OASDI Financial Effects of the "Social Security Guarantee Plus Plan"


MEMORANDUM
Date:	December 13, 2001	Refer To:	TCA
To:	Representative Clay Shaw, Chairman Subcommittee on Social Security
From:	Stephen C. Goss, Chief Actuary Alice H. Wade, Deputy Chief Actuary
Subject:	OASDI Financial Effects of the "Social Security Guarantee Plus Plan"--INFORMATION

This memorandum provides long-range estimates of the financial effects on the Social Security (OASDI) program for enactment of the "Social Security Guarantee Plus Plan" as it has been described to us by Kim Hildred and Sophia Wright of your staff. This plan would provide for an annual contribution from the General Fund of the Treasury to Social Security Guarantee (SSG) Accounts equal to between 2 and 3 percent of each worker's OASDI taxable earnings beginning with earnings in 2002. Participation in the accounts would be voluntary. However, participation is assumed to be universal for estimates presented here because all participants would be guaranteed to receive total monthly payments that are at least as large as the Social Security benefit amount payable for a non-participant, plus a lump sum payment at initial benefit entitlement equal to 5 percent of the account balance at that time.

Proceeds from these accounts (less the 5-percent lump sum payment) would, commencing at the worker's retirement (or disability), be transferred to the OASDI trust funds on a gradual basis. Benefits paid by the OASDI program would be the higher of benefits scheduled under current law and the scheduled SSG withdrawal rate based on a CPI-indexed, unisex life-annuity calculation. The life-annuity calculation would be on a joint-and-survivor basis for married workers.

For workers who die before OASDI benefit entitlement, the SSG Account balance would go to the worker's estate, tax free. For workers who die after OASDI benefit entitlement and are survived by their current spouse, the SSG withdrawal rate is adjusted to reflect the survivor portion of the annuity calculation. For workers who die after OASDI benefit entitlement and were not married at death, the remaining SSG Account balance is transferred to the OASI trust fund.

If the projected financing of the OASDI program at some future date indicates a sustained surplus and a growing ratio of OASDI trust fund assets to net program cost, then the Managing Trustee would be required to make recommendations to the Congress indicating the extent to which the Trust Funds are expected to be able to finance part or all of the contributions to the SSG Accounts, in lieu of financing from the General Fund of the Treasury. The Congress would decide whether or not to act on such recommendations. The proposal would also include a number of specific changes in OASDI benefits, including the gradual elimination of the Social Security retirement earnings test for beneficiaries age 62 and older between 2002 and 2007.

Enactment of this proposal, as specified, would be expected to eliminate the estimated long-range OASDI actuarial deficit (1.86 percent of taxable payroll under present law) based on "intermediate" assumptions described below. Under these assumptions, revenue transferred from the SSG Accounts to the trust funds would be expected to be sufficient to allow a reduction in the combined OASDI payroll tax rate of 0.4 percentage point in 2035 (from 12.4 to 12.0 percent) and further reductions thereafter, reaching a level equal to the cost of SSG Account contributions by 2060. However, the financial status of the OASDI program would be very sensitive to the actual yields realized on SSG Accounts, particularly yields on equities (see sensitivity analysis below).

All estimates assume elimination of the OASDI retirement earnings test for ages 62 and older, gradually between 2002 and 2007. (This change has a very small effect on the long-range financial status of the OASDI program.) All estimates in this memorandum are based on the intermediate assumptions of the 2001 Trustees Report, except as indicated below.

The proposal would provide Social Security covered workers with refundable tax credits equivalent to 3 percent of their OASDI taxable earnings up to 21 percent of the OASDI taxable maximum amount, and 2 percent of taxable earnings above that level, starting with earnings for calendar year 2002. Credits would be increased with interest from July 1 of the year of taxable earnings, at the market yield provided for securities newly issued to the OASI and DI Trust Funds, until paid. Credits would be paid from the General Fund of the Treasury as soon as practicable in the following calendar year (expected to be by October 15 for wages and salaries and by December 1 for self-employment earnings) for the sole purpose of deposit in a SSG Account.

Accounts would be established as soon as is practicable. For the purpose of these estimates it is assumed that accounts would be established by the end of 2003. Delay to 2004 would not materially affect the results. Account balances would be collectively invested in qualified mutual funds, managed by certified account managers under contract with and regulation by the Social Security Guarantee (SSG) Board. The Board would consist of the six individuals with staggered 9-year appointments.

Individuals would be required to hold all SSG Account assets in a single fund and could change funds at most once per year. Annual SSGP credits would be pooled and transmitted to the mutual fund managers under regulations prescribed by the Treasury in consultation with the SSG Board. Account holders would receive annual notice of assets, investment performance, and administrative costs in their Social Security statements.

The proposal requires that all account balances be invested in qualified mutual funds maintained with a portfolio allocation of 60 percent stock index funds and 40 percent high-grade corporate bond index funds. The charge for annual administrative expenses would be limited to 25 basis points after the first 5 years of operation. Allowance for administrative expense approved by the Board in excess of 25 basis points would be made for the first 5 years (2003-7) and would be payable from the General Fund of the Treasury. Withdrawals prior to reaching retirement (or disability) would not be permitted.

Upon divorce before benefit entitlement from a marriage that lasted 1 year or longer, the amounts attributable to contributions during the marriage (including earnings on those contributions) in each spouse's SSG Account would be reallocated evenly between the SSG Accounts of the spouses.

Under the plan, workers would receive 5 percent of the account balance as a lump sum payment upon benefit entitlement. The remainder of the SSG Account balance for workers who become entitled to OASDI retirement or disability benefits would gradually be transferred to the OASDI trust funds. Upon entitlement for Social Security retirement or disability benefits, the Social Security Administration would compute the monthly payment that could be provided from a life annuity purchased with the holdings in the SSG Account remaining after the lump sum payment. The annuity calculation would reflect the anticipated yield on the SSG account (60 percent stock and 40 percent corporate bonds, less 25 basis points for administration) and indexing of annuity payments for price inflation (as for the Social Security COLA). The annuity calculation would also roughly reflect the expected payment of aged spouse and aged survivor benefits if the worker has a current spouse, by using a joint annuity with two-thirds of the base payment continuing for either spouse as a survivor.

If the computed monthly annuity amount exceeds the level of current law scheduled OASDI benefits, then the Social Security Administration would guarantee payment from the trust funds of the computed annuity amount for life. If the computed annuity amount is less than the level of the OASDI benefit, then the OASDI benefit would be payable for life. Each month after benefit entitlement the computed annuity amount based on entitlement of the worker and any aged spouse(s) would be transferred from the SSG Account to the OASDI trust funds.

Because the computed annuity amount is based on a life annuity calculation, the SSG Account would be expected to be depleted at the point where the beneficiary(ies) reach their life expectancy, as estimated at the time of benefit entitlement. Thus, for about half of the SSG Accounts, benefits will be payable after exhaustion of the SSG Account entirely at the expense of the OASDI trust funds. For the other half, death before life expectancy will leave remaining SSG balances that are transferred to the Trust Funds (to assist in the payment of benefits to those who live beyond life expectancy).

For married workers who die after becoming entitled to OASDI retirement or disability benefits, SSG Account withdrawals will continue to be paid to the OASI Trust Fund in the amount of the survivor portion of the annuity calculation. When an unmarried person dies after benefit entitlement, the remaining balance in the SSG Account is transferred to the OASI Trust Fund.

For workers who die before becoming entitled to OASDI retirement or disability benefits, the SSG Account balance is transferred to the estate of the deceased worker.

All yields on account balances would accumulate tax free. Annuitized distributions would be transferred to the Trust Funds to finance the payment of OASDI benefits that would be taxable as under current law. Lump sum distributions at benefit entitlement will be taxed as OASDI benefits. However, the percentage of the lump sum to be included as taxable will be equal to the percentage of OASDI monthly benefits for the year that are included in taxable income without including the lump sum payment in the calculation. Distributions of account balances to the estates of workers who die before benefit entitlement would not be taxable as benefits, nor would they be subject to estate tax.

Aged surviving spouses would have the ability to receive 75 percent of the benefit that the couple would have been receiving if both were still alive, if advantageous. The benefit under this option is limited to the benefit that would be payable to the survivor as a retired worker, reflecting the average PIA for all retired worker beneficiaries in the year prior to entitlement to the option, and subject to actuarial reduction as a retired worker (based on the survivor's age at earliest entitlement to a worker or aged spouse or surviving spouse benefit, but not before 62). This option is effective for all benefit entitlement for months beginning with December of the calendar year of enactment which are generally payable in the following month. Implementation of this provision alone would increase the size of the OASDI actuarial deficit by an amount estimated at 0.09 percent of taxable payroll.

For benefit entitlement for months beginning with December of the calendar year of enactment, allow disabled widows of any age to be eligible for disabled surviving spouse benefits. Remarriage before age 50 would terminate eligibility for the disabled surviving spouse benefit. Implementation of this provision alone would increase the size of the OASDI actuarial deficit by a negligible amount (i.e., less than 0.005 percent of taxable payroll).

For benefit entitlement for months beginning with December of the calendar year of enactment, eliminate the requirement for disabled widow(er) benefits that disability must occur no later than 7 years after the worker's death, or after surviving spouse with child-in-care benefits were payable. Implementation of this provision alone would increase the size of the OASDI actuarial deficit by a negligible amount (i.e., less than 0.005 percent of taxable payroll).

For benefit entitlement for months beginning with December of the calendar year of enactment, waive the two-year duration of divorce requirement for divorced spouse benefit recipients, in cases where the worker remarries someone other than the claimant before the two-year period has elapsed. Implementation of this provision alone would increase the size of the OASDI actuarial deficit by a negligible amount (i.e., less than 0.005 percent of taxable payroll).

For benefit entitlement for months beginning with December of the calendar year of enactment, provide child-care credits for up to 5 years during which the worker was living with and providing care to his/her own child (or spouse's child) under the age of 7. The child-care credit would raise reported earnings for a qualifying year up to 25 percent of the AIME that would have been determined if the worker had become entitled for disabled worker benefits in January of the qualifying year. Child-care credits would not be used to establish insured status not already earned by the worker through actual earnings in covered employment. Implementation of this provision alone would increase the size of the OASDI actuarial deficit by an amount estimated at 0.06 percent of taxable payroll.

The present-law GPO provision reduces OASDI auxiliary benefits for spouses and surviving spouses by two-thirds of any non-covered government pension that they receive. For benefit entitlement for months beginning with December of the calendar year of enactment, this provision would change this reduction to one-third of any non-covered government pension. Implementation of this provision alone would increase the size of the OASDI actuarial deficit by an amount estimated at 0.02 percent of taxable payroll.

The Social Security retirement earnings test annual exempt amounts would be raised according to a specified schedule through 2006, and the test would be eliminated starting 2007 for all beneficiaries age 62 or older. For beneficiaries under age 62, the current test would remain unchanged. The exempt amounts would be specified for the test applicable at ages 62 up to the year of attainment of NRA as $15,000, $20,000, $25,000, $30,000, and $35,000, for years 2002 through 2006, respectively. This provision alone would have a negligible effect, increasing the estimated size of the present law OASDI actuarial deficit by less than 0.005 percent of taxable payroll.

All workers with OASDI taxable earnings for 2002 and later are assumed to participate in the SSGP plan. By participating every worker would be guaranteed to receive more than if they did not participate on the basis of one or more of the following: a lump sum payment of 5 percent of the account balance is payable upon benefit entitlement, the entire account balance goes to the estate at death before benefit entitlement, and in some cases the annuity calculation will produce monthly payments that are greater than the OASDI benefit that would otherwise be payable.

SSG Account portfolios are required to be invested, both prior to retirement (or disability) benefit entitlement and after benefit entitlement in qualified SSG funds that must be maintained at 60 percent equity index funds and 40 percent in high-grade corporate bond index funds, with an annual administrative expense charge of 25 basis points.

The long-term ultimate average real yield on stock investments made in the future is assumed to be 6.5 percent, somewhat less than the 7-percent real yield that was assumed for the 1994-96 Advisory Council. This reduction in expected average yield is consistent with both (1) a growing consensus among economists that the market may value equities at somewhat higher average price-to-earnings ratios in the future based on broader access and a reduction in the perceived level of risk, and (2) the Trustees' increase in the assumed real yield on treasury bonds from the level assumed in 1995.

The ultimate real yield on long-term high-grade corporate bonds is assumed to average 3.5 percent, or 0.5 percentage point higher than the 3.0 percent real yield for U.S. Government long-term securities, as assumed for the 2001 Trustees Report. This spread between corporate and U.S. Government bond yields is consistent with the spread experienced over the past 40 or 70 years, on average. It should be noted, however, the spread has been much smaller over the past 20 years. The expected ultimate real portfolio yield for the base projection (alternative 1) would thus be 5.05 percent, net of administrative expense,

Due to the large degree of uncertainty associated with future returns on stock, sensitivity analysis provided below illustrates the effect of varying the yield on the SSG Account by plus and minus one percentage point. An illustration assuming that SSG Accounts achieve a yield no better than expected for government bonds is also included.

A range of administrative expense factors was assumed for individual accounts proposed by the 1994-96 Advisory Council on Social Security. For the Individual Account (IA) plan, individual contributions were assumed to be collected and recorded by central institution, invested in large blocks with financial institutions, and invested in a limited number of indexed funds. Based on experience of TIAA and the Federal Employee Thrift Savings Plan (TSP) it was assumed that the IA plan could be administered with an expense of 10.5 basis points per year. For the Personal Security Accounts (PSAs), individual accounts were assumed to be invested on an individual basis, resulting in an annual administrative expense of 100 basis points. Because the description of SSG individual accounts is far closer to the individual accounts for the IA plan than to the individual accounts for the PSA plan, the specified administrative-expense limitation of 25 basis points for SSG Accounts appears to be reasonable.

Upon the death of an individual who has not yet become entitled for OASDI benefits, the SSG Account goes to the estate of the deceased tax free. If an individual reaches normal retirement age and is not eligible for any OASI benefit, the SSG Account balance is payable to the individual. Upon benefit entitlement, the worker receives a lump sum payment of 5 percent of the SSG Account balance at entitlement. The balance of this section describes how the remainder of the account is distributed after benefit entitlement.

Life annuity calculations for the purpose of determining the size of monthly transfers from SSG balances to the OASDI trust funds assume a real yield equal to the net expected real yield on SSG Accounts, as specified. Mortality estimates for these calculations are based on the intermediate projections of the 2001 Trustees Report.

Annuity calculations at the time of future benefit entitlements are assumed to be made on a unisex basis for workers with no spouse at the time of benefit entitlement. For those with a spouse at entitlement, annuity calculations would be on a joint and survivor basis intended to roughly match the expected payment of OASDI benefits. For the purpose of these calculations, a joint and 2/3 survivor annuity is assumed. Thus, the amounts transferred to OASDI from the SSG Account of a married beneficiary would be reduced by 1/3 upon the death of either the worker or the spouse.

With the yields assumed for these estimates, expected transfers from SSG Accounts after benefit entitlement would generally be less than expected OASDI monthly benefits. However, single workers with very high earnings, close to or above the OASDI maximum taxable amount throughout their careers would have transfers from their SSG Accounts greater than current law benefits if the investment return during their working years exceeded the assumed long-range average return used for these estimates. High-earning married workers would be far less likely to have transfers that exceed current-law benefits because the joint-and-survivor annuity calculation would provide lower transfers than for single workers, and current law OASDI benefits for married workers would tend to be higher. Estimates for this proposal take into account the likely variability in account returns.

The combined effect of the seven additional changes to OASDI benefits listed above would reduce (worsen) of the OASDI actuarial balance by about 0.18 percent of taxable payroll, from a balance of -1.86 percent of payroll under current law to an actuarial balance of -2.04 percent of payroll.

However, the expected effects of the reduction in benefit payments that must be met from current payroll tax contributions as a result of the payments from the SSG Accounts to the Trust Funds, the overall financial status of the OASDI program would be improved greatly under this plan.

The balance of this section presents estimates for this plan under assumptions for expected future yield on SSG Accounts as well as sensitivity analysis for a range of possible variation in yields. The table below provides the estimated OASDI actuarial balance, the change in the actuarial balance for the SSGP Plan as described above.

Estimated Effects on OASDI Financial Status of the
Social Security Guarantee Plus (SSGP) Plan
	Estimated OASDI Actuarial Balance	Estimated Change in OASDI Actuarial Balance	Year Exhaust OASDI Trust Funds
	(percent of taxable payroll)
Present Law (No SSGP)	-1.86	--	2038
(1) SSGP Plan with Full Payroll Tax for OASDI
60% Stock, 40% Corp Bond Assess only 0.25% Admin Cost	+0.63	2.49	NA
(2)SSGP Plan With Potential Financing of SSG Contributions from Payroll Tax 1/
60% Stock, 40% Corp Bond Assess only 0.25% Admin Cost	+0.04	1.91	NA
1/ SSG contributions would be financed totally from the payroll tax starting 2060.
Based on intermediate assumptions of the 2001 Trustees Report and other assumptions described in the text.

Under the SSGP Plan with full payroll taxes retained for the OASDI program (Table 1), the OASDI actuarial balance would be improved by 2.49 percent of effective taxable payroll, from a balance of -1.86 percent under current law to a balance of 0.63 percent of payroll under the plan. The OASDI trust fund as a percent of annual OASDI outgo (the trust fund ratio) would be expected to remain positive throughout the long-range 75-year projection period, thus allowing timely payment of benefits in full through 2075, and beyond. The trust fund ratio would be expected to decline to about 147 percent at the beginning of 2043, and to increase thereafter, reaching over 950 percent by the end of 2075.

The table above also includes an illustration of the potential financial effect of the SSGP Plan on Social Security if the SSG contributions are partially financed from the payroll tax during the period 2035-2059 and fully financed from the payroll tax beginning 2060. The payroll tax that is redirected from directly financing OASDI to financing SSG contributions is expected to be 0.4 percentage point in 2035-2039 and to increase thereafter reaching about 2.47 percentage points (reflecting the entire 2-3 percent contribution rate) by 2060. Under this illustration, the OASDI actuarial balance would be improved by 1.91 percent of taxable payroll, from a balance of -1.86 percent under current law to a positive balance of 0.04 percent of payroll. The OASDI trust fund ratio would be expected to rise to about 1.6 times annual outgo by the end of the long-range period.

The effect of the SSGP Plan on the financial status of the OASDI program would depend greatly on the actual yield that is achieved for investments in the SSG Accounts. Returns on all investments are uncertain, and returns on stocks are particularly variable and uncertain over time. For this reason it is important to consider the sensitivity of the financial status of the OASDI program to possible variation in expected investment yield. Note that the 2001 Trustees Report provides this sensitivity analysis for the OASDI program under current law on pages 132 through 141.

The table below provides the estimated OASDI actuarial balance, the change in the actuarial balance, and the estimated year of combined OASDI trust fund exhaustion for the SSGP Plan with three different SSG Account yield assumptions in order to illustrate the sensitivity of the proposal to possible variation in the ultimate average returns on stock and corporate bonds.

Under sensitivity illustration 3, the average yield on SSG Accounts is assumed to be 1 percentage point higher than expected for the accounts invested in 60 percent stock and 40 percent corporate bonds. Under this illustration, the OASDI trust fund ratio would be expected to reach a low of about 220 percent at the beginning of 2038, and to increase substantially thereafter. OASDI would be substantially overfinanced and the SSG Account contributions could be paid entirely from the payroll tax rate as early as 2050.

Under sensitivity illustration 4, the average yield on SSG Accounts is assumed to be

1 percentage point lower than expected for the accounts invested in 60 percent stock and 40 percent corporate bonds. Under this illustration, the OASDI trust fund ratio would be expected to reach a low of only 18 percent around 2060, and would be expected to rise slowly thereafter, reaching about 37 percent by the end of the 75 year period. The OASDI actuarial balance would be improved by about 1.81 percent of taxable payroll under this assumption, leaving an actuarial deficit of only 0.06 percent of payroll.

Sensitivity Analysis: Effect of Variation in Expected SSG Account
Investment Yield Rates on OASDI Financial Status
	Estimated OASDI Actuarial Balance	Estimated Change in OASDI Actuarial Balance	Year Exhaust OASDI Trust Funds
	(percent of taxable payroll)
Present Law (No SSGP)	-1.86	--	2038
(3) SSGP Plan with 1% Higher Than Expected Yield 1/
6.05% average net yield	+1.47	3.34	NA
(4) SSGP Plan with 1% Lower Than Expected Yield
4.05% average net yield	-0.06	1.81	NA
(5) SSGP Plan with Yield Equal to Expected Yield on Government Bonds
2.75% average net yield	-0.68	1.18	2043
1/ No payroll tax rate reduction.
Based on intermediate assumptions of the 2001 Trustees Report and other assumptions described in the text.

Under sensitivity illustration 5, the average yield on SSG Accounts is assumed to be only 2.75 percent above price inflation (the rate for government bonds less 25 basis points for administrative expense). Under this illustration, the OASDI trust fund ratio would be expected to become exhausted in 2043, or 5 years later than projected to occur under current law. The OASDI actuarial balance would be improved by about 1.18 percent of taxable payroll under this assumption, leaving an actuarial deficit of 0.68 percent of payroll.

Annual Estimates of SSG Fund Operations and Estimated Effects on the Unified Budget Balance

Tables 1b and 2b, attached, provide estimates of aggregate SSG Account balances, total contributions to and transfers from SSG accounts, and rough estimates of the effects of the additional changes to OASDI program benefits.

A very rough estimate of the effects of the SSG Plan on the annual Federal unified budget balance for calendar years 2003 and later is also provided.

These estimates are based completely on the intermediate assumptions of the 2001 Trustees Report, including the trust-fund interest assumption, and thus are not consistent with projections made by CBO and OMB (which use different assumptions). However, differences in payroll and benefit estimates are not large during the first 10 projection years so these values can be viewed as very rough approximations of the magnitude of effects on the unified budget balances through this period.

Under the SSGP plan with the expected yield on the specified account portfolio, amounts transferred from the SSG Accounts to the OASDI trust funds would at first be small, but would exceed contributions to the SSG Accounts from the General Fund of the Treasury by about 2036. Including the relatively small effects of the elimination of the additional benefit changes, the estimated change in the unified budget "cash flow" (excluding interest effects) would also be negative until 2037.

Including the cumulative effects of interest, the year in which the effect of the SSGP plan on the unified budget annual balance would be expected to become permanently positive is 2060 if the full payroll tax is retained for OASDI (table 1b). If the SSG contributions are financed with payroll tax revenue, partially beginning in 2035, and fully in 2060 and later (table 2b), the effect on the unified budget is essentially the same as shown in table 1b, where the full payroll tax is retained for OASDI. This results because retaining the full payroll tax (12.4 percent) for OASDI has the essentially same effect on the unified budget as does redirecting a portion of the payroll tax to the General Fund of the Treasury for the purpose of financing SSG contributions.


Stephen C. Goss

Alice H. Wade