Short-Range Actuarial Projections of the Old-Age, Survivors, and Disability Insurance Program, 2001 Actuarial Study No. 115 Chris Motsiopoulos and Tim Zayatz, A.S.A.

## II. ASSUMPTIONS

Income and outgo to the OASI and DI Trust Funds depend on many economic, demographic, and programmatic factors. These include labor force participation, unemployment, productivity, inflation, fertility, mortality, net immigration, marriage, divorce, retirement patterns, and disability incidence and termination. Income depends on how these factors affect the size and composition of the working population and the general level of earnings. Similarly, outgo depends on how these factors affect the size and composition of the beneficiary population and the general level of benefits.

Estimates for the annual Trustees Report are prepared under a range of assumptions:

• Alternative I is characterized as low-cost-it assumes relatively rapid economic growth, low inflation, and favorable (from the standpoint of program financing) demographic conditions.

• Alternative II is characterized as intermediate-it represents the Trustees' best estimates of likely future economic and demographic conditions.

• Alternative III is characterized as high-cost-it assumes slow economic growth, more rapid inflation, and financially disadvantageous demographic conditions.

Sections II, III and IV of this study present estimates from the intermediate set of assumptions for the 2001 Trustees Report. Section V presents results based on the low-cost and high-cost alternatives.

### A. ECONOMIC ASSUMPTIONS

An econometric model designed by the Office of the Chief Actuary relates the various economic assumptions to produce estimates critical to the OASDI program. These include: total and average wages in covered employment; the number of workers in covered employment; automatic cost-of-living adjustments (COLAs); and average wages used for Social Security indexing purposes.

Table II.1 summarizes the principal economic assumptions under the intermediate estimates. In the discussion that follows, assumptions under the low-cost and high-cost alternatives are presented for comparison. For details regarding the alternative assumptions, refer to tables V.A1 and V.B1.

#### 1. Gross Domestic Product

One of the broadest measures of the future course of the economy is the estimated growth in GDP-the total dollar value of all goods and services produced by labor and property located in the U.S. Under intermediate assumptions, the average annual growth rate in real GDP over the next 10 years, 2001-10, is estimated to be 2.4 percent. This is somewhat slower than the average growth rate of 3.4 percent over the most recent 10-year period, 1991-2000 due to slower projected growth in labor force and productivity.

In contrast, the low-cost alternative predicts an annual growth rate of 2.9 percent over the next 10 years due to a higher assumed rate of growth in labor productivity. The high-cost alternative predicts increased inflation and weaker economic growth as two intermittent recessions and modest recoveries characterize the next 10 years.

#### 2. Covered Wages

The average covered wage is the average amount of total wages in covered employment for each year, including wages in excess of the OASDI contribution and benefit base. Preliminary estimates show that the average wage in covered employment increased by 5.5 percent in 2000. Projected covered wage increases equal the percentage increase in CPI plus the real-wage differential.

#### 3. Consumer Price Index

Prices rose by 3.5 percent in 2000, as measured by the rate of increase in the CPI (Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W). Under intermediate assumptions, the average annual inflation rate over the period 2001-10 is roughly 3.2 percent. This is somewhat higher than the average annual inflation rate of 2.9 percent experienced during the 1990s.

In contrast, over the next 10 years the low-cost alternative predicts average annual inflation of 2.4 percent, whereas the high-cost alternative predicts 4.3 percent. Ultimate rates of inflation for the different alternatives are as follows: 2.3 percent for low-cost, attained in 2004; 3.3 percent for intermediate, attained in 2006; and 4.3 percent for high-cost, attained in 2008.

#### 4. Real-Wage Differential

The real-wage differential is the difference between nominal wage growth and inflation. Historically, it is calculated as the percentage increase in the average nominal wage in OASDI covered employment, minus the percentage increase in the CPI. The ultimate real-wage differentials for the low-cost, intermediate, and high-cost alternatives are 1.5, 1.0, and 0.5 percent, respectively.

The primary factor in projecting real-wage differentials is growth in productivity-a measure of real output per hour worked. The ultimate annual increases in productivity for the low-cost, intermediate, and high-cost alternatives are 1.8, 1.5, and 1.2 percent, respectively.

Note that the real wage gains are not equivalent to the gains in productivity. However, they are closely related and the econometric model links the two by further considering changes in: the average number of hours worked; labor's share of output; the proportion of compensation paid as wages; and technical price adjustments.

#### 5. Unemployment

The unemployment rate is based on the Bureau of Labor Statistics (BLS) definition from the Current Population Survey, and represents the average weekly number of unemployed persons, age 16 and over, in the U.S. in a calendar year. It is calculated as the ratio of unemployed persons to the civilian (non-military) labor force. The intermediate estimates assume the unemployment rate will increase gradually from 4.0 percent in 2000 to an ultimate value of 5.5 percent by 2010. In contrast, ultimate unemployment rates for the low-cost and high-cost alternatives are 4.5 and 6.5 percent, respectively.

Note that estimates after the first several projected years are intended to represent the average experience for those years, and do not necessarily reflect year-over-year levels. Actual future unemployment rates-as well as other economic parameters found in this section-will likely exhibit fluctuations or cyclical patterns, as in the past.

#### 6. Labor Force

Like the unemployment rate, the total labor force is based on the BLS definition representing the average weekly number of employed persons age 16 or over. The intermediate assumptions predict a significant slowing of growth in the working-age population as the baby-boomers approach retirement, and lower-birth-rate cohorts attain working age. In addition it predicts a slowing of the rapid growth in female labor force participation rates experienced during the 1990s. During the 1980s, the average annual rate of growth in the labor force was roughly 1.7 percent; during the 1990s average annual growth fell to 1.1 percent; over the next 10 years annual growth is expected to fall to 0.8 percent.

#### 7. Indexing Wages

The average wage indexing series is similar to the covered wage series in that both reflect amounts above the contribution and benefit base. However, the indexing series reflects wages not covered by the OASDI program1. The average wage index for each year after 1950 is used to index the earnings of most workers who become eligible for benefits in 1979 or later. This procedure converts a worker's past earnings to relatively equivalent values around the time of retirement or other eligibility. The worker's indexed earnings are used to calculate the Average Indexed Monthly Earnings (AIME), which in turn is used to calculate the Primary Insurance Amount (PIA) and Monthly Benefit Amount (MBA). The average wage index is also used for adjusting most of the program amounts that are subject to the automatic-adjustment provisions.

Table II.2 shows the historical average wage indexing series for 1951-99, and projected values for 2000-10. Tables V.A2, and V.B2 show low-cost and high-cost alternatives, respectively.

Table II.3 shows the automatic COLA (benefit increase), the increase in the average wage index, the OASDI contribution and benefit base (wage base), and the retirement test exempt amounts. Table II.4 shows other OASDI program amounts determined under the automatic-adjustment provisions.

The benefit increase for December 2000 is 3.5 percent, based on the increase in the CPI from the third quarter of 1999 through the third quarter of 2000. The increase first applies to the December benefit, which is payable in January 2001.

The wage index for 1999 is \$30,469.84, and is used to determine each of the following items:

• The wage base for 2001 is \$80,400. Employees and employers will each pay a tax rate of 6.2 percent on wages up to the wage base-that is, a person with \$80,400 or more in wages will pay the maximum \$4,984.80 in OASDI taxes in 2001. Refer to appendix A. for details on determining the wage base.

• The retirement test exempt amounts for 2001 are \$10,680 for beneficiaries under normal retirement age (NRA)-currently 65; and \$25,000 for those age NRA-69. The latter amount is provided by Public Law 104-121. Under the retirement test, beneficiaries under NRA will have a \$1 reduction in benefits for every \$2 in earnings over \$10,680. Public Law 106-182 eliminates the earnings test for workers attaining NRA through age 69 in 2000 or later. However, the limits still apply to all months prior to the beneficiary's birthday in the year he or she attains NRA, specifically a \$1 reduction in benefits for every \$3 in earnings over \$25,000.

• The bend points used in determining a beneficiary's PIA are \$561 and \$3,381. For an old-age beneficiary retiring at age 62 in 2001, the PIA is determined as follows: (90 percent of the first \$561 of AIME) + (32 percent of AIME in excess of \$561 but not in excess of \$3,381) + (15 percent of AIME in excess of \$3,381).

• The bend points used in determining a beneficiary's maximum family benefit (MFB) are \$717, \$1,034, and \$1,349. For an old-age beneficiary retiring at age 62 in 2001, the MFB is determined as follows: (150 percent of the first \$717 of PIA) + (272 percent of PIA in excess of \$717 but not in excess of \$1,034) + (134 percent of PIA in excess of \$1,034 but not in excess of \$1,349) + (175 percent of PIA in excess of \$1,349).

• The amount of earnings required to receive one quarter of coverage in 2001 is \$830. In order to be insured for benefits, the beneficiary must acquire a requisite number of quarters of coverage.

• The "old-law" contribution and benefit base for 2001 is \$59,700. This is the base that would have been in effect before the enactment of the 1977 amendments. The old-law base is used in determining special-minimum benefits for certain workers who have many years of low earnings in covered employment, and also in calculating OASDI benefits for workers who are eligible to receive pensions based on noncovered employment. In addition, it is used for certain purposes under the Railroad Retirement program, and in determining the maximum pension guaranteed under ERISA.

Details on determining each year's average wage index and related OASDI program amounts are described in a separate actuarial note.2

#### 9. Nominal Interest Rates

Investment policy for the trust funds is set by law (see Interest in section IV. TRUST FUND INCOME AND OUTGO for more detail). Non-marketable securities called special issues are issuable only to the trust funds and include certificates of indebtedness-short-term securities maturing within 12 months of issue-and bonds maturing 1 to 15 years in the future. Interest rates earned by these securities are based on the average market yield of all U.S. Treasury securities maturing 4 or more years in the future. Rates are calculated at the beginning of each month and apply to all new investments purchased during the month. Table II.5 shows the nominal monthly rates and the average nominal rate for the year.

Although most of the trust fund assets are currently invested in non-marketable special issues-all but \$40.25 million as of the end of 2000-assets may be invested in any interest bearing security issued by the Federal Government. Marketable securities include publicly traded Treasury bonds, notes, and bills.

#### 10. Effective Interest Rates

Also shown in Table II.5 is the annual effective rate earned by the overall assets of the trust funds in each year. This rate is calculated as the amount of interest earned during the year divided by the average level of assets for the year. Since almost all of the interest to the trust funds is paid at the end of June and December, an average balance is calculated for each calendar half-year based on detailed cash flow data of the trust funds. Dividing total interest earned by the sum of the average balances for each half-year produces the desired effective rate.

Effective rates can also be estimated by calculating the dollar-weighted rate of return for the year-or for each half- year period compounded to yield an annual rate. The dollar-weighted return is the interest rate that satisfies the following equation:

$assets$bop + PV(income) = PV(outgo) + PV(assetseop)

In words, the desired effective rate equates (i) the assets at the beginning of the period plus the present value of trust fund income, to (ii) the present value of trust fund outgo plus the present value of assets at the end of the period. Income and outgo are discounted from various times throughout the month based on detailed cash flow data.

### B. DEMOGRAPHIC ASSUMPTIONS

Table II.6 summarizes the principal demographic assumptions under the intermediate estimates. In the discussion that follows, principal demographic assumptions under the low-cost and high-cost alternatives are presented for comparison. For details regarding the alternative assumptions, refer to tables V.A5 and V.B5.

#### 1. Fertility Rate

For the intermediate projection, the assumed ultimate total fertility rate of 1.95 children per woman is attained in 2025 after a gradual decline from the 2000 level of 2.07. In contrast, ultimate levels of fertility for low-cost and high-cost alternatives by 2025 are 2.2 and 1.7, respectively. Estimates are based on recent fertility rates and evolving trends in age-specific birth rates.

#### 2. Death Rate

The age-sex-adjusted death rate is assumed to decrease steadily during the entire projection period. The intermediate assumption predicts a total reduction of 40 percent from the 2000 level by 2075. In contrast, over the same period the low-cost alternative predicts a total reduction of 17 percent; the high-cost alternative predicts a total reduction of 60 percent.

Of the estimated 2.52 million deaths that occurred in 2000, 1.89 million (75 percent) were individuals age 65 or older. Since changes in mortality at these ages directly affect benefit payments, death rates for ages 65 and older are an integral part of the future financial status of the OASDI program. Since 1900, mortality at ages 65 and older has declined roughly 0.74 percent per year. Since 1982, the rate of decline has been less dramatic, about 0.40 percent annually. However, based on potential future changes in health care and life style, the assumed ultimate average annual rate of decline in age-sex-adjusted death rates for ages 65 and older is 0.65 percent under the intermediate assumptions.

#### 3. Life Expectancy

A period life expectancy table is based on observed mortality rates for all ages in a given year. For example: age-65 period life expectancy in 2000 is based on age-65 mortality in 2000, age-66 mortality in 2000, etc. A cohort life expectancy table is based on an assumed set of mortality rates for all future years. For example: age-65 cohort life expectancy in 2000 is based on age-65 mortality in 2000, age-66 mortality in 2001, etc.

Under intermediate assumptions, period life expectancy for a newborn increases from 73.8 years in 2000 to 80.9 years by 2075 for a male; and from 79.5 years in 2000 to 85.0 years in 2075 for a female. Life expectancy at age 65 increases from 15.7 years in 2000 to 19.7 years by 2075 for a male; and from 19.1 years in 2000 to 22.6 years in 2075 for a female.

Under the low-cost alternative, period life expectancy for a newborn increases to 77.4 years for a male and 81.7 years for a female, by 2075. Life expectancy at age 65 increases to 17.1 years for a male and 19.9 years for a female, by 2075.

Under the high-cost alternative, period life expectancy for a newborn increases to 85.2 years for a male and 89.0 years for a female, by 2075. Life expectancy at age 65 increases to 23.0 years for a male and 25.9 years for a female, by 2075.

Although not shown, cohort life expectancies are somewhat greater than period life expectancies. This is because death rates for any given age are assumed to decline in the future.3

#### 4. Immigration

Total net immigration is assumed to be 900,000 persons per year for the intermediate projection. The assumed level of net annual immigration is the combination of 600,000 net legal immigrants per year and 300,000 net other-than-legal immigrants per year. In contrast, annual net immigration for the low-cost and high-cost alternatives is estimated to be 1,210,000 and 655,000, respectively.

Actual future values for the demographic factors will likely exhibit cyclical fluctuations; the values assumed here are intended to represent the average experience for such cycles. Details of the various factors used to derive the demographic assumptions are described in a separate actuarial study.4

### C. PROGRAMMATIC ASSUMPTIONS

Table II.7 summarizes the principal programmatic assumptions under the intermediate estimates. In the discussion that follows, principal programmatic assumptions under the low-cost and high-cost alternatives are presented for comparison. For details regarding the alternative assumptions, refer to tables V.A6 and V.B6.

#### 1. Coverage Rate

The projection of the number of people working in covered employment is developed within the econometric model referred to earlier. The coverage rate summarizes the number of persons with any covered employment during the year as a percentage of the working-age population.

#### 2. Fully Insured

Fully insured status is required of a worker for most types of OASDI benefits. This status is obtained by earning one quarter of coverage (QC)5 for each year after attainment of age 21 and before the earliest of (i) attainment of age 62, (ii) onset of disability, or (iii) death. Projections of the fully insured population are made by age and gender based on recent experience and projected labor force participation rates, as described in section III. As shown, the percentage of the population age 62 or older that is fully insured increases throughout the short-range period to roughly 84 percent by 2010. This pattern is attributable in part to the increase in female labor force participation experienced during the 1990s.

#### 3. Disability Insured

Disability insured status is required of a worker for eligibility for a primary disability benefit and auxiliary benefits to family members. To be insured for disability benefits, a worker must accrue a sufficient number of QCs to be deemed fully insured, and in addition must have worked recently in covered employment. The number of required QCs varies by age, and ranges from 6 out of the last 12 quarters, to 20 out of the last 40. The disability insured population expressed as a percentage of the fully insured population is projected by age and gender based on recent experience and labor force participation rates, as described in section III.A. The disability insured rates shown are ratios of the disability insured population to the total population aged 15 to normal retirement age, as of December 31. Overall, the percentage of the population that is disability insured is projected to steadily rise throughout the short-range period.

#### 4. Disability Incidence Rate

The general decline in disability incidence between 1975-82 is attributable in part to a "stricter" program. Following a period of very low growth in incidence from 1983-89, the DI program experienced a surge in disability claims beginning in 1990 and incidence rates rose significantly through 1995. Most recently, the prevailing economic and political environment has been characterized by robust economic expansion, low unemployment, and legislative restrictions on certain impairments. These and other factors have contributed to the decline in applications and awards over the last several years. The intermediate estimates show a slight increase in incidence from roughly 4.6 disabled workers per thousand insured in 2000, to 4.8 per thousand by 2010. In contrast, the low-cost alternative predicts a decline in incidence to 4.0 per thousand by 2010; the high-cost alternative predicts an increase to 5.5 per thousand.

#### 5. Disability Termination Rate

Most disabled worker benefits are terminated as a result of death or conversion to old-age benefits. Recovery is a smaller yet more volatile termination category, subject to significant swings as it is influenced by new legislation and budgetary constraints. The downward trend in the overall disability termination rate is the result of two significant trends in the DI rolls that have developed over the years: (i) falling death rates, and (ii) the prominence of mental impairments, which has led to an increase in younger and physically healthier beneficiaries. The result has been fewer old-age conversions, as well as fewer deaths. These trends are expected to continue at a more moderate pace as the termination rate falls from 88.6 per thousand beneficiaries in 2000 to 83.4 per thousand in 2002.

In 2003, the termination rate falls sharply reflecting a large decline in conversions as the normal retirement age begins to increase 2 months each year until reaching age 66. As a result, a portion of the annual conversions get deferred from one year to the next until the transition is complete by 2009. This accounts for the sharp increase in the termination rate in that year. For more details, see Conversion in section III. Benefit Payments.

Further details on trends in disability incidence and termination are described in the next section. A complete discussion can be found in Actuarial Study No. 114.6

1 For a more precise definition and history of the indexing series, see Title 20, Chapter III, section 404.211(c) of the Code of Federal Regulations, and Actuarial Note No. 103: Average Wages for Indexing Under the Social Security Act and the Automatic Determinations for 1979-81 (Eli Donkar, May 1981).

2 Actuarial Note No. 133: Average Wages for 1985-90 for Indexing Under the Social Security Act (Michael Clingman and Jeffrey Kunkel, September 1992).

3 For details on period and cohort life expectancies, refer to Actuarial Study No. 107: Life Tables for the United States Social Security Area 1900-2080 (Felicitie Bell, Alice Wade, and Stephen Goss, August 1992).

4 Actuarial Study No. 112: Social Security Area Population Projections: 1997 (Felicitie Bell, August 1997).

5 In 2001, a worker receives one QC (up to a maximum of four) for each \$830 of annual covered earnings. This dollar amount is indexed each year by increases in average wages.

6 Actuarial Study No. 114: Social Security Disability Insurance Program Worker Experience (Tim Zayatz, June 1999).

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December 26, 2001