SOCIAL SECURITY PROJECTIONS VS. POLITICAL PREDICTIONS—
AN ACTUARY’S VIEW

There’s a misapprehension abroad in the land. Politicians, media people, and other societal leaders are drawing unjustified conclusions from mathematical estimates. How? By ignoring the probabilistic nature of long-term forecasts and expressing 100 percent certitude that Social Security is doomed to fiscal collapse.

These alchemists transmute uncertain projections into hard and fast predictions. For example, in his article in the Wall Street Journal, Bob Kerrey says that in eight years, income from payroll taxes will (emphasis added) be insufficient to pay Social Security benefits owed at that time. Meanwhile, Treasury Secretary John Snow tells Congress that everyone needs to agree that the Social Security System is “headed for ruin.” George Bush, more folksy, but with hardly less hyperbole, says that Social Security will be “flat bust, bankrupt” in 40 years unless Congress acts now.

In the first place, the word “bankrupt” is a red herring. Under the system’s most used set of actuarial assumptions (the “intermediate” ones), benefits are still expected to be paid at 70 cents on the dollar after 2042, the year the Social Security Trust Fund is projected to “run dry”. Moreover, under the Congressional Budget Office’s assumptions, this becomes 78 cents on the dollar after the year 2052. And only eight years ago, 2030 was the projected run dry date.

Why all these contradictory claims about the Social Security Trust Fund’s solvency? It’s because small changes in assumptions can result in large changes in projected financial results. For example, under another set of assumptions (the “optimistic ones”) used by the system’s trustees, the projections indicate no solvency problems for 75 years. And looking retrospectively, this set of assumptions more accurately predicted the course of events over the last 10 to 15 years than did the intermediate ones, which are giving rise to all the concern.

Because nobody knows what the future holds, it’s necessary to make assumptions about what’s coming. Projections based upon these assumptions give a hazy, but useful, view of the future. For private-sector defined benefit pension plans, the principal assumptions are for mortality, investment return, and pay increases. For Social Security, actuaries need to look ahead 75 years and make many more assumptions concerning the economy and demographic trends—for example, rates of change in the labor force, productivity, inflation, immigration, fertility, disability and perhaps the most significant of all (because it influences many of the other assumptions), rates of growth in the Gross Domestic Product.

Many people mistakenly believe that Social Security’s long-term solvency problems arise because of an expected decline in the number of workers per beneficiary—from 3.3 currently to 2 or fewer in 75 years. What they don’t know is that this decline has been factored in to all the projections made since the early 1980s. So what’s giving rise to the reported looming Social Security insolvency? It’s the increasingly pessimistic economic assumptions adopted by the system’s trustees.

Spurred on by Bush’s recent comments about Social Security’s long-term crisis, many economists have argued that the intermediate economic assumptions picked by the system’s trustees are far too pessimistic and that it doesn’t make sense to assume that the economy will operate in the future at a much lower rate than in the past. So perhaps the Gross Domestic Product average increase assumption could justifiably be raised from its current level of about 2% per year. (Historically, GDP growth has averaged about 3.5% per year.) Estimates indicate that raising this assumption to only 2.6% would project System solvency for 75 years!

Another assumption worthy of discussion is the one that predicts future investment returns. In the private sector pension plan arena, it’s well known that an increase of only one percentage point in the investment return assumption makes a plan’s long-term costs appear to drop by about 25 percent! Perhaps it’s time to follow the lead of state and federal agency pension funds and invest a portion of the Social Security Trust Fund in the private sector’s bond and stock markets. Were this to be approved, new projections would be required using a higher investment return assumption— and some or all of the long-term Social Security deficit would simply go away.

Investing in private sector assets has other advantages: the System would benefit from higher investment earnings and Congress would be unable to use the funds for other purposes. Also, it would silence those critics who carp that the Social Security Trust Fund holds treasury IOUs rather than real treasury bonds—as if an IOU from the U.S. Treasury is somehow worth less than a treasury bond. Even more egregiously, our president has averred, “There is no trust fund”and has stated that individual accounts would “replace the empty promises of government with real assets.” Empty promises, my foot! Someone needs to explain to the president that Social Security benefits are statutory—as well as moral—obligations of the United States government. They result from what is, in effect, a powerful intergenerational contract, enforced by a strong political expectation created by the payroll tax.

In my view, all of the above considerations argue for a moratorium on the political debates now raging in the halls of Congress and in the media. (OK, call me overly optimistic.) Instead, we need a new debate about assumptions by leading independent economic, demographic and actuarial professionals. Also, we could benefit from a debate in Congress about the advisability of investing some of the Social Security Trust Fund in private-sector securities.

Whether or not these debates take place, reason dictates that we abjure this administration’s “sky is falling “ approach and discuss the pros and cons of any privatization scheme on its own merits. Indeed, the president’s aides have opened the door to separate discussion of privatization by admitting that the proposed system of individual accounts will do nothing to solve Social Security’s financial problems—a long term “net neutral effect” is the jargon du jour.

For reasons known best to themselves, a vocal minority of “privatizers” has been attacking the Social Security System for years. We should not let ourselves be overly influenced by the hucksters, the alchemists and the crisis-mongers. Better to heed the wisdom of former Social Security Commissioner Robert Ball who says, “We have to stop acting as if 75-year estimates are absolute…it would be foolish to make too much of 75-year prophecies.” Ball knows full well that the more assumptions an actuary makes, and the longer the time period for which he makes them, the more his financial projections will fall wide of the mark. And we need to always remember the equally sound advice of Yogi Berra: “It’s tough to make predictions, especially about the future.”

PHILIP J. FEUER
FELLOW OF THE SOCIETY OF ACTUARIES