Inconsistent Economic Assumptions Used by Social Security Actuaries Favored Privatization Proposals

N E W S R E L E A S E Academy agrees assumptions were inconsistent

by David Langer, Actuary, 100 West 57th Street, Suite 2K New York, NY 10019
Tel: 212-986-2942 
[email protected] www.davidlanger.com

The American Academy of Actuaries has acknowledged that inconsistent assumptions about the economic future have been used by the Social Security Administration’s actuaries and others in making financial projections for proposals to privatize Social Security. In an issue paper released on August 12, the Academy noted the effect is that “The advantages touted for a particular reform plan may be the result more of the assumptions used by its supporters than of the actual provisions of the proposal.”

The Academy’s paper is a momentous one, because the factors used by the Social Security actuaries in their projections to compare the national social insurance program with the privatization proposals heavily favored the latter. For example, the average gross domestic product used for the 75 year financial projections for Social Security was a mere 1.5%, while the range underlying those for the privatization proposals was 3.5% to 5%, enabling the use for the latter of an investment yield on equities of 7%.

The importance of this inconsistency is that if the same 3.5% to 5% GDP range had been used by the actuaries for the 75 year cost projections they prepared for the Social Security trustees’ Annual Reports, then the more than 2% deficit they calculated would have vanished. In other words, there would not be the so-called financial problem that has been used by the privatization groups to blacken the eye of Social Security. Conversely, if the privatization proposals were based on the same 1.5% GDP as for Social Security, then the yield on equities would likely be under 5%, and the projected privatized benefits would be far less attractive when compared to those arising from Social Security and thus much less deserving of attention as viable alternatives.

As a result of the Academy’s issue paper, interesting decisions now confront all those who have been involved in the process of making financial projections. For instance, the 13 members of the Social Security Advisory Council, 1994-1996, could conceivably request a redoing of its report issued in January 1997, which put forward two privatization proposals for serious consideration by the public. The decision to put them forward had been made by the council’s Chairman, Edward Gramlich, over the objections of Howard Young, an actuary and then chairman of the Advisory Council’s Technical Panel on Assumptions and Methods, who asserted that his panel had not been given the opportunity to evaluate the privatization proposals.

Moreover, what will be the reaction of the members of Congress who have submitted legislative proposals based on the tainted projections of the Social Security actuaries? They could conceivably ask for a rerun of the projections, or simply drop their proposals.

Finally, the SSA actuaries and the trustees now need to resolve the inconsistent use of the GDP insofar as the Annual Reports prepared by the Social Security trustees are concerned. The reports do not, of course, make use of a stock market yield — the trust fund is legally required to invest solely in Treasury bonds; however, if the decision is made by the trustees not to raise the current average GDP up from the projected 75 year average of 1.5%, then the actuaries will be constrained under the Academy’s issue paper to lower the yield used to evaluate future privatization proposals to probably less than 5%, which, as we have seen, will dampen interest in them. On the other hand, if the actuaries and trustees go to an average GDP of around 3%, then the projected 75 year deficit will cease to exist, and the trustees may then wish to issue an addendum to their 1999 annual report letting the public know that Social Security has no financial problem, which will be most welcome news.

Some observers believe the issue paper is the Academy’s response to my earlier assertions that there have been three violations of the Academy’s professional standards, of which inconsistent assumptions was one. A second has now become reasonably certain: the nondisclosure of the input of the OASDI trustees on actuarial matters. The third, the failure to take prior actuarial experience into account in setting assumptions, may be the result of the trustees’s non-actuarial input.