SOCIAL SECURITY

| MEMORANDUM |
|------------|
| Date:      | January 31, 2002 | Refer To:    | TCA |
| To:        | Daniel Patrick Moynihan and Richard D. ParsonsCo-Chairs, President's Commission to Strengthen Social Security |
| From:      | Stephen C. Goss, Chief ActuaryAlice H. Wade, Deputy Chief Actuary |
| Subject:   | Estimates of Financial Effects for Three Models Developed by thePresident's Commission to Strengthen Social Security |

In the report, titled **Strengthening Social Security and Creating Personal Wealth for All Americans** and initially released on December 21, 2001, the President's Commission to Strengthen Social Security (PCSSS) presented three models for modifying the current Social Security program. Each of these models would include provisions for voluntary personal accounts and associated offsets to Social Security retirement benefits based on the earnings of workers who elect to have personal accounts.

This memorandum provides a description of the three models, as we understand them, and estimates of the expected effects of these models on selected aggregate and individual financial measures. The aggregate measures include the financial operations of the combined Trust Funds of the Old-Age and Survivors Insurance (OASI) and the Disability Insurance (DI) programs, aggregate flows and accumulations for personal accounts, effects on annual Federal unified budget balances, and cash flows from the General Fund of the Treasury to the OASDI Trust Funds. The individual measures include expected future total personal account accumulations and expected total benefit levels at retirement, under a range of assumptions. The terms, personal accounts and individual accounts, are used interchangeably in this memorandum.

All estimates are based on the intermediate assumptions of the 2001 OASDI Trustees Report, with additional assumptions related to returns on private securities, individual account and annuity administrative expenses, and individual account participation rates. These assumptions are described later in the memorandum. Estimates shown in this memorandum reflect the efforts of many individuals in the Office of the Chief Actuary, but particularly those of Jason Schultz, Michael Clingman, Michael Miller, Chris Chaplain, and Seung An.

I. Model 1 Specifications: 2-Percent Personal Account with Benefit Offset

a. Basic Provisions--Modification of OASDI Benefits

Under Model 1, OASDI benefit provisions would be unchanged from the specifications of current law. Thus, benefit levels specified in law for those who do not participate in the personal account option would be the same as under current law. However, based on the intermediate assumptions of the 2001 OASDI Trustees Report, OASDI Trust Funds and cash revenue would be insufficient to pay specified benefits through the next 75 years. Thus, under Model 1, as for current law, future modifications of revenue sources and/or benefit provisions would be needed to bring the program into long-range solvency.

b. Individual Accounts and Benefit Offset

Under this model, a voluntary option is provided starting in 2004 for workers covered under the OASDI program to have an amount equal to 2 percent of their OASDI taxable earnings deposited annually in a personal account. This option would be limited to workers who have not yet attained age 55 at the beginning of 2002.

Account contributions would be collected using the existing structure for collecting OASDI payroll tax contributions. In addition, account contributions would be managed by a central authority in a manner similar to that of the Federal Employee Thrift Savings Plan. Initially, available investment choices would be limited to a first tier of options that would include several broad index funds (equity, government bonds, and corporate and other bonds) plus several balanced funds. After several years, the board of the central authority would expand the options to include a second tier for individuals who had accumulated some threshold amount in their account. The second tier, still managed centrally, would offer a range of funds provided by approved private investment firms. The worker would select an investment firm and the funds offered by that firm. For both tiers, the central authority would maintain individual account records and would combine account transactions in aggregate amounts when dealing with the private investment firms.

For workers who participate in the individual account option, retirement and aged survivor benefits payable based on their earnings will be reduced according to a hypothetical account accumulation and annuity computation using a specified "offset yield rate". The offset yield rate for this plan is intended to be (or to average) 3.5 percent over price inflation. In practice, the offset yield rate could be computed as either (a) 3.5 percent above the realized or expected CPI inflation rate or (b) 0.5 percent above the realized or expected market yield on long-term Treasury bonds for each year.

The hypothetical account accumulation at retirement would be equal to the worker's personal account contributions accumulated using the specified offset yield rate for each past year. The retirement (and aged survivor) benefit offset would be equal to the computed amount of a CPI-indexed life annuity purchased with this hypothetical accumulation, and based on the expected future mortality, inflation, and real interest rates used for the intermediate assumptions of the most recent OASDI Trustees Report. Offset annuities would be based on expected unisex mortality for workers who are not married at retirement. Joint and 2/3 survivor life annuities would be computed for workers who are married at retirement, reflecting the actual ages of each spouse.

c. Financing of Individual Account Contributions

Model 1 is described as a *flexible framework* in which the personal account contributions might be financed entirely as a "redirect" of OASI payroll tax revenue, entirely from the General Fund of the Treasury, or with some combination of the two. Any portion of the contributions based on wages that is financed as a redirect from payroll tax revenue is assumed to be divided equally between employee and employer payroll taxes. Three variations on Model 1 are provided in the financial estimates in this memorandum all of which have a 2-percent total personal account contribution. These are "Model 1 (2+0)" with financing of account contributions entirely from OASI payroll tax revenue, "Model 1 (1+1)" with half (1-percentage-point) of the financing from payroll taxes and the rest from general revenue, and "Model 1 (0+2)" with financing entirely from general revenue.

d. Account Distributions and Taxation

Estimates provided in this memorandum assume that individuals would not have access to personal account accumulations prior to retirement. Allowing such access would diminish the account balance at retirement and thus the available retirement income thereafter. For death before retirement, account balances would be transferred to the account of the surviving spouse, if any, and otherwise to the worker's estate.

Upon entitlement to OASI benefits as a retired worker, aged spouse, or aged surviving spouse, the worker would have access to the account accumulation. Disabled workers would have access to their accounts when they convert to become retired worker beneficiaries. The benefit estimates in this memorandum assume that all account balances would be used to purchase life annuities at retirement. It is assumed that married workers would purchase joint and 2/3 survivor annuities. To the extent that lump-sum distributions are allowed under the model, monthly retirement annuity income would be diminished.

Personal account and annuity distributions would be treated like OASDI benefits for personal income tax purposes.

II. Model 2 Specifications: CPI Indexed OASDI Benefits and 4% (up to $1,000)       Personal Account with Benefit Offset

Model 2 includes three basic provisions, an optional personal account with benefit offset, and a provision for additional transfers from the General Fund of the Treasury to the Trust Funds as needed.

a. Basic Provisions--Modification of OASDI Benefits 

1) *CPI-Indexed Benefits*: Modify the primary insurance amount (PIA) formula factors (90, 32, and 15) starting in 2009, reducing them successively by the measured real wage growth in the second prior year. Modified PIA factors would be applicable for OASDI beneficiaries becoming eligible for benefits in 2009 and later. This provision would result in increasing benefit levels for individuals with equivalent lifetime earnings across generations (relative to the average wage level) at the rate of price growth (increase in the CPI), rather than at the rate of growth in the average wage level as in current law. Calculation of the average indexed monthly earnings (AIME) used in computing the PIA would be unaffected by this provision. This provision alone would increase the size of the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 2.07 percent of taxable payroll.

2) *Enhanced Benefit Level for Low Earners*: This provision would gradually raise the PIA starting 2009 with an ultimate increase for 2018 and later of 40.4 percent (relative to the level provided under provision 1 above) for a 30-year minimum wage worker.1 The combined effect of provisions 1 and 2 for such workers is expected to be a PIA equal to 120 percent of the aged poverty level for 2018. Thereafter the PIA would be indexed by the CPI as specified in provision 1, which is the same rate of growth specified for the poverty level.

The provision would provide the same 40.4 percent increase for 30-year workers with average earnings below that of the 30-year minimum wage worker. This 40.4 percent increase would be reduced for workers with higher career-average earnings levels (AIME), reaching 0 for those with AIMEs at twice the level of a 35-year minimum wage worker. For workers with more than 30 years of work, the percentage increase is maintained at the same level as specified for workers with the same AIME level and only 30 years of work. However, the percentage increase is reduced for workers with fewer than 30 years of work, reaching 0 for those with 20 or fewer years of work. Thus, no enhancement is provided by this provision for retirees with 20 or fewer years of employment. The year-of-work requirements would be "scaled" to the length of the elapsed period from age 22 to benefit eligibility for workers who become disabled or die before reaching age 62.2 The incremental effect of this provision after provision 1 would be to reduce the size of the long-range OASDI actuarial balance by an estimated 0.13 percent of taxable payroll.

The table below illustrates the effect of the benefit enhancement for workers with low earnings.

 

| Number ofYears ofWork | Quarters ofCoverage(QCs) | **Average Earnings Level in Years Worked (2002 wage levels)** |
|-----------------------|--------------------------|---------------------------------------------------------------|
||
||
||
| 10                    | 40                       | 0                                                             | 0 | 0 | 0 | 0 | 0 | 0 |
| 15                    | 60                       | 0                                                             | 0 | 0 | 0 | 0 | 0 | 0 |
| 20                    | 80                       | 0                                                             | 0 | 0 | 0 | 0 | 0 | 0 |
| 25                    | 100                      | 20                                                            | 20 | 18 | 10 | 0 | 0 | 0 |
| 30                    | 120                      | 40                                                            | 40 | 28 | 10 | 0 | 0 | 0 |
| 35                    | 140                      | 40                                                            | 35 | 21 | 0 | 0 | 0 | 0 |
| 40                    | 160                      | 40                                                            | 35 | 21 | 0 | 0 | 0 | 0 |
| 1Ultimate increase is phased in over 10 years, 2009-18. For workers with a given AIME, the increase is the same for 30 or more years of work. Increase reduced to 0 for 20 years of work or less. Based on intermediate assumptions of the 2001 Trustees Report.Based on intermediate assumptions of the 2001 Trustees Report. |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

*The benefit enhancement under this provision would be computed according to the following formula*:

For all workers whose AIME is less than twice the AIME for a 35-year minimum wage worker, the PIA is multiplied by

1 + applicable percentage x AIME factor x coverage factor.

In the above formula,

"Applicable percentage" is equal to 4.04 percent for beneficiaries initially eligible in 2009, 8.08 percent for those initially eligible in 2010, ..., and 40.4 percent for those initially eligible in 2018 and later;

"AIME factor" is equal to

| {                    | 1                     | if AIME < M |
|----------------------|-----------------------|----------------|
| (A - AIME) / (A - M) | if M < AIME < A |