2005 OASDI Trustees Report

IV. ACTUARIAL ESTIMATES

B. LONG-RANGE ESTIMATES

Three types of financial measures are useful in assessing the actuarial status of the Social Security trust funds under the financing approach specified in current law: (1) annual cash-flow measures, including income and cost rates, and balances, (2) trust fund ratios, and (3) summary measures like actuarial balances and unfunded obligations. The first long-range estimates presented are the series of projected annual balances (or net cash flow), which are the differences between the projected annual income rates and annual cost rates. In assessing the financial condition of the program, particular attention should be paid to the level of the annual balances at the end of the long-range period and the time at which the annual balances may change from positive to negative values. The next measure discussed is the pattern of projected trust fund ratios. The trust fund ratio represents the proportion of a year's projected cost that can be paid with the funds available at the beginning of the year. Particular attention should be paid to the level and year of maximum trust fund ratio, to the year of exhaustion of the funds, and to stability of the trust fund ratio in cases where the ratio remains positive at the end of the long-range period. The final measures discussed in this section summarize the total income and cost over valuation periods that extend through 75 years, and to the infinite horizon. These measures indicate whether projected income will be adequate for the period as a whole. The first such measure, actuarial balance, indicates the size of any shortfall as a percentage of the taxable payroll over the period. The second, open group unfunded obligation, indicates the size of any shortfall in present-value discounted dollars. This section also includes a comparison of workers to beneficiaries, a generational decomposition of the infinite future unfunded obligation, the long-range test of close actuarial balance, and the reasons for change in the actuarial balance from the last report.

If the 75-year actuarial balance is zero (or positive), then the trust fund ratio at the end of the period, by definition, will be at 100 percent (or greater) and financing for the program is considered to be adequate for the 75-year period as a whole. (Financial adequacy, or solvency, for each year is determined by whether the trust fund is zero or positive throughout the year.) Whether or not financial adequacy is stable in the sense that it is likely to continue for subsequent 75-year periods in succeeding reports is also important when considering the actuarial status of the program. One indication of this stability, or sustainable solvency, is the behavior of the trust fund ratio at the end of the projection period. If trust fund ratios for the last several years of the long-range period are positive and constant or rising, then it is likely that subsequent Trustees Reports will also show projections of financial adequacy (assuming no changes in demographic and economic assumptions, or the law). The actuarial balance and the open group unfunded obligation for the infinite future provide additional measures of the financial status of the program for the very long range.

1. Annual Income Rates, Cost Rates, and Balances

Basic to the consideration of the long-range actuarial status of the trust funds are the concepts of income rate and cost rate, each of which is expressed as a percentage of taxable payroll. Other measures of the cash flow of the program are shown in appendix F. The annual income rate is the ratio of income from payroll tax contributions and the taxation of benefits to the OASDI taxable payroll for the year. The OASDI taxable payroll consists of the total earnings which are subject to OASDI taxes, with some relatively small adjustments.1 As such, it excludes net investment income and reimbursements from the General Fund of the Treasury for the costs associated with special monthly payments to certain uninsured persons who attained age 72 before 1968 and who have fewer than 3 quarters of coverage.

The annual cost rate is the ratio of the cost of the program to the taxable payroll for the year. The cost is defined to include scheduled benefit payments, special monthly payments to certain uninsured persons who have 3 or more quarters of coverage (and whose payments are therefore not reimbursable from the General Fund of the Treasury), administrative expenses, net transfers from the trust funds to the Railroad Retirement program under the financial-interchange provisions, and payments for vocational rehabilitation services for disabled beneficiaries. For any year, the income rate minus the cost rate is referred to as the balance for the year. (In this context, the term balance does not represent the assets of the trust funds, which are sometimes referred to as the balance in the trust funds.)

Table IV.B1 presents a comparison of the estimated annual income rates and cost rates by trust fund and alternative. Detailed long-range projections of trust fund operations, in nominal dollar amounts, are shown in table VI.F8.

The projections for OASI under the intermediate assumptions show the income rate increasing slowly and steadily due to the gradually increasing effect of the taxation of benefits. The pattern of the cost rate is much different. It is projected to remain fairly stable for the next several years. However, from about 2010 to 2030 the cost rate increases rapidly as the baby-boom generation reaches retirement age. Thereafter, the cost rate rises steadily, but slowly, reflecting projected reductions in death rates and continued relatively low birth rates, reaching 16.57 percent of taxable payroll for 2079. By comparison, the income rate reaches 11.51 percent of taxable payroll for 2079.

Projected income rates under the low cost and high cost sets of assumptions are very similar to those projected for the intermediate assumptions as they are largely a reflection of the tax rates specified in the law. OASI cost rates for the low cost and high cost assumptions differ significantly from those projected for the intermediate assumptions, but follow generally similar patterns. For the low cost assumptions, the cost rate declines somewhat for the first 5 years, and then rises, reaching the current level around 2013 and a peak of 13.09 percent of payroll for 2035. The cost rate then declines gradually, reaching a level of 12.09 percent of payroll for 2079 (at which point the income rate reaches 11.26 percent). For the high cost assumptions, the cost rate rises generally throughout the 75-year period. It rises at a relatively fast pace between 2010 and 2030 because of the aging of the baby-boom generation. During the third 25-year subperiod, the projected cost rate continues rising and reaches 23.33 percent of payroll for 2079.

The pattern of the projected OASI annual balance is important in the analysis of the financial condition of the program. Under the intermediate assumptions, the annual balance is positive for 13 years (through 2017) and is negative thereafter. This annual deficit rises rapidly, reaching over 2 percent of taxable payroll by 2025, and continues rising thereafter, to a level of 5.07 percent of taxable payroll for 2079.

Under the low cost assumptions, the projected OASI annual balance is positive for 16 years (through 2020) and thereafter is negative. The annual deficit under the low cost assumptions rises to a peak of 1.82 percent of taxable payroll for 2035, but declines over the next 15 to 20 years, as the effect of the baby-boom generation diminishes and the assumed higher fertility rates increase the size of the work force. The deficit under the low cost assumptions continues to decline, but at a relatively slow pace over the period 2051 through 2079. Under the high cost assumptions, however, the OASI balance is projected to be positive for only 10 years (through 2014) and to be negative thereafter, with a deficit of 1.80 percent for 2020, 7.12 percent for 2050, and 11.45 percent of payroll for 2079.

Notes:
1. The income rate excludes interest income and certain transfers from the General Fund of the Treasury.
2. Some historical values are subject to change due to revisions of taxable payroll.
3. Totals do not necessarily equal the sums of rounded components.

Under the intermediate assumptions, the cost rate for DI generally increases over the long-range period from 1.83 percent of taxable payroll for 2005, reaching 2.51 for 2079. The income rate increases only very slightly from 1.82 percent of taxable payroll for 2005 to 1.87 percent for 2079. The annual balance is a very small negative in 2005, and the annual deficit reaches 0.64 percent for 2079.

Under the low cost assumptions, the DI cost rate is fairly stable over the long-range period, reaching 1.76 percent for 2079. The annual balance is positive throughout the long-range period. For the high cost assumptions, DI cost rises much more, reaching 3.43 percent for 2079. Annual deficits begin in 2005 and reach 1.53 percent for 2079.

Figure IV.B1 shows in graphical form the patterns of the OASI and DI annual income rates and cost rates. The income rates shown here are only for alternative II in order to simplify the graphical presentation because, as shown in table IV.B1, the variation in the income rates by alternative is very small. Income rates increase generally, but at a slow rate for each of the alternatives over the long-range period. Both increases in the income rate and variation among the alternatives result from the relatively small component of income from taxation of benefits. Increases in income from taxation of benefits reflect increases in the total amount of benefits paid and the fact that an increasing share of individual benefits will be subject to taxation, because benefit taxation threshold amounts are not indexed.

The patterns of the annual balances for OASI and DI are suggested by figure IV.B1. For each alternative, the magnitude of each of the positive balances in the early years, as a percent of taxable payroll, is represented by the distance between the appropriate cost-rate curve and the income-rate curve above it. The magnitude of each of the deficits in subsequent years is represented by the distance between the appropriate cost-rate curve and the income-rate curve below it.

In the future, the cost of OASI, DI and the combined OASDI programs as a percent of taxable payroll will not necessarily be within the range encompassed by alternatives I and III. Nonetheless, because alternatives I and III define a reasonably wide range of demographic and economic conditions, the resulting estimates delineate a reasonable range for consideration of potential future program costs.

Figure IV.B1.—Long-Range OASI and DI Annual Income Rates and Cost Rates

[As a percentage of taxable payroll]

[D]

The cost of the OASDI program has been discussed in this section in relation to taxable payroll, which is a program-related concept that is very useful in analyzing the financial status of the OASDI program. The cost can also be discussed in relation to broader economic concepts, such as the gross domestic product (GDP). OASDI outlays generally rise from about 4.3 percent of GDP currently to about 6.4 percent of GDP by the end of the 75-year projection period under alternative II. Discussion of both the cost and the taxable payroll of the OASDI program in relation to GDP is presented in appendix VI.F.2.

2. Comparison of Workers to Beneficiaries

The primary reason that the estimated OASDI cost rate increases rapidly after 2010 is that the number of beneficiaries is projected to increase more rapidly than the number of covered workers. This occurs because the relatively large number of persons born during the baby-boom will reach retirement age, and begin to receive benefits, while the relatively small number of persons born during the subsequent period of low fertility rates will comprise the labor force. A comparison of the numbers of covered workers and beneficiaries is shown in table IV.B2.