nottheaverageactuary

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Too Big to Fail – When State Benefit Schemes Become Insolvent

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Social Security is an insurance programme consisting of Old-Age (pension), Survivor and Disability (OASID) insurance. It was originally signed into law in 1935 by President Franklin Roosevelt as the Social Security Act and has subsequently undergone several amendments to include other social welfare programmes, nonetheless the core benefits remain OASID.

Social Security is funded by federal payroll taxes paid by employees and their employers. The taxes are collected by the Internal Revenue Service (IRS) and entrusted to the Federal Old-Age and Survivors Insurance (OASI) Trust Fund, the Federal Disability Insurance (DI) Trust Fund. The trusts are used as an internal accounting measure for the federal government and as the accumulated holdings of the Social Security programme.

The underlying assets which are purchased with the taxes are special issues federal government securities. Special issue in the sense that they are always redeemable at any time at par and they can be issued at any amount. The tax revenues exchanged for the federal government securities are deposited into the general fund of the U.S. Treasury and are indistinguishable from revenues in the general fund that come from other sources. This highlights the importance of the trusts as an accounting measure as the trust fund balance represents the amount of money owed by the general fund of the U.S. Treasury.

The structure of social security can be considered as a DB fund as the benefits are calculated according to a person’s lifetime earnings (formula can be found in https://www.ssa.gov/planners/benefitcalculators.html). Although Social Security is often viewed as a single programme, its financing comes from two legally distinct funds. As the law currently stands, the OASI and DI funds are legally distinct and do not have the authority to borrow from each other.

Members of Congress and the public have raised concerns over the solvency of the DI fund from which disability benefits are paid. Since 2005, total expenditures have exceeded non-interest income and as of 2009 they have surpassed total income (including interest). According to projections from the Congressional Research Service, the fund will be exhausted by the end of 2016.

This did not cause much concern in the past as Congress approved temporary cash infusions to increase reserves of depleted funds. This was used as a short term measure to give lawmakers time to develop and implement longer-term solutions. However, given the current political and economic state in which the U.S. finds itself, there is genuine concern that this option is no longer viable.

Given that the OASI fund will be solvent until 2036, congress could authorize interfund borrowing to cover the shortfall of the DI fund. However, this is also not a sustainable solution as this is projected to bring down the solvency of the OASI fund significantly. Another proposed short-term intervention is to change the tax allocation to bolster the DI fund, however this strategy will again undermine the solvency of the OASI fund.

The government could try to raise taxes and/or cut benefit payments. Both methods are very unpopular and given that this is an election year both parties are shying away from addressing that topic, given that people who receive benefits or are close to receiving benefits are a significant portion of the electorate. A couple of candidates have proposed raising taxes on the rich but according to the IRS, this will not make a significant difference and taxes will have to be raised on everybody to fund benefits.

The most likely scenario is that the DI fund will have to borrow the money to pay benefits. This again is very problematic given the current federal debt levels and economic growth projections (slow employment growth results in lower taxes collected). Even though the DI can borrow from the federal government itself, through the issue of special securities, future taxpayers will be responsible for both their own future benefits as well as the interest-accumulating debt on past collections. This fundamentally goes against the idea of fairness as future members are unduly burdened.

The whole Social Security structure has to go through radical reform to ensure its existence to current and future beneficiaries. Although the DI fund is the most at strain, all trusts of Social Security are projected to be depleted within the next generation of workers. This means that people starting their careers now and paying taxes will most likely not receive any benefits when they become eligible. Unlike a private benefit scheme where there are a number of avenues the scheme can go into to get rid of the liability, e.g. pay out the benefits in cash lump sums or buy insurance contracts for the individuals, this is not a simple task for Social Security due to funding levels, dependents’ benefits, intergenerational fairness issues and political constraints.

The question of what the proper role of government is in the U.S. has been fought for centuries since the inception of the country. Few other issues have divided the nation as much as Social Security. It has reached a point where the programme has become too big to fail with no possibility of a bail out. However this situation plays out, actuaries should always keep in mind the long term consequences of any programme/scheme and should advise governments appropriately. Keynes did say that in the long run we are all dead but future beneficiaries will most likely still be alive and they shouldn’t have to pay for the mistakes of the past-generations.

Sources:

History of retirement

http://www.nytimes.com/1999/03/21/jobs/the-history-of-retirement-from-early-man-to-aarp.html

Social Security Website

https://www.ssa.gov/oact/progdata/fundFAQ.html#&a0=2

Congressional Research Service Repoert.   Social Security: The Trust Funds

https://www.fas.org/sgp/crs/misc/RL33028.pdf

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