Effect of Pensions and Disability Benefits on Retirement in the United Kingdom

This paper examines to what extent differences in employment rates across those in better and worse health in the UK can be explained by the availability of publicly-funded disability insurance and the financial incentives provided by other retirement income schemes. Using an option value approach, we find that individuals' labor force participation is affected by financial incentives. A one standard deviation change in the option value is estimated to reduce the likelihood of an individual leaving the labor market in the next year by between 2.7 and 3.1 percentage points, relative to an average exit probability of 9.4%. This suggests the variation in financial incentives across different individuals could explain a significant proportion of retirements. However, we find no evidence that individuals with different levels of health respond to our measure of financial incentives differently. We conclude that it would require a major change in disability insurance program stringency to generate an economically significant change in overall employment rates of older workers in the UK. The level of disability benefits they might receive is low relative to the amount they could earn and, therefore, large changes in rates of eligibility would not induce large changes in overall employment rates.