Wealth-dependent versus uniform ceilings in public annuity plans

Abstract

As part of efforts to enhance old-age security, public annuities have been introduced to help retirees hedge against longevity risk. To prevent retirees from purchasing excessive amounts of annuities, two types of ceiling restrictions are implemented in these plans: wealth-dependent ceilings and uniform ceilings. However, the impact of these ceilings remains underexplored. To address this gap, we develop a simple model of public annuities in which adverse selection is the primary market imperfection. Our findings indicate that a wealth-dependent ceiling outperforms a uniform ceiling in providing a higher annuity payout, provided that the wealth-health correlation is sufficiently weak. However, this does not necessarily translate into greater welfare improvement. When the correlation is strong enough, the opposite holds true. Additionally, the effectiveness of a ceiling depends on whether it is set sufficiently high. Our study highlights the importance of considering the wealth-health correlation when designing public annuity plans with ceiling restrictions.