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 By Jack Cumming

Do you trust that Social Security will be there for you when you need it? After all, you paid into the “trust fund” when you were just starting out. Then, it was hard for you to make ends meet. That FICA deduction from your paycheck took a big bite. You may not even have known what “FICA” meant. Now you do — it’s the Federal Insurance Contributions Act. It’s efficient, and it affects everyone from birth till beyond the grave.

My joy as an actuary comes from creating sound financial programs that give people security. There are many credentialed actuaries, accountants, and economists who calculate and produce plausible numbers. Strong actuaries, though, exercise judgment and discretion to give people the assurance that others may think impossible. It’s fun to create financial structures that people can rely on. I love working as a humanist actuary.

Social Insurance

A few weeks back, I was talking with a group of experts in aging. The conversation turned to social insurance. These are well-informed thinkers. As an actuary, listening to the conversation, I realized how little understanding most people have. Social Security, Medicare, and Medicaid are central for the senior living industry. Congress has given us a tangled social insurance web that we need to unravel to make the complex simple and the unfathomable understandable.

Today’s popular dialogue tends to have more mythology than reason. That’s not helpful. For instance, while people are living longer, actuaries have long projected today’s improving longevity and incorporated that into their calculations. There’s a myth that today’s longevity wasn’t anticipated.

People think that social insurance is sound because it’s governmental, but social insurance is not even held to the same high financial standards as are licensed insurance companies. Government is less regulated than is private industry.

The list of popular myths is long.

Can Social Insurance Be Trusted?

But, back to the question of trust. Consider two alternative principles, one of which might be chosen to guide the management of the Social Security System. The first holds that each generation should pay into the trust fund enough during its earning years to pay the full cost, as best it can be discerned, of its benefits during its pension years. Think of that — every generation pays for its own retirement. Would that be fair? Would that be sufficient?

Now think of another principle that might guide the system. This principle holds that each generation, whether large or small, should pay during its earning years for the pension years of another generation, regardless of the size of that other generation. Now that doesn’t seem quite as fair, does it? Can it be sufficient? Can a small generation afford the cost of supporting a larger, older pensioned generation?

Consider the Obvious

Let’s pause here for just a moment to acknowledge the obvious. All else being equal, with either principle, the ultimate payout in benefits — i.e., the future benefit cost to be funded … or not — will be the same regardless of how we anticipate those future obligations. This discussion has nothing to do with the benefits. This is about how those benefits are funded and about who pays for what.

Of course, circumstances can change. The benefits could be reduced … or increased; the economy might falter … or thrive. Interest rates rise … and fall. Thus, depending on how judiciously we anticipate that future, Social Security funding will be too much, too little, or just right. For those who depend on the deferred benefits, too much is better than too little.

We can start with how that first, fairer principle might be possible. Actuaries can project the amount sufficient to pay future Social Security benefits if funds are set aside and invested to earn interest. Similarly, that amount can be apportioned over working years on a level percentage payment basis using projected future Social Security taxed earnings.

In other words, the amount needed to provide the benefits on a financially sound and predictable basis can be accrued over the working years of a cohort or generation. The accumulating funds can be invested to accrue interest, say, in special government debt securities or more broadly invested.

The current shortfall, due to past political concepts, can likewise be calculated and amortized over a period of, say, 75 years. Wise, constrained, unbiased judgment is what lifts professional actuaries above mere mathematics.

The Story of Good Intentions

It’s that simple. So, why isn’t that done? That brings us to a story. It was in the time of the Great Depression, 1939. Old people were dependent on their children or charity for their retirement. The Franklin Roosevelt administration wanted to pump more cash into the economy both to help economic recovery and to win votes.

Just a few years after Social Security was instituted, Congress shifted from the first principle — each generation for itself — to the second — tax workers to pay retirees. The trust funds, held for those who paid in, were diverted to give benefits to those who had never paid in.

The new recipients had retired before Social Security was enacted. With that, Social Security shifted from a “trust” fund program for each generation to a “pay-as-you-go” generational transfer program in which workers pay for benefits to those who are no longer working.

More Politics

Management of the trust fund, consistent with its trust nature, was separate from the federal budget until 1968. President Lyndon Johnson then brought all trust funds into what his administration called a “unified budget.” This had the effect of reducing the appearance of the federal deficit. The trust fund “savings” offset part of the “guns and butter” spending.

This practice was later reversed by President Ronald Reagan for fiscal year 1985 and later. Social Security is often thus impacted by political decision-making. The alternative view is that, as a trust undertaking, it should be managed apart from overall federal budgeting, with decisions confined to what impacts the Social Security program in and by itself.

Two Options

This leaves us with twin questions:

  1. Was it wise in 1939 to change to pay-as-you-go?
  2. Is pay-as-you-go wise today?

If it’s still wise, then we need do nothing, and the system will change when it runs out of funds, most likely then drawing on general revenues to continue benefits. If it’s unwise, what would it take to change it to a trustworthy, reliable, sound, and fair system? There are two ways to fund anything: Pay less now or pay more later.

When defined benefit pension plans were still common, employer pension costs were often actuarially determined as a level percentage of an employer’s payroll. The IRS intervened to change that, and over time defined benefits became less common. Pension benefits are a form of employee compensation related to payroll. That same idea of a level percentage of payroll has guided the funding of Social Security by the FICA payroll tax.

Giving benefits retroactively in 1939 to those who predated Social Security created a liability that still hangs over the system. The alternative of intergenerational pay-as-you-go funding is unfair to small generations and over-generous to big ones. You can’t change what you don’t acknowledge. Recognizing that initial liability can open ways of funding that liability so that the system is fair and sound for all generations.

Thus, if we are to put Social Security on a sound basis, we need to forego the myth that government is perpetual and has unlimited money. We can easily put Social Security and its trust fund on a permanently sound basis. “Permanence” would, of course, require economic stability and predictable currency value.

The First Step Toward Restoring Trust

It’s simple. We have to remove the political temptations of Congress so that social insurance can be trusted. Politicians are dependent in the here and now on votes and on campaign donors. There is a tendency for politicians to look for short-term advantage, rather than converging around what’s best. Social Security, and all social insurance, should be freed from political manipulations. Instead, we need apolitical governance, similar to the military’s apolitical tradition, to serve the general welfare without partisan self-dealing.

Social insurance is an enterprise, and it needs to be regulated as such. That means removing it from notions such as sovereign immunity or coercive use of governmental power. There will be political pressure to do the minimum, to create the appearance of trust independence without the reality.

Nominal independence hasn’t worked for the post office, Amtrak, or other federal programs. They are still subject to Congressional meddling.

Social insurance should be free but regulated (including anti-monopoly regulation). Governing boards should be chosen for skills, competence, and collegiality rather than politically appointed, and ownership should be separated from the government.

The Second Step Toward Restoring Trust

Next is to establish Social Security, and other social insurance programs, on a fair and sufficient financial foundation. This goes beyond mere cash adequacy.

Economic projections showing that cash will match payouts for some number of years in the future do not address the fundamental questions of intergenerational equity. Accountants may suggest that “cash is king.” That can lead to a hope that the system is sound as long as there is cash from younger earners to pay benefits to older pensioners. That premise will crash when the cash runs out. Cash is not king. Integrity and fair dealing are paramount.

Social Security can be as solvent — as are annuity plans issued by licensed insurance companies — and regulated, as are insurers. The 1939 decision to pay benefits to people who hadn’t paid in was well intended and depended on the optimistic assumption that the system was perpetual. That optimism, though, overlooked the challenge of intergenerational fairness. Now is the time to reform the system to put it back on the soundly funded basis that was originally enacted in 1935.

Funded Social Security can be accomplished. Make the trust fund a truly trusted fund apart from government and subject to the oversight required of trust institutions. Perhaps it should be maintained by a consortium of trust banks and other financial fiduciaries.

Then, recognize the existing liability for promised benefits embedded in the system, and establish an interest-bearing governmental indebtedness to amortize that liability over a reasonable period, such as the 75 years now used in many Social Security cash projections.

Political resistance will argue that the amount is too big. $20 trillion would be a big number, indicative of weak Congressional oversight. Still, there are lots of Americans, and a Social Security deficit of $20 trillion would be about $60,000 each. Think of how home values can rise in a prosperous economy. We can manage a debt like that over 75 years. Moreover, the continuously dropping value of the dollar will help.

There will be political pressure to maintain the status quo. There will be politicians who will assert that funding social insurance will slow the economy by favoring savings over spending. The argument in 1939 was that sound funding would be “socialism by the back door.” The truth is that money invested in private enterprise can help build the economy by funding businesses and longer-term consumer undertakings like home ownership.

Moving money from spending to investing can make America stronger and more prosperous. Think of all the jobs and opportunities that invested trust funds, even with index investing, can create. America is still the land of opportunity. Untold prosperity is ours to have and to hold.

What About Health Care?

With health care, as with Social Security, we can do better if we start from principles instead of from the quest for political advantage. The principles, on which most thinkers might agree, are that health care be universal, comprehensive, and accessible. The mess we’ve gotten ourselves into is evident in our having seven major government health care programs even though one principled system would suffice.

The seven programs are Medicare, Medicaid, Affordable Care Act plans, the Children’s Health Insurance Program, the Department of Defense TRICARE and TRICARE for Life programs, the Veterans Health Administration program, and the Indian Health Service program. This omits the multiplicity of employers’ plans. No wonder it’s little understood. That multiplicity of special programs is good for politicians but not good for the nation. We don’t need to mention that cost has been allowed to balloon beyond all reason. Most interested people know that.

My impression is that the most popular of these programs is Medicare. While it is a government program, those eligible have the option to choose private Medicare Advantage programs if private alternatives are found to be better than the government default. While some allege that the private alternatives unfairly take advantage of the public default program, there is little credible evidence to prove that.

It would not be difficult to extend Medicare to all, to make it universal (after all, contagion knows no borders or legalities), and to forego copays for those who are indigent. That one plan could then replace all of the other alternatives, and the effort could be put into improving quality and outcomes while containing costs. There is evidence that some Medicare Advantage plans, notably the staff model Kaiser Permanente and PACE (Program of All-Inclusive Care for the Elderly) plans, already do improve care at lower cost.

Paying for Health Care

The funding for Medicare Part A (inpatient care in hospitals, care in skilled nursing facilities, hospice care, and some home health care and lab tests) is similar to that for Social Security. There is a special tax collected through the Social Security FICA mechanism, which is intended to fund that “Part.”

If we take that precedent and extend it to put American health care on a sound basis, then here’s an approach that could work. Instead of having Congress mandate a FICA tax that may or may not be sufficient, have the Office of the Actuary in the Centers for Medicare and Medicaid Services annually project the rate needed to pay the total cost for health care — i.e., not just a “part” — for the coming year, and set the health care portion of the FICA tax to that rate. That would ensure that over time, the cost of American health care would be fully funded.

This would meet the desirability to have a program that is universal, comprehensive, and accessible, leaving only the excess cost of the current system to be brought down over time. In the meantime, it could be a program that all generations could count on. Moreover, by uncoupling comprehensive health care from employment, we would free employees to seek opportunity where they can find it, without today’s common health care job trap.

Why Are We Where We Are?

If it’s simple, why hasn’t it been done? Social Security now is not an actuarial program, nor is it an economically sound program, nor even an accounting compliant system. It’s a political system. Politicians don’t get elected to solve problems. They benefit from lingering challenges, controversy, and popular plausibility in pursuit of votes. We need to raise our social insurance systems above political bickering and deliberatively put them on a basis that the public can trust.