May 4, 2005
According to a column written for the Wall Street
Journal by Arthur Leavitt, former chairman of the Securities and Exchange
Commission, reducing guaranteed benefits in social security to fund
individual retirement accounts is too risky for most individuals.
Mr. Leavitt cited simulations run by Robert Schiller, a
Yale economist, that showed individuals would have been worse off more than
70 percent of the time if they had used private accounts instead of the
guaranteed social security benefits that otherwise would have been provided.
To be sure, a vicious bear market undermined returns on
equity in recent years. But why
could that not happen again? Should
individuals accept the added risk to have an opportunity to improve the
growth of their retirement nest eggs and to pass that nest egg on to heirs?
Of course, the Schilling simulations not only used some
difficult stock market performance (as well as some very good performing
years) but they assumed that the private accounts would be funded from the
reduced benefits and accumulated interest that otherwise would be purchased
by 4 percent contributions by employees.
While I believe the assumed funding for the private accounts used by
Schilling is consistent with statements made by the President, no precise
financing for the private accounts has been offered by the Bush
All of which leads to two issues. Are the additional returns from private accounts over
guaranteed social security benefits sufficient to justify additional
individual risks? Furthermore,
what do the private accounts do to assure that social security can pay the
benefits already promised?
Almost any simulations of historical equity performance
cannot provide enough returns for private accounts to allow benefit
reductions to those individuals sufficient to meet the unfunded liability of
social security and still provide gains for the individual account holders.
In other words, private accounts cannot solve the social security
problem under any simulated investment performances on historical data.
So why are we talking about private accounts as a
solution to the social security problem?
Perhaps this is the real reason why the President is having so much
trouble convincing the public that private accounts are good for the social
While I am not surprised that private accounts appear
to be more a smoke screen than a solution to social security problems, I am
amazed that private accounts cannot outperform the current social security
system in more than 70 percent of the cases.
Almost any professional financial advisor probably
would assume that social security could get higher investment returns over
time by using a richer choice of investment instruments than the mix of
government bonds that currently are credited to the social security surplus.
Then why do so many individual accounts with the opportunity to use
more efficient investments than currently employed actually perform worse
under simulation than current reality?
My guess is that Schilling is assuming that a portion
of the current promised benefits are the alternative to the private
accounts. But we do not have
enough funds to meet those promises. This is why we have a social security
problem. If the simulations
were adjusted to compare with a likely discount to promised benefits to
reflect underfunded programs, I would expect the private accounts would
outperform current benefits adjusted for funding shortfalls.
(I must admit that I am surprised that a former head of
the SEC does not have the financial acumen to question the validity of the
However, Leavitt still raises a legitimate point.
Risk is undesirable. Private
accounts are risky. Many
individuals will not do as well with the private accounts as with the
guaranteed benefits. Are the expected returns on private accounts sufficiently
high to justify the additional risk?
That is where the analysis really gets interesting.
Who can handle higher risk? The
wealthy. Therefore, those who already have a nest egg can benefit from
the choice offered by individual accounts.
Those who must survive on social security cannot tolerate the risk.
I would maintain that this argues for better investment of social security surplus without establishing individual accounts. However, even the best investment of that surplus will not fund all the promised benefits. Either benefits must be cut (by lowering the payout or delaying the retirement age) or funding must be increased. When will the President show leadership in outlining a program that really will restore the soundness of social security?