Designing benefit rules for flexible retirement: actuarial fairness versus efficiency
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Diamond and Mirrlees (1978), considering disability retirement under conditions of asymmetric information, determined the socially optimal, incentive-compatible benefit-retirement age scheme that does not follow traditional actuarial fairness. Eso and Simonovits (2002) did the same for flexible old-age retirement. In the latter model, individuals (types) have private information about their expected life spans. The government's goal is to design a pension system (a function relating benefits to retirement age) that maximizes a social-welfare function and satisfies the social budget constraint and incentive compatibility constraints: a second-best redistributive solution. This paper replaces the social constraint by type-specific ones and determines the fair second-best solution. The fair solution is, however, frequently inefficient, because it is often Pareto-dominated by the redistributive one.
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