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.

Notes:
1. The number of beneficiaries does not include uninsured individuals who receive benefits under Section 228 of the Social Security Act. Costs are reimbursed from the General Fund of the Treasury for most of these individuals.
2. Historical covered worker data are subject to revision.
3. Totals do not necessarily equal the sums of rounded components.

The impact of the demographic shifts under the three alternatives on the OASDI cost rates is readily seen by considering the projected number of beneficiaries per 100 workers. As compared to the 2004 level of 30 beneficiaries per 100 covered workers, this ratio is estimated to rise significantly by 2080 to 41 under the low cost assumptions, 54 under the intermediate assumptions, and 71 under the high cost assumptions. The significance of these numbers can be seen by comparing figure IV.B1 to figure IV.B2.

For each alternative, the shape of the curve in figure IV.B2, which shows beneficiaries per 100 covered workers, is strikingly similar to that of the corresponding cost-rate curve in figure IV.B1, thereby emphasizing the extent to which the cost of the OASDI program as a percentage of taxable payroll is determined by the age distribution of the population. Because the cost rate is basically the product of the number of beneficiaries and their average benefit, divided by the product of the number of covered workers and their average taxable earnings (and because average benefits rise at about the same rate as average earnings), it is to be expected that the pattern of the annual cost rates is similar to that of the annual ratios of beneficiaries to workers.

Figure IV.B2.—Number of OASDI Beneficiaries Per 100 Covered Workers

[D]

Table IV.B2 also shows that the number of covered workers per beneficiary, which was about 3.3 in 2004, is estimated to decline in the future. Based on the intermediate assumptions, the ratio declines to 2.1 by 2031, and 1.9 workers per beneficiary by 2062. Based on the low cost assumptions, for which high fertility rates and small reductions in death rates are assumed, the ratio declines to 2.3 by 2032, and then rises back to a level of 2.4 by 2045. Based on the high cost assumptions, for which low fertility rates and large reductions in death rates are assumed, the decline is much greater, reaching 1.8 by 2038, and 1.4 workers per beneficiary by 2075.

3. Trust Fund Ratios

Trust fund ratios are useful indicators of the adequacy of the financial resources of the Social Security program at any point in time. For any year in which the projected trust fund ratio is positive (i.e., the trust fund holds assets at the beginning of the year), but is not positive for the following year the trust fund is projected to become exhausted during the year. Under present law, the OASI and DI Trust Funds do not currently have the authority to borrow. Therefore, exhaustion of the assets in either fund during a year would mean there are no longer sufficient assets in the fund to cover the full amount of benefits scheduled for the year under present law.

The trust fund ratio also serves an additional important purpose in assessing the actuarial status of the program. When the financing is adequate for the timely payment of full benefits throughout the long-range period, the stability of the trust fund ratio toward the end of the period indicates the likelihood that this projected adequacy will continue for subsequent Trustees Reports. If the trust fund ratio toward the end of the period is level (or increasing), then projected adequacy for the long-range period is likely to continue for subsequent reports.

Table IV.B3 shows, by alternative, the estimated trust fund ratios (without regard to advance tax transfers that would be effected after the end of the 10-year, short-range period) for the separate and combined OASI and DI Trust Funds. Also shown in this table is the year in which a fund is estimated to become exhausted, reflecting the effect of the provision for advance tax transfers. The patterns of the OASI and DI trust fund ratios, over the 75-year period, are shown graphically in figure IV.B3 for all three sets of assumptions. A graphical presentation of the combined OASDI ratios is shown in figure II.D7.

Based on the intermediate assumptions, the OASI trust fund ratio rises steadily from 341 percent at the beginning of 2005, reaching a peak of 469 percent at the beginning of 2015. This increase in the OASI trust fund ratio results from the fact that the annual income rate (which excludes interest) exceeds annual outgo for several years (see table IV.B1). Thereafter, the OASI trust fund ratio declines steadily, with the OASI Trust Fund becoming exhausted in 2043. The DI trust fund ratio follows a pattern that is similar but unfolds more rapidly. The DI trust fund ratio is estimated to peak at 215 percent at the beginning of 2005, declining thereafter until becoming exhausted in 2027.

The trust fund ratio for the combined OASI and DI Trust Funds rises from 320 percent for 2005 to a peak of 418 percent at the beginning of 2015. Thereafter, the ratio declines, with the combined funds becoming exhausted in 2041. Based on the intermediate estimates in last year's report, the peak fund ratio for the combined funds was estimated to be 448 percent for 2015 and the year of exhaustion was estimated to be 2042.

The trust fund ratio for the OASDI program first declines in 2016, about 1 year before annual expenditures begin to exceed noninterest income. This occurs because the increase in trust fund assets during 2015, which reflects interest income and a small excess of noninterest income over cost, occurs at a slower rate than does the increase in the annual cost of the program between 2015 and 2016.

After 2015 the dollar amount of assets is projected to continue to rise through the beginning of 2027 because interest income more than offsets the shortfall in noninterest income. Beginning in 2017, the OASDI program is projected to experience increasingly large cash-flow shortfalls that will require the trust funds to redeem special public-debt obligations of the General Fund of the Treasury. This will differ from the experience of recent years when the trust funds have been net lenders to the General Fund of the Treasury. The change in the cash flow between the trust funds and the general fund is expected to have important public policy and economic implications that go well beyond the operation of the OASDI program itself.

Based on the low cost assumptions, the trust fund ratio for the DI program increases throughout the long-range projection period, reaching the extremely high level of 1,401 percent for 2080. At the end of the long-range period, the DI trust fund ratio is rising by 23 percentage points per year. Thus, subsequent reports are likely to contain projections of adequate long-range financing of the DI program under a similar optimistic set of assumptions. For the OASI program, the trust fund ratio rises to a peak of 551 percent for 2019, dropping thereafter to a level of 333 percent by 2080. At the end of the period the OASI trust fund ratio is declining by 3 percentage points per year. The long-term outlook for the DI program is improved more than for the OASI program largely because lower assumed disability incidence rates have a substantial effect on the DI program but little net effect on the OASI program. For the OASDI program, the trust fund ratio peaks at 523 percent for 2021, and then generally falls to 468 percent for 2080, and is rising by 1 percentage point per year. Thus, due to the size of the trust fund ratios and their near stability, subsequent Trustees Reports are likely to contain projections of adequate long-range financing of the OASI and combined OASI and DI program under the low cost assumptions. A stable trust fund ratio at the end of the valuation period indicates that the actuarial balance for Trustees Reports in subsequent years can be expected to remain about the same as long as assumptions are realized.

In contrast, under the high cost assumptions, the OASI trust fund ratio is estimated to peak at 395 percent for 2009, thereafter declining to fund exhaustion by the end of 2033. The DI trust fund ratio is estimated to peak at 209 percent for 2005, thereafter declining to fund exhaustion by the end of 2014. The combined OASDI trust fund ratio is estimated to rise to a peak of 347 percent for 2008, declining thereafter to fund exhaustion by the end of 2030.

Thus, because large ultimate cost rates are projected under all but the low cost assumptions, it is likely that income will eventually need to be increased, and/or program costs will need to be reduced in order to prevent the trust funds from becoming exhausted.

Even under the high cost assumptions, however, the combined OASI and DI funds on hand plus their estimated future income would be able to cover their combined cost for 25 years into the future (until 2030). Under the intermediate assumptions the combined starting funds plus estimated future income would be able to cover cost for about 36 years into the future (until 2041). The program would be able to cover cost for the foreseeable future under the more optimistic low cost assumptions. In the 2004 report, the combined trust funds were projected to become exhausted in 2031 under the high cost assumptions and in 2042 under the intermediate assumptions.

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Note: See definition of trust fund ratio. The combined ratios shown for years after the DI fund is estimated to be exhausted are theoretical and are shown for informational purposes only.

A graphic illustration of the trust fund ratios for the separate OASI and DI Trust Funds is shown in figure IV.B3 for each of the alternative sets of assumptions. A graphic illustration of the trust fund ratios for the combined trust funds is shown in figure II.D7.

Figure IV.B3.—Long-Range OASI and DI Trust Fund Ratios

[Assets as a percentage of annual expenditures]

[D]

4. Summarized Income Rates, Cost Rates, and Balances

Summarized income and cost rates, along with their components, are presented in table IV.B4 for 25-year, 50-year, and 75-year valuation periods. Income rates reflect the scheduled payroll tax rates and the projected income from the taxation of scheduled benefits expressed as a percentage of taxable payroll. The current combined payroll tax rate of 12.4 is scheduled to remain unchanged in the future. In contrast, the projected income from taxation of benefits, expressed as a percent of taxable payroll, is expected to increase continually throughout the long-range period. This is because increasing income from taxation of benefits reflects not only rising benefit and income levels, but also the fact that benefit-taxation threshold amounts are not indexed. Summarized income rates also include the starting trust fund balance. Summarized cost rates include the cost of reaching a target trust fund of 100 percent of annual cost at the end of the period in addition to the cost included in the annual cost rates.

It may be noted that the payroll tax income expressed as a percentage of taxable payroll is slightly smaller than the actual tax rates in effect for each period. This results from the fact that all OASDI income and cost amounts presented in this report are computed on a cash basis, i.e., amounts are attributed to the year in which they are actually received by, or expended (payable) from, the fund, while taxable payroll is attributed to the year in which earnings are paid. Because earnings are paid to workers before the corresponding payroll taxes are credited to the funds, payroll tax income for a particular year reflects a combination of the taxable payrolls from that year and from prior years, when payroll was smaller. Dividing payroll tax income by taxable payroll for a particular year, or period of years, will thus generally result in an income rate that is slightly less than the applicable tax rate for the period.

Summarized values for the full 75-year period are useful in analyzing the long-range adequacy of financing for the program over the period as a whole under present law and under proposed modifications to the law.

Table IV.B4 shows summarized rates for valuation periods of the first 25, the first 50, and the entire 75 years of the long-range projection period, including the funds on hand at the start of the period and the cost of accumulating a target trust fund balance equal to 100 percent of annual cost by the end of the period. The actuarial balance for each of these three valuation periods is equal to the difference between the summarized income rate and the summarized cost rate for the corresponding period. An actuarial balance of zero for any period would indicate that estimated cost for the period could be met, on average, with a remaining trust fund balance at the end of the period equal to 100 percent of the following year's cost. A negative actuarial balance indicates that, over the period, the present value of income to the program plus the existing trust fund falls short of the present value of the cost of the program plus the cost of reaching a target trust fund balance of 1 year's cost by the end of the period. Combined with a falling trust fund ratio, this signals the possibility of continuing cash-flow deficits, implying that the current-law level of financing is not sustainable.

The values in table IV.B4 show that the combined OASDI program is expected to operate with a positive actuarial balance over the 25-year valuation period under the low cost and intermediate assumptions. For the 25-year valuation period the summarized values indicate actuarial balances of 1.94 percent of taxable payroll under the low cost assumptions, 0.83 percent under the intermediate assumptions, and -0.60 percent under the high cost assumptions. Thus, the program is more than adequately financed for the 25-year valuation period under all but the high cost projections. For the 50-year valuation period the OASDI program would have a positive actuarial balance of 0.67 percent under the low cost assumptions, but would have deficits of 1.13 percent under the intermediate assumptions and 3.40 percent under the high cost assumptions. Thus, the program is more than adequately financed for the 50-year valuation period under only the low cost set of assumptions.

For the entire 75-year valuation period, the combined OASDI program would again have actuarial deficits except under the low cost set of assumptions. The actuarial balance for this long-range valuation period is projected to be 0.38 percent of taxable payroll under the low cost assumptions, -1.92 percent under the intermediate assumptions, and -4.96 percent under the high cost assumptions.

Assuming the Trustees' intermediate assumptions are realized, the deficit of 1.92 percent of payroll indicates that financial adequacy of the program for the next 75 years could be restored if the Social Security payroll tax were immediately and permanently increased from its current level of 12.4 percent (combined employee-employer shares) to 14.32 percent. Alternatively, all current and future benefits could be reduced by 12.8 percent (or there could be some combination of tax increases and benefit reductions). Changes of this magnitude would be sufficient to eliminate the actuarial deficit over the 75-year projection period. However, because of the projected increase in the average age of the population, projected annual deficits begin in 2017 and increase to levels nearly 6 percent of taxable payroll by the end of the 75-year period.

The large annual deficits at the end of the projection period indicate that the annual cost will very likely continue to exceed tax revenues after 2079 under the intermediate assumptions. As a result, ensuring the sustainability of the system would eventually require larger changes than those needed to restore actuarial balance for the 75-year period. For the infinite future, the actuarial deficit is estimated to be 3.5 percent of taxable payroll under the intermediate assumptions. This means that financial adequacy of the OASDI program could be restored permanently if the combined payroll tax rate were immediately and permanently raised from 12.4 percent to about 15.9 percent, or if all current and future benefits were immediately reduced by 22 percent.

As may be concluded from table IV.B4, the financial condition of the DI program is substantially weaker than that of the OASI program for the first 25 years. Summarized over the full 75-year period, however, long-range deficits for the OASI and DI programs under intermediate assumptions are more similar, relative to the level of program costs.

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