Senate Special Committee on Aging
St. Joseph's University, June 30, 1998
Testimony by David Langer, Consulting Actuary

The challenge Social Security faces today

I am pleased to have been invited here to provide testimony on my perspective of the challenges facing our Social Security system. Having examined the privatization issues for the past three years, I appreciate the opportunity provided here to look back with an eye to typing things together. I hope this will be as helpful to the Committee as it is for me.

While the public, many members of Congress, and the President now see a financial problem as the key challenge facing Social Security, I see it instead as the need to undo a number of misconceptions about the system and to fend off the movement to radically change it, both of which have been promoted by those who wish to privatize it, and whom I will refer to as "privatizers." I believe the privatizers's motivations are either that they abhor Social Security for ideological reasons, or see privatization as a business opportunity, or both. They come largely from financial companies and, not surprisingly, would like to play a major role in managing all, or as much as they can negotiate, of the $400 billion in annual contributions. They currently seek legislation to permit them to oversee 5% of the 6.2% worker's contribution rate, or about $160 billion out of the $400 billion.

Achilles was lucky in a way -- he had but one area of vulnerability. The proposals to privatize are much less fortunate -- they have many Achilles's Heels, and I will now enumerate them.

The financial shortfall is an actuarial construct
The financial shortfall that is at the heart of what has been called Social Security's impending bankruptcy is an actuarial construct. The economic assumptions employed by the actuaries at the Social Security Administration for their financial projections have been made increasingly conservative since 1979, and it is this that has caused the program to look as shaky as it is said to be today. If, on the other hand, liberal assumptions had been used, we might believe today that not only is there no problem, but we could be here discussing instead an increase in benefits or a reduction in the contribution rate. Tilting the assumptions either way is obviously not desirable, and that is why there are published actuarial guidelines intended to prevent such tilting. These state as follows:

"Because no one knows what the future holds with respect to economic and other contingencies, the best an actuary can do is to estimate possible future outcomes based on past experience and future expectations."

I have prepared a chart of the past experience of the Gross Domestic Product (GDP) from 1960, over as many years as were made available in the last 20 annual reports prepared by the Trustees of the Social Security Trust Fund. If you will examine the chart, you will note that the GDP factors for the future 75 years have been ratcheted downward almost routinely for the past 20 years, and that past experience was apparently ignored in developing the future GDP factors. You will note that while the average actual GDP was 3.3% for the 20 years, the average for each individual year ranged narrowly from 3.5% to 2.9%; however, the intermediate assumed factors, which were used for the official financial projections, dropped 50%, from 3% to 1.5%.

If past experience was not used, then this implies that the actuaries relied on what they expect future experience to be; but as we all know, economic projections, even for a year, can put you on shaky ground. Thus it is most important to rely on past experience as much as possible. Conservatism is essential for life insurance companies and private pension plans to enable the build-up of sufficient assets to protect those covered, but it is not deemed desirable for a social insurance program, where large asset accumulations are not appropriate or desirable. This is Achilles Heel one

The privatizers's apple and orange comparison

While Social Security's actuaries have utilized a dismal view of the future economy, as expressed by the 1.5% future average GDP, the privatizers make a strikingly rosy assumption when they project that stock market performance over the next 75 years will match its 7% average annual performance over the past 75 years. If in fact the economy were so solid as to enable a 7% yield, then there would be no need to fix Social Security -- the Trust Fund would not run dry in the year 2032 and might never do so. Conversely, with an average GDP of only 1.5%, then a privatized stock portfolio can only reasonably expect about a 4% yield, not 7%.

The privatizers may want to have it both ways: Social Security going belly up because of a crummy future economy and a great stock market despite it. This is Achilles Heel two

The baseless criticisms
Since the early 1980s, the public has seen Social Security subjected to sharp criticisms in the media and meetings throughout the country. They include the following, and I am sure you will recognize most of them: Social Security going bankrupt, young people won't get their money's worth, it is a Ponzi scheme, the investments are mere IOUs subject to embezzlement, it is an entitlement program that needs to be curtailed, the burden created by the baby boomers will cause intergenerational conflict, and there is an enormous unfounded past service liability.

While these criticisms might be scored collectively a 10 as imaginative ways to frighten and otherwise turn the public away from Social Security, they still add up to zero for content. I would therefore call them the third Achilles Heel.

Chilean social security fails as a role model
Chile's fully privatized social security has been used to sell the concept worldwide, and the marketing has been successful in a number of countries. However, the sales effort has spared the public knowledge of the less attractive features; e.g., the exorbitant expenses, the lack of choice of investments, the less than awesome yields when the expenses are taken into account, and the extensive financial obligations and regulatory role the Chilean government has been saddled with.

This failure to fully disclose vital facts, the fourth Achilles Heel, can also be readily seen in the selling of privatization to this country. Consider that the public knows little yet about the cost to privatize, the operating expenses, the income to the private managers, the uncertainty of achieving higher benefits than under Social Security, the need for the government to create a whole new legal and regulatory apparatus and to underwrite the effect of a market calamity, and the opportunities for fraud.

Ironies
There are two ironies in all this that make up our last Achilles Heel. The privatizers ask Congress to mandate that 141 million workers invest $160 billion of Social Security contributions annually in the private securities market, when it was the collapse of the private markets in 1929 that led to the demand for a non-market-oriented Social Security in the thirties. Finally, we see the promoters of financial free enterprise, who bristle at the thought of government telling them how to invest their money, seeking to force 141 million workers to ante up capital for the use of the very same free enterprisers, but without federal interference, of course.

© 2001 DAVID LANGER COMPANY, INC.