Thursday, April 26, 2012

Social Security Slated to Run Dry in 2033?

On Monday, Social Security Board of Trustees released its annual report on the financial health of the Social Security Trust Funds:
The combined assets of the Old-Age and Survivors Insurance, and Disability Insurance (OASDI) Trust Funds will be exhausted in 2033, three years sooner than projected last year.

The DI Trust Fund will be exhausted in 2016, two years earlier than last year’s estimate. The Trustees also project that OASDI program costs will exceed non-interest income in 2012 and will remain higher throughout the remainder of the 75-year period.

In the 2012 Annual Report to Congress, the Trustees announced:

  • The projected point at which the combined Trust Funds will be exhausted comes in 2033 – three years sooner than projected last year. At that time, there will be sufficient non-interest income coming in to pay about 75 percent of scheduled benefits.
  • The projected actuarial deficit over the 75-year long-range period is 2.67 percent of taxable payroll -- 0.44 percentage point larger than in last year’s report.
  • Over the 75-year period, the Trust Funds would require additional revenue equivalent to $8.6 trillion in present value dollars to pay all scheduled benefits.

“This year’s Trustees Report contains troubling, but not unexpected, projections about Social Security’s finances. It once again emphasizes that Congress needs to act to ensure the long-term solvency of this important program, and needs to act within four years to avoid automatic cuts to people receiving disability benefits,” said Michael J. Astrue, Commissioner of Social Security.

Other highlights of the Trustees Report include:

  • Income including interest to the combined OASDI Trust Funds amounted to $805 billion in 2011. ($564 billion in net contributions, $24 billion from taxation of benefits, $114 billion in interest, and $103 billion in reimbursements from the General Fund of the Treasury—almost exclusively resulting from the 2011 payroll tax legislation.)
  • Total expenditures from the combined OASDI Trust Funds amounted to $736 billion in 2011.
  • Non-interest income fell below program costs in 2010 for the first time since 1983. Program costs are projected to exceed non-interest income throughout the remainder of the 75-year period.
  • The assets of the combined OASDI Trust Funds increased by $69 billion in 2011 to a total of $2.7 trillion.
  • During 2011, an estimated 158 million people had earnings covered by Social Security and paid payroll taxes.
  • Social Security paid benefits of $725 billion in calendar year 2011. There were about 55 million beneficiaries at the end of the calendar year.
  • The cost of $6.4 billion to administer the program in 2011 was a very low 0.9 percent of total expenditures.
  • The combined Trust Fund assets earned interest at an effective annual rate of 4.4 percent in 2011.

The Board of Trustees is comprised of six members. Four serve by virtue of their positions with the federal government: Timothy F. Geithner, Secretary of the Treasury and Managing Trustee; Michael J. Astrue, Commissioner of Social Security; Kathleen Sebelius, Secretary of Health and Human Services; and Hilda L. Solis, Secretary of Labor. The two public trustees are Charles P. Blahous, III and Robert D. Reischauer.

Following the press release, a lot of misinformation was spread. Mark Miller of Reuters reports, Is Social Security really "exhausted?" Not at all:

It's rare to see a federal official publicly beg reporters to get a story right, but the commissioner of the Social Security Administration seemed ready to get down on his hands and knees at a Monday press briefing. Michael Astrue was cautioning journalists not to scare the public about the meaning of the word "exhaustion."

"Please, please remember that exhaustion is an actuarial term of art and it does not mean there will be no money left to pay any benefits" he warned in issuing the trustees' annual report on the financial health of the Social Security program.

"After 2033, even if Congress does nothing, there will still be sufficient assets (from payroll taxes) to pay about 75 percent of benefits. That's not acceptable, but it's still a fact that there will still be substantial assets there," Astrue insisted.

This year's report shows some acceleration of the drawdown of Social Security's vast trust fund reserves. Absent Congressional action, the trust funds of the retirement and disability programs are expected to be exhausted in 2033 as baby-boomer retirements accelerate - three years sooner than projected a year ago.

But Astrue went out of his way to emphasize that the program is far from broke. Social Security took in $69 billion more than it spent last year, according to the report, when you include tax receipts and interest on bonds held in the Social Security Trust Fund (SSTF). The SSTF had reserves of $2.7 trillion last year.

Yet the press plowed right ahead with stories warning that the Social Security retirement program is running out of money. "There won't be much money left for you" after 2033, warned a public radio reporter - a line that pretty well summed up the coverage and nearly forced me to run my car into a ditch.

Americans need to get this right, because Social Security is the primary source of retirement security for most Americans - and it will be even more important in the future as we continue to dig our way out of the rubble of the Great Recession.

So, what's really going on with Social Security?

1. Social Security isn't running out of money.

The long-range actuarial shortfall is projected to be 2.67 percent of taxable payroll - in other words, 2.67 percent of all the earnings subject to Social Security contributions. That's a modest shortfall - and it fluctuates over time due to economic cycles and changes in assumptions about growth in taxable earnings. For example, the projected year of SSTF exhaustion was as far off as 2042 in 2003 in the wake of the dot-com bubble; it was as close as 2029 in 1994 due to changed expectations about real wage gains.

2. Yes Virginia, there is a Trust Fund.

Social Security's critics love to argue that the SSTF is a myth, but it's not. Although Social Security was designed as a pay-as-you-go program, every penny it receives is credited to the SSTF, which has been building enormous reserves following benefit cuts enacted in 1983.

The Trustee report confirms - again - that the surplus funds are invested in "special issue Treasury bonds" and that they are "full faith and credit" obligations of the government to Social Security. Since Social Security can't borrow money by law, it uses those reserves to pay benefits whenever cash on hand runs short.

3. This year's news is not about our aging population.

The accelerated SSTF exhaustion date stems from two factors: a 1.6 percent drop in taxable earnings due to the ongoing depressed economy, and a 3.6 percent cost-of-living adjustment awarded for this year.

Our aging demographics do play a role in the longer range imbalance after 2033, because we have not raised revenue sufficient to match the projected growth in our retired population.

"The choice is to either reduce benefits 25 percent, or raise revenues 33 percent to adapt," says Steve Goss, chief actuary of the Social Security Administration. Making reforms sooner rather than later would allow for a more gradual phase-in, giving the public plenty of time to plan and adjust accordingly.

I'm in favor of a modest, graduated payroll tax increase. Social Security benefits are modest, averaging $1,230 per month this year. It's the main source of income for most people over age 65 - more than half for nearly one in two married couples and two in three unmarried individuals, according to the National Academy of Social Insurance.

A gradual increase in payroll taxes over the next decade would eliminate a sizable portion of the imbalance; another approach is to lift or remove entirely the cap on wages subject to payroll taxes, which currently is set at $110,100.

Perhaps that won't be too exhausting an idea for Congress and the media to embrace.

I think it makes perfect sense to entirely remove the cap on wages subject to payroll taxes but don't count on any reforms taking place in an election year.

What is most troubling is the irresponsible coverage from the media. A similar situation happened here in Canada last week when Jim Leech, President and CEO of the Ontario Teachers' Pension Plan, spoke in Hamilton.

Some pension analysts harped on the media coverage stating that Mr. Leech was offering a dose of reality, The Alliance for Retirement Income Adequacy (ARIA), produced a fact sheet dispelling myths surrounding Ontario Teachers' Pension Plan.

In fact, if you read his speech carefully, he didn't warn of any crisis. Quite the opposite, he explicitly stated: "Let me stress that Teachers’ is not in any short term financial crisis. We have over $117 billion in assets and can pay pensions for decades without any changes."

Jim Leech then went on to vigorously defend defined-benefit (DB) plans (added emphasis mine):
Let me return for a moment to the DB-DC debate and sound a word of caution: We must not allow “pension envy” to define that debate. There is a danger that this could happen, however, as the private sector increasingly moves toward Defined Contribution plans - and away from the Defined Benefit model - saying it is unaffordable.

The truth is that DB Plans are far better vehicles for pension saving. I know that this flies in the face of conventional wisdom, but it is true.

A report by the US National Institute on Retirement Security finds that there are four main reasons for this:
  • Individuals in a DC Plan must plan to live a long life – out to the maximum on the actuarial table, as you don’t want to run out of money part way through your retirement! Because individuals can’t pool longevity risk, like DB plans do, they’re forced to accumulate more in their DC plan than would be necessary to fund an equivalent DB plan, which can be based on actuarial averages.
  • Because DB plans are ageless, they can perpetually maintain an optimally balanced investment portfolio. Individuals, on the other hand, must downshift dramatically in order to lower their risk/return as they age. Transaction costs of such rebalancing are very high.
  • By pooling their savings in a DB Plan, the participants can afford to engage professional investment advisors – something that the average worker with a DC Plan or RRSP cannot afford. When I compare the returns I have realized in my own self-managed RRSP with those of Teachers’, I know I could use some expert advice.
  • DC Plans and RRSPs are usually invested in retail products that carry large administrative fees – sometimes as high as 2% per annum. Contrast that with the cost at Teachers’ of only 25 basis points. The extra 1.75% over a working lifetime is a huge cost - amounting to just under 40% of the total funds you could have for your retirement.
The social costs that the private sector’s shift to defined contribution plans will impose in the future have not been widely acknowledged. Members of such plans will likely retire with inadequate retirement incomes.

Their combined individual defined contribution shortfalls will likely dwarf any potential valuation shortfalls of defined benefit plans, possibly imposing obligations on future governments (read: taxpayers) for further retirement income assistance.

So, we as a society are in a pickle: Defined Benefit plans are being terminated and replaced by Defined Contribution plans which are inadequate.

But a wholesale shift from pure DC to pure DB is not a panacea, either.

It’s time to take a look at a hybrid model.

The recent market chaos should be a wake-up call to everyone – companies, governments and citizens – that our current pension system needs to be overhauled.
The recent market chaos should indeed be a wake-up call to policymakers that our current pension system needs to be overhauled. But politicians worried about being elected will put off any drastic reforms until some catastrophe strikes.

As for U.S. Social Security, it is on sound footing but it too needs reforms, including a possible shift away from the current model to investing in public and private equities much like the Canada Pension Plan. In fact, 10 years ago, Mark Sarney and Amy Prenata of Social Security wrote a paper on this topic. If Social Security does adopt a CPP model, it needs to also adopt their governance.

Bernard Dussault, Canada's former Chief Actuary, shared these comments with me:
I can hardly believe the optimistic views expressed on the OASDI such as "After 2033, even if Congress does nothing, there will still be sufficient assets (from payroll taxes) to pay about 75 percent of benefits. That's not acceptable, but it's still a fact that there will still be substantial assets there," Astrue insisted." Gee! Payroll taxes are not assets, they are income. And a 25% pay-as-you-go shortfall is no case for any complacency.

Because of that complacency, the OASDI was not reformed in the mid-1990s as was the CPP by accelerating the required increases in contribution rates so that the investment earnings on the resulting additional fund can help reducing the contribution rate. It is now too late to do that because the aging of the population has now reached a point where the OASDI contribution rate (12.4%) would need to be increased to more than the paygo contribtion that is now close to 18%.
Below, PBS News Hour's Ray Suarez, Nancy Altman of Social Security Works and the Heritage Foundation's David John discuss its long-term health of Social Security amid a retiring baby boomer population and a weakened economy. Transcript is available here.

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