soa 2005 annual meeting - social security: what are the facts?

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SOCIAL SECURITY –WHAT ARE THE FACTS?

Moderator: Ian Duncan, FSA FIA FCIA MAAA, Solucia Inc.

Panelists: Thomas Saving, Ph.D., Texas A&M University;

Former Public Trustee of the Social Security and Medicare Programs

Steve Goss, ASA, MAAA, Chief Actuary, Social Security Administration

Society of Actuaries, Annual MeetingNew York, November 15, 2005

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Agenda

• Introduction: our speakers• Session format

SOA 2005 Annual Meeting - 90PD, Social Security: What are the Facts?

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Question 1

What is the early history of the Social Security System and attempts to change/reform it?

4

The Beginning

• 1935---Middle of the Depression

• A “National” Pension Plan is Born– 1937 Payroll tax

• 1% each Employee and Employer• On earnings to $3,000• No Change until 1950


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5

Benefits Start

• Until 1940, only return of contributions

• 1940– Retired worker, spouse, and widow benefits at age 65– Required work after 1936– Only 222,000 beneficiaries qualified– But 35 million workers contributed

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Contribution Rates Rise

• 1950 1.5% employee and employer each• 1954 2% each, on earnings to $3,600• 1960 3% each, on earnings to $4,800• 1966 3.85% each, on earnings to $6,600• 1969 4.2% each, on earnings to $7,800• 1974 4.95% each, earnings to $13,200• 1984 5.7% each, on earnings to $37,800• 1990 6.2% each, on earnings to $51,300


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7

As Benefits Expand

• 1956—Disability Benefits Added

• By 1975– Program is Mature– 31 million Beneficiaries– 100 million Workers Contribute– 3.2 Workers per Beneficiary

• Today– 3.3 Workers per Beneficiary– 48 million Beneficiaries– 159 million Workers Contribute

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Old-Age and Survivors Insurance Program “Matures” by 1975

Number of OASI Beneficiaries as a Percentage of the Population Aged 62 and Over

0%20%40%60%80%

100%

1940 1960 1980 2000 2020 2040 2060 2080


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9

Disability Insurance Program “Matures” by 1975

Number of DI Beneficiaries as a Percentage of the Population Aged 50 Through NRA

0%5%

10%15%20%

1940 1960 1980 2000 2020 2040 2060 2080

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And Changing Replacement Rates

Retiree Benefit at 65 as a Perecentage of Former Earnings Level

-

10

20

30

40

50

60

70

1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070

Year of Retirement at Age 65

Perc

ent

S c a l e d l o w

S c a l e d m e d i u m

S ca le d high e a rne r

S t e a d f y m a x i m u m e a rn e r


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11

Last 2 Major Changes

• 1977 Amendments– Benefit tables were out of control

• Double Indexing of Benefit levels– Created “Wage-Indexing” for Initial Benefits

• Constant replacement rates• 1983 Amendments

– Raise Retirement Age– Tax Benefits/Increase Coverage– Solvency expected for 75 years

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Question 2

What are the current projections for Social Security solvency?


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13

Projected Social Security Costsand Revenues (OASDI)

8

10

12

14

16

18

20

2000 2010 2020 2030 2040 2050 2060 2070 2080

Perc

ent o

f Tax

able

Pay

roll

Costs

Tax Revenues

Source: 2005 Trustees Report (OASDI), Table IV. B1.

2017

2041

Why Not Just Stay in the Current System?


8

15

Social Security Surpluses and Deficits 2005$

-1000

-800

-600

-400

-200

0

200

2000 2010 2020 2030 2040 2050 2060 2070 2080

Billi

ons o

f 200

5$

Source: 2005 Trustees Report (OASDI).

2027

200

355

Trust Fund Exhaustion Date

2041

The Pure Tax Solution:Erase the Actuarial Deficit:

What Does It Buy You?


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Closing the Social Security Actuarial Deficit: What Do We Gain?

8

10

12

14

16

18

20

2000 2010 2020 2030 2040 2050 2060 2070 2080

Perc

ent o

f Tax

able

Pay

roll

Costs

Tax Revenues

Source: 2005 Trustees Report (OASDI), Table IV. B1.

2017

20232041

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The Pure Tax SolutionSome Qualifications:

• Every dollar of surplus between now and 2030 must be invested in stocks and bonds, not in special issue Trust Fund bonds (special public-debt obligations).

• Every dollar of the special issue bonds currently in the Trust Fund must be redeemed and invested in stocks and bonds (representing ownership and claims on corporations).

• This implies that the Federal Government would control sizable voting interests in US corporations.


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Why not Continue to Invest the Surpluses in Special Issue Trust Fund

Bonds?

These [Trust Fund] balances are available to finance future benefit payments and other trust fund expenditures—but only in a bookkeeping sense. These funds are not set up to be pension funds, like the funds of private pension plans. They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures. The existence of large trust fund balances, therefore, does not, by itself, have any impact on the Government’s ability to pay benefits.

Analytical Perspectives, Budget of the United States Government, Fiscal Year 2000. p. 337.


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The Trust Fund is a bit like your left hand writing your right hand a billion dollar bond and then your right hand claiming that it is rich. Try taking that to the bank. Your banker is sure to ask, what’s in your left hand? Why, surprise, it’s a billion dollar liability!

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Social Security Budget Requirements and the Trust Fund Balance

-200

0

200

400

600

800

1000

2000 2010 2020 2030 2040 2050 2060 2070 2080Soci

al S

ecur

ity B

udge

t Req

uire

men

t Bill

ions

20

04$

-4-202468101214161820

Trus

t Fun

d in

Tri

llion

s 20

04$

Budget Transfer Requiredto Pay Scheduled Benefits

Trust Fund if 6%Real Interest is PaidCurrent Tax Rate

Trustees ProjectedTrust Fund

Current Tax Rate


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Question 3

What kinds of reforms are currently being considered?

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Without Change, Trust Funds Will Run Out and Benefits Will Be Reduced

OASDI Trust Fund Ratio(as percent of annual program cost)

0

100

200

300

400

500

600

1940 1960 1980 2000 2020 2040 2060 2080

High Cost

Low Cost

74% of scheduled benefits payable

68% of scheduled benefits payable


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We Have A Choice

1) Raise Scheduled Revenue2) Lower Scheduled Benefits3) Increase Retirement Age

• Must do at least one• Enacting Change Relatively Soon

More advance noticeGradual changeMore options

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The Next Changes• Fix for the next 75 Years• Make Financing Stable at the End

– Get cost and income in sync– Get Trust Funds stable or rising– Restore Solvency for foreseeable future

• By end of 75 years: Need--– One third lower cost or– Increase revenue by half or– Some combination of these


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Some Options

• Retirement Age• Benefit Formula• Cost-of-Living Adjustment

• Payroll Tax Rate• Taxable Maximum• Cover State and Local Government employees

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Individual Accounts

• Could contribute to solvency– If financed from General Revenue– AND have benefit offset or clawback

• But will not help solvency if “carveout”– Even assuming there is a benefit offset


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Anatomy of the Carveout IA

• 1) Specify a portion of the OASI payroll tax to transfer to individual accounts

• 2) Specify a benefit offset mechanism that will eventually pay back a portion of the contributions

• 3) Provide general revenue transfers to offset the expenditures in early decades when little benefit offset is realized

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Variability of IA OutcomeStochastic Distribution of Expected Net Average Real Yield on Portfolios of

Equities and Treas Bonds Over a Full Career Accumulation for a Scaled Worker with a Constant % Contribution

-4

-2

0

2

4

6

8

10

12

14

16

0 10 20 30 40 50 60 70 80 90 100

Percentile

All Stock65 / 3550 / 5035 / 65All T-Bonds


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A Reform Consistent with The President’s Outline

• All individuals currently 55 years and older stay in the old system.• Participation is voluntary, at any time workers can “opt in” by making a

one-time election to enter the new system.• Beginning in 2009 individual participants under age 59, will be allowed

to invest 4 percentage points of their Social Security taxes in private accounts up to $1,000 per year

• The $1,000 cap on contributions will grow $100 per year, plus growth in average wages.

• Benefits will be subject to progressive price indexation, low income benefits will be fully wage indexed while high income benefits will be fully price indexed.

• At retirement the annuity value of private accounts offset the defined benefit payments at the realized real rate of return on Government Bonds.

• The total retirement benefit is not guaranteed.

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Whose benefits are not affected by the This Reform Plan?

• Individuals born in 1950 and earlier receive Social Security benefits as they are currently scheduled.

• Low income workers receive the Social Security benefits as they are currently scheduled plus the net value of their Personal Retirement Account annuity.


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33

Total Retirement Benefits Under a Plan Consistent with the President’s Outline

As a percent of Scheduled Benefits

115.8

111.0

101.4

Very Low Income

114.4

110.8

100.4

Low Income

High Income

Medium IncomeBirth Year

108.1

106.3

96.8

100.62000

96.41980

92.51960

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Composition of Reformed Benefitsfor Workers born in 1980 and 2000 by Lifetime Earnings Group

0

20

40

60

80

100

120

140

PRA AnnuityDefined Benefit

1980 2000 1980 2000 1980 2000 1980 2000

very low low medium high

30.0% 35.7%40.5% 48.7%

57.5% 71.6%61.9%

88.1%


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Annual Revenues and Costs of OASI with and without Reform

0

2

4

6

8

10

12

14

16

18

2005 2015 2025 2035 2045 2055 2065 2075

Calendar Year

as a

per

cent

of p

ayro

ll

Status Quo Cost

Status Quo Income

Source: 2005 Trustees Report and author’s estimates.

Reform Costs After Benefit Offset

Reform Income

2055

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Diamond-Orszag Plan Compared to Status Quo (OASDI)

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10

12

14

16

18

20

2000 2010 2020 2030 2040 2050 2060 2070 2080

Perc

ent o

f Tax

able

Pay

roll

Status Quo Costs

Status Quo Tax Revenues

Source: 2004 Trustees Report (OASDI), Table IV. B1. and Office of the Actuary Social Security AdministrationOctober 6, 2003 Solvency Memorandum.

Diamond-OrszagCosts

Diamond-OrszagTax Revenues2018

2020


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The Bottom Line

• Fundamental reform with prepayment can revitalize Social Security while reducing government debt.

• Over the short term, reform is not free.• Over the long term, reform reduces taxes and

restores Social Security to a sound fiscal position. • Reform will eventually benefit recipients and workers

alike by bestowing real ownership of pension benefits.

• Even if we succeed with Social Security reform, the even larger Medicare debt will remain.

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Another Bottom Line (Steve)

• This Plan Specification is Not Complete• Progressive Indexing (affecting disabled)

– 1.43% improvement in 1.92% 75-year deficit– 4.62% improvement in 5.70% 2079 deficit– But President suggests don’t affect disabled

• Net effect of Individual Accounts and Offset– Worsen 75-year actuarial deficit– Help 2079 annual deficit

• Bottom Line– Need at least significant “transition investment”


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Question 4

What are the implications of Social Security financing for Public Finances?

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The Hard Facts of Transfer Systems

– The Debt Owed Current Generations

– Must be Paid by New Generations


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41

Social Security Debt

13.7

0.9

-15

-10

-5

0

5

10

15Tr

illio

ns (2

005$

)

What We Owe All Current Participants The Contribution of Future Participants

Source: Table IV.B7, 2005 Trustees Report

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Social Security (OASDI) Surpluses and Deficits as a Percentage of Federal Income Tax Revenues

-10

-5

0

5

10

15

20

25

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

Perc

enta

ge

4.55%4.0%

2017

2022

2027


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Question 5

What is the rate of return on my Social Security contributions?

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Internal Real Rates of Return—2-Earner CouplesYear Both Both BothAttain Low Medium MediumAge 65 Earners Earners Earners

Scheduled Benefits and Taxes2014 3.46% 2.39% 1.73%2050 3.49 2.45 1.82

Scheduled Benefits and Increased Taxes2014 3.46% 2.39% 1.73%2050 3.38 2.33 1.67

Reduced Benefits and Scheduled Taxes2014 3.44% 2.37% 1.70%2050 2.49 1.43 0.78

Source: SSA Actuarial Note 2004.5 Tables 4, 5, 6


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Question 6

Is it possible to move to a funded Social Security system?

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Possibilities

• Invest in the Trust Funds– Can this be done?

• Invest in Individual Accounts– How much difference would this make on total

national saving and investment?


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Some Fundamentals of Reform with Individual Accounts

• Who participates in the reformed system?• Where do IA Contributions come from?• Are participants compensated for accrued benefits?• How does the benefit structure compare to current

Social Security?• Are there any guarantees, and if so, what do they

cost?• How much of the current Social Security debt does

the reform pay off?• How much additional General Revenue is needed?

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Are we in a PAYGO world?

• Can we really effect additional advance funding through either Trust Fund or IA investments?

• To increase saving, we need to have someone decrease consumption, at least in the near term

• Is it worth while to increase the rate of return on Social Security if it is simply at the expense of returns elsewhere in the economy?

• Or can we really create a climate with more saving and less spending?


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49

Stock Market Peaks and TroughsAnnual Rates of Return on 35-year Portfolios

0

2

4

6

8

10

12

09/29-07/32 03/37-04/42 02/66/05/70 01/73-12/74 08/87-11/87 01/00-07/02

Peaks - Troughs

PeakTrough

Peaks and troughs as defined by E.S. Browning (WSJ, 08/05/02) based on Dow Jones Industrial Average

9.28

2.61

7.31

3.06

10.48

8.1

9.22

5.77

6.64

4.88

9.74

7.35


soa 2005 annual meeting - social security: what are the facts?

Documents

scheduled

benefit offset

trust fund

social security

low income

scheduled

2005 trustees

individual