Soc Sec XLII: Unfunded Obligation and Transition Cost
In a really timely fashion the Office of the Chief Actuary released their Actuarial Note 2008.1 with the above title last month. It is well worth the read for anyone wanting to cut through the conceptual tangle raised in the recent posts on ‘Unfunded Liabilities’ and ‘Backwards transfers’. In addition it provides us with some new useful terms of art. (h/t Andrew Biggs)
Actuarial Note 2008.1: Unfunded Obligation and Transition Cost. (The Note itself is a frame within the page. Click on HTML and then July and the actual text pops up.) While the substitution of ‘obligation’ for ‘liability’ may seem like a minor point, it actually marks a major sea change in how we think about potential gaps between future Social Security cost and income. A list of new definitions lies below the fold. I’ll try to use these in consistent fashion going forward.
The whole thing is an important read for anyone seriously interested in understanding the actuarial position Social Security is in today and what it would take to transition it to a fully funded pension system along the lines of LMS. And the tables present a nice picture of how that actuarial position has changed over time not only in dollars but as a percentage of payroll and GDP.
Accrued benefit obligations—Future benefit obligations based on past earnings as of the valuation date. Thus, these accrued benefit obligations are relevant only to current participants as of the valuation date. The accrued benefit obligations are based on the primary insurance amount (PIA), the early retirement or delayed retirement factors, and other rules of payment. The accrued benefit obligations include:
1) Benefits scheduled to be paid for current (i) retired-worker beneficiaries and (ii) disabled-worker beneficiaries who continue to be disabled after the valuation date.
2) Retired worker benefits based on PIAs determined as of the valuation date for workers who have reached benefit eligibility age (62) and are not yet receiving benefits.
3) Benefits calculated on a proportional past-service-credit basis determined as of the valuation date for current active participants under age 62. These benefits require a computation of a PIA (PIADIB), as of the valuation date, as if the worker had just became eligible to receive a disabled-worker benefit. These benefits are then adjusted so they may be viewed as benefit levels of a worker aged 62. The adjustments are made depending on the type of worker, as illustrated below.4
a. For workers who survive to age 62 and are not disabled after the valuation date, PIADIB would be indexed to age 62 by the Social Security Average Wage Index, and would then be multiplied by the fraction
(age as of the valuation date – 22) / 40.
b. For workers who survive to age 62, are not disabled as of the valuation date, and become disabled before age 62, PIADIB would be indexed to the date of disability by the Social Security Average Wage Index, and would then be multiplied by the fraction
(age as of the valuation date – 22) /
(age as of the date of disability – 22).
c. For beneficiaries who are disability beneficiaries as of the valuation date, recover from disability before age 62, and survive to age 62, benefits would equal the disability benefit scheduled to be paid until recovery. After reaching age 62, benefits would be computed based on indexing the final disability benefit received before recovery (PIADIB-RECOV) to age 62 by the Social Security Average Wage Index, and would then be multiplied by the fraction
(age as of recovery from disability – 22)/40.
Benefits for auxiliary beneficiaries would be based on the primary worker’s benefits as described above.
Closed group transition cost—Computed like the open group unfunded obligation for a 100-year projection period with the exception that future participants are not included. Specifically, the future cost and future scheduled tax income for only current participants are included in the calculations along with the trust fund assets at the start of the period. The period is extended to 100 years past the valuation date in order to capture the lifetime of all the current participants included in the valuation.
Current participants—All individuals (generations) who are age 15 and older as of the valuation year. This includes all individuals who have been, are, or will be workers and/or beneficiaries. (As noted in Table 3, the age 15 varies for valuation dates before 1984.)
Future cost—The value of OASDI program benefits scheduled in current law and the cost of administering the program.
Future participants—Future workers and beneficiaries, who are under age 15 or not yet born, as of the valuation year. (As noted in Table 3, the age 15 varies for valuation periods before 1984.)
Future scheduled tax income—OASDI tax income scheduled in current law.
Maximum transition cost—The cost of meeting the accrued benefit obligations of the old form while continuing the Social Security program in a completely different form, with all payroll taxes for work after the valuation date credited to the new benefit form. The maximum transition cost is determined as of the valuation date for current and past participants only. It is computed as the difference between
(a) The present value of all future accrued benefit obligations payable on the old form; and
(b) The value of the assets on the valuation date plus the present value of revenue from taxation of future accrued benefit obligations payable on the old form.
The projection period ends 100 years past the valuation date in order to capture the lifetime of all the current participants included in the valuation.
Open group unfunded obligation—Determined as of the valuation date over a specified time period (such as over the long-range 75-year period), computed as the difference between:
(a) The present value of the future cost of the program between the valuation date and the end of the specified time period, and
(b) The sum of the assets in the trust fund as of the valuation date and the present value of the future scheduled tax income of the program between the valuation date and the end of the specified time period.
Future scheduled tax income and cost are projected using the intermediate assumptions for the indicated Trustees Report (the year of the Trustees Report corresponds with the year of the valuation date). All current participants, as well as future participants to the system, over the specified time period are included in the computations.
Past participants—Those who contributed money to the program or received benefits from the program and are no longer alive as of the valuation date.
Sustainable solvency—Indicates that the combined OASDI Trust Funds are expected to be able to pay all scheduled benefits on time over the 75-year projection period and to continue paying all benefits on time for the foreseeable future. Thus, the following two conditions are required to be met:
(a) The level of the trust funds at each point in time during the 75-year projection period is zero or positive, and
(b) The level of the trust funds, expressed as a percent of annual program cost, is stable or rising at the end of the 75-year period.
Valuation date—Beginning of the projection period or January 1 of the starting projection year. This date defines the point in time for determining present values.
Valuation year—First year of the projection period. This year is used to determine current and future participants.