Thursday, June 23, 2005
Private Accounts with a guarantee - a Social Security reform proposal
LOOKING AHEAD by Wally Dobelis
I have been confronted about the recent Social Security article in this column by several neighbors, favoring private accounts as a future way of assuring SS retirement benefits for their children. My crossover concept, of private accounts with a guarantee, may strike a familiar cord with the many insurance professionals of our neighborhood, present and retired employees of MetLife, New York Life and The Guardian. It might even be a suitable counterproposal for the Democratic opponents of the President’s ideas. Pass it along.
There is no doubt that the SS system is in trouble, long run. There is no doubt that people are living longer, that life expectancy has risen from 62 to 79 since 1935, cancer cures are on the threshold of success, early retirement is prevalent. It already takes 2.8 workers to support one retiree, and that’s not including the coming wave of Baby Boomers. A change that lightens the load of this “pay benefits from current income” SS system is needed, preferably by shifting the some of the burden to the world of private accounts, particularly through investments in equities (stocks), which historically have had an upward growth in excess of GDP, recessions notwithstanding. It should be noted that this is a bi-partisan solution, that President Clinton already in 1998 looked toward “harnessing the returns from private markets to help SS.” But the risk aspect, fear of a March 2000-type collapse, has turned the public negative towards the President’s plan of transferring over 25% of their SS income to the vagaries of the marketplace
There is a solution. The experience of the insurance business may provide an answer. .
The traditional life insurance and annuity companies, investing its reserves in rock-solid bonds, in the past decades had seen a shift in public attitudes towards the right-risk and high-return mutual funds. To counter it, their actuaries invented an equity based line of products, Variable Life and Annuity, that experienced a burst in the high-flying years, with even traditional Ordinary or Whole Life shifting into equity investments and generating a “vanishing premium” experience, where growth of policy and annuity reserves invested in the upward market generated enough revenue to make premium payments unnecessary. But that reversed after March 2000, the high growth yield disappeared, the policies and annuities lost value, the premiums returned, the surrender value of annuities dropped below the original investment, and the public turned sour.
In response, the actuaries offered a family of “secondary guarantee” riders, in principle guaranteeing that the original investment would never be reduced. Thus, no loss. The actuaries, trained to mathematically assess the mortality and morbidity risks, now bravely entered the unknown market risk area, confident that the premiums charged for the extra market exposure would be backed up by the company surpluses and the reserves guaranteeing their conventional life insurance portfolios. To date the experience has been acceptable.
Can this experience be applied to SS, to allay the recipients’ fears of market risk, the concern that the investments,, instead of producing extra retirement income, will whittle down their savings? Some form of “secondary guarantee” should be developed, assuring the SS recipients that their investment will be guaranteed and will produce no less income and benefits than it had remained fully within the traditional SS fold.
Can this be done?
Well, various economic research organizations offer the analysis that within the limited number of probable mixes to be offered to fund private portfolios – straight bonds only, bonds and stocks, low-risk stocks only - the returns over the long pull will be anywhere from 1% to 5% above those guaranteed by the SS system. Let’s assume that the President’s proposed private accounts are funded by 4% of income, or over 25% of the 15.6% of income contributed to SS. Given today’s technology, the value of each participant’s private account can be tracked, over each participants’ years of unemployment and employment at various rates, and, most importantly, mirrored to what it would be under the SS system. Depending on the mix chosen for the private portfolio and its risk, a variable insurance premium could then be deducted from the account, to cover the contingency that the value of the portfolio should drop below the mirrored image. Add to the deduction another premium, for the 25% of disability and death benefits no longer provided by SS.
With this approach, no one should be worried about losing the investment in a private account due to market risks. The income from the proposed annuity purchased with the private fund at retirement would always equal the amount guaranteed by SS, and most probably exceed it. Any COLAs, increases in benefits due to inflation, would have to be configured in, and the retirement date prefigured, to avoid arush to early retirement in bad years.
This is really an exposure draft, to open the discussion about a SS reform that is socially less worrisome than the President’s approach. There will be more on my blog, accessible through the website, www.dobelis.net.
I have been confronted about the recent Social Security article in this column by several neighbors, favoring private accounts as a future way of assuring SS retirement benefits for their children. My crossover concept, of private accounts with a guarantee, may strike a familiar cord with the many insurance professionals of our neighborhood, present and retired employees of MetLife, New York Life and The Guardian. It might even be a suitable counterproposal for the Democratic opponents of the President’s ideas. Pass it along.
There is no doubt that the SS system is in trouble, long run. There is no doubt that people are living longer, that life expectancy has risen from 62 to 79 since 1935, cancer cures are on the threshold of success, early retirement is prevalent. It already takes 2.8 workers to support one retiree, and that’s not including the coming wave of Baby Boomers. A change that lightens the load of this “pay benefits from current income” SS system is needed, preferably by shifting the some of the burden to the world of private accounts, particularly through investments in equities (stocks), which historically have had an upward growth in excess of GDP, recessions notwithstanding. It should be noted that this is a bi-partisan solution, that President Clinton already in 1998 looked toward “harnessing the returns from private markets to help SS.” But the risk aspect, fear of a March 2000-type collapse, has turned the public negative towards the President’s plan of transferring over 25% of their SS income to the vagaries of the marketplace
There is a solution. The experience of the insurance business may provide an answer. .
The traditional life insurance and annuity companies, investing its reserves in rock-solid bonds, in the past decades had seen a shift in public attitudes towards the right-risk and high-return mutual funds. To counter it, their actuaries invented an equity based line of products, Variable Life and Annuity, that experienced a burst in the high-flying years, with even traditional Ordinary or Whole Life shifting into equity investments and generating a “vanishing premium” experience, where growth of policy and annuity reserves invested in the upward market generated enough revenue to make premium payments unnecessary. But that reversed after March 2000, the high growth yield disappeared, the policies and annuities lost value, the premiums returned, the surrender value of annuities dropped below the original investment, and the public turned sour.
In response, the actuaries offered a family of “secondary guarantee” riders, in principle guaranteeing that the original investment would never be reduced. Thus, no loss. The actuaries, trained to mathematically assess the mortality and morbidity risks, now bravely entered the unknown market risk area, confident that the premiums charged for the extra market exposure would be backed up by the company surpluses and the reserves guaranteeing their conventional life insurance portfolios. To date the experience has been acceptable.
Can this experience be applied to SS, to allay the recipients’ fears of market risk, the concern that the investments,, instead of producing extra retirement income, will whittle down their savings? Some form of “secondary guarantee” should be developed, assuring the SS recipients that their investment will be guaranteed and will produce no less income and benefits than it had remained fully within the traditional SS fold.
Can this be done?
Well, various economic research organizations offer the analysis that within the limited number of probable mixes to be offered to fund private portfolios – straight bonds only, bonds and stocks, low-risk stocks only - the returns over the long pull will be anywhere from 1% to 5% above those guaranteed by the SS system. Let’s assume that the President’s proposed private accounts are funded by 4% of income, or over 25% of the 15.6% of income contributed to SS. Given today’s technology, the value of each participant’s private account can be tracked, over each participants’ years of unemployment and employment at various rates, and, most importantly, mirrored to what it would be under the SS system. Depending on the mix chosen for the private portfolio and its risk, a variable insurance premium could then be deducted from the account, to cover the contingency that the value of the portfolio should drop below the mirrored image. Add to the deduction another premium, for the 25% of disability and death benefits no longer provided by SS.
With this approach, no one should be worried about losing the investment in a private account due to market risks. The income from the proposed annuity purchased with the private fund at retirement would always equal the amount guaranteed by SS, and most probably exceed it. Any COLAs, increases in benefits due to inflation, would have to be configured in, and the retirement date prefigured, to avoid arush to early retirement in bad years.
This is really an exposure draft, to open the discussion about a SS reform that is socially less worrisome than the President’s approach. There will be more on my blog, accessible through the website, www.dobelis.net.
# posted by Wally Dobelis @ 3:14 AM 
