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.