This post is a geeky dive into the primary metric used to measure Social Security’s funded status and how similar this metric is to the Funded Status measure generated by the Actuarial Financial Planner (AFP) that we encourage retired households to use in their financial planning.
In our last post, we encouraged you to determine your household “Funded Status” with the help of our Actuarial Financial Planner (AFP) model. Your Funded Status is simply the the present value of your household assets (including future payments from various income sources) divided by the present value of your spending liabilities. Monitoring increases or decreases in your Funded Status over time can help you make decisions about how much you can afford to spend in retirement and actions you may need to consider to strengthen your household Funded Status if it should become necessary.
We have indicated in many of our prior posts (most recently in our post of March 5, 2023) that the actuarial principles used in the AFP (which are described in more detail in that March 5 post) are very similar to the principles employed by the Social Security actuaries and pension plan actuaries to measure the funded statuses of such systems.
The Social Security trustees just released their 2023 OASDI Trustees Report. Instead of dividing the present value of system assets by the present value of system liabilities to determine the system’s long-range funded status, the trustees and Social Security actuaries use the difference between these two values, expressed as a percentage of the present value of future system payroll, as their measure of long-range funded status over a 75-year projection period. The long-range actuarial balance percentage determined in the 2023 trustees report was -3.61% of taxable payroll as of January 1, 2023, based on the trustees’ intermediate assumptions about the future.
Several organizations (including the American Academy of Actuaries) have recently released tools that quantify the expected impact on Social Security’s long-range actuarial balance (or deficit) associated with various possible system changes. The Academy’s tool is referred to as the Social Security Challenge. With this tool, users are encouraged to “fix” Social Security by selecting a package of reform options designed to eliminate the current (actually 2022) long-range actuarial deficit.
In this post, we will, for purposes of comparison with the AFP Funded Status metric, use the results contained in this year’s trustees report to calculate Social Security’s long-range funded status as of January 1, 2023 by dividing system assets by system liabilities instead of subtracting its liabilities from assets, and we will discuss:
- The pattern of Social Security funded status measurements since 1983 and expectations for future years,
- General limitations of funded status calculations,
- The process currently used to change system benefit and/or tax provisions and how that process might be changed to improve intergenerational equity and avoid large disruptive changes, and
- The conceptual difference between “strengthening” Social Security’s funded status and “fixing” the system or “solving” Social Security’s long-range financial problem.
The key take-aways in this post are:
- Funded status calculations are snapshot comparisons of the present value of system (or household) assets and system (or household) liabilities as of a given date based on deterministic assumptions about the future. Using different assumptions about the future will produce different funded status estimates. Being “in actuarial balance” in the current year does not guarantee being in actuarial balance next year or any future year.
- The 75-year actuarial balance calculation used by the Social Security trustees does not consider significant revenue shortfalls expected to occur after the end of the 75-year projection period. Therefore, possible reform “solutions” that place the system back into long-range actuarial balance may fall short of maintaining actuarial balance over time even if assumptions about the future are exactly realized.
- Possible Social Security reform “solutions” developed in website tools frequently assume immediate adoption of system changes, rather than gradual implementation. If changes to the system are gradually implemented, the required increases in tax revenue or benefit decreases may need to be larger than estimated by the tool to achieve actuarial balance.
- The success of Social Security reforms will depend on how well actual future experience compares with the assumptions made by the trustees and the Social Security actuaries. There is no mechanism in current Social Security law to maintain the system’s actuarial balance once it has been achieved. Therefore, there can be no guarantee that the system’s long-term problem will be “fixed” or “solved” for any specific length of time by enacting specific system changes.
- A financial system that balances the present value of its assets with the present value of its liabilities is still potentially subject to cash-flow risk if system assets are relatively backloaded or system liabilities are relatively front-loaded. Social Security reform will need to consider this cash-flow risk in addition to strengthening the system’s funded status.
- Automatic adjustments to maintain the Social Security’s long-range actuarial balance on some reasonable, more frequent basis may be preferrable to less frequent (but more substantial) changes enacted legislatively.
What is Social Security’s current funded status based on the Trustees Intermediate Assumptions?
The 2023 long-range actuarial balance for Social Security based on intermediate assumptions is -3.61% of taxable payroll. The information used to calculate this percentage is shown in Table IV.B6 of the OASDI Trustees Report—Components of 75-Year Actuarial Balance and Unfunded Obligation underIntermediate Assumptions and is summarized below. Amounts shown below are in billions of dollars.
1. PV Assets | $81,118 (payroll taxes) + $6,290 (tax revenue) + $2,830 (trust fund) = $90,238 |
2. PV Liabilities | $112,660 (cost) + $1,201 (ending trust fund) = $113,861 |
3. PV Future Taxable Payrolls | $655,013 |
4. Actuarial Balance (Deficit) [(1) – (2)] / (3) | (.0361) |
By comparison, if Social Security’s funded status had been developed by dividing system assets by system liabilities (like we suggest for determining your household funded status) the result for this year under the intermediate assumptions would have been 79.3% ($90,238 / $113,861). To achieve a funded status of 100%, the present value of system assets as of January 1, 2023 would have to be increased by about 26% or the present value of system liabilities as of January 1, 2023 would have to be decreased by about 21% (or some combination of asset increases and liability decreases achieving the same result).
Selecting different assumptions than the intermediate assumptions selected by the Trustees will affect the long-range actuarial balance. For example, in their 2022 report, the Congressional Budget Office (CBO) estimated the 75-year Social Security long-range actuarial deficit to be 4.9% of taxable payroll compared with the Trustees 2022 calculation of 3.42%.
We have no idea whether the OASDI Trustees or the CBO have selected the more accurate assumptions about future Social Security experience. The key point here is not which assumption set is more accurate but that actual future experience may deviate from assumed experience, and it is highly unlikely that assumptions selected today will be exactly accurate for the next 75 years. If actual future experience turns out to be closer to that assumed by the CBO, the funded status included in annual Trustees Reports will decrease over time, all things being equal.
Pattern of Social Security funded status measures since 1983 and expectations for future funded status measurements
Actuarial Note #8 (known this year as Actuarial Note 2023.8) is a little-known, but very informative supplement to the annual Trustees Report. Table 1 of this Actuarial Note is essentially a gain/loss by source analysis for Social Security since the 1983 Amendments. It shows the long-range actuarial balance calculation for each year since 1982. Changes in the long-range actuarial balance calculation are broken down by major source. It is of interest to note that 64% of the decrease in the funded status of Social Security since 1983 is attributable to changes in the valuation date each year, 30% of the decrease is attributable to economic data and assumptions and 13% is attributable to disability data and assumptions. The remaining sources (including demographic data and assumptions) have contributed very little to the decrease in the system’s funded status since 1983. This latter fact is important because it seems to contradict the frequently heard assertion that Social Security’s funded status has deteriorated largely due to demographic experience since 1983.
Actuarial Note 2023.8 also shows that the system has not been in actuarial balance since 1983. And while the decreases in the system’s funded status have not been continuous, the message delivered by the general pattern of decreases is that the system has needed to increase assets or decrease benefits to achieve an actuarial balance for many years now. But, because there was no immediate risk of trust fund depletion, no action has been taken.
Looking at the change in the system’s long-range actuarial balance each year attributable to the change in valuation date in Table 1 of Actuarial Note 2023.8 shows that it is likely that the system’s long-range actuarial balance will continue to decrease each year in the future even if all actuarial assumptions are realized and could easily be in excess of 4% by 2033 if the -.05 annual decreases continue. Ignoring the significant shortfall that may reasonably be expected after the end of the 75-year valuation period each year is essentially equivalent to assuming that annual system cost will equal annual system income for each year subsequent to the end of the 75-year valuation period and effectively results in an overstatement of the system’s current funded status. For some reason unknown to us, this overstatement is not quantified or discussed in the annual Trustees reports.
General limitations of funded status calculations
As discussed above, Social Security’s (or your household) funded status measurement depends on assumptions made about the future. If experience is less favorable than assumed, the funded status will decrease over time. This is generally not as big a problem for households as it is for Social Security as adjustments can periodically be made to strengthen the household funded status by increasing assets or decreasing spending liabilities as the poorer than expected experience emerges. For Social Security, however, Congress has shown that declining funded status measurements due to experience less favorable than assumed (including the 75-year valuation period problem) can be ignored for many years absent the existence of a cash-flow problem.
A second (cash flow) problem associated with funded status calculations can result when assets are relatively back-loaded and or liabilities are relatively front-loaded. This may happen, for example, if Social Security reform includes overly back-loaded benefit reductions/ tax increases designed to bring the system into actuarial balance and, at the same time, preserving (or increasing) benefits for those individuals who are retired or near retired.
The process for making changes to the system--More frequent, but smaller automatic adjustments to system benefit/tax provisions vs. less frequent, but larger adjustments to maintain the system’s long-range actuarial balance
Under current Social Security law, changes in system tax or benefit provisions have to be made through the legislative process, which is never easy. As discussed above, the Social Security Trustees reports have sent clear messages for many years that the system needs tax increases and/or benefit reductions to restore long-range actuarial balance, but no action has been taken by Congress. It can be argued that this delay has resulted in failure by the baby boom generation to properly fund their promised benefits. Some have suggested that a reasonable automatic adjustment approach be enacted to automatically maintain the system’s actuarial balance over time as needed. This would entail more-frequent, but smaller system adjustments rather than less-frequent larger more disruptive adjustments.
Reform that restores the system’s actuarial balance will not guarantee system solvency for a specified period of time, let alone 75 years
Because the system’s long-range actuarial balance depends on the accuracy of 75 years of assumptions and because the current funded status metric effectively assumes that annual system cost will equal annual system income after the end of the 75-year projection period, any reform that simply reduces the long-range actuarial deficit to zero will not guarantee system solvency for any specified period of time, let alone 75 years as may be implied. It is important to consider such reform to be a strengthening of the system’s funded status rather than a fix or a solution to the system’s funding problems. The same would be true, for example, of actions you might take to increase (strengthen) your household funded status from 85% to 100%.
Summary
The actuarial principles used to measure Social Security’s long-range financial condition are very similar to the principles we recommend to help retirees and near retirees with their financial planning. As Social Security reform proposals are examined, it is important to remember that the success of any proposed package of Social Security reforms will depend on how well actual future experience compares with the assumptions made by the trustees and the Social Security actuaries. There is no mechanism in current Social Security law to maintain the system’s actuarial balance once it has been achieved. Therefore, there can be no guarantee that the system’s long-term problem will be “fixed” or “solved” for any specific length of time by enacting specific system changes.
