financially knowledgeable, female, white, married, higher educated respondents with higher probability of recent parent death are more likely to report  Implications for interpretation of findings – Over-representation of sicker knowledgeable respondents who have given more thought to time horizon  Could exaggerate effect of SLE given omission of folks who have not thought about it as much  Policies effects could be smaller than predicted COMMENTS/AREAS FOR IMMPROVEMENT

RRC, Slide 15 Most thorough research on SLE and Retirement Planning -Provides strong evidence that policies aimed at prolonging work life should consider expected longevity – not just actual -Comment: Consider ambiguous wealth effect in hypotheses formation -Comment: Consider sample selection regarding SLE responses Weaker impact on actual behavior – which is ultimately what matters - motivates further research on what drives differences in expected and actual retirement FINDINGS ARE POLICY RELEVANT