|
Social
Security's finances are in fine shape
Remarks
by David Langer, Consulting Actuary
January
21, 1999
Congressional
conference to fight Social Security privatization
Rayburn
House Office Building, Washington, D.C.
For
many years the public has come to believe that Social Security
is faced with a severe financial problem. However, my analysis
of the data produced by the Social Security Administration (SSA)
actuaries during the past 20 years has led me to conclude that
the imputed financial problem arises from projections based
on faulty actuarial assumptions resulting from an apparent failure
of SSA's actuaries to observe published actuarial standards
of practice. The actuaries have relied almost exclusively on
macroeconomic speculation based on a dismal view of the future
economy. Their actuarial assumptions are thus overly conservative,
generate higher costs than warranted, and result in a large
imbalance of costs (benefits and expenses) over income for the
75 year measuring period equal to 2.19% of taxable payroll (1.1%
each for workers and employers). Using appropriate financial
projections would show Social Security to be in balance, with
income expected to adequately cover all payments due.
There is a great deal
at stake in a 2.19% deficiency. Consider that a leading argument
for privatization is that it will correct the financial trouble
facing Social Security and that cutting the benefit formula directly,
or by raising the retirement age, or both, also enlarges the Social
Security surplus and this enables additional federal spending
or a tax cut. (The accumulated surpluses, $800 billion, are expected
to rise to four trillion. No small potatoes.)
A social insurance
program such as Social Security does not require actuarial conservatism
as do insurers and private pension plans. One reasonably expects
that our federal government, as opposed to a private employer
or insurer, will continue indefinitely. Also, workers and employers
are required by law to participate and thus cannot opt out of
paying the Social Security payroll taxes.
The greater certainties
of the federal umbrella eliminate the need for conservative financial
projections. Assumptions that contain either a conservative or
liberal bias can, in fact, raise questions: the former may make
the program appear to be in poor shape when it isn't and require
fixing, while the latter may give the impression the program is
financially strong and benefits can therefore be raised when they
should not be.
But then how does
one go about developing suitable actuarial assumptions for the
SSA's actuaries annual projection of benefit costs and income
for up to 75 years? To assist actuaries in making the choice,
the Actuarial Standards Board of the American Academy of Actuaries
publishes guidelines called Actuarial Standards of Practice (ASP).
The relevant provisions governing Social Security are to be found
in ASP No. 32, which emphasizes that "the actuary should consider
the actual past experience of the social insurance program, over
both short- and long-term periods, also taking into account relevant
factors that may create material differences in future experience...If
assumptions differ from recent experience...the report should
discuss [the factors] that led to the choice of the assumptions
used."
We need to examine
the approach used by SSA's actuaries to see to what extent they
abided by these professional standards.
The Gross Domestic
Product (GDP) is the key economic assumption in estimating costs
and is an indicator of the economic health of the country. The
outlook for the GDP will also influence the level of four of the
six economic assumptions: the average wage, real wage differential,
unemployment rate, and increase in labor force.
First let's examine
to what extent the actuaries considered the actual experience
"over both short- and long-term periods." For this purpose, the
enclosed chart, GDP: actual 10 and 30 year averages,
compares the projected average Intermediate GDP factors used in
making the projection, for each report year, with the historical
average of the actual GDP values for both the ten year and thirty
year periods preceding such year. Note that the Intermediate projected
averages are well below the actual 30 year average values: the
mean shortfall is 37% less over the full twenty years of reports
and is 49% less in the last five years. The mean reduction from
the actual 10 year value is 22% less for the full twenty years
and drops to 40% for the last five years. Observe also that while
the most recent historical 10 year GDP average is 2.5% and the
30 year average is 2.8%, the Intermediate GDP factors average
but 1.5%, about one-half less, for the next 75 years.
There is thus little
apparent reliance on recent experience or longer term experience
as prescribed by ASP No. 32. We need therefore to look to the
Trustees' Annual Reports for the requisite discussion of why factors
were chosen that differ so greatly from historical experience.
However, one finds no statement acknowledging this marked departure
from prior experience. There is, instead, a rationale in terms
of the future. For example, "The intermediate set of assumptions
reflects the Trustees' consensus expectation of moderate economic
growth throughout the projection period." This explanation is
one of future expectations in terms of macroeconomics, and it
is therefore a venture onto a slippery slope, given the great
difficulty of making even short-term predictions and the degree
to which differences of opinion can be found even on those.
To sum up, SSA's actuaries
do not appear to have followed the provisions of ASP No. 32. They
gave little weight to actual economic history in developing actuarial
assumptions and did not explain this. They relied instead on macroeconomic
scenarios, assuming an economy operating at a much lower level
than over the past 70 years or more.
This suggests that,
not having any better stars to guide us, it is best to place a
greater degree of reliance on actual prior experience as set forth
in the Actuarial Standards of Practice. The extensive GDP data
available have the merit of being a blend of diverse phenomena,
including a depression, recessions, periods of prosperity, wars,
globalization, etc.
One suggested alternative
would be to use a combination of past history and the factors
derived from the future oriented method adopted by SSA's actuaries,
while giving appropriately greater weight to past history.
As an example, the
actual average GDP since 1930 is 3.2% and the projected average
GDP used by the actuaries in the Trustees' 1998 Annual Report
is 1.5% . If we weight the past 3.2% by 80% and the projected
1.5% by 20%, we get an average GDP factor of 2.9%. On the basis
of an approximation used by the SSA's actuaries, the increase
in the GDP from 1.5% to 2.9% would reduce the current 75 year
deficit of 2.19% by 1.48% to 0.71%. There is a further reduction
of 0.47% due to the recent 0.25% downward technical adjustment
in the CPI by the Bureau of Labor Statistics, which lowers the
0.71% deficit to 0.24%. This is deemed to be in long-range actuarial
balance, because it is smaller than the "minimum allowable balance"
of 0.78% (5% of the "summarized cost rate" of 15.64 for the 75
year period).
Further support for
this result, that the 75 year projection is now in actuarial balance,
can be found by noting that the Optimistic set of assumptions
generates a surplus position of 0.25% in comparison with
the 2.19% deficit for the Intermediate set. The 2.2% average GDP
factor for the Optimistic set is nearly 25% smaller than the 2.9%
developed in the preceding paragraph. Since most of the other
economic assumptions are related to the GDP, it is reasonable
to consider that the Optimistic set of assumptions is more appropriate
than the Intermediate one.
Conclusion. Using
assumptions that rely on historic experience, as called for by
the Actuarial Standards of Practice, leads to the conclusion there
is no looming imbalance in Social Security's financial position
and that the system is in fine shape. There is thus no need to
be agonizing over whether the program needs to be privatized to
save it, or to make substantial cuts in benefits, or to raise
the retirement age, or to raise the contribution level.
|
