The Effect of Health on Consumption Decisions in Later Life

1. The Effect of Health on Consumption Decisions in Later Life Eleni Karagiannaki Centre for Analysis of Social Exclusion, LSE Presentation prepared for the WPA Seminar series, London 10th December 2008

2. Motivation This project is motivated by a theoretical puzzle and by a pressing social need. The theoretical puzzle: • In contrast to the main prediction of the lifecycle model most empirical studies document falling consumption with age and no significant wealth decumulation. Various explanations have been put forward and the one we examine here is the role of ill health: consumption may be constrained by illness or disability, or individuals may reduce consumption in anticipation of future healthcare or long-term care costs. The social need: • The onset of ill health and impairment is one of the most significant risks faced by older people, and yet we know very little about its impact on expenditure patterns and possible needs for financial support

3. Mechanisms by which health may affect consumption in later life Mechanisms leading to higher consumption • Current health related costs • Subjective life expectancy Mechanisms leading to lower consumption • Constraints on opportunity to spend • Anticipated future health-related costs

4. Literature on the effects of health on wealth Literature on the links between health and wealth. Example of such studies include Smith (1999, 2003), Wu (2004), Hurd and Kapteyn (2001), Adams et al. (2002) All studies find a significant negative effect of health shocks on wealth among younger older people but much smaller effects for the oldest old Evidence on the pathways through which the effect operate remain unclear

5. Literature on the effects of health on consumption Literature on the links between health and consumption is more limited and mainly focuses on people of working age. Examples of such studies include, Stephens, 2001; Getler and Gruber, 2002. Most results indicate that households are not fully insured against illness onset.

6. Objectives The central objective of the research is to study the effects of changes in health on the consumption behaviour of older people in Britain The five questions that we address are: • Are poor health and/or poor physical functioning associated with higher (or lower) consumption in retirement? • How does the composition of consumption differ between those with and without poor health and/or poor physical functioning? • Is deterioration in health and/or the onset of impairment associated with an increase (or decrease) in consumption? • How does the composition of consumption change following deterioration in health and/or the onset of impairment? • To what extent does the evidence allow us to distinguish between the possible mechanisms

7. Data and empirical strategy Data BHPS waves 1-14 ELSA waves 1 and 2 Sample selection criteria We focus on a sample of retired people in order to abstract from the potential labour supply effects

8. Data and empirical strategy cont… • We use three different health indicators: • Poor health: Dichotomous variable indicating poor health based on respondents’ self-reported health status • ADL: Dichotomous variable indicating limitations in performing ADL and IADL • MJHC: Dichotomous variable indicating major health conditions (i.e. conditions relating to cardiovascular and respiratory)

9. Data and empirical strategy cont… Each of these indicators is hypothesised to affect consumption patterns differently. • ADL – higher non-medical needs – more constraints on spending • MJHC – higher subjective mortality expecations

10. Data and empirical strategy cont... Spending categories in BHPS: • Food in the house, • Food out of the house (from wave 7onwards) , • Leisure (from wave 7onwards) and • Heating and electricity Spending categories in ELSA: • Food in (waves 1 and 2), • Food out (waves 1 and 2), • Leisure (wave 2) • Transfers (wave 2) • Clothing (wave 2) • Heating & electricity (only wave 2)

11. Data and empirical strategy cont... Additional indicators Perceptions about financial hardship (BHPS) Monthly saving (BHPS) Net total wealth (ELSA)

12. First Part: Descriptive analysis • Age health profiles • Age health transition profiles • Age profile in income, wealth, savings and in perceptions about financial hardship by health status • Age profiles in total spending by health • Age profiles in various spending components by health status • Age profiles in income/consumption by health status transition

13. Age health profiles

14. Age health transition profiles

15. Income profiles by health status

16. Wealth profiles by health status

17. Age savings profiles by health status

18. Age profile of perceptions about financial hardship by health status

19. Age spending profiles by health

20. Spending patterns: ELSA

21. Spending Patterns: BHPS

22. Income and consumption at baseline by health transitions

23. Spending patterns at baseline by health transitions

24. Savings and financial hardship at baseline by health transitions

25. Summary of results from the descriptive analysis • Health worsens with age in terms of all health indicators • The income health gradient is strong at younger ages but gets less pronounced with age. • The health wealth gradient is much stronger than that of income at all ages. • The fact that income health gradient gets less pronounced with age reflects the effect of differential mortality, and the universal deterioration of health with age • Perceptions about financial hardship are strongly associated with health. • The probability of being in financial hardship diminish with age. • Differences in the perceptions about financial hardship between people in poor and good health are eliminated at older ages for couples but remain strong for single people

26. Summary of results from the descriptive analysis cont… • Mean expenditures are lower for people with poorer self-reported health status both overall and within each spending category • Food out, leisure, clothing and transfers are the spending categories for which we observe the largest differences while spending for food consumed at the house, and heating and electricity are the spending categories with the smaller differences

27. Multivariate analysis The basic model for estimating the health effect on consumption involves estimating the following reduced-form consumption functions: Cit=β0 + β1hit + γXit + λZit+εit i indexes households and t indexes waves of the surveys. Cit is log household spending (total and for each consumption component) hi is health (measured by SRHS, ADL and MJHC measures) Zit is other household characteristics The empirical analysis proceed in four stages • STAGE 1: OLS models (does not take into account the effect of unobserved heterogeneity in driving health and consumption correlations) • STAGE 2: OLS models controlling for initial health conditions. In that way we are partially able to control for differences in initial unobservable characteristics (including differences in lifetime resources of people with different health at baseline) • STAGE 3: Fixed effect model (takes into account the effect of unobserved heterogeneity)

28. OLS estimates: BHPS

29. OLS estimates: ELSA

30. OLS estimates: Regular savings

31. Fixed effect estimates: BHPS

32. The probability of being financially worse off and health change

33. Summary of results: OLS models • OLS estimates suggest that poor health is associated with decreased spending on some discretionary spending categories, such as leisure, food out, clothing and transfers • A negative effect on these consumption items is also identified based on the ADL measure • The fact that ADL is associated with lower spending on these items gives support for the potential constraining effect of ill health on consumption • A positive effect is identified on heating and electricity spending - a result that provides support for the hypothesis that illness onset is associated with increased costs

34. Summary of results: Fixed effect models • Controlling for household fixed effects has a significant impact on all estimates. • Most estimates get smaller in magnitude and many turn insignificant. • Deteriorating health and the onset of limitations in activities of daily living is associated with decreased expenditure in some discretionary spending categories, such as leisure and food out, • Deteriorating health is also found to be associated with an increase in heating and electricity spending.

35. Summary of results: Fixed effect models cont… The additional questions on perceptions of financial situation allowed us to confirm that there was a perception of increased costs among people with deteriorating health and those experiencing the onset of limitations in ADL The effect on savings and total wealth is insignificant which confirms that the effect of health changes 0othe composition of consumption operates through a reallocation of spending across the various spending categories This reallocation of expenditure is consistent with changing priorities through increased needs and decreasing marginal utility of some types of consumption