1957-59 Advisory Council
1957-59 Advisory Council
MANAGEMENT
AND INVESTMENT OF FEDERAL OLD-AGE AND SURVIVORS INSURANCE AND DISABILITY
INSURANCE TRUST FUNDS Questions with Regard
to Management and Investment of the Trust Funds for which the Subcommittee
on Investment Policy of the Advisory Council on Social Security Financing
has Requested Answers 9. What changes in law
or practice would be required to give the Secretaries of Labor and HEW
a more constructive role than they now have in the administration of social
security trust funds?
1. In what respects does the handling of the Trust Funds differ from the practices of managers of private pension funds? What are the reasons for these differences? The handling of the investments for the Old-Age and Disability Insurance Funds differs from the practices of managers of private pension funds mainly by reason of the fact that the Managing Trustee of the Funds is limited by law to investments in United States securities or in securities guaranteed as to principal and interest by the United States. Usually there are no such limitations affecting the managers of private pension funds, although various State laws place some degree of protection and control over the operations of the private funds. In general, there are two types of private pension plans: (1) trusteed plans, usually administered as far as investments are concerned, by trust departments of commercial banks, and (2 ) insured plans, administered by life insurance companies. Most private pension plans are of the insured type although the trusteed plans probably involve the greatest amount of money. In the case of the trusteed plans the trusts are usually segregated from the other funds managed by the trustee. Generally, each pension trust stands on its own, enjoying the benefits of investment success and bearing the consequences of investment adversity. The pension funds are not subject to specific statutory regulation, but are subject to the rules governing investment by a fiduciary, although the grantor, by provision in the trust agreement, can exempt the trust from the operation of the statute and give the trustee broad latitude in the investment of trust assets. It is customary for the trustee to have considerable discretion. Trustees generally have placed great emphasis on Government obligations and high-grade corporate bonds, although in recent years there has been an increasing acquisition of common stocks. Under the Internal Revenue Code the investment earnings of a qualified "stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries" are not subject to Federal income taxes. Under an insured pension plan the moneys are placed with an insurance company and pooled with other income and invested, giving the plan the advantages of the company's diversified investments. Life insurance company investments are controlled by State laws, both as to type of investment and proportion of holdings. In particular, the proportion of their funds which can be invested in common stocks is limited, being prohibited altogether in some States. Investment income of life insurance companies is subject to Federal income taxes at a special tax rate. Insurance companies rely for their investment income mainly on real estate mortgages, corporate securities, income-producing real estate, State and local obligations, and Federal Government obligations. Fundamentally the very nature of trust funds under the management and control of the Federal Government prohibits their handling in the same manner as private trust funds. This is amplified in the answer to question No. 2. 2. What would be the advantages and disadvantages of permitting the investment of the assets of Trust Funds in private stocks and bonds, mortgages, obligations of State and local governments or Federal obligations not guaranteed as to principal and interest? Obviously if all or part of the assets of the Trust Funds were invested in such securities as corporate bonds and mortgages or in common stocks, the only readily apparent advantage would be the potential to increase the Funds' earnings. On the other side of the picture there would appear to be overriding disadvantages. By no means should the whole criteria be based upon the level of prospective earnings. Safety of principal, along with stability of income should be paramount objectives and were, no doubt, leading considerations followed by the Congress in limiting the Funds' investments to obligations of the United States or obligations guaranteed as to principal and Interest by the United States. Aside from the question of safety of principal, there are other important considerations. To go into the corporate bond market and the stock market on a regular basis involving a large volume of purchases (and at times a large volume of liquidations) would have a tremendous impact on these markets. Undoubtedly, there would be major effects on prices and yields. There would arise many questions including a basic question as to the propriety and wisdom of Government ownership of securities and equities of private industries, and the consequent influence of the Federal Government in the operation of industries. In recent times there has developed a practice whereby the strongest issuers of corporate securities have sold them by direct placement with insurance companies and other large investors. If investments were to be made for the Trust Funds in this manner there would undoubtedly arise questions as to propriety of direct dealings. The administration of such an investment program without danger of political influence or other undesirable developments would be a serious problem. There would be required a tremendous amount of portfolio management. A large staff would be necessary to make continuous reviews of financial conditions and prospects of companies whose securities would be held. The purchase of mortgages would carry with it the problems and costs of servicing them. Investments in obligations of State and local governments would result in acquisition of tax-exempt securities, with correspondingly lower yields, for Funds that have no tax liabilities and no need for tax-exempt income. There exists authority for a number of Government trust funds to invest in non-guaranteed obligations of certain Federal agencies. For example, the law provides the following with regard to obligations of the Federal National Mortgage Association, which are not guaranteed by the United States: 12 U.S.C. 1723c, "All obligations issued by the Association shall be lawful investments, and may be accepted as security for all fiduciary, trust and public funds, the investment or deposit of which shall be under the authority and control of the United States or any officer or officers thereof." The above authority, contained in the Act approved August 21, 1954, applied to the Old-Age Trust Fund until the Social Security Amendments of 1956. Those Amendments included the re-enactment of the provision limiting the Fund's investments to United States securities, or securities guaranteed by the United States. This latter provision takes precedence over the earlier law. The Treasury would have no objection to amendment to the Social Security Act that would make non-guaranteed obligations of Federal agencies eligible as investments for the Funds. 3. Could the interest earnings of the Funds be significantly increased by investing the entire Fund or the major part of it in marketable Federal Government issues? Whether the interest earnings would be increased by investing the entire Funds or the major part of them in marketable public debt obligations would depend upon such factors as (1) the level of yields in the market at the time the investments were made; (2) the effects on market yields of such a large volume of purchases; and (3) the distribution of market acquisitions between short, medium, and long-term. Presently yields in the market range from about 1% on 91-day Treasury bills to about 3-1/4% on long-term Treasury bonds. Generally the yields are the lowest for the short maturities and highest for the long maturities, although there are exceptions here and there. For example, the 3-1/2% bonds of February, 1990 are selling to yield 3.27%, on a bid basis, while the 3% bonds of February, 1995 are yielding 3.12% {1} In the maturity area of 1974 through 1995 there are only four issues outstanding, aggregating only $6.7 billion. The prices of these issues would be very quickly pushed upward, and the yields diminished by a relatively small buying demand; a sizeable demand would affect them greatly. Market purchases for trust funds in any substantial volume would require the Treasury to replace special issues by new market borrowing. To the extent these new maturities were in the same areas as acquisitions by the Trust Funds their issuance would restore some balance to prices and yields in those areas, although there might be considerable fluctuation between the time of the Trust Fund purchases and the new issues. A large volume of Trust Fund purchases, say in the long-term area, might not necessarily be replaced by new long-term issues as the Treasury would then have to consider existing economic conditions and the availability of long-term money. In the past there have been periods when it was not deemed advisable to issue long-term debt. For example, following the Victory Loan in December, 1945, and up until April, 1953, there were no offerings of long-term marketable securities. If all, or a substantial portion, of the Trust Funds were invested in market issues, a large part of the portfolio would have to be in short and medium-term issues to provide necessary liquidity. On the basis of present market yields the Funds would not necessarily obtain a better average return than on their present holdings, which is 2.55%. Another consideration is the probability that the average uninvested balances would be larger than at present because there would be delays involved in completing large market orders in order to avoid disruptive influences on the market. The Treasury has followed the practice of acquiring public issues for the Trust Funds from time to time, by purchases in the market and by allotments at original issue. On March 31, 1958, the Old-Age and Disability Insurance Trust Funds held $22,121,513,250 of public debt obligations, of which $3,114,279,250, or 14%, represented public issues. Special issues amounted to $19,007,234,000, or 86%. The average coupon interest rate on the public issues is 2.84%. Currently the interest rate on the special issues is 2-1/2%. In weighing the best interests of the Government and of the Trust Funds the Treasury has had a consistent policy of investing the greater part of trust fund accumulations in special issues. With regard to providing such issues for investment of the Adjusted Service Certificate Fund, the following was included in a statement by Secretary of the Treasury Mellon on January 2, 1925: "This method of handling the adjusted service certificate fund has the following advantages: 1. The securities exactly fit the actuarial requirements which are by law made the basis for fixing the appropriations for the fund. 2. The bond market is not disturbed by a purchase of a very large block of securities early in January and by a subsequent continuous pressure for the sale of securities to provide cash for the fund throughout the year, the effect of which would be buying on a high market and selling on a low market. 3. Commissions to brokers on the purchase and sale of Government securities are saved. 4. It is not necessary to borrow on December 15 (the usual financing day nearest January 1) additional cash and carry this cash, with a consequent loss of interest, until it can be invested in Government securities on the market after the first of the year when the appropriation becomes available. 5. Cash demands of the fund can be immediately satisfied by the redemption by the Treasury of the special certificates of indebtedness and the whole plan has great flexibility. 6. When the adjusted service certificates mature about 1944, the Treasury will be in position to do the necessary financing to meet the conditions then existing, without being compelled to sell a lot of miscellaneous Government securities perhaps unsuited to the market and to the Treasury's program. The Annual Report of the Secretary of the Treasury for the fiscal year 1940 contained the following: "The practice of issuing special obligations to Government trust funds, instead of permitting them to satisfy their investment requirements through open market purchases of Government obligations, has been followed because of certain important advantages that have become apparent. Among these have been the following: (1) The bond market is not disturbed periodically by purchases and sales of large blocks of securities; (2) the trust funds are provided with a ready avenue of investment and no attention need be given to short-term fluctuations in market prices; (3) in the case of retirement and social security funds, the funds can always earn the interest return specified by Congress when it fixed the appropriations for the funds; and (4) savings can be effected because of the smaller number of securities to administer, and commissions to brokers on purchases and sales are eliminated." The Treasury believes that the advantages of special obligations for Trust Funds, as they appeared in 1925 and 1940, are still valid today. {1} Yields are based on closing quotations of April 8, 1958. 4. How much would the interest earnings be increased if the income were invested more frequently than three times a month? Would this entail any other changes and what would be the cost of such changes in existing procedures? Special obligations are issued to the Funds generally three times each month and are dated approximately the first, fifteenth and twenty-fifth of the month, coincident with the formal bookkeeping transfers from the general fund to the trust funds of the social security taxes. On the last day of each month, based upon information from the Social Security Administration as to the amounts needed, special issues are redeemed in order to provide disbursing funds for benefit payments and administrative expenses for the succeeding month. Benefit checks bear issue dates of the third day of each month and are placed in the mail a day or two earlier. These redemptions at the end of each month have the effect of keeping the Funds more fully invested than would be the case if current receipts were held uninvested and accumulated for this purpose. Tests have been made to determine the advantage to the Old-Age Trust Fund of more frequent investments, covering the quarter ended December 31, 1957, the most recently completed quarter, and the quarter ended June 30, 1957, the largest quarter during calendar year 1957 from the standpoint of volume of receipts. During those two quarters combined there was an average daily uninvested balance in the Trust Fund of about $60 million. At the current interest rate on the special issues of 2-1/2% the Fund would receive additional interest earnings of about $1.5 million on an annual basis if this uninvested balance was fully invested. From a practical standpoint, if it were decided to keep the Fund more fully invested, the effect of daily investments could be obtained by average dating of the special issues. On this basis the additional administrative cost would be very low. In attempting to measure the question of equity to the Trust Fund, although it may appear reasonable at the outset to keep the Fund more fully invested, there may be some offsetting considerations. It is obvious that the Congress has not provided for precision in determining either the receipts or the out-payments of the Fund. The estimated receipts appropriated to the Fund are adjusted, as provided by law, on the basis of reports of wage records -- not on the basis of a determination of actual taxes paid to the Treasury. The Fund, therefore, does not suffer penalty by reason of delinquent and uncollectible taxes, aggregating substantial amounts. On the other side of this the Fund does not get the benefit of relatively small amounts of fines and penalties connected with social security taxes. The Fund is required to reimburse the general fund for refunds of taxes, currently about $72 million per year. The transfer out of the Trust Fund to take care of these refunds is based upon wages subject to refund as reported from the records of the Social Security Administration, and is reimbursed to the account for refunding Internal Revenue collections. Because the actual refunds have been made by the Treasury in cash, or taken by taxpayers as credits against current taxes, an average of several months before the Trust Fund is charged for the refunds, the Fund gains an interest-earning advantage thereby. No provision has been made for charging certain costs to the Fund. For example, the Fund does not bear the cost of audit by the General Accounting Office. Although rental of space occupied by offices of the Bureau of Old-Age and Survivors Insurance and by other activities that benefit the Trust Fund is paid out of the Trust Fund, the value of such space in Federally owned buildings is not charged against the Fund. By no means are these factors set down for the purpose of arguing that the law should be changed to provide absolute equity for the Trust Fund. On the other hand, the Treasury feels that they are considerations which must be given some weight in arriving at decisions affecting the investment operations of the Trust Funds. 5. What are the advantages and disadvantages of retaining the option of purchase of marketable Federal Government issues by the Trust Funds? Obligations may be acquired by the Trust funds on original issue at par, or by purchase in the market. The law authorizes the issuance of public-debt obligations (special issues) for acquisition by the Funds, and specifies that special obligations shall be issued to the Funds only if the Managing Trustee determines that the purchase of other eligible securities is not in the public interest. Marketable public issues acquired by the Funds may be sold at any time at their market price. In handling the operations of the Trust Funds the general policy of the Treasury Department has been to make investments which in its determination appear to be in the best interest of the Funds and of the United States Government. In most cases when market obligations have been obtained this policy has resulted in acquiring securities on the basis of maximum yields available in the market at time of purchase, and in all instances the yields have exceeded the interest rates that were currently obtainable on special issues. Marketable securities are disposed of in the market only at such times as disposal will produce an investment advantage for the Funds. There are advantages to both the Trust Funds and the Treasury growing out of the authority to invest in marketable obligations. Reasonable amounts of marketable issues acquired from time to time for the Funds have enabled them to increase their earnings. From the standpoint of the Treasury, purchases in the market have at times operated in the direction of a minor stabilizing influence on the Government securities market, although as brought out in the answer to question No. 8 it would require a tremendous volume of market purchases to provide any real support in an abnormal or weak market. The only apparent disadvantage to retaining the option of purchasing marketable issues by the Trust Funds would be the possibility at some future time of building up too large a proportion of marketable investments at the expense of proper liquidity. This would not be appropriate or proper trust fund management and it is not believed it presents a real disadvantage.
Alternative (4), based upon the average
coupon rate on all outstanding public issues, would be similar to the
formula existing between 1939 and 1956, except that it would eliminate
special issues from the computation. The rates on a number of the special
issues bear only a remote relationship to the general interest rate
pattern. For example, the Railroad Retirement Account special issues
have a statutory rate of 3%, while those for Veterans' Life Insurance
Funds are based upon interest rates specified by Congress in establishing
the actuarial basis of the Funds -- 3% in the case of the National Service
Life Insurance Fund (World War II) and 3-1/2% for Government Life Insurance
Fund (World War I). 7. What would be the advantages and disadvantages of crediting interest on special issues more frequently than semi-annually? Paying interest on special issues to the Trust Funds more frequently than semi-annually, say quarterly, would result in small additional earnings for the Funds with a minor amount of additional work in the Treasury. However, the Treasury would not favor a change from the present basis. Interest on all marketable and non-marketable public debt obligations (except 91-day Treasury bills) is paid on a semi-annual basis. Interest on most of the special issues held by the various Government trust funds and investment accounts is paid semi-annually, although in a few cases it is paid annually. It is not believed there would be any justification for deviating from normal and usual practices in paying interest on investments of the Old-Age and Disability Insurance Trust Funds. If this practice should be adopted for these Funds, then in all fairness it should be adopted for special issues held by all other trust funds. This would involve an increase of approximately $5,000,000 in the interest cost to the Treasury on special issues on the basis of present amounts of special issues outstanding and present interest rates. 8. How might the Trust Funds be used for stabilization purposes? What would be the consequences for the Funds? The Treasury does not feel that it is properly within its province to attempt general stabilization of the Government securities market through the use of social security or other trust funds. For one thing the Treasury would be limited by the available cash that could be used for market purchases. Frequent trips to the market to replenish this cash, along with normal borrowing needs, would tend to keep the securities market constantly unsettled. To the extent it became necessary to accomplish this expanded market borrowing through selling an increased volume of securities to banks, inflationary effects would be produced, thus complicating the task of the Federal Reserve System in carrying out its responsibilities for controlling the supply of credit. It is believed that the Congress intended for trust fund investments to be managed in a reasonably normal manner, primarily in the interest of the Trust Funds rather than to support the Government securities market. It is not possible to forecast the consequences for the Funds if they should be used vigorously for purposes of market stabilization. 9. What changes in law or practice would be required to give the Secretaries of Labor and HEW a more constructive role than they now have in the administration of social security trust funds? In establishing a Board of Trustees the law prescribes its duties as follows: It shall be the duty of the Board of Trustees to -- (1) Hold the Trust Funds; (2) Report to the Congress not later than the first day of March of each year on the operation and status of the Trust Funds during the preceding fiscal year and on their expected operation and status during the next ensuing five fiscal years; (3) Report immediately to the Congress whenever the Board of Trustees is of the opinion that during the ensuing five fiscal years either of the Trust Funds will exceed three times the highest annual expenditures from such Trust Fund anticipated during that five-fiscal year period, and whenever the Board of Trustees is of the opinion that the amount of either of the Trust Funds is unduly small; and (4) Recommend improvements in administrative procedures and policies designed to effectuate the proper coordination of the old-age and survivors insurance and Federal-State unemployment compensation program." The law gives the Managing Trustee certain duties and directions, most significantly the responsibility "to invest such portion of the Trust Funds as is not, in his judgment, required to meet current withdrawals". An important responsibility of the Board relates to the annual report to the Congress on the operation and status of the Trust Funds. The members of the Board share this responsibility, with the Department of Health, Education and Welfare customarily handling the greater portion of the work in preparing the reports, including the drafting. On infrequent occasions the Board has met and there would be nothing to prevent more frequent meetings if desired by its members. It goes without saying that any member has the right to criticize or to make suggestions regarding any of the operations or procedures. The Managing Trustee clears matters of major importance with the other members of the Board. As an example, the 1956 Amendments provide that special obligations shall have maturities fixed with due regard for the needs of the Trust Funds. The Treasury felt that this required a change in the long-standing practice of issuing special one-year obligations maturing on June 30 of each year. Accordingly, there was suggested to the members of the Board a proposal to reinvest the special securities so that maturity dates would be spaced approximately equally over one to twenty years. The Secretary of HEW expressed his feeling that this would not work to the advantage of the Trust Funds as the assets would be "frozen" in obligations with maturities ranging up to twenty years at the then current interest rate being paid on marketable debt not due or callable in five years, which rate was relatively low compared to the market rates on the same securities. He agreed that the changes proposed by the Treasury carried out the intent of the 1956 Amendments, but asked whether the Treasury could modify its proposal to avoid the immediate impact on the Funds investments in special issues. Accordingly, the Treasury reconsidered its proposal and adopted a procedure that is designed to gradually spread the maturities over one to fifteen years. The Treasury feels that the Secretaries of Labor and HEW already have a constructive role in the administration of social security trust funds. It is believed that it would be unwieldy and inefficient to divide the duties of the Managing Trustee. day-to-day investment operations would be difficult to carry out, and delays in taking action would result if it were necessary to clear with individuals outside the Treasury. Because the interests of the Treasury and the interests of the Funds are so interwoven it is felt that the designation in the law of the Secretary of the Treasury as Managing Trustee is sound and desirable. It is not believed that it would be any more appropriate to divide the duties of the Managing Trustee than it would be to divide the duties of the Secretary of Health, Education and Welfare in the operation of the Social Security Administration. Purchases and Sales in Market and Allotments on Original Issue at Par for Government Trust Funds and Investment Accounts **
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||