Health risks and insurance against work incapacity over the life-cycle
This paper proposes a structural life-cycle model to analyze the links between individuals' health, labor market participation, wealth accumulation, and early retirement. I rely on the framework of a dynamic programming discrete choice model which is estimated using data from the German Socio-Economic Panel Study. A sequential Expectation-Maximization algorithm is used to obtain good starting values for a subsequent full information maximum likelihood estimation. A policy analysis focuses on the early retirement option of the German statutory pension scheme which constitutes an insurance against work incapacity. I simulate scenarios where health shocks do or do not occur at different ages during the life-cycle for individuals with differing endowments at age 40. A comparison of expected consumption paths and net present values of expected life-cycle incomes between the scenarios sheds some light on health-related poverty risks and the magnitude of risks being uninsured by the German early retirement scheme. Furthermore, I investigate a counterfactual policy scenario where reductions on the pension benefits of early retirees are abolished for individuals who are in bad health.