SOCIAL SECURITY

| MEMORANDUM |
|------------|
| Date:      | August 24, 2001 | Refer To:    | TCC |
| To:        | Representative Jim KolbeRepresentative Charles Stenholm |
| From:      | Stephen C. Goss, Chief ActuaryAlice H. Wade, Deputy Chief Actuary |
| Subject:   | Estimated Long-Range OASDI Financial Effects of the **21st Century Retirement Act** -- **INFORMATION** |

This memorandum provides long-range estimates of the financial status of the OASDI program assuming enactment of the **21****st****Century Retirement Act (H.R. 2771, introduced on August 2, 2001**) with modifications noted below. The principal staff contacts are Jen Olsen from Representatives Kolbe's staff and Ed Lorenzen from Representatives Stenholm's staff. The comprehensive proposal described in **H.R. 2771** (with modifications) would:

Modify the computation of OASDI benefit levels in several ways,

Transfer specified amounts from the General Fund of the Treasury to the OASDI Trust Funds,

Credit all revenue from taxation of OASDI benefits (including disbursements from individual accounts) to the OASDI Trust Funds,

Change the indexing of the benefit and contribution base, and

Establish individual accounts for workers who are under age 55 in 2003 by redirecting a portion of their payroll tax. 

The estimates provided in this memorandum (below and in table 1) reflect the intent of the legislation as stated by Representative Kolbe's and Representative Stenholm's staff. All estimates are based on the intermediate assumptions of the 2001 Trustees Report plus additional assumptions described below.

The stated intent of several provisions differs from the language of **H.R. 2771**, as initially introduced. These discrepancies are indicated in table 2. It is anticipated that technical amendments to the bill that will conform to the stated intent will be forthcoming.

Enactment of the comprehensive proposal described in this memorandum would improve the long-range OASDI actuarial balance by an estimated 1.92 percent of taxable payroll, changing the present-law actuarial deficit of 1.86 percent to an actuarial balance of +0.06 percent of taxable payroll. The OASDI annual balance for the year 2070 would improve by 6.42 percent of payroll, to an estimated level of +0.64 percent of payroll. The trust fund ratio for the combined OASDI program would increase to a peak of 375 percent in 2014, then decline to 57 percent in 2053. After 2054, the trust fund ratio would begin to rise, reaching 179 percent at the end of the long-range period, at which time the ratio would be rising by about 8 percentage points per year. OASDI trust fund levels under this proposal are thus projected to be (1) positive throughout the long-range (75-year) period and (2) stable or rising as a percentage of the annual cost of the program at the end of the period. On this basis we conclude that enactment of this proposal would be expected to provide for the full payment of benefits (as modified) throughout the period, and beyond.

The remainder of this memorandum provides the following:

Description of the equity yield assumption used in estimating the income taxes payable on individual account disbursements (which are transferred to the trust funds),

Sensitivity analysis with regard to the equity yield assumption,

Description of the provisions of this bill (with modifications to reflect intent) as they would affect the Social Security program, 

Brief listing of the individual provisions of the proposal, including the effect of each provision, separately, on the long-range OASDI actuarial balance (shown in table 1), and

Listing of discrepancies between bill language and intent (shown in table 2).

Description of the equity yield assumption used in estimating income taxes payable on individual account disbursements

As indicated above, estimates provided in this memorandum are based on the intermediate assumptions of the 2001 Trustees Report. In addition, the long-term ultimate average annual real yield assumed for equities is assumed to be 6.5 percent. This is slightly lower than the expected real equity yield used for estimates produced by the Office of the Chief Actuary over the last several years.

A consensus is forming among economists that equity pricing as indicated by price-to-earnings ratios may average somewhat higher in the long-term future than in the long-term past. This is consistent with broader access to equity markets and the belief that equities may be viewed as somewhat less "risky" in the future than in the past. Equity pricing will vary in the future as in the past. Price-to-earnings ratios were very high in the recent past, and are now lower.    The ultimate average real equity yield assumed for estimates in this memorandum is consistent with an average ultimate level of equity pricing somewhat above the average level of the past. The extent of this ultimate change is unknown, but it is consistent with assuming a real equity yield somewhat below the long-range past average of about 7 percent.

The assumption for an ultimate real equity yield of 7 percent that was used until this year was developed in 1995 with the 1994-6 Advisory Council. At the time, the Trustees assumption for the ultimate average real yield on long-term Treasury bonds was 2.3 percent. Real yields on corporate bonds are believed to bear a close relationship to Treasury bond yields of similar duration. The 2001 Trustees Report includes the assumption that the ultimate real yield on long-term Treasury bonds will average 3 percent, or 0.7 percentage point higher than in 1995. This increase in the assumed bond yield is consistent with a reduction in the perceived risk associated with equity investments.

Sensitivity analysis with regard to the equity yield assumption

If actual real yields on equities held in individual accounts over the next 75 years were to average only 3 percent, the same level as assumed for long-term Treasury bonds, this comprehensive proposal would still provide for adequate financing for the OASDI program through the provisions described above. The long-range OASDI actuarial balance would improve by an estimated 1.87 percent of taxable payroll, changing the present-law actuarial deficit of 1.86 percent to an actuarial balance of +0.01 percent of taxable payroll. 

It must be noted that the uncertainties associated with equity investments, bond yields, and mortality improvement, as well as with a number of additional variables means that actual experience could vary substantially from the estimates provided in memorandum.   In particular, there is a potential that long-range ultimate equity yields could average less than the 3 percent, although this is not very likely. 

Description of the provisions of this bill (modified to reflect stated intent) as they would affect the Social Security program

Provision 1: Reduce the COLA by 0.33 percentage point

This provision is intended to reduce the present-law OASDI annual cost-of-living adjustment (COLA) for monthly OASDI benefits by an average 0.33 percentage point from the level currently anticipated under the assumptions of the 2001 Trustees Report. The reduction would start with the COLA scheduled for December 2001 and continue indefinitely thereafter. The proposal would require a reduction in the computed percentage increase in the CPI-W upon which the COLA is based, before rounding to the nearest one-hundredth of a percentage point. The reduction would be equal to 0.33 percentage point less the sum of the following: 

(a)	Starting with the first year for which the COLA is based on a CPI that eliminates upper level substitution bias (should such a change be enacted in the future), the average size of the bias that has been eliminated, as estimated by the Bureau of Labor Statistics (BLS) and 

(b)	The average size of the change in the annual growth rate in the CPI used to compute the COLA based on other modifications (than described in (a) above) to remove bias in the CPI that are implemented after January 31, 2001, as estimated by the BLS. 

However, the 0.33-percentage-point reduction would in no case be diminished to less than zero by (a) and (b) above.

Provision 2: Eliminate the hiatus in the currently scheduled increase in normal retirement age (NRA); Modify actuarial reduction and increment factors

Eliminate the hiatus in the currently scheduled increase in NRA

Under current law, the NRA increases from age 65 by two months a year beginning with individuals attaining age 62 in the year 2000, until it reaches 66 for individuals attaining age 62 in the year 2005. While current law then leaves the NRA at 66 for several years, this provision would continue to phase the NRA upwards by two months a year until it reaches 67 for individuals reaching age 62 in 2011. The NRA would remain at age 67 for all individuals reaching age 62 after 2011.

Modify actuarial reduction and increment factors

In addition, the early retirement reduction factors and delayed retirement credits would be changed in an attempt to reflect the fact that the marginal increase in the full benefit level (i.e., the PIA) for earnings after reaching retirement eligibility age is, generally, relatively small. (Reduction and increment factors provided under current law are intended to provide actuarially equivalent lifetime benefits for a fixed earnings history regardless of the age at which retirement benefits start.) This relatively small marginal increase results from both the AIME formula, which uses 35 years of earnings, and the weighted PIA benefit formula. Together, these provide a larger marginal amount of benefit per dollar of additional earnings for low earners and for earnings earned early in a worker's career. This provision is intended to provide a greater marginal incentive to work past the retirement earliest eligibility age (EEA). Because the degree of this marginal effect depends upon the extent and level of earnings a worker has had in earlier years, no absolute adjustment can be provided that would be appropriate for all workers. Rough estimates of adjustments to the reduction and increment factors have thus been developed.

The chart below displays the proposed monthly early retirement reductions that would be applicable for retired worker beneficiaries for the first 36 months for which benefits are received prior to NRA under both current law and the provision. (Different factors apply to aged spouse beneficiaries and aged widow beneficiaries.)

| Age 62 in:  | 2001   | 2002   | 2003   | 2004   | 2005   | 2006+  |
|-------------|--------|--------|--------|--------|--------|--------|
| Present Law | 20/36% | 20/36% | 20/36% | 20/36% | 20/36% | 20/36% |
| Proposal    | 20/36% | 21/36% | 22/36% | 23/36% | 24/36% | 25/36% |

Similar increases for aged spouse beneficiaries would be applied, increasing the monthly reduction for the first 36 months of entitlement before NRA from 25/36 percent under present law to 30/36 percent under the provision.

The reductions that are proposed for the fourth and fifth year of benefit entitlement before NRA are 12/24% per month (current law reductions are 10/24% per month) for both retired worker and aged spouse beneficiaries. The reductions for the fourth and fifth year of entitlement before NRA are applicable to all new eligibles who reach age 62 after 2005 and are phased in for those newly eligible in 2002 through 2005.

The ultimate percentages of PIA payable for retired workers by age at initial benefit entitlement are shown in the table below. 

| Age at Initial Entitlement: | NRA-5 | NRA-4 | NRA-3 | NRA-2 | NRA-1 | NRA  |
|-----------------------------|-------|-------|-------|-------|-------|------|
| Present Law                 | 70%   | 75%   | 80%   | 86.7% | 93.3% | 100% |
| Proposal                    | 63%   | 69%   | 75%   | 83.3% | 91.7% | 100% |

The percentage of PIA payable for non-disabled aged widow beneficiaries newly eligible at age 60 would remain at 71.5 percent. The percentages payable for those newly eligible at ages between 60 and the NRA would scale linearly between 71.5 and 100 percent, as under present law. 

The delayed retirement credit (DRC) under present law is scheduled to increase to 8% per year for workers attaining age 65 after 2007. Under **H.R. 2771**, the DRC would continue to increase at the rate of 0.5 percentage point every two years, with the first new increase applied to those attaining age 65 in 2010. An ultimate factor of 10 percentage points per year would be reached for workers reaching 65 after 2015. The delayed retirement credit applies for those months between NRA and age 70 in which no retired worker benefit is received. 

The legislative language in **H.R. 2771** does not mention the intended increases (described above) for aged spouse beneficiaries.

Provision 3: Adjust the PIA levels to reflect changes in life expectancy for persons newly eligible after 2011

Adjust the PIA levels of retired worker beneficiaries newly eligible after 2011 to reflect changes in life expectancy at age 62, based on period life tables produced by the Office of the Chief Actuary in the Social Security Administration. This provision does not apply to disabled worker beneficiaries.   In addition, only a portion of the amount of reduction due to this provision would apply to the benefits of retired worker beneficiaries who convert from disabled worker beneficiary status. 

*Adjustment to benefits of retired workers with no disability periods*

The intent of this provision is to adjust benefit levels to reflect actual measured changes in longevity. The adjustment would be applied beginning with workers turning age 62 in 2012, the first year after the year in which the NRA under this proposal reaches its maximum of 67 years. The adjustment would be a ratio of:

The life expectancy at age 62 from the period life table for the calendar year 2008 to 

The life expectancy at age 62 from the period life table for the calendar year that is three years prior to the year in which the retiree turns age 62.

For example, the benefit of a worker reaching EEA, age 62, in 2012 would be reduced based on the increase in period life expectancy at age 62 between 2008 and 2009. The two years would generally be the two most recent years of complete data.   If the life expectancy at age 62 increased from 20.02 to 20.05 between 2008 and 2009, then the benefit level of the worker would be multiplied by 0.9985 (=20.02/20.05), for a reduction of 0.15 percent. For a worker retiring at age 62 in 2013, the reduction in benefit level would be based on the increase in life expectancy at age 62 between 2008 and 2010. The chart below provides the expected life-expectancy adjustment factors and the benefit reduction percents that would apply to selected retired-worker beneficiaries using the intermediate assumptions of the 2001 Trustees Report.

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