A third demographic component, which acts to partially offset macro-aging, is net immigration. Because immigrants tend to be younger, higher immigration can offset some of the change in the age distribution of the population caused by lower birth rates.
An additional significant component of differences between low-cost, intermediate, and high-cost projections is the real-wage growth (specifically the difference between inflation and real-wages, or the real-wage differential). Actuarial balances at all durations as well as the projected depletion dates change materially based on changes to this component.
The ratio of covered workers to Social Security beneficiaries is expected to decrease significantly from 2.8 in 2015 to 2.2 in 2035, primarily due to macro-aging, and then to decrease more slowly, primarily due to micro-aging, to 2.0, by the end of the 75-year projection period. This decrease over the projection period of approximately 30 percent is important in a system in which the dollars paid in must equal the dollars paid out–a PAYGO system.
Figure 3 shows the projected growth in the number of Social Security beneficiaries relative to the covered working population, under the three sets of assumptions. Because the program financing is nearly PAYGO, the three alternative projections of long-range cost show similar patterns.
Low-cost, intermediate, and high-cost projections are labeled I, II, and III respectively.
The Social Security Committee of the
American Academy of Actuaries believes that any modifications to the Social Security system should include sustainable solvency as a primary goal. Sustainable solvency means that not only will the program be solvent for the next 75 years under the reform methods adopted, but also that the trust fund reserves at the end of the 75-year period will be stable or increasing as a percentage of annual program cost. Refer to the appendix for a more complete explanation of sustainable solvency.
The metrics used by the trustees to present the program’s financial status are discussed in more detail below.
Actuarial balance is calculated as the difference between the summarized income rate and the summarized cost rate over a period of years. The summarized income rate is the ratio of any existing trust fund plus the sum of the present value of scheduled tax income for each year of the period to the sum of the present value of taxable payroll for each year of the period. The summarized cost rate is the ratio of the sum of the present value of cost for each year of the period, including one year’s outgo at the end of the period, to the sum of the present value of taxable payroll for each year of the period. Table 1 shows the components of actuarial balance.
In the 75-year period, 2016–2090, the actuarial deficit is 2.66 percentage points. The actuarial deficit decreased from the comparable figure of 2.68 percentage points a year ago due to a combination of factors, including changes in demographic data and assumptions, changes in economic data and assumptions and legislative and policy changes.
An immediate increase of 2.58 percentage points in the payroll tax (from 12.4 percent of payroll to 14.98 percent of payroll), a benefit reduction of about 16 percent, or some combination of the two, would pay all benefits during the period, but would
not end the period with any trust fund reserve.
The high-cost 75-year projection in the Trustees Report shows a far greater actuarial deficit–6.30 percent of taxable payroll. The low-cost projection is much more favorable, with a small positive actuarial balance for the 75-year period.
Trust Fund Ratios
The
trust fund ratio, equal to trust fund assets as a percentage of the following year’s cost, is an important measure of short-term solvency. A trust fund ratio of at least 100 percent indicates the ability to cover the expected scheduled benefits and expenses for the next year without any additional income. Figure 4 shows projected trust fund ratios under all three sets of assumptions.
As a measure of long-range solvency, the trust fund ratio shows when the program is expected to deplete reserves and become unable to pay full benefits scheduled under current law. Figure 4 illustrates that trust fund reserve depletion occurs in 2034 under the intermediate projection. The high-cost projection moves the trust fund reserve depletion date up by approximately five years to 2029, while the low-cost projection shows no trust fund reserve depletion during the 75-year period.
Low-cost, intermediate, and high-cost projections are labeled I, II, and III, respectively.
Sustainable Solvency
Sustainable solvency means the program is not expected to deplete reserves any time in the 75-year projection period, and trust fund ratios are expected to finish the 75-year projection period on a stable or upward trend.
The results shown in the Actuarial Balance column may not be equal to the difference between Summarized Income Rate and Summarized Cost Rate because of rounding.
Sustainable solvency is a stronger standard than actuarial balance in two ways. First, actuarial balance is based on averages over time, without regard to year-by-year figures that could indicate inability to pay full benefits from trust fund assets at some point along the way. Second, actuarial balance can exist even when trust fund ratios toward the end of the period are trending sharply downward.
Sustainable solvency, in contrast, requires strict year-by-year solvency AND trust fund ratios that are level or trending upward toward the end of the period. For example, following the last major Social Security reform, the 1983 Trustees Report projected a positive actuarial balance under the intermediate assumptions, but the annual balances were negative and declining at the end of the 75-year period. That report was in actuarial balance but did not show sustainable solvency. As a result, the actuarial balance generally has been declining since then, primarily as a consequence of the passage of time. It is important to note that this result was exactly what the Trustees Report projected in 1983. More than 30 years later, it should be no surprise that large and growing actuarial deficits are now projected at the end of the long-range projection period. Adequate financing beyond 2090, or sustainable solvency, would require larger program changes than needed to achieve actuarial balance.
Unfunded Obligation
The
unfunded obligation is another way of measuring Social Security’s long-term financial commitment. To compute it, discount with interest the year-by-year streams of future cost and income and then sum them to obtain their present values. Based on these present values, the general formula for computing the unfunded obligation is:
Present value of future cost (benefits and expenses),
minus the present value of future income from taxes,
minus current trust fund reserves. |
The unfunded obligation may be computed and presented in several ways. Perhaps the most useful way is based on taxes and benefits for an open group of participants over the next 75 years, including many people not yet born, the same as was calculated in the basic projections. That methodology is consistent with the primarily pay-as-you-go way the program is designed and currently run. Although the trustees provide alternative calculations based on the closed group of current participants, we believe the open-group basis makes more sense for Social Security and avoids certain misleading outcomes. For example, if the program were in exact actuarial balance, the open group measure of the unfunded obligation would be zero, while the closed group measure would show a substantial unfunded obligation.
The dollar amount of unfunded obligation is easier to interpret if put in perspective, for example, by comparing it with the size of the economy over the same period. The unfunded obligation is often presented as a percentage of the present value of either taxable payroll or of gross domestic product (GDP). At the beginning of 2016, the open-group unfunded obligation over the next 75 years was $11.4 trillion (up from $10.7 trillion last year). This now represents 2.49 (2.53 last year) percent of taxable payroll, or 0.9 percent (same as last year) of GDP.
In recent years, the Trustees’ Reports have also presented the unfunded obligation based on stretching the 75-year projection period into infinity. The infinite horizon projections project all annual balances beyond 75-years assuming that the current law, demographic assumptions, and economic trends from the 75-year projection continue indefinitely; in practice, this is highly problematic. Projections over an infinite time period have an extremely high degree of uncertainty. Troublesome inconsistencies can arise among demographic and program-specific assumptions. By assuming that longevity keeps increasing forever while retirement ages remain static, for example, the infinite time period forecast will eventually result in an extremely long period of retirement.
Measures of Uncertainty
Because the future is unknown, the trustees use alternative projections and other methods to assess how the financial results may vary with changing economic and demographic experience.
Alternative Sets of Assumptions
Table 2 shows a comparison between recent values and ultimate long-range values of five key assumptions used in each of the three projections. With the exception of productivity growth, where the ultimate values have not changed from last year’s report, the ultimate values of the other assumptions exhibit some minor changes when compared to last year’s Trustees Report.
Sensitivity Analysis
The low-cost and high-cost projections change all the major intermediate assumptions at once in the same direction, either favorably or unfavorably. In contrast, there might be some interest in how the projections change when only one key assumption is changed at a time, either favorably or unfavorably. A sensitivity analysis shows exactly this. Just one assumption is changed at a time to determine the financial impact. Table 3 gives results of three sensitivity tests focusing on total fertility rate, mortality reduction, and real-wage growth.
If the real-wage growth assumption were changed from 1.21 percent to 1.83 percent, for example, the actuarial deficit would be reduced from 2.66 percent of taxable payroll to 1.64 percent, and the year of trust fund asset reserve depletion would be extended from 2034 to 2038.
References
American Academy of Actuaries Issue Briefs on Social Security