II. ACTUARIAL ANALYSIS

A. SOCIAL SECURITY AMENDMENTS SINCE THE 1995 REPORT

Since the 1995 Annual Report was transmitted to the Congress on April 3, 1995, one law affecting the OASDI program in a significant way has been enacted. The Senior Citizens' Right to Work Act of 1996 (Title I of Public Law 104-121, enacted into law on March 29, 1996) included a number of provisions affecting the OASDI program. The more important provisions, from an actuarial standpoint, are described in the following paragraphs.

• The annual amount of earnings exempted under the retirement earnings test is gradually increased to $30,000 by 2002 for beneficiaries under age 70 who have reached the normal retirement age, which is currently age 65. Under prior law, the annual exempt amount for such beneficiaries was $11,520 for 1996. Under the new law, the exempt amount is $12,500 for 1996, and that amount increases by $1,000 each year through 1999. For the years 2000-02, the new exempt amounts are $17,000, $25,000, and $30,000, respectively. After 2002, annual indexing of the exempt amount by average wages will be resumed, starting from the $30,000 amount for 2002.
• Under prior law, the amount of earnings that constitutes substantial gainful activity, in any given year, for persons who are statutorily blind was defined to be the same as the retirement test exempt amount, in that year, for beneficiaries between the normal retirement age and age 70. However, under the new law, the substantial gainful activity amount for statutorily blind persons will be equal to the retirement test exempt amount that would have applied under prior law to beneficiaries between the normal retirement age and age 70.
• Eligibility to disability insurance benefits is prohibited for individuals whose drug addiction and/or alcoholism is a contributing factor material to the finding of disability. This provision applies to individuals who file for benefits on or after the date of enactment (March 29, 1996) and to individuals whose claims are finally adjudicated on or after the date of enactment. The provision also becomes effective for current beneficiaries on January 1, 1997, after notification within 90 days following enactment. New medical determinations must be completed by January 1, 1997, for current beneficiaries who are affected and who request a determination within 120 days after the date of enactment.
• Additional funds are authorized for fiscal years 1996 through 2002 for the purpose of conducting continuing disability reviews of disability insurance beneficiaries by increasing the amount of funds available for appropriations under the discretionary spending cap on administrative expenses. The funds made available under this provision are to be used, to the greatest extent practicable, to maximize the combined savings to the OASDI, Supplementary Security Income, Medicare, and Medicaid programs. The estimates in this report are based on the assumption that the authorized funds will be appropriated.
• Under prior law, a stepchild was deemed to be dependent on a stepparent if the child were living with the stepparent or were receiving at least one-half support from the stepparent. The new law is more restrictive in that it requires a stepchild to be receiving at least one-half support from the stepparent, whether or not the child is living with the stepparent. This provision is effective for benefits of individuals who become entitled after June 1996. Also, if the natural parent and the stepparent of an entitled child divorce, benefits to the stepchild based on the work record of the stepparent would terminate the month after the month in which the divorce becomes final. This provision is effective for final divorces occurring after June 1996.

The actuarial estimates shown in this report reflect the anticipated effects of these changes, which are based in part on the assumptions noted above concerning funds authorized for continuing disability reviews.

B. DESCRIPTION OF THE TRUST FUNDS

The Federal Old-Age and Survivors Insurance Trust Fund was established on January 1, 1940, as a separate account in the United States Treasury. All the financial operations of the OASI program are handled through this fund. The Federal Disability Insurance Trust Fund is another separate account in the United States Treasury; it was established on August 1, 1956. All the financial operations of the DI program are handled through this fund.

The primary receipts of these two funds are amounts appropriated to each of them under permanent authority on the basis of contributions payable by workers, their employers, and individuals with self-employment income, in work covered by the OASDI program. All employees, and their employers, in covered employment are required to pay contributions with respect to their wages. Employees, and their employers, are also required to pay contributions with respect to cash tips, if the individual's monthly cash tips amount to at least $20. All self-employed persons are required to pay contributions with respect to their covered net earnings from self-employment. In addition to paying the required employer contributions on the wages of covered Federal employees, the Federal Government also pays amounts equivalent to the combined employer and employee contributions that would be paid on deemed wage credits attributable to military service performed after 1956 if such wage credits were covered wages.

In general, an individual's contributions, or taxes, are computed on wages or net earnings from self-employment, or both wages and net self-employment earnings combined, up to a specified maximum annual amount. The contributions are determined first on the wages and then on any net self-employment earnings, such that the total does not exceed the annual maximum amount. An employee who pays contributions on wages in excess of the annual maximum amount (because of employment with two or more employers) is eligible for a refund of the excess employee contributions.

The monthly benefit amount to which an individual (or his or her spouse and children) may become entitled under the OASDI program is based on the individual's taxable earnings during his or her lifetime. For almost all persons who first become eligible to receive benefits in 1979 or later, the earnings used in the computation of benefits are indexed to reflect increases in average wage levels.

The contribution, or tax, rates applicable in each calendar year and the allocation of these rates between the OASI and DI Trust Funds are shown in table II.B1.

For 1997 and later, the rates shown in table II.B1 are those scheduled in present law. (The total contribution rates for the OASDI and Hospital Insurance (HI) programs combined, and for each program separately, are shown in appendix A, table III.A1.) The maximum amount of earnings on which OASDI contributions are payable in a year, which is also the maximum amount of earnings creditable in that year for benefit-computation purposes, is called the contribution and benefit base. The contribution and benefit base for each year through 1996 is also shown in table II.B1.

All contributions are collected by the Internal Revenue Service and deposited in the general fund of the Treasury. The contributions are immediately and automatically appropriated to the trust funds on an estimated basis. The exact amount of contributions received is not known initially because the OASDI and HI contributions and individual income taxes are not separately identified in collection reports received by the Internal Revenue Service. Periodic adjustments are subsequently made to the extent that the estimates are found to differ from the amounts of contributions actually payable as determined from reported earnings. Adjustments are also made to account for any refunds to employees (with more than one employer) who paid contributions on wages in excess of the contribution and benefit base.

From May 1983 through November 1990, amounts representing the estimated total collections of OASDI contributions for each month were credited to the trust funds on the first day of the month. The "Omnibus Budget Reconciliation Act of 1990" amended the law in effect since 1983 to provide that such advance transfers would be used only if the trust funds drop to such a low level that advance transfers are needed in order to pay benefits.

Beginning in 1984, up to one-half of an individual's or couple's OASDI benefits was subject to Federal income taxation under certain circumstances. Effective for taxable years beginning after 1993, the maximum percentage of benefits subject to taxation was increased from 50 percent to 85 percent. The proceeds from taxation of up to 50 percent of benefits are credited to the OASI and DI Trust Funds in advance, on an estimated basis, at the beginning of each calendar quarter, with no reimbursement to the general fund for interest costs attributable to the advance transfers. (The additional tax revenues resulting from the increase to 85 percent are transferred to the HI Trust Fund.) Subsequent adjustments are made based on the actual amounts as shown on annual income tax records. The amounts appropriated from the general fund of the Treasury are allocated to the OASI and DI Trust Funds on the basis of the income taxes paid on the benefits from each fund. (A special provision applies to benefits paid to nonresident aliens. Under Public Law 103-465, effective for taxable years beginning after 1994, a flat-rate tax, usually 25.5 percent, is withheld from the benefits before they are paid and, therefore, remains in the trust funds. From 1984 to 1994 the flat-rate tax that was withheld was usually 15 percent.)

Another source of income to the trust funds is interest received on investments held by the trust funds. That portion of each trust fund which, in the judgment of the Managing Trustee, is not required to meet current expenditures for benefits and administration is invested, on a daily basis, primarily in interest-bearing obligations of the U.S. Government (including special public-debt obligations described below). Investments may also be made in obligations guaranteed as to both principal and interest by the United States, including certain Federally sponsored agency obligations that are designated in the laws authorizing their issuance as lawful investments for fiduciary and trust funds under the control and authority of the United States or any officer of the United States. These obligations may be acquired on original issue at the issue price or by purchase of outstanding obligations at their market price. Thus, all of the investments held by the trust funds are backed by the full faith and credit of the U.S. Government.

The Social Security Act authorizes the issuance of special public-debt obligations for purchase exclusively by the trust funds. The Act provides that these obligations shall bear interest at a rate equal to the average market yield (computed on the basis of market quotations as of the end of the calendar month next preceding the date of such issue) on all marketable interest-bearing obligations of the United States then forming a part of the public debt which are not due or callable until after the expiration of 4 years from the end of such calendar month. These special issues are redeemable at all times at par value and thus bear no risk with respect to changes in interest rates (i.e., principal price fluctuations).

Income is also affected by provisions of the Social Security Act for (1) transfers between the general fund of the Treasury and the OASI and DI Trust Funds for any adjustments to prior payments for the cost arising from the granting of noncontributory wage credits for military service prior to 1957, according to periodic determinations made by the Secretary of Health and Human Services; (2) annual reimbursements from the general fund of the Treasury to the OASI Trust Fund for any costs arising from the special monthly cash payments to certain uninsured persons - i.e., those who attained age 72 before 1968 and who generally are not eligible for cash benefits under other provisions of the OASDI program; and (3) the receipt of unconditional money gifts or bequests made for the benefit of the trust funds or any activity financed through the funds.

The primary expenditures of the OASI and DI Trust Funds are for (1) OASDI benefit payments, net of any reimbursements from the general fund of the Treasury for unnegotiated benefit checks, and (2) expenses incurred by the Social Security Administration, the Department of Health and Human Services, and the Department of the Treasury in administering the OASDI program and the provisions of the Internal Revenue Code relating to the collection of contributions. Such administrative expenses include expenditures for construction, rental and lease, or purchase of office buildings and related facilities for the Social Security Administration. The Social Security Act does not permit expenditures from the OASI and DI Trust Funds for any purpose not related to the payment of benefits or administrative costs for the OASDI program.

The expenditures of the trust funds are also affected by (1) costs of vocational rehabilitation services furnished as an additional benefit to disabled persons receiving cash benefits because of their disabilities where such services contributed to their successful rehabilitation, and (2) the provisions of the Railroad Retirement Act which provide for a system of coordination and financial interchange between the Railroad Retirement program and the Social Security program. Under the latter provisions, transfers between the Railroad Retirement program's Social Security Equivalent Benefit Account and the trust funds are made on an annual basis in order to place each trust fund in the same position in which it would have been if railroad employment had always been covered under Social Security.

The net worth of facilities and other fixed capital assets is not carried in the statements of the operations of the trust funds presented in this report. This is because the value of fixed capital assets does not represent funds available for the payment of benefits or administrative expenditures, and therefore is not considered in assessing the actuarial status of the trust funds.

C. SUMMARY OF THE OPERATIONS OF THE OLD-AGE AND SURVIVORS INSURANCE AND DISABILITY INSURANCE TRUST FUNDS, FISCAL YEAR 1995

1. Old-Age and Survivors Insurance Trust Fund

A statement of the income and disbursements of the Federal Old-Age and Survivors Insurance Trust Fund in fiscal year 1995, and of the assets of the fund at the beginning and end of the fiscal year, is presented in table II.C1.

During fiscal year 1995, total receipts amounted to $326.1 billion, and total disbursements were $294.5 billion. The assets of the OASI Trust Fund thus increased by $31.6 billion during the year, to a total of $447.9 billion on September 30, 1995.

Included in total receipts during fiscal year 1995 were $289.3 billion in payroll tax contributions appropriated to the fund. Another $0.2 billion was received from the general fund of the Treasury representing payment for the taxes that would have been paid on estimated deemed wage credits for military service in 1995 if such credits had been considered to be covered wages. (Included in this payment are adjustments for revised estimates of deemed wage credits in prior years.) Normally, these tax receipts are offset by a transfer to the general fund of the Treasury for the estimated amount of refunds to employees who worked for more than one employer during a year and paid contributions in excess of the contribution and benefit base. The transfer was delayed to October 11, 1995, after the close of fiscal year 1995.

Payroll tax contributions thus amounted to $289.5 billion. While taxable earnings increased, contributions to the OASI Trust Fund in fiscal year 1995 were 6.1 percent less than in the previous year because of the reallocation of the OASDI tax rate under Public Law 103-387. The rate allocated to the DI Trust Fund for 1994 through 1996 was increased from 0.60 percent to 0.94 percent for employees and employers, each. The tax rate allocated to DI in later years was also increased. The tax rate allocated to the OASI Trust Fund was reduced by an equal amount, so that the total OASDI tax rate remained unchanged. Because the new law was passed in October 1994 (after the start of fiscal year 1995) and required that the reallocation be effective retroactive to January 1, 1994, the differences in taxes resulting from the reallocation for the first 9 months of calendar year 1994 were transferred to the DI Trust Fund in fiscal year 1995. This resulted in the large increase in payroll tax contributions to the DI Trust Fund discussed in the next section. The combined payroll tax contributions to OASDI actually increased by 4.7 percent in fiscal year 1995 due to increased earnings and the increases in the contribution and benefit base that became effective on January 1 of each year 1994 and 1995. (Table II.B1 in the preceding section shows the tax rates and contribution and benefit bases now in effect.)

Income from taxation of benefits amounted to $5.1 billion, of which nearly 98 percent represented amounts credited to the trust funds in advance, on an estimated basis, together with adjustments to 1992 transfers to account for actual experience. The remaining 2 percent of the total income from taxation of benefits represented amounts withheld from the benefits paid to nonresident aliens.

Special payments are made to uninsured persons who either attained age 72 before 1968, or who attained age 72 after 1967 and had 3 quarters of coverage for each year after 1966 and before the year of attainment of age 72. The costs associated with providing such payments to persons having fewer than 3 quarters of coverage are reimbursable from the general fund of the Treasury. Accordingly, a reimbursement of $6,994,000 was transferred to the OASI Trust Fund in fiscal year 1995, as required by section 228 of the Social Security Act. The reimbursement reflected the costs of payments made in fiscal year 1993.

The OASI Trust Fund was credited with interest totaling $31.4 billion which consisted of (1) interest earned on the investments of the trust fund, plus (2) interest on transfers between the trust fund and the general fund account for the Supplemental Security Income program due to adjustments in the allocation of administrative expenses, and (3) interest arising from the revised allocation of administrative expenses among the trust funds, less (4) interest paid to the DI Trust Fund on the transfer of taxes required by the reallocation of the OASDI tax rate retroactive to January 1, 1994.

The remaining $54,108 of receipts consisted of gifts received under the provisions authorizing the deposit of money gifts or bequests in the trust funds.

Of the $294.5 billion in total disbursements, $288.6 billion was for net benefit payments. The amount of net benefit payments in fiscal year 1995 represents an increase of 4.5 percent over the corresponding amount in fiscal year 1994. This increase was due primarily to (1) the automatic cost-of-living benefit increases of 2.6 percent and 2.8 percent which became effective for December 1993 and December 1994 respectively, under the automatic-adjustment provisions in section 215(i) of the Social Security Act, (2) an increase in the total number of beneficiaries, and (3) an increase in the average benefit amount resulting from the rising level of earnings.

As described in the preceding section, certain provisions of the Railroad Retirement Act coordinate the Railroad Retirement and OASDI programs and govern the financial interchanges arising from the allocation of costs between the two programs. Under those provisions, the Railroad Retirement Board and the Commissioner of Social Security determined that a transfer of $4.1 billion to the Social Security Equivalent Benefit Account from the OASI Trust Fund was required in June 1995.

The remaining $1.8 billion of disbursements from the OASI Trust Fund represented net administrative expenses. The expenses of administering the OASDI and Medicare programs are allocated and charged directly to each of the various trust funds, through which those programs are financed, on the basis of provisional estimates. Similarly, the expenses of administering the Supplemental Security Income program are also allocated and charged directly to the general fund of the Treasury on a provisional basis. Periodically, as actual experience develops and is analyzed, adjustments to the allocations of administrative expenses for prior periods are effected by interfund transfers and transfers between the OASI Trust Fund and the general fund account for the Supplemental Security Income program, with appropriate interest adjustments.

Section 1131 of the Social Security Act authorizes annual reimbursements from the general fund of the Treasury to the OASI Trust Fund for additional administrative expenses incurred as a result of furnishing information on deferred vested benefits to pension plan participants, as required by the Employee Retirement Income Security Act of 1974 (Public Law 93-406). The reimbursement in fiscal year 1995 amounted to $1,359,789.

The assets of the OASI Trust Fund at the end of fiscal year 1995 totaled $447.9 billion, consisting of $447.9 billion in U.S. Government obligations and, as an offset, an extension of credit amounting to $0.8 million. Table II.C2 shows the total assets of the fund and their distribution at the end of each fiscal year 1994 and 1995.

All securities held by the trust funds are backed by the full faith and credit of the United States Government. Those currently held by the OASI Trust Fund are special issues (i.e., securities sold only to the trust funds). These are of two types: short-term certificates of indebtedness and long-term bonds. The certificates of indebtedness are issued through the investment of receipts not required to meet current expenditures, and they mature on the next June 30 following the date of issue. Special-issue bonds, on the other hand, are normally acquired only when special issues of either type mature on June 30. The amount of bonds acquired on June 30 is equal to the amount of special issues maturing, less amounts required to meet expenditures on that day.

The effective annual rate of interest earned by the assets of the OASI Trust Fund during calendar year 1995 was 7.9 percent, as compared to 8.0 percent earned during calendar year 1994. The interest rate on special issues purchased by the trust fund in June 1995 was 6.5 percent, payable semiannually. Special-issue bonds with a total par value of $64.0 billion were purchased in June 1995.

Section 201(d) of the Social Security Act provides that the public-debt obligations issued for purchase by the OASI and DI Trust Funds shall have maturities fixed with due regard for the needs of the funds. The usual practice has been to spread the holdings of special issues, as of each June 30, so that the amounts maturing in each of the next 15 years are approximately equal. Accordingly, the amounts and maturity dates of the OASI special-issue bonds purchased on June 30, 1995, were selected in such a way that the maturity dates of the total portfolio of special issues were spread evenly over the 15-year period 1996-2010.

2. Disability Insurance Trust Fund

A statement of the income and disbursements of the Federal Disability Insurance Trust Fund during fiscal year 1995, and of the assets of the fund at the beginning and end of the fiscal year, is presented in table II.C3.

During fiscal year 1995, total receipts amounted to $70.2 billion, and total disbursements were $41.4 billion. The assets of the trust fund thus increased by $28.8 billion during the year, to a total of $35.2 billion on September 30, 1995.

Included in total receipts were $67.9 billion representing payroll tax contributions appropriated to the fund and $67,222,000 in payments from the general fund of the Treasury representing taxes that would have been paid on estimated deemed wage credits for military service in 1995 if such credits had been considered to be covered wages.

Total contributions amounted to $68.0 billion, an increase of 105.8 percent from the amount in the preceding fiscal year. This increase is primarily attributable to the reallocation of the OASDI tax rate that accounted for the reduction in contributions to the OASI Trust Fund in fiscal year 1995. Income from the taxation of benefit payments amounted to $0.3 billion in fiscal year 1995.

Interest totaling $1.9 billion consisted of interest on the investments of the fund and interest on amounts of interfund transfers.

Of the $41.4 billion in total disbursements, $40.2 billion was for net benefit payments. This represents an increase of 9.2 percent over the corresponding amount of benefit payments in fiscal year 1994. This increase is due in part to the same factors that resulted in the net increase in benefit payments from the OASI Trust Fund. In the case of DI, however, the number of persons receiving disabled worker benefits continued to increase rapidly in 1995. Section II.F1. presents a more detailed discussion of this rapid growth.

Provisions governing the financial interchanges between the Railroad Retirement and OASDI programs are described in the preceding section. Under those provisions, $67,786,000 was transferred to the Social Security Equivalent Benefit Account from the DI Trust Fund in June 1995.

The remaining disbursements amounted to $1.1 billion for net administrative expenses (including $2,418,404 for demonstration projects and experiments to test the effect of alternative methods for assisting disabled beneficiaries' attempts to work), and $38,794,496 for the costs of vocational rehabilitation services furnished to disabled-worker beneficiaries and to those children of disabled workers who were receiving benefits on the basis of disabilities that began before age 22. Reimbursement from the trust funds for the costs of such services is made only in those cases where the services contributed to the successful rehabilitation of the beneficiaries.

The assets of the DI Trust Fund at the end of fiscal year 1995 totaled $35.2 billion, consisting of $35.2 billion in U.S. Government obligations and, as an offset, an extension of credit amounting to $19,146,366. Table II.C4 shows the total assets of the fund and their distribution at the end of each fiscal year 1994 and 1995.

The effective annual rate of interest earned by the assets of the DI Trust Fund during calendar year 1995 was 7.4 percent, as compared to 8.2 percent earned during calendar year 1994. The interest rate on public-debt obligations issued for purchase by the trust fund in June 1995 was 6.5 percent, payable semiannually. Special-issue bonds with a total par value of $28.8 billion were purchased in June 1995. The usual practice of spreading the holdings of special issues, as described earlier, was not followed. The amounts and maturity dates of the DI special-issue bonds purchased on June 30, 1995, were selected in such a way that the maturity dates of the total portfolio of special issues were spread over the 13-year period 1996-2008.

The investment policies and practices described for the OASI Trust Fund apply as well to the investment of the assets of the DI Trust Fund.

3. Old-Age and Survivors Insurance and Disability Insurance Trust Funds, Combined

A statement of the operations of the income and disbursements of the OASI and DI Trust Funds, on a combined basis, is presented in table II.C5. The entries in this table represent the sums of the corresponding values from tables II.C1 and II.C3. For a discussion of the nature of these income and expenditure transactions, reference should be made to the preceding two subsections covering OASI and DI separately.

Table II.C6 compares past estimates of contributions and benefit payments for fiscal year 1995, as shown in the 1991-95 Annual Reports, with the corresponding actual amounts in 1995. The estimates shown are the ones based on the alternative II assumptions.

A number of factors can contribute to differences between estimates and subsequent actual amounts, including actual values for key economic, demographic, and other variables that differ from assumed levels. In addition, amendments to the Social Security Act can cause actual taxes or benefits to vary from earlier estimates. For example, the reallocation of the OASDI tax rate, enacted in October 1994, makes comparison of tax estimates in the 1991-94 Annual Reports with actual taxes in fiscal year 1995 meaningless for OASI and DI taken separately. The comparisons in table II.C6 indicate that combined actual OASI and DI tax contributions in fiscal year 1995 were significantly lower, generally, than estimates in the 1991 report (due primarily to lower than expected inflation). Estimates of OASI benefit payments were generally close to actual payments in 1995. The actual amount of DI benefit payments in 1995, however, was significantly above estimates in the 1991-92 reports, due to faster-than-expected growth in the number of disabled workers.

At the end of fiscal year 1995, about 43.3 million persons were receiving monthly benefits under the OASDI program. Of these persons, about 37.5 million and 5.8 million were receiving monthly benefits from the OASI Trust Fund and the DI Trust Fund, respectively. The number of persons receiving benefits from the OASI and DI Trust Funds grew by 0.8 percent and 5.2 percent, respectively, during the fiscal year. The estimated distribution of benefit payments in fiscal years 1994 and 1995, by type of beneficiary, is shown in table II.C7 for each trust fund separately.

Net administrative expenses charged to the OASI and DI Trust Funds in fiscal year 1995 totaled $2.9 billion. This amount represented 0.8 percent of contribution income and 0.9 percent of expenditures for benefit payments. Corresponding percentages for each trust fund separately and for the OASDI program as a whole are shown in table II.C8 for each of the last 5 years.

Tables II.C2 and II.C4, presented in the two preceding subsections, showed the assets of the OASI and DI Trust Funds at the end of fiscal years 1994 and 1995. The changes in the invested assets of the funds between those two dates are a result of the acquisition and disposition of securities during fiscal year 1995. Table II.C9 presents these investment transactions for each trust fund separately and combined. All amounts shown in the table are at par value.

D. PRINCIPAL ECONOMIC AND DEMOGRAPHIC ASSUMPTIONS

The future income and outgo of the OASDI program depend on many economic and demographic factors, including gross domestic product, labor force, unemployment, average earnings, productivity, inflation, fertility, mortality, net immigration, marriage, divorce, retirement patterns, and disability incidence and termination. The income will depend on how these factors affect the size and composition of the working population and the level and distribution of earnings. Similarly, the outgo will depend on how these factors affect the size and composition of the beneficiary population and the general level of benefits.

Because precise prediction of these various factors is impossible, estimates are shown in this report on the basis of three sets of assumptions, designated as intermediate (alternative II), low cost (alternative I), and high cost (alternative III). The intermediate set, alternative II, represents the Board's best estimate of the future course of the population and the economy. In terms of the net effect on the status of the OASDI program, the low cost alternative I is the more optimistic, and the high cost alternative III is the more pessimistic of the plausible economic and demographic conditions.

The values assumed after the first 5 to 25 years for both the economic and the demographic factors are intended to represent the average experience and are not intended to be exact predictions of year-by-year values. Actual future values will likely exhibit fluctuations or cyclical patterns, as in the past.

Although these sets of economic and demographic assumptions have been developed using the best available information, the resulting estimates should be interpreted with care. In particular, the resulting estimates are not intended to be exact predictions of the future status of the OASDI program, but rather, they are intended to be indicators of the trend and range of future income and outgo, under a variety of plausible economic and demographic conditions.

1. Economic Assumptions

The principal economic assumptions for the three alternatives are summarized in table II.D1.

Alternatives I, II, and III present a range of generally consistent sets of economic assumptions which have been designed to produce variation in Social Security's financial status that should encompass most of the possibilities that might be encountered. The intermediate set of assumptions (alternative II) represents the Trustees' consensus expectation of moderate economic growth throughout the projection period. The low cost assumptions (alternative I) represent a more optimistic outlook, with relatively strong economic growth projected during the short-range period and tapering off a little during the long-range period. The high cost assumptions (alternative III) represent a relatively pessimistic forecast in which the economy experiences generally weak economic growth and business cycles with two recessions in the short-range period. Economic cycles are not included in assumptions beyond the first 5 to 10 years of the projection period because inclusion of such cycles has little effect on the long-range estimates of financial status.

A period of sustained real economic growth began in 1982 and ended with the recession that started with the third quarter of 1990. After a total decline in real GDP of 2.2 percent through the first quarter of 1991, and three quarters of slow growth following the recession, the return to steady economic growth which began in 1992 is assumed to continue for alternatives I and II, albeit at a somewhat slower pace. For the short-range period (1996-2005), average annual real GDP growth is assumed to be about 2.7 percent for alternative I and 2.0 percent for alternative II.

For alternative III, weak growth and an increasing rate of price inflation are assumed for the first quarter of 1996. The first projected recession begins in the second quarter of 1996, lasts 3 quarters, and results in a total decline in real GDP of 1.4 percent. After 8 quarters of recovery, a second recession, with a total decline in real GDP of 3.0 percent, is assumed to begin in the first quarter of 1999, lasting 4 quarters. After the second recession, a moderate economic recovery is assumed through the year 2002.

After the year 2005, the projected rates of growth in real GDP, for all three alternatives, are determined by the assumed rates of growth in employment, average hours worked, and labor productivity. The trend toward slower growth in real GDP after 2005 results primarily from much slower growth in the working age population, as the baby-boom generation approaches retirement and succeeding generations reflecting lower birth rates reach working age. The slowdown in the growth rate in real GDP also reflects the assumed leveling of labor force participation rates for women, which have risen substantially over the past 20 years, and the continuation of the historical downward trend of labor force participation rates among men in the future. The annual rate of growth in total labor force decreased from 2.3 percent in 1994 to 0.9 percent in 1995. After 1995 the labor force is projected to increase at about 0.9 percent per year, on average, through 2002, and to increase more slowly thereafter, reflecting the projected slowing of growth of the working-age population as compared with the experience of the 1980s and early 1990s.

Since last year's report, the Bureau of Economic Analysis has changed from a fixed-weighted to a chain-weighted price measure for the purpose of calculating the real-growth component of GDP and has revised the historical values of real GDP growth over the period 1959-94. While the data shown in table II.D1 for historical years reflect these revisions, the projected growth rates in real GDP for years after 1995 do not reflect changes in methodology. The analysis necessary to fully incorporate the implications of the revisions will be completed for the next report.

The age-sex adjusted unemployment rate, for alternatives I and II, is assumed to move gradually toward ultimate average levels of 5.0 and 6.0 percent, respectively, by 2006. For alternative III, the age-sex-adjusted unemployment rate is assumed to reach its ultimate average level of 7.0 percent by 2006, after a recovery that is assumed to follow the projected recession in 1999.

Unemployment rates through 2005 are in the most commonly cited form, the civilian rate, which describes the differences between aggregate civilian labor force and aggregate civilian employment. For years after 2005, however, total rates are presented. These include the military (which reduces the rate by about 0.1 percent relative to the civilian rate) and are age-sex adjusted to the 1994 labor force. Such total rates better represent the total population covered by the OASDI program and adjust for the changing age-sex distribution of the labor force, which can obscure the comparison of unemployment rates over different time periods.

Unemployment rates for the years 1994 and later are based on the new survey methodology used by the Bureau of Labor Statistics. Though unemployment rates based on this new method were initially expected to be about 0.5 percentage point higher than if based on the old method, comparisons for 1994 have shown little or no difference.

For the intermediate projection, each of the other economic parameters is selected reflecting what the Trustees believe to be the most likely future course of the economy at the time of preparation of this report, consistent with the assumed pattern of real GDP growth. The annual rate of change in the average wage in covered employment is assumed to rise, generally, from the estimated 4.1 percent increase for 1995, averaging about 4.5 percent for the period 1996 through 2005. Growth in the average wage (which is equal to price inflation plus the real-wage differential) through 2005 averages somewhat less than the ultimate assumed rate of 5.0 percent primarily because price inflation averages less than its ultimate level through this period. Between 2005 and 2020, growth in the average covered wage is slightly higher than the assumed ultimate rate of 5.0 percent, reflecting the gradual movement toward complete inclusion of Federal civilian employees. After 2020, the average covered wage growth rate remains at the ultimate assumed rate of 5.0 percent.

The annual rate of increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) was 2.9 percent in 1995. For alternative II, the CPI-W (hereinafter denoted as "CPI") is assumed to increase 2.7 percent in 1996 and 3.2 percent in 1997, moving toward the assumed ultimate rate of 4.0 percent by 2003. For alternative I, the CPI is projected to increase 2.4 percent in 1996 and 2.8 percent in 1997, moving toward the assumed ultimate rate of 3.0 percent by 1998. For alternative III, the CPI is projected to increase from a relatively low 2.7 percent in 1996 to a relatively high 5.4 percent in 1998 and 1999, eventually stabilizing at the assumed ultimate rate of 5.0 percent in 2001. Recent and expected future changes by the Bureau of Labor Statistics to correct the "formula bias" in the CPI have not been reflected in assumptions for future price inflation in this report. The analysis necessary to reflect these changes, along with those recently made by the Bureau of Economic Analysis in the methodology used in measuring real GDP growth, will be completed for the 1997 report.

The real-wage differential (i.e., the difference between the annual rates of change in the average wage in covered employment and in the CPI) is estimated to be 1.2 percent in 1995. After 1995, under the intermediate alternative, the real-wage differential is projected to be between 0.7 and 1.3 percent for the years 1996 through the year 2020, thereafter remaining at the ultimate assumed differential of 1.0 percent. For the low cost alternative I, the real-wage differential is assumed to be in the range of 1.5 percent to 1.8 percent between 1996 and 2020, thereafter remaining at the ultimate assumed real-wage differential of 1.5 percent. For the high cost alternative III, a more pessimistic real-wage differential is assumed for the short-range period, averaging 0.2 percent per year. After 2030, the real-wage differential is assumed to be 0.5 percent per year for alternative III.

Under the intermediate alternative, the average annual interest rate for securities newly issued to the trust funds is assumed to decrease from 6.9 percent in 1995 to 6.4 percent for 1996, and remain around 6.5 percent until 2004. After 2005, the average annual interest rates are assumed to be 6.0, 6.3, and 6.5 percent for alternatives I, II, and III, respectively.

For alternatives I and III, respectively, values for each of the economic parameters are selected to generally reflect a more optimistic and a more pessimistic future financial status of the program. Some of the parameters would normally be expected to deviate in opposite directions from the values assumed for the intermediate alternative. Thus, alternatives I and III also assume structural economic shifts in the relationships among parameters which tend toward low cost and high cost, respectively.

2. Demographic Assumptions

The principal demographic assumptions for the three alternatives are shown in table II.D2.

For the intermediate projection, the assumed ultimate total fertility rate of 1.9 children per woman is attained in 2020 after a gradual decline from the preliminary estimate for 1995 of 2.04 children per woman. The age-sex-adjusted death rate is assumed to decrease steadily during the entire projection period, with a total reduction of 36 percent from the 1995 level by 2070. Life expectancies at birth in 2070 are 78.4 years for men and 84.1 years for women, compared to 72.3 and 79.2 years, respectively, in 1995. Life expectancies at age 65 in 2070 are projected to be 18.4 years for men and 22.2 years for women, compared to 15.4 and 19.2 years, respectively, in 1995. The projected death rates reflect the effects of assumed cases of Acquired Immunodeficiency Syndrome (AIDS), using estimates prepared by the Centers for Disease Control and Prevention (CDC) as a starting point. Total net immigration is assumed to rise over the next several years reaching an ultimate level of 900,000 persons per year by the year 2000. The ultimate 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.

For the low cost alternative I, the total fertility rate is assumed to rise to an ultimate average level of 2.2 children per woman by 2020. The age-sex-adjusted death rate is assumed to decrease more slowly than for the intermediate alternative II, with the total reduction from the 1995 level being 16 percent by 2070. Life expectancies at birth in 2070 are 75.6 years for men and 81.1 years for women, while at age 65 they are 16.2 and 19.7 years, respectively. Total net immigration is ultimately assumed to be 1,150,000 persons per year. The assumed level of net annual immigration is the combination of 700,000 net legal immigrants per year and 450,000 net other-than-legal immigrants per year.

For the high cost alternative III, the total fertility rate is assumed to decrease to an ultimate level of 1.6 by 2020. The age-sex-adjusted death rate is assumed to decrease more rapidly than for alternative II, with the total reduction from the 1995 level being 55 percent by 2070. Life expectancies at birth in 2070 are 82.3 years for men and 88.0 years for women, while at age 65 they are 21.4 and 25.4 years, respectively. Total net immigration is ultimately assumed to be 750,000 persons per year, the combination of 550,000 net legal immigrants per year and 200,000 net other-than-legal immigrants per year.

In addition to the assumptions discussed above, many other factors are necessary to prepare the estimates presented in this report. Section II.H includes a discussion of many of those factors.

The ultimate values presented in table II.D2 reflect little change from the ultimate values used for last year's report. The ultimate rates of change in mortality for the age groups under 65 were increased for this report so that they would be higher than the ultimate rates of change for older groups, consistent with historical experience throughout this century. In addition, ultimate net immigration rates were redistributed by increasing other-than-legal and decreasing legal net immigration. The decrease of 50,000 legal immigrants reflects the lower numbers currently being admitted by the Immigration and Naturalization Service (INS). The increase of 50,000 other-than-legal immigrants is based on continuing studies done by INS and the Bureau of the Census which show increasing numbers of illegal immigrants. The effect on the financing of the OASDI program of these and other changes is discussed in section II.F2.

E. AUTOMATIC ADJUSTMENTS

In this section, values are shown for the program amounts that are subject to automatic adjustment, from the time that such adjustments became effective through 2005. Projected values for future years are based on the economic assumptions described in the preceding section of this report. Appendix F, in addition to providing the most recent determinations of program amounts under the automatic adjustment provisions, also provides a more complete description of such amounts.

Under the automatic-adjustment provisions affecting cost-of-living increases, benefits generally are increased once a year. These provisions were originally enacted in 1972 and first became effective with the benefit increase effective for June 1975. The 1983 amendments changed the effective month to December for years after 1982. For persons becoming eligible for benefits in 1979 and later, the increases generally begin with the year in which the worker reaches age 62, or becomes disabled or dies, if earlier. An automatic cost-of-living benefit increase of 2.6 percent, effective for December 1995, was announced in October 1995, as described in appendix F. The automatic cost-of-living benefit increase for any year is normally based on the change in the CPI from the third quarter of the previous year to the third quarter of the current year.

Under section 215(b)(3) of the Social Security Act, the national average wage index for each year after 1950 is used to index the earnings of most workers first becoming eligible for benefits in 1979 or later. This procedure converts a worker's past earnings to approximately their equivalent values near the time of the worker's retirement or other eligibility, and these indexed values are used to calculate the worker's benefit. The average wage index is also used to adjust most of the program amounts that are subject to the automatic-adjustment provisions. Table II.E1 shows the average wage index as determined for each year 1951 through 1994.

The law provides for an automatic increase in the OASDI program's contribution and benefit base, based on the increase in the average wage index, for the year following a year in which an automatic benefit increase became effective. As described in appendix F, the contribution and benefit base for 1996 was determined to be $62,700.

Under the retirement earnings test, earnings below certain amounts are exempted from the withholding of benefits payable to beneficiaries under age 70. Different exempt amounts apply for beneficiaries under age 65 and for those aged 65 to 69. The automatic adjustment provisions require that such exempt amounts be increased in the year following a year in which an automatic cost-of-living benefit increase becomes effective. Generally, increases in the exempt amounts are based on increases in the average wage index. Public Law 104-121, however, mandates a fixed series of exempt amounts for persons aged 65 to 69, for years 1996-2002. After 2002, the exempt amounts are indexed.

Table II.E2 shows historical automatic cost-of-living benefit increases for the years 1975-95 and assumed increases through 2005. The table also shows historical year-to-year percentage increases in the average wage index for 1975-94 and assumed increases through 2005. As noted above, the OASDI contribution and benefit base and the retirement test exempt amounts are adjusted on the basis of such wage increases. The historical and projected amounts for this base and the exempt amounts are also shown in table II.E2. The projections are shown under the three alternative sets of economic assumptions described in the previous section.

Other wage-indexed amounts are shown in table II.E3. The table provides historical values from 1978, when the amount of earnings required for a quarter of coverage was first indexed, through 1996, and also shows projected amounts under the intermediate assumptions through the year 2005. These other wage-indexed program amounts are described in the following paragraphs.

As noted earlier, a worker who becomes eligible for benefits in 1979 or later generally receives a benefit based on his or her indexed earnings. These indexed earnings are used to calculate the worker's Average Indexed Monthly Earnings (AIME). The basic formula used to compute the Primary Insurance Amount (PIA) for workers who reach age 62, become disabled, or die in 1996 is:

• 90 percent of the first $437 of AIME, plus
• 32 percent of AIME in excess of $437 but not in excess of $2,635, plus
• 15 percent of AIME in excess of $2,635.

The amounts separating the individual's AIME into intervals - the bend points - are adjusted automatically by the changes in average wages as specified in section 215(a)(1)(B) of the Social Security Act.

A similar formula is used to compute the maximum total amount of monthly benefits payable on the basis of the earnings of a retired or deceased individual. This formula is a function of the individual's PIA, and is shown below for workers who first became eligible for benefits, or who died before becoming eligible, in 1996:

• 150 percent of the first $559 of PIA, plus
• 272 percent of the PIA in excess of $559 but not in excess of $806, plus
• 134 percent of the PIA in excess of $806 but not in excess of $1,052, plus
• 175 percent of the PIA in excess of $1,052.

An individual's insured status depends on the number of quarters of coverage he or she has earned while in covered employment. The 1977 amendments specified the amount of earnings required in 1978 to be credited with a quarter of coverage and provided for automatic adjustment of this amount for years thereafter.

The law provides for the determination of the OASDI contribution and benefit bases that would have been in effect in each year after 1978 under the automatic-adjustment provisions as in effect before the enactment of the 1977 amendments. This old-law base is used in determining special-minimum benefits for certain workers who have many years of low earnings in covered employment. Beginning in 1986, the old-law base is also used in the calculation of OASDI benefits for certain 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 the Employee Retirement Income Security Act of 1974.

F. ACTUARIAL ESTIMATES

The required information for the fiscal year that ended September 30, 1995, is presented in section II.C of this report. Estimates of the operations and status of the trust funds during fiscal years 1996-2005 are presented in this section. In addition, similar estimates for calendar years 1996-2005 are presented. A description of the actuarial status of the trust funds over the next 75 years, including long-range estimates of program income and program costs over that period, is also included in this section. The methods used to estimate the short-range operations of the trust funds and the long-range actuarial status are described in section II.H.

A number of different measures are useful in evaluating the financial status of the trust funds over the next 75 years. In addition to actuarial balance, and summarized income and cost rates, which are described in detail below, these measures include (1) the levels of future annual income and outgo, both in terms of dollars and relative to annual taxable earnings or payroll, including the pattern and ultimate values of such levels; (2) the annual differences between income and outgo, i.e., the annual balances, in dollars and relative to taxable payroll; (3) the size of future fund accumulations, in dollars and relative to future annual expenditures; and (4) the year in which trust fund exhaustion is estimated to occur. Estimates of all these indicators are presented in this section or in the appendices of this report. However, more attention is focused on certain elements of these measures, as described below.

In the short range, the adequacy of the trust fund level is generally measured by the "trust fund ratio," which is defined to be the assets at the beginning of the year expressed as a percentage of the outgo during the year. (For the years 1984-90, the assets at the beginning of the year also included advance tax transfers for the month of January. Assets at the beginning of subsequent years include advance tax transfers only if such transfers are needed to enable the timely payment of benefits.) The trust fund ratio represents the proportion of a year's outgo which can be paid with the funds available at the beginning of the year. During periods when trust fund disbursements exceed income, as might happen during an economic recession, trust fund assets are used to meet the shortfall. In the event of recurring shortfalls for an extended period, the trust funds can allow sufficient time for the development, enactment, and implementation of legislation to restore financial stability to the program.

The test of financial adequacy over the short-range projection period (the next 10 years), is applicable to each of the OASI and DI Trust Funds, separately, as well as to the combined funds. The requirements of this test are as follows: If the estimated trust fund ratio for a fund is at least 100 percent at the beginning of the projection period, then it must be projected to remain at or above 100 percent throughout the 10-year projection period. Alternatively, if the ratio is initially less than 100 percent, then it must be projected to reach a level of at least 100 percent by the beginning of the sixth year and to remain at or above 100 percent throughout the remainder of the 10-year period. In addition, the fund's estimated assets at the beginning of each month of the 10-year period must be sufficient to cover that month's disbursements. This test is applied on the basis of the intermediate (alternative II) estimates. Failure to meet this test by either trust fund is an indication that solvency of the program over the next 10 years is in question and that Congressional action is needed to improve the short-range financial adequacy of the program.

Basic to the discussion of the long-range actuarial status are the concepts of "income rate" and "cost rate," each of which is expressed as a percentage of taxable payroll. The annual income rate is the ratio of income from revenues (payroll tax contributions and income from 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. Because the taxable payroll reflects these adjustments, the annual income rate can be defined to be the sum of the OASDI combined employee-employer contribution rate (or the payroll-tax rate) scheduled in the law and the rate of income from taxation of benefits (which is, in turn, expressed as a percentage of taxable payroll). As such, it excludes 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, transfers under the interfund borrowing provisions, and net investment income.

The annual cost rate is the ratio of the cost (or outgo, expenditures, or disbursements) of the program to the taxable payroll for the year. In this context, the outgo is defined to include 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; it excludes special monthly payments to certain uninsured persons whose payments are reimbursable from the general fund of the Treasury (as described above), and transfers under the interfund borrowing provisions. 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.)

The long-range actuarial status of the trust funds has generally been summarized by the calculation of the "actuarial balance." The actuarial balance for a specified valuation period is defined as the difference between the summarized income rate and the summarized cost rate over that period. The summarized income rate over a period of years is equal to the ratio of (a) the sum of the trust fund balance at the beginning of the period plus the present value of the total income (excluding interest earnings) during the period, to (b) the present value of the taxable payroll for the years in the period. The summarized cost rate is equal to the ratio of (a) the sum of the present value of the outgo during the period plus the present value of a targeted trust fund level at the end of the period equal to the following year's outgo to (b) the present value of the taxable payroll for the years in the period. A targeted ending trust fund level of 1 year's expenditures is considered to be an adequate reserve for unforeseen contingencies; thus, in addition to the total outgo during the projection period, the summarized cost rate includes the cost of reaching and maintaining a target trust fund ratio of 100 percent through the end of the projection period.

The present-value calculations take account of the effect of interest on future income and outgo. In calculating the present value of future income, for example, the income in each year of the projection period is discounted to the beginning of the period using the interest rate assumed for calculating the interest earnings of the trust funds during the period. Thus, the calculations of the summarized income and cost rates are consistent with the estimates of trust fund operations over the projection period.

If the program is in exact actuarial balance for a particular period (that is, if the actuarial balance is zero), then the present value of estimated future income for all years in the period, plus the beginning trust fund balance, is exactly equal to the present value of estimated future expenditures for all years in the period, plus the present value of targeted trust fund assets at the end of the period in the amount of the next year's estimated outgo. A negative actuarial balance indicates that future estimated income and the beginning trust fund balance together are not sufficient to accumulate to the level of the targeted assets while also covering all estimated expenditures in the period. A positive actuarial balance indicates that in addition to covering all estimated expenditures in the period, the estimated ending trust fund assets are more than the targeted level.

The size of the actuarial balance represents a measure of the program's financial adequacy for the period in question. The actuarial balance can be interpreted as that amount which, if added to the combined employee-employer contribution rate scheduled under present law for each of the next 75 years, would bring the program into exact actuarial balance. Of course, there are any number of different ways to increase taxes or to reduce expenditures, as well as different combinations of such changes, that would have an equivalent effect on the actuarial balance. Any one of these different sets of changes would, therefore, bring the program into exact actuarial balance.

The long-range test of close actuarial balance applies to a set of valuation periods beginning with the first 10 years and continuing through the first 11 years, the first 12 years, etc., up to and including the full 75-year projection period. Under the long-range test, summarized income rates and cost rates are calculated for each of the 66 valuation periods in the full 75-year long-range projection period, with the first of these periods consisting of the next 10 years. Each succeeding period becomes longer by 1 year, culminating with the period consisting of the next 75 years. The long-range test is met if, for each of the 66 time periods, the actuarial balance is not less than zero or is negative by, at most, a specified percentage of the summarized cost rate for the same time period. The percentage allowed for a negative actuarial balance is 5 percent for the full 75-year period. For shorter periods, the allowable percentage begins with zero for the first 10 years and increases uniformly for longer periods, until it reaches the maximum percentage of 5 percent allowed for the 75-year period. The criterion for meeting the test is less stringent for the longer periods in recognition of the greater uncertainty associated with estimates for more distant years.

When a negative actuarial balance in excess of the allowable percentage of the summarized cost rate is projected for one or more of the 66 separate valuation periods, the program fails the long-range test of close actuarial balance. Being out of close actuarial balance indicates that the program is expected to experience financial problems in the future and that ways of improving the financial status of the program should be considered. The sooner the actuarial balance is less than the minimum allowable balance, expressed as a percentage of the summarized cost rate, the more urgent is the need for corrective action. However, it is recognized that necessary changes in program financing or benefit provisions should not be put off until the last possible moment if future beneficiaries and workers are to be able to effectively plan for their retirement.

It was noted earlier in this section that in addition to the measures used in the tests of the overall financial condition of the program, other financial measures are also presented in this report. All of these measures are important factors in arriving at a full understanding of the financial position of the OASDI program.

1. Operations and Status of the Trust Funds During the Period October 1, 1995, to December 31, 2005

These estimates indicate that the assets of the OASI Trust Fund would continue to increase throughout the next 10 years, rapidly under the intermediate and low cost assumptions and moderately under the high cost assumptions. The estimates indicate that the assets of the DI Trust Fund would also continue to increase throughout the next 10 years under the intermediate and low cost assumptions, at a slightly lower rate than for the OASI Trust Fund. Under the high cost assumptions, DI assets would increase for a few years before declining and becoming insufficient to permit the timely payment of benefits by the middle of 2005.

As will be shown later in this subsection, the OASI and DI Trust Funds, both individually and combined, meet the requirements of the Trustees' test of short-range financial adequacy.

a. OASI Trust Fund Operations

The increases in estimated income shown in table II.F1 under each set of assumptions reflect increases in estimated taxable earnings and growth in interest earnings on the invested assets of the trust fund. For each alternative, employment and earnings are assumed to increase in every year through the year 2005 (with the exception that employment is estimated to decline temporarily during the economic recessions assumed under alternative III). The number of persons with taxable earnings would increase on the basis of alternatives I, II, and III from 141 million during calendar year 1995 to about 157 million, 152 million, and 148 million, respectively, in 2005. The total annual amount of taxable earnings is projected to increase from $2,925 billion in 1995 to $5,056 billion, $4,793 billion, and $4,726 billion, in 2005, on the basis of alternatives I, II, and III, respectively. (In 1995 dollars - taking account of assumed increases in the CPI from 1995 to 2005 under each alternative - the estimated amounts of taxable earnings in 2005 are $3,784 billion, $3,368 billion, and $3,004 billion, respectively.) These increases in taxable earnings are due primarily to (1) projected increases in employment levels and average earnings in covered employment, (2) increases in the contribution and benefit base in 1996-2005 under the automatic adjustment provisions, and (3) various provisions enacted in 1983 and later, including extensions of coverage to additional categories of workers.

Growth in interest earnings represents a significant component of the overall increase in trust fund income during this period. Although interest rates payable on trust fund investments are not assumed to change substantially from current levels, the continuing rapid increase in OASI assets will result in a corresponding increase in interest income. By the year 2005, interest income to the OASI Trust Fund is projected to range from 11 to 15 percent of total trust fund income (depending on alternative), as compared to 10 percent in 1995.

Rising expenditures during 1996-2005 reflect automatic benefit increases as well as the upward trend in the numbers of beneficiaries and in the average monthly earnings underlying benefits payable by the program. The growth in the number of beneficiaries in the past and the expected growth in the future result both from the increase in the aged population and from the increase in the proportion of the population which is eligible for benefits. The latter increase is primarily due to various amendments enacted after 1950 which modified eligibility provisions and extended coverage to additional categories of employment.

Growth has also occurred, and will continue to occur, in the proportion of eligible persons who, in fact, receive benefits. This growth is due to several factors, among which are (1) the amendments enacted since 1950 which affect the conditions governing the receipt of benefits and (2) the increasing percentage of eligible persons who are aged 70 and over and who therefore may receive benefits regardless of earnings.

The estimates shown in table II.F1 indicate that income to the OASI Trust Fund would substantially exceed expenditures in every year of the short-range projection period, under each of the three sets of assumptions used in this report. The assets of the OASI Trust Fund at the beginning of 1995 were equal to 139 percent of the fund's expenditures in 1995. As described in the introduction to this section, this ratio is known as the "trust fund ratio;" it provides a useful measure of the relative level of trust fund assets. During 1995, income exceeded disbursements by $45.0 billion. As a result, the trust fund ratio increased to about 148 percent at the beginning of 1996.

Assets are estimated to increase substantially in each year of the short-range projection period, based on each of the three alternative sets of assumptions. The increase in the trust fund ratio from 148 percent at the beginning of 1996 to the range of 166-317 percent at the beginning of the year 2005 is due, in part, to the increases in the OASI tax rate that became effective in 1988 and 1990 (even though much of the increase was reallocated to the DI Trust Fund in 1994). Asset growth is also assisted by growth in taxable earnings that is projected to exceed the growth in benefit payments throughout the short-range projection period (except for certain years under alternative III).

As noted in section II.B, the portion of the OASI Trust Fund that is not needed to meet day-to-day expenditures is used to purchase investments, generally in special public-debt obligations of the U.S. Government. The cash used to make these purchases becomes part of the general fund of the Treasury and is used to meet various Federal outlays. Interest is paid to the trust fund on these securities and, when the securities mature or are redeemed prior to maturity, general fund revenues are used to repay the principal to the trust fund. Thus, the investment operations of the trust fund result in various cash flows between the trust fund and the general fund of the Treasury.

Currently, the excess of tax income to the OASI Trust Fund over the fund's expenditures results in a substantial net cash flow from the trust fund to the general fund. Sometime after the turn of the century, as shown in the following subsection, this cash flow will reverse; as trust fund securities are redeemed to meet benefit payments and other expenditures, revenue from the general fund of the Treasury will be drawn upon to provide the necessary cash. The accumulation and subsequent redemption of substantial trust fund assets has important public policy and economic implications that extend well beyond the operation of the OASDI program itself. Discussion of these broader issues is not within the scope of this report.

Based on the intermediate (alternative II) assumptions, the assets of the OASI Trust Fund would continue to exceed 100 percent of annual expenditures by a steadily increasing amount through the end of the year 2005. Consequently, the OASI Trust Fund satisfies the test of short-range financial adequacy by a wide margin. The estimates in table II.F1 also indicate that the short-range test would be satisfied even under the high cost assumptions.

In interpreting the trust fund ratios in table II.F1, it should be noted that at the beginning of any month there must be sufficient assets on hand to meet the benefit payments that are payable at the beginning of that month. The specific minimum amount of assets required for this purpose depends on a number of factors and varies somewhat from month to month. Assets of roughly 8 to 9 percent of annual expenditures are normally sufficient for this purpose. If the assets of either the OASI or DI Trust Fund at the end of a month fall below the minimum amount needed to meet the benefits payable at the beginning of the next month, section 201(a) of the Social Security Act provides for an advance transfer to the trust fund of all the taxes that are expected to be received by the fund in the next month. Thus, the difference between (1) the sum of the estimated trust fund ratios shown in table II.F1 and the advance tax transfers for January expressed as a percentage of total expenditures in the year and (2) the minimum required level of about 8-9 percent, represents the reserve available to handle adverse contingencies.

b. DI Trust Fund Operations

Expenditures are estimated to increase because of automatic benefit increases and projected increases in the amounts of average monthly earnings on which benefits are based. In addition, on the basis of all three sets of assumptions, the number of DI beneficiaries is projected to continue increasing throughout the short-range projection period. The projected growth in the number of DI beneficiaries is attributable to several factors, including (1) gradual increases in the number of persons estimated to be insured for disability benefits and (2) an assumption that the number of insured workers who apply for and are awarded disability benefits will continue to substantially exceed the number of disabled worker beneficiaries whose benefits terminate each year as a result of death, recovery, or attainment of normal retirement age.

The proportion of insured workers who apply for and are awarded disability benefits in a given year is referred to as the "disability incidence rate." This rate has fluctuated substantially in past years and the causes for the variation have not been precisely determined. Incidence rates increased during 1970-75, declined during 1976-82, increased again during 1983-85, and remained steady in 1986-89. During 1990-92 the incidence rate resumed increasing, with unusually rapid increases (on a relative basis) of 8, 12, and 17 percent in those 3 years. In 1993-95, the observed incidence rate declined slightly from the 1992 level. There remains, however, a backlog of pending disability applications awaiting final adjudication that is relatively large compared to historical levels. This suggests that the recent declines in the incidence rate may, in part, represent a delay in awards from 1993-95 to later years.

The rapid increases in disability benefit applications and awards during 1990-92 appear to be attributable, in part, to the rise in unemployment associated with the 1990-91 economic recession (although the evidence is not conclusive). Other explanatory factors may include changes to the conditions governing receipt of disability benefits, as introduced through recent legislation, regulations, and court decisions, and increased awareness of the DI program by the public.

These and other factors were discussed at some length in a report issued December 1992, entitled "The Social Security Disability Insurance Program: An Analysis" prepared by the Department of Health and Human Services at the request of the Board of Trustees. Subsequent to that report, the Social Security Administration, together with the Office of the Assistant Secretary for Planning and Evaluation in the Department of Health and Human Services, commissioned a series of studies attempting to quantify some of the reasons for the rapid growth in the DI program on the early 1990s. Reference should be made to these studies for further details on the possible factors contributing to the increases in disability incidence rates observed in the period 1990-92, and the subsequent decline observed since 1992.

Due to the substantial variation exhibited by incidence rates in the past and the difficulty in determining reliable explanatory factors for this variation, any projection of future incidence rates necessarily will be uncertain. The 1995 disability incidence rate (calculated on an age-sex-adjusted basis) was 5.25 awards per 1,000 insured workers. This figure was about 15 percent higher than the average incidence rate of 4.6 per thousand that was experienced during 1975 through 1995. Under the intermediate assumptions, incidence rates are assumed to increase by another 1 percent in 1996-97 and then to decline gradually for the remainder of the short-range projection period, to about 3 percent below the level experienced in 1995. A small portion of this decline is attributable to the prohibition on future awards of benefits to persons disabled by drug addiction or alcoholism enacted in Public Law 104-121. Under the low cost alternative, incidence rates decline by about 18 percent during 1996-2005, dipping slightly under the 1975-95 average at the end of the period. The high cost alternative assumes that incidence rates increase by another 18 percent over the next 7 years (nearing briefly the highest levels experienced during the 1970s) and then decline slightly over the remaining 3 years of the short-range period.

The proportion of DI beneficiaries whose benefits terminate in a given year has also fluctuated significantly in the past. Over the last 20 years, the rates of benefit termination due to death or conversion to retirement benefits (at attainment of normal retirement age) have declined very gradually. This trend is attributable, in part, to the lower average age of new beneficiaries. The termination rate due to recovery has been much more volatile. Currently, the proportion of disabled beneficiaries whose benefits cease because of their recovery from disability is very low in comparison to past levels.

In this report, termination rates due to attainment of normal retirement age are estimated to continue their downward trend through 2002. This rate would drop in 2003 and remain at a depressed level for 5 more years as a result of the increase in the normal retirement age) which begins in that year. Age-specific death rates for disabled beneficiaries are assumed to remain at about their current level. Terminations due to recovery are assumed to increase from their current levels in response to the additional funding for continuing disability reviews authorized under Public Law 104-121. In addition, the prohibition placed by Public Law 104-121 on benefits payable to individuals disabled by drug addiction and alcoholism, is expected to result in a one-time increase in terminations during 1997. Ignoring this one-time effect, the overall termination rate (reflecting all causes) is projected under all three alternatives to continue declining gradually during 1996-98 and level off during 1999-2002. The overall rate then declines in 2003 due largely to the increase in the normal retirement age cited above.

The continuing spread of Acquired Immunodeficiency Syndrome (AIDS) has contributed to the recent increases in DI awards. Due to the extremely high mortality rates of affected individuals, the total number of disabled workers currently receiving benefits has not increased greatly as a result of AIDS. Although many aspects of the AIDS epidemic are well understood, there remains considerable uncertainty regarding future medical advances and future incidence of HIV infection. To reflect this uncertainty, the projected numbers of benefit awards to AIDS patients are varied by alternative. Under the intermediate assumptions, benefit awards to persons with AIDS are projected to increase slightly through 2000 before beginning to decline. Under the low cost assumptions, the number of new awards declines gradually throughout the projection period, while the number projected under the high cost assumptions increases at a rapid rate through 2001 before beginning to decline.

At the beginning of calendar year 1995, the assets of the DI Trust Fund represented 55 percent of annual expenditures. During 1995, DI income exceeded DI expenditures by $14.6 billion, with the result that the trust fund ratio for the beginning of 1996 increased to about 83 percent. Under the intermediate and low cost sets of assumptions, income is estimated to exceed expenditures in each year of the short-range projection period. The increase in the trust fund ratio from 55 percent at the beginning of 1995 to 83 percent at the beginning of 1996, and the further increase to 136 percent at the beginning of 2002 on the basis of the intermediate assumptions, are largely due to the tax rate reallocation enacted in 1994. The decline in the trust fund ratio to 127 percent at the beginning of 2005 is an early warning of trouble for the DI Trust Fund soon after the short-range period.

Under the low cost assumptions, the trust fund ratio would increase rapidly to 264 percent at the beginning of 2005. Under the high cost assumptions, the assets of the DI Trust Fund would increase through 1999, decline steadily thereafter, and would be exhausted in 2005.

Because DI assets reach the level of 1 year's expenditures at the beginning of 1997 under the intermediate assumptions and would remain above that level in 1998 and later, the DI Trust Fund satisfies the Trustees' short-range test of financial adequacy. However, as indicated above, under the high cost assumptions not only does DI fail to meet the short-range test of financial adequacy, but the DI Trust Fund is exhausted near the end of the short-range projection period.

c. Combined OASI and DI Trust Fund Operations

At the beginning of 1995, the trust fund ratio for the OASI and DI Trust Funds combined was 128 percent, as shown in table II.F3. During 1995, total income to the two trust funds was $59.7 billion higher than total expenditures. As a result of this increase, combined OASDI assets at the beginning of 1996 represented about 140 percent of estimated combined expenditures for the year. Based on the intermediate assumptions, the trust fund ratio for the combined funds is projected to increase substantially, to 221 percent by 2005. The ratio would grow at an even faster rate under the low cost assumptions, reaching 309 percent at the beginning of the year 2005. Under the high cost assumptions, assets would grow more slowly, reach a maximum of 159 percent in 1999-2000, and decline to 139 percent at the beginning of 2005.

Under the intermediate assumptions, the total assets of the OASI and DI Trust Funds would remain above 100 percent of annual OASDI expenditures throughout the short-range projection period. Therefore, the combined trust funds meet the requirements of the short-range test of financial adequacy. Under the high cost assumptions, the fund ratio for OASI and DI combined would still remain above 100 percent through 2005 (although, as indicated in the section on long-range projections, the ratio would fall below this level shortly thereafter). Thus, even under adverse conditions the combined funds would satisfy the short-range test of financial adequacy, although by a narrower margin.

Section 215(i) of the Social Security Act includes a provision to stabilize automatic benefit increases in the event of high inflation at a time when the combined assets of the OASI and DI Trust Funds are at very low levels (see section II.E of this report). Under all three alternatives, the level of OASDI assets during 1996-2005 would substantially exceed the applicable threshold. Thus, the stabilizer provision would not be triggered during the short-range projection period under any of the sets of assumptions used in this report.

Figure II.F1 presents the estimated total assets of the OASI and DI Trust Funds at the end of each year 1996-2005, based on the three sets of assumptions (together with actual assets at the end of each year 1985-95). Figure II.F2 illustrates the pattern of actual past and estimated future OASDI trust fund ratios under the three alternatives. Trust fund ratios for selected years prior to 1996, and estimates for 1996-2005 under the three alternatives, are shown in table II.F4 for OASI, DI, and both funds combined. In evaluating the ratios shown in figure II.F2 and table II.F4, it should be recalled that a minimum of roughly 8 to 9 percent is generally needed to meet monthly cash-flow requirements. The shaded area in figure II.F2 depicts this requirement.

The factors underlying the changes in the intermediate estimates for the OASI Trust Fund, from last year's annual report to this year's, are analyzed in table II.F5. In the 1995 Annual Report, the trust fund ratio for OASI was estimated to reach 246 percent at the beginning of the year 2004 - the tenth projection year from that report. The corresponding ratio shown in this report for the tenth projection year (2005) is 239 percent. As indicated in table II.F5, the net effect of the provisions in Public Law 104-121 affecting OASI (liberalization of the retirement earnings test for persons aged 65-69 and restrictions on benefits payable to stepchildren) was to reduce the tenth-year ratio by 2 percentage points. If there had been no changes to the projections other than those necessitated by this legislation, then the estimated ratio at the beginning of 2005 would have been 12 percentage points higher than at the beginning of 2004. There were changes, however, to reflect the latest actual data, as well as adjustments to the assumptions for future years. The cumulative net effects of changes in economic assumptions (including re-estimates of future tax revenue consistent with recent revisions to historical data) resulted in a decrease in the trust fund ratio of 13 percentage points by the beginning of 2005. Finally, the tenth year trust ratio was reduced an additional 4 percentage points due to the net effect of revised assumptions regarding future average benefit levels and projected numbers of survivor beneficiaries.

Corresponding estimates of the factors underlying the changes in the financial projections for the DI Trust Fund, and for the OASI and DI Trust Funds combined, are also shown in table II.F5. As was the case for OASI, the key factors affecting the new estimates for the DI Trust Fund were legislation, and the cumulative effects of changes in assumptions related to economic performance and terminations of disability benefits.

For the DI Trust Fund during 1996-2005, the estimated operations in this report under all three alternatives show a slight worsening since the 1995 Annual Report, primarily due to the downward revisions in projections of tax revenue. As for benefit payments from the DI Trust Fund, the number of new disability awards to insured workers in 1995 was less than anticipated in last year's report, but (as noted earlier) the backlog of pending disability claims continued to remain at a high level. The assumed disability incidence rates for the 1996 Annual Report are similar to the corresponding rates from the 1995 report, with a slight reduction in the number of awards in the next few years.

The overall disability termination rate experienced in 1995 was only slightly higher than assumed under the intermediate assumptions of the 1995 Annual Report (9.6 percent versus 9.5 percent). Consequently, the termination rate assumptions for this report were not changed significantly as compared to the 1995 Annual Report, except for the effects of Public Law 104-121 on continuing disability reviews and benefits payable to individuals disabled by drug addiction and alcoholism.

Table II.F6 shows that total expenditures in calendar year 1995 from the OASI and DI Trust Funds increased to 11.64 percent of taxable payroll for the year - 0.95 percentage point less than the income rate of 12.59 percent. This increase in the total cost rate for OASDI is primarily attributable to the re-estimate of the OASDI taxable payroll, as described previously. Under the intermediate assumptions, the OASDI cost rate would increase gradually during the short-range projection period, to 12.07 percent in 2005. Based on the low cost assumptions, the cost rate is estimated to decline steadily, reaching 10.58 percent in 2005. The high cost alternative indicates a significant increase, to 13.72 percent in 2005.

These cost rate projections are shown in table II.F6 for both trust funds, separately and combined. Table II.F6 also shows a comparison of the cost rates with the corresponding income rates. As explained previously, the income rate represents the sum of the combined employee-employer payroll tax rate and the income derived from the Federal income taxation of OASDI benefits, expressed as a percentage of taxable payroll. The difference between the income rate and the cost rate for a year is referred to as the "balance" for that year.

Estimates of the operations of the trust funds during calendar years 1996-2005 have been presented in the preceding tables on the basis of three different sets of economic assumptions, because of the uncertainty of future economic and demographic developments. Under the provisions of the Social Security Act, estimates of the expected operations and status of the trust funds during the next 5 fiscal years are required to be shown in this report. Accordingly, detailed estimates of the expected operations and status of the trust funds during fiscal years 1996-2000 are shown in the remaining tables of this section for the intermediate assumptions (alternative II) only. Similar detailed estimates are also shown for 5 additional fiscal years (2001-05) and on a calendar-year basis for 1996-2005.

Data on the actual operations of the OASI Trust Fund for selected years during 1940-95, and estimates of the expected operations of the trust fund during 1996-2005 on the basis of the intermediate assumptions, are shown in tables II.F7 and II.F8 on a fiscal- and calendar-year basis, respectively. Corresponding figures on the operations of the DI Trust Fund are shown in tables II.F9 and II.F10. Operations of both trust funds combined are shown in tables II.F11 and II.F12. (Data relating to the operations of the two trust funds for years not shown in tables II.F7 - II.F12 are contained in past annual reports.) The figures shown in tables II.F8, II.F10, and II.F12 for 1987, 1988, 1992, and 1993 are adjusted to reflect 12 months of benefit payments in each year. The amounts estimated for 1998 and 1999 are similarly adjusted.

2. Long-Range Actuarial Status of the Trust Funds

Beginning with the 1991 Annual Report, actuarial balances have also been computed based on the intermediate (alternative II) assumptions for valuation periods that are 10 years, 11 years, and continuing through 75 years in length. This series of actuarial balances provides the basis for the test of long-range close actuarial balance, described earlier in this section.

In addition to these actuarial balances, other indicators of the financial condition of the program are shown in this report. One is the series of projected annual balances (that is, the differences between the projected annual income rates and annual cost rates), with particular attention being 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. Another is the series of projected trust fund ratios, with particular attention being paid to the amount and year of maximum fund ratio accumulation and to the year of exhaustion of the funds. These additional indicators are defined in the introduction to this section.

The estimates are sensitive to changes in the underlying economic and demographic assumptions. The degree of sensitivity, however, varies considerably among the various assumptions. For example, variations in assumed fertility rates have little effect on the estimates for the early years, because almost all of the covered workers and beneficiaries projected for the early years were born prior to the start of the projection period. However, lower fertility rates have large impacts on the actuarial balance in the later years. Variations in economic factors, such as interest rates and increases in wages and prices, have significant effects on the estimates for the short term, as well as for the long term. In general, the degree of confidence that can be placed in the assumptions and estimates is greater for the earlier years than for the later years. Nonetheless, even for the earlier years, the estimates are only an indication of the expected trend and general range of future program experience. Section II.G contains a more detailed discussion of the effects on the estimates of varying certain economic and demographic assumptions.

a. Annual Income Rates, Cost Rates, and Balances

The projections for OASDI under the intermediate alternative II assumptions show income rates that increase slowly and steadily due to the combination of the flat payroll tax rate and the gradually increasing effect of the taxation of benefits. The pattern followed by the cost rates is much different. Costs as a percent of taxable payroll are projected to rise slowly for the next 15 years and then to increase rather rapidly for about the next 20 years (through 2030) as the baby-boom generation reaches retirement age. Cost rates continue rising slowly through 2036 and then decline slightly for the next 6 years as the baby-boom generation ages and the relatively small birth cohorts of the late 1970s reach retirement age. Thereafter, cost rates rise steadily, but slowly, reflecting projected increases in life expectancy. The cost rates during the third 25-year subperiod rise to a level of nearly 19 percent of taxable payroll under the intermediate alternative II assumptions. The income rate during the third 25-year subperiod is just over 13 percent of taxable payroll under alternative II.

Projected income rates under the low cost and high cost sets of assumptions (alternatives I and III, respectively) are very similar to those projected for alternative II as they are largely a reflection of the tax rates specified in the law. OASDI combined cost rates for alternatives I and III differ significantly in size from those projected for alternative II, but follow generally similar patterns. For the low cost alternative I, cost rates decline somewhat for about the first 12 years, and then rise, reaching the current level around 2015 and a peak of 14.26 percent of payroll in 2032. Thereafter, cost rates decline gradually, reaching a level of 13.12 percent of payroll in 2070. For the high cost alternative III, cost rates rise throughout the 75-year period, but at a relatively faster pace during the next 5 years due to the assumed economic recessions, and 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 28.02 percent of payroll in 2070.

The projected pattern of the OASDI annual balances (that is, the difference between the income rates and the cost rates) is important in the analysis of the financial condition of the program. Under the alternative II assumptions the annual balances are positive for 16 years (through 2011) and are negative thereafter. This annual deficit rises rapidly reaching 2 percent of taxable payroll by 2020 and continues rising thereafter, to a level of 5.51 percent of taxable payroll for 2070.

Under alternative I, projected OASDI annual balances are positive for 25 years (through 2020), and thereafter are negative. Deficits under alternative I rise to a peak of 1.27 percent of taxable payroll in 2032, but diminish thereafter, as the effect of the baby-boom generation diminishes and the assumed higher fertility rates increase the work force. Deficits under alternative I diminish to 0.08 percent of payroll by 2070. Under the more pessimistic alternative III, however, the OASDI actuarial balance is projected to be positive for only 4 years (through 1999) and to be negative thereafter, reaching deficits of 4 percent of payroll by 2020, nearly 10 percent by 2050, and over 14 percent of payroll by 2070.

Also of interest are the long-range financial conditions of the separate OASI and DI programs. Annual balances under alternative II remain positive through 2013 for the OASI program, but only through 2002 for the DI program.

Figure II.F3 shows in graphical form the patterns of the OASDI annual income rates and cost rates. The income rates are shown only for alternative II in order to simplify the graphical presentation and because, as shown in table II.F13, the variation in the income rates by alternative is very small. The OASDI long-range summarized income rates for alternatives I and III, for the 75-year valuation period, differ by only about 0.3 percent of taxable payroll. By 2070, the annual income rates under alternatives I and III differ by less than 0.8 percent of taxable payroll. Only small fluctuations are projected in the income rate, as the rate of income from taxation of benefits varies only slightly, for each alternative, reflecting changes in the cost rate and the fact that benefit-taxation threshold amounts are not indexed.

The patterns of the annual balances are indicated in figure II.F3. 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 the OASDI program, 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 economic and demographic conditions, the resulting estimates delineate a reasonable range for future program costs.

b. Summarized Income Rates, Cost Rates, and Balances

Table II.F14 shows rates on a present-value basis summarized for each of the 25-year subperiods, excluding both the funds on hand at the beginning of the period and the cost of accumulating a target trust fund balance by the end of the period. These rates are useful for comparing the cash flows of tax income and expenditures, as an indicator of the degree to which tax income during the period is sufficient to meet the outgo estimated for the period.

Table II.F15 shows summarized rates 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 expenditures by the end of the period, for valuation periods of the first 25 years, the first 50 years, and the entire 75-year period. Therefore, the actuarial balance for each of these three valuation periods is equal to the difference between the summarized income rate and cost rate for the corresponding period. A balance of zero for any period on this basis would indicate that estimated outgo for the period could be met, on the average, with a remaining trust fund balance at the end of the period equal to 100 percent of the following year's outgo.

The values in table II.F15 show that the combined OASDI program is expected to operate with a positive balance over shorter valuation periods under alternatives I and II. For the first 25-year valuation period the summarized values indicate balances of 1.75 percent of taxable payroll under alternative I, 0.36 percent under alternative II, and -1.18 percent under alternative III. Thus, the program is more than adequately financed for the next 25-year valuation period under all but the high cost alternative III projections. Over the 50-year valuation period, 1996-2045, the OASDI program would have a positive balance of 0.65 percent under alternative I, but would have deficits of 1.39 percent under alternative II and 3.82 percent under alternative III. Thus, the program is more than adequately financed for the 50-year valuation period under only the low cost set of assumptions, alternative I.

For the entire 75-year valuation period, the combined OASDI program would again have actuarial deficits except for the low cost set of assumptions, alternative I. The actuarial balance for this long-range valuation period is projected to be 0.46 percent of taxable payroll under alternative I, -2.19 percent under alternative II, and -5.67 percent under alternative III.

As may be concluded from tables II.F14 and II.F15, the financial condition of the DI program is somewhat poorer 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 about the same relative to program costs.

c. Test of Long-Range Close Actuarial Balance

Table II.F16 presents a comparison of the estimated actuarial balances with the minimum allowable balance (or maximum allowable deficit) under the long-range test, each expressed as a percentage of the summarized cost rate, based on the intermediate alternative II estimates. Values are shown for only 14 of the valuation periods: those of length 10 years, 15 years, and continuing in 5-year increments through 75 years. However, each of the 66 periods - those of length 10 years, 11 years, and continuing in 1-year increments through 75 years - is considered for the test. These minimum allowable balances are calculated to show the limit for each valuation period resulting from the graduated tolerance scale. The patterns in the estimated balances as a percentage of the summarized cost rates, as well as that for the minimum allowable balance, are presented graphically in figure II.F4, for the OASI, DI and combined OASDI programs. Values shown for the 25-year, 50-year, and 75-year valuation periods correspond to those presented in table II.F15.

As discussed earlier, a program is found not to be in long-range close actuarial balance if, for any of the valuation periods ending with the 10th through 75th years of the projection period, the estimated actuarial balance is less than the minimum allowable balance. The minimum allowable balance as a percentage of the summarized cost rate is -5.0 percent for the full 75-year long-range period and is reduced uniformly for shorter valuation periods, reaching zero for the 10-year valuation period.

For the OASI program, the estimated actuarial balance as a percentage of the summarized cost rate exceeds the minimum allowable for valuation periods of length 10 years through 33 years, under the intermediate alternative II estimates. For valuation periods of length greater than 33 years, the estimated actuarial balance is less than the minimum allowable. For the full 75-year long-range period the estimated actuarial balance reaches -13.90 percent of the summarized cost rate, for a shortfall of nearly 9 percent, from the minimum allowable balance of -5.0 percent of the summarized cost rate. Thus, although the OASI program satisfies the short-range test of financial adequacy (as discussed earlier in this section), it is not in long-range close actuarial balance.

For the DI program, the estimated actuarial balance as a percentage of the summarized cost rate exceeds the minimum allowable balance for valuation periods of length 10 through 12 years under the intermediate alternative II estimates. For valuation periods of length greater than 12 years, the estimated actuarial balance is less than the minimum allowable. The shortfall from the minimum allowable balance rises to a level of 15.54 percent of the summarized cost rate for the full long-range period, for a shortfall of over 10 percent, from the minimum allowable balance of -5.0 percent of the summarized cost rate. Thus, although the DI program satisfies the short-range test of financial adequacy (as discussed earlier in this section), it is also not in long-range close actuarial balance.

As indicated above, financing for the DI program is less adequate than for the OASI program during the first 25 years even though long-range actuarial deficits are comparable over the entire 75-year period. This occurs because the cost of the OASI program rises much faster during the long-range period. As a result, tax rates that are relatively more adequate for the OASI program during the first 25 years, become relatively less adequate thereafter.

For the combined OASDI program, the estimated actuarial balance as a percentage of the summarized cost rate exceeds the minimum allowable balance for valuation periods of length 10 years through 31 years. For valuation periods of length greater than 31 years, the estimated actuarial balance is below the minimum allowable balance. The size of the shortfall from the minimum allowable balance rises gradually reaching 9.13 percent of the summarized cost rate for the full 75-year long-range valuation period. Thus, although the OASDI program satisfies the short-range test of financial adequacy (as discussed earlier in this section), it is out of long-range close actuarial balance.

The OASI and DI programs, both separate and combined, were also found to be out of close actuarial balance in last year's report. The estimated deficits for the OASI, DI, and combined OASDI programs in this report are similar to those shown in last year's report.

d. Income and Cost Rates by Component

Summarized values for the annual income and cost rates, along with their components, are presented in table II.F18 for 25-year, 50-year, and 75-year valuation periods. Summarized income rates include the starting trust fund balance in addition to the components included in the annual income rates. The summarized cost rates include the cost of reaching and maintaining an ending trust fund target of 100 percent of annual expenditures by the end of the period in addition to the expenditures included in the annual cost rates. Thus, the total summarized rates shown in table II.F18 are the same as the summarized income and cost rates shown in table II.F15 for the 25-year, 50-year, and 75-year valuation periods.

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 outgo 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 from, the fund, while taxable payroll is allocated 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.

e. Comparison of Workers to Beneficiaries

Table II.F19 shows that the number of covered workers per beneficiary, which was about 3.3 in 1995, is estimated to decline in the future. Based on alternative I, for which high fertility rates and small reductions in death rates are assumed, the ratio declines to a level of 2.3 by 2030, and increases slowly thereafter. Based on alternative III, for which low fertility rates and substantial reductions in death rates are assumed, the decline is much greater, reaching 1.3 workers per beneficiary by 2065. Based on alternative II, the ratio declines to 1.8 workers per beneficiary by 2065.

The impact of the demographic shifts under the three alternatives on the OASDI cost rates is better understood by considering the projected number of beneficiaries per 100 workers. As compared to the 1995 level of 31 beneficiaries per 100 covered workers, this ratio is estimated to rise by the year 2070 to significantly higher levels, which are 41 under alternative I, 56 under alternative II, and 78 under alternative III. The significance of these numbers can be seen by comparing figure II.F3 to figure II.F5.

For each alternative, the shape of the curve in figure II.F5, which shows beneficiaries per 100 covered workers, is strikingly similar to that of the corresponding cost-rate curve in figure II.F3, thereby emphasizing the extent to which the cost of the OASDI program is determined by the age patterns 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. A graphical presentation of covered workers per beneficiary is shown in section I.H of the Overview.

f. Trust Fund Ratios

Based on alternative II, the OASI trust fund ratio rises steadily from 148 percent at the beginning of 1996, reaching a peak of 284 percent at the beginning of 2012. This increase in the OASI trust fund ratio results from the fact that the annual income rate (excluding interest) exceeds annual outgo for several years (see table II.F13). Thereafter, the OASI ratio declines steadily, with the OASI Trust Fund becoming exhausted in 2031. The DI trust fund ratio follows a similar pattern, except that it unfolds more rapidly. The DI trust fund ratio is estimated to rise from 83 percent at the beginning of 1995 to a peak of 136 percent in 2002, and to decline thereafter until becoming exhausted in 2015.

The trust fund ratio for the hypothetical combined OASI and DI Trust Funds rises from 140 percent for 1996 to a peak of 245 percent at the beginning of 2011. Thereafter, the ratio declines, with the combined funds becoming exhausted in 2029. Based on the intermediate estimates in last year's report, the peak fund ratio for the combined funds was estimated to be 269 percent and the year of exhaustion was estimated to be 2030.

The trust fund ratio for the combined OASDI program begins to decline in 2012, the same year annual expenditures begin to exceed noninterest income. Although the dollar amount of assets will continue to rise through the beginning of 2018, because interest income more than offsets the shortfall in noninterest income, revenue from the general fund of the Treasury will be needed in increasingly large amounts, beginning in 2012, to redeem the trust funds' public-debt obligations due to the cash-flow shortfall. This will differ from the experience of recent years when the trust funds have been net lenders to the general fund. 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. Discussion of these issues is outside the scope of this report.

Based on the low cost alternative I assumptions, the trust fund ratio for the DI program increases throughout the long-range projection period, reaching an extremely high level by 2070, of 1,390 percent. For the OASI program, the trust fund ratio rises to a peak of 487 percent in 2017, dropping thereafter to a stable level around 340 percent by 2045. For the combined OASDI program, trust fund ratios follow a pattern similar to that for OASI, peaking at 479 percent in 2018, and then falling, until around 2040, but increasing thereafter, to a level of 471 percent for 2070.

In contrast, under alternative III, the OASI trust fund ratio is estimated to peak at 172 percent in 2001, thereafter declining to fund exhaustion by the end of 2020. The DI Trust Fund is estimated to begin declining in 2000, becoming depleted in 2005. The combined trust fund ratio is estimated to rise to a peak of 159 percent in 2000, declining thereafter to fund exhaustion by the end of 2016.

The fact that the financing for the DI program is relatively more adequate compared to the financing for the OASI program under low cost assumptions, but relatively less adequate under high cost assumptions is due to the tax rate reallocation enacted in 1994. This reallocation roughly equalized the size of the long-range actuarial deficits of the OASI and DI programs in relation to the summarized cost rates under intermediate assumptions. A smaller reallocation would have been needed to equalize the deficits in this manner under low cost alternative I assumptions, while a larger reallocation would have been needed under high cost alternative III assumptions.

Thus, because of the high ultimate cost rates that are projected under all but the most optimistic assumptions, 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 expenditures for 20 years into the future (until 2016). Under the alternative II assumptions the combined starting funds plus estimated future income would be able to cover expenditures for about 33 years into the future (until 2029). The program would be able to cover expenditures for the indefinite future under the more optimistic assumptions in alternative I. In the 1995 report, the combined trust funds were projected to be exhausted in 2016 under alternative III and in 2030 under alternative II.

A graphic illustration of the trust fund ratios for the combined trust funds is shown in figure II.F6 for each of the alternative sets of assumptions.

g. Reasons for Change in Actuarial Balance From Last Report

Legislation enacted since last year's report (see section II.A) is estimated to increase the long-range OASDI actuarial balance. The Senior Citizens' Right to Work Act of 1996 (Title I of Public Law 104-121) made several changes affecting OASDI benefits, including an increase in the retirement earnings test exempt amount for persons between their normal retirement age and age 70. Three provisions of this Act resulted in significant changes in the OASDI actuarial balance. Disability benefits will no longer be payable to persons found unable to work solely because of drug addiction or alcohol dependency. Additional funding will be provided through 2002 for periodic continuing disability reviews of disabled beneficiaries who were earlier found to have impairments that are not permanent. Benefits for a stepchild will be terminated if the stepparent, upon whose earnings record benefits are based, divorces the natural parent.

In changing from the valuation period of last year's report, which was 1995-2069, to the valuation period of this report, 1996-2070, the relatively large negative annual balance for the year 2070 is included. This results in a decrease in the long-range actuarial balance. (Note that the positive balance for 1995 is, in effect, retained because the funds accumulated during the year are included in the income rate and the actuarial balance for this year's report.)

Several demographic assumptions were modified: (1) the starting population was updated to reflect revised postcensal estimates (1990 through 1994) by the Bureau of the Census, which showed fewer people at working ages than did earlier estimates; (2) projected mortality rates were decreased, reflecting the latest data, which were, on balance, lower than expected for 1992 through 1994; (3) the ultimate rates of improvement in mortality for persons under age 65 were increased relative to the rates of improvement for older persons, consistent with long-term historical data; (4) projected fertility rates were decreased slightly through 2005, consistent with recent data that shows lower birth rates than did earlier estimates; (5) projected marriage and divorce rates were lowered, based on recent data; and (6) net legal immigration was decreased by 50,000 per year and net other-than-legal immigration was increased by 50,000 per year based on recent analysis by the Immigration and Naturalization Service. These modifications result in a net decrease in the long-range actuarial balance.

Ultimate economic assumptions were not changed for this report. However, revised short-range economic assumptions, including reduced revenue from payroll taxes based on revised earnings data for recent years, resulted in a reduction in the long-range actuarial balance.

Disability incidence rates were lowered throughout the 75-year projection period to reflect the exclusion of persons unable to work due to drug addiction or alcohol dependence, and recovery termination rates were increased within the first 25-year subperiod to reflect the increased funding provided for periodic continuing disability reviews; the effects of these changes are reflected under legislation, as they are based on provisions of Public Law 104-121. Additional changes in disability rates include (1) slightly lower ultimate incidence rates for males and higher incidence rates for females, consistent with recent data; and (2) lower death termination rates for disabled workers, in relation to general population death rates, consistent with recent data. These modifications result in a reduction in the long-range actuarial balance for the DI program.

Several significant improvements and updates were made in the methods used to project the cost and income of the OASDI program. The method used for projecting the number of dually entitled beneficiaries (those receiving both a retired or disabled worker benefit, and a residual spouse or survivor benefit) was changed to better reflect the projected population by marital status. This change significantly increased the long-range actuarial balance for the OASI program. The rate of change in benefits for female retired workers, after first becoming entitled, was increased, reflecting recent data. Benefits tend to increase after entitlement faster than suggested by the cost-of-living adjustment because of increments based on benefit withholding for earnings, and because individuals with higher benefits tend to have slightly lower death rates. This change resulted in a small reduction in the OASDI actuarial balance. Updated sample data for benefits awarded in 1994 were used as the starting point for projecting the level of average benefits for future beneficiaries. The increase in average benefit levels from the previous sample, for 1993 awards, to the new sample was slightly higher than had been previously projected, resulting in a small reduction in the OASDI actuarial balance. An error that resulted in an understatement of the estimated amount of revenue from taxation of benefits in the 1995 report was corrected, resulting in a small increase in the actuarial balance.

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 a little less than 5 percent of GDP currently to about 6.6 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 C.

G. LONG-RANGE SENSITIVITY ANALYSIS

Each table that follows shows the effects of changing a particular assumption on the OASDI summarized income rates, summarized cost rates, and actuarial balances (as defined earlier in this report) for 25-year, 50-year, and 75-year valuation periods. Because the income rate varies only slightly with changes in assumptions, it is not considered in the discussion of the tables. The change in each of the actuarial balances is approximately equal to the change in the corresponding cost rate, but in the opposite direction.

1. Total Fertility Rate

For the 25-year period, the cost rate for the three fertility assumptions varies by only about 0.07 percent of taxable payroll. In contrast, the 75-year cost rate varies over a wide range, decreasing from 16.02 to 15.05 percent, as the assumed ultimate total fertility rate increases from 1.6 to 2.2. Similarly, while the 25-year actuarial balance varies by only 0.07 percent of taxable payroll, the 75-year actuarial balance varies over a much wider range, from -2.66 to -1.76 percent.

During the 25-year period, the very slight effect of changes in fertility on the working population is more than offset by increases in the number of child beneficiaries. Hence, the program cost slightly increases with higher fertility. For the 75-year long-range period, however, changes in fertility have a relatively greater impact on the labor force than on the beneficiary population. As a result, an increase in fertility significantly reduces the cost rate. Each increase of 0.1 in the ultimate total fertility rate increases the long-range actuarial balance by about 0.15 percent of taxable payroll.

2. Death Rates

The variation in cost for the 25-year period is less pronounced than the variation for the 75-year period because the decreases in death rates are assumed to occur gradually. The 25-year cost rate increases from 12.95 percent (for 16-percent lower ultimate death rates) to 13.40 percent (for 55-percent lower ultimate rates). The 75-year cost rate increases from 14.77 to 16.37 percent. The actuarial balance decreases from +0.59 to +0.15 percent for the 25-year period, and from -1.48 to -3.00 percent for the 75-year period.

Lower death rates cause both the income (as well as taxable payroll) and the outgo of the OASDI program to be higher than they would otherwise be. The relative increase in outgo, however, exceeds the relative increase in taxable payroll. For any given year, reductions in the death rates for people who have attained the retirement eligibility age of 62 (people whose death rates are the highest) increase the number of retired-worker beneficiaries (and, therefore, the amount of retirement benefits paid) without adding significantly to the number of covered workers (and, therefore, to the taxable payroll). Although reductions for people aged 50 to retirement eligibility age do result in significant increases to the taxable payroll, those increases are not large enough to offset the sum of the additional retirement benefits mentioned above and the disability benefits paid to additional beneficiaries in this pre-retirement age group. At ages under 50, death rates are so low that even substantial reductions would not result in significant increases in the numbers of covered workers or beneficiaries. Consequently, if death rates for all ages are lowered by about the same relative amount, outgo increases at a rate greater than the rate of growth in payroll, thereby resulting in higher cost rates. Each additional 10-percentage-point reduction in the age-sex-adjusted death rate assumed to occur in 1995-2070, relative to the 36-percent reduction assumed for alternative II, decreases the long-range actuarial balance by about 0.39 percent of taxable payroll.

3. Net Immigration

For all three periods, the cost rate decreases with increasing rates of net immigration. For the 25-year period, the cost rate decreases from 13.23 percent of taxable payroll (for annual net immigration of 750,000 persons) to 13.11 percent (for annual net immigration of 1,150,000 persons). For the 50-year period, it decreases from 14.83 percent to 14.62 percent, and for the 75-year period, it decreases from 15.63 percent to 15.38 percent. The actuarial balance increases from +0.32 to +0.42 percent for the 25-year period, from -1.47 to -1.28 for the 50-year period, and from -2.29 to -2.06 percent for the 75-year period.

The cost rate decreases with increasing rates of net immigration because immigration occurs at relatively young ages, thereby increasing the numbers of covered workers earlier than the numbers of beneficiaries. Each additional group of 100,000 immigrants relative to the 900,000 net immigration assumed for alternative II, increases the long-range actuarial balance by about 0.06 percent of taxable payroll.

4. Real-Wage Differential

For the 25-year period, the cost rate decreases from 13.58 percent (for a real-wage differential of 0.5 percentage point) to 12.78 percent (for a differential of 1.5 percentage points). For the 50-year period, it decreases from 15.32 to 14.17 percent, and for the 75-year period it decreases from 16.14 to 14.90 percent. The actuarial balance increases from +0.01 to +0.71 percent for the 25-year period, from -1.91 to -0.87 for the 50-year period, and from -2.75 to -1.63 percent for the 75-year period.

The cost rate decreases with increasing real-wage differentials, because the higher real-wage levels increase the taxable payroll, while benefit increases are not affected. Although the initial benefit levels are higher because of the higher wages, these increases are more than offset by the increases in the taxable payroll of future workers. Each 0.5-percentage-point increase in the assumed real-wage differential increases the long-range actuarial balance by about 0.56 percent of taxable payroll.

5. Consumer Price Index

For all three periods, the cost rate decreases with greater assumed rates of increase in the CPI. For the 25-year period, the cost rate decreases from 13.32 (for CPI increases of 3.0 percent) to 13.03 percent (for CPI increases of 5.0 percent). For the 50-year period, it decreases from 14.95 to 14.54 percent, and for the 75-year period, it decreases from 15.76 to 15.29 percent. The actuarial balance increases from +0.23 to +0.49 percent for the 25-year period, from -1.58 to -1.20 for the 50-year period, and from -2.41 to -1.98 percent for the 75-year period.

The patterns described above result primarily from the time lag between the effects of the CPI changes on taxable payroll and on benefit payments. When assuming a greater rate of increase in the CPI (in conjunction with a constant real-wage differential), the effect on taxable payroll of the implied greater rate of increase in average wages is experienced immediately, while the effect on benefits of the greater rate of increase in the CPI is experienced with a lag of about 1 year. In addition, the effect on benefits of the greater rate of increase in average wages is experienced no sooner than 2 years later. Thus, the higher taxable payrolls have a stronger effect than the higher benefits, thereby resulting in lower cost rates. The effect of each 1.0-percentage-point increase in the rate of change assumed for the CPI is an increase in the long-range actuarial balance of about 0.22 percent of taxable payroll.

6. Real Interest Rate

For the 25-year period, the cost rate decreases slightly with increasing real interest rates from 13.28 percent (for an ultimate real interest rate of 1.5 percent) to 13.10 percent (for an ultimate real interest rate of 3.0 percent). For the 50-year period, it decreases from 15.04 to 14.49 percent, and for the 75-year period, it decreases from 15.97 to 15.15 percent. The actuarial balance increases from +0.22 to +0.48 percent for the 25-year period, from -1.73 to -1.10 percent for the 50-year period, and from -2.68 to -1.78 percent for the 75-year period. Each 0.5-percentage-point increase in the assumed real interest rate increases the long-range actuarial balance by about 0.30 percent of taxable payroll.

7. Disability Incidence Rates

For the 25-year period, the cost rate increases with increasing disability incidence rates from 12.98 percent (for the relatively low rates assumed for alternative I) to 13.39 percent (for the relatively high rates assumed for alternative III). For the 50-year period, it increases from 14.48 to 15.03 percent, and for the 75-year period, it increases from 15.24 to 15.84 percent. The actuarial balance decreases from +0.56 to +0.15 percent for the 25-year period, from -1.13 to -1.68 percent for the 50-year period, and from -1.92 to -2.51 percent for the 75-year period.

8. Disability Termination Rates

For alternative II, death-termination rates by age and sex are assumed to decline until they reach levels by the end of the 75-year period that, in comparison to the corresponding annual rates experienced during the base period 1977-80, are lower by about 43 percent for men and 36 percent for women. For the other alternatives, the rates are assuemd to spread gradually from the rates for alternative II. By the end of the projection period, for men the rates are 27 persent lower for alternative I and 59 percent wower for alternative III, and for women they are 16 percent lower for alternative I and 55 percent lower for alternative III.

For alternative II, ultimate recovery-termination rates by age and sex are assumed to be attained in 2010; such rates are assumed to be about 50 percent lower than those experienced in the base period, 1977-80. For the other alternatives, the rates are assumed to spread gradually from the rates for alternative II; from that year until the end of the projection period the rates under alternativeI and III are 20 percent higher and lower, respectively, than the rates for alternative II.

For the 25-year period, the cost rate increases with decreasing disability termination rates from 13.14 percent (for the relatively high rates assumed for alternative I) to 13.21 percent (for the relatively low rates assumed for alternative III). For the 50-year period, it increases from 14.68 to 14.79 percent, and the 75-year period, it increases from 15.46 to 15.59 percent. The actuarial balance decreases from +0.40 to +0.33 for the 25-year period, from -1.33 to -1.44 percent for the 50-year period, and from -2.13 to -2.26 for the 75-year period.

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H. ASSUMPTIONS AND METHODS UNDERLYING THE
ACTUARIAL ESTIMATES

1. Total Population

Historically, fertility rates in the United States have fluctuated widely. The total fertility rate is defined to be the average number of children that would be born to a woman in her lifetime if she were to experience the birth rates by age observed in, or assumed for, the selected year, and if she were to survive the entire child-bearing period. The total fertility rate decreased from 3.3 children per woman after World War I to 2.1 during the Great Depression, rose to 3.7 in 1957, and then fell to 1.7 in 1976. After 1976, the total fertility rate began to rise again, reaching a level of 2.07 for 1991. Since then, it has declined slightly to a level currently estimated at 2.04 for 1993 and 1994.

These variations in fertility rates have resulted from changes in many factors, including social attitudes, economic conditions, and the use of birth-control methods. Future fertility rates may be expected to remain close to recent levels. The recent historical and projected trends in certain population characteristics are consistent with a continued relatively low fertility rate. These trends include the rising percentages of women who have never married, of women who are divorced, and of young women who are in the labor force. Based on consideration of these factors, ultimate total fertility rates of 2.2, 1.9, and 1.6 children per woman were selected for alternatives I, II, and III, respectively. For each alternative, the total fertility rate is assumed to reach its ultimate level in 2020. A rate of 2.1 would ultimately result in a nearly constant population if net immigration were zero and if death rates were constant.

Historically, death rates in the United States have declined fairly steadily. Historical rates used in preparing this report were calculated using data from the National Center for Health Statistics (NCHS) that are final for 1900-91 (by cause of death starting in 1968) and provisional for 1992 through 1994. For ages 65 and over, Medicare final data for years 1968 through 1993, and provisional data for 1994 were used. The age-sex-adjusted death rate - which is calculated here as the crude rate that would occur in the enumerated total population as of April 1, 1980, if that population were to experience the death rates by age and sex for the selected year - declined at an average rate of 1.2 percent per year between 1900 and 1993. Between 1968 and 1991, the period for which death rates are available by cause, the age-sex adjusted death rate (for all causes combined) declined at an average rate of 1.4 percent per year. However, since 1982, age-sex adjusted death rates have declined more slowly, at average rates of 0.7 percent both between 1982 and 1991, and between 1982 and 1993.

Reductions in death rates have resulted from many factors, including increased medical knowledge and availability of health-care services, and improvements in personal health-care practices such as diet and exercise. Based on consideration of the expected rate of future progress in these and other areas, three alternative sets of ultimate annual percentage reductions in central death rates by age, sex, and cause of death were selected for 2020 and later. The intermediate set, which is used for alternative II, is considered to be the most likely to occur. Except for those causes of death which primarily affect children and people of working age, the average annual percentage reductions used for alternative I are smaller than those for alternative II, while those used for alternative III are greater.

Between 1993 and 2020, the reductions in central death rates for alternative II are assumed to change gradually from the average annual reductions by age, sex, and cause of death observed between 1968 and 1991, to the ultimate annual percentage reductions by age, sex, and cause of death assumed for 2020 and later. Alternative I reductions are assumed to change gradually from 50 percent of the average annual reductions observed between 1968 and 1991, while alternative III reductions are assumed to change gradually from 150 percent of the average annual reductions observed between 1968 and 1991.

After adjustment for changes in the age-sex distribution of the population, the resulting death rates were projected to decline at an average annual rate of about 0.2 percent, 0.6 percent, and 1.1 percent between 1994 and 2070 for alternatives I, II, and III, respectively.

For calendar years 1994 and 1995, the net legal immigration is estimated to be 600,000 and 565,000 persons per year, respectively. In addition, for these years the net other-than-legal immigration is estimated to be 300,000 persons per year. The Immigration and Naturalization Service (INS) is currently in the process of revising its estimates of net illegal immigration based on (1) information provided by persons legalized under the Immigration Reform and Control Act of 1986, (2) counts of unauthorized immigrants in census surveys, (3) the number of overstays of legally admitted persons, and (4) other INS statistics. Based on information provided by the INS, assumed annual rates of net other-than-legal immigration have been increased by 50,000 per year in this report. The Bureau of the Census also is increasing its estimates.

The Immigration Act of 1990 increased substantially the number of legal immigrants permitted starting in 1992. For calendar year 1996, net immigration is assumed to be 1,110,000, 875,000, and 700,000 persons per year for alternatives I, II, and III, respectively. Of these net numbers of immigrants, 660,000, 575,000, and 500,000, respectively, are assumed to be legal, and the remainders are assumed to be other-than-legal. Based on changes in immigration categories and limits specified in the 1990 legislation, the estimated level of net legal immigration varies for years through 2000, reaching an assumed ultimate level for 2001 and later. Net immigration for 1997 through 1999 is assumed to be 1,125,000, 885,000, and 725,000 persons per year for alternatives I, II, and III, respectively. Of these net numbers of immigrants, 675,000, 585,000, and 525,000, respectively, are assumed to be legal, and the remainders are assumed to be other-than-legal. Net immigration for 2000 and later is assumed to be 1,150,000, 900,000, and 750,000 persons per year for alternatives I, II, and III, respectively. Of these net numbers of immigrants, 700,000, 600,000, and 550,000, respectively, are assumed to be legal, and the remainders are assumed to be other-than-legal.

Table II.H1 shows the projected population as of July 1 by broad age group, for the three alternatives. Also shown are tabulated aged dependency ratios (see table footnotes for definitions). Because eligibility for many types of OASDI benefits depends on marital status, the population was projected by marital status, as well as by age and sex. Marriage and divorce rates were based on recent data from the National Center for Health Statistics (NCHS).

2. Covered Population

Labor force participation rates were projected by age and sex, taking into account projections of the percentage of the population that is married, the percentage of the population that is disabled, the number of children in the population, the level of retirement benefits, and the state of the economy. For men, the projected age-adjusted labor force participation rates for the year 2070 for alternatives I, II, and III are 1.9, 2.6, and 3.2 percentage points lower, respectively, than the 1995 level of 75.5 percent. For women, the projected age-adjusted labor force participation rates increase for alternatives I and II and decrease for alternative III. The projected age-adjusted rates for 2070 are 1.7, 0.7, and -1.1 percentage points, respectively, different from the 1995 level of 59.1 percent.

The total age-sex-adjusted unemployment rate averaged 5.8 percent for the last 30 years 1966-95 and 6.0 percent for the 10 years 1986-95. The ultimate total age-sex-adjusted unemployment rate is assumed to be 5.0, 6.0, and 7.0 percent for alternatives I, II, and III, respectively. Unemployment levels off to the assumed ultimate age-sex-adjusted rate by the year 2006, for each of the three alternatives.

The projected age-adjusted coverage rate for men changes from its 1995 level of 74.1 percent to 72.5, 71.7, and 70.8 percent in 2070 for alternatives I, II, and III, respectively. For women, it changes from its 1995 level of 61.5 percent to 61.8, 60.3, and 57.9 percent for alternatives I, II, and III, respectively.

3. Average Earnings, Inflation, and Real Interest Rate

Increases in average earnings were projected in two components - average earnings of wage-and-salary workers, usually referred to as average wages (and shown for OASDI covered employment in table II.D1 of this report), and average net earnings of self-employed persons. Each of these was subdivided into increases in real average earnings and increases in the CPI. For simplicity, real increases in the average covered wage are sometimes expressed in the form of real-wage differentials - i.e., the percentage increase in the average nominal wage minus the percentage increase in the CPI.

The assumed ultimate increases in average real earnings are based on analysis of trends in productivity gains and the factors linking productivity gains with increases in average real earnings. For the 40 years 1955-94, annual increases in productivity for the total U.S. economy averaged 1.8 percent, the result of average annual increases of 2.8, 2.1, 1.4, and 1.0 percent for the 10-year periods 1955-64, 1965-74, 1975-84 and 1985-94, respectively. Meanwhile, the average annual rate of change in average real earnings for the total U.S. economy was an increase of 0.9 percent for the 40 years 1955-94, the result of average annual changes of 2.3, 1.2, -0.6, and 0.7 percent, respectively, for the aforementioned 10-year periods. The change in the linkages between annual changes in productivity and real earnings averaged -0.9 percent for the 40 years 1955-94, and -0.5, -0.9, -1.9, and -0.2 percent, respectively, for the aforementioned 10-year periods. The change in the linkages reflects changes in such factors as the average number of hours worked per year, labor's share of total output, the proportion of employee compensation paid as wages, and price adjustment reflecting the ratio of the GDP implicit price deflator to the CPI.

The average annual rate of change in the average real wage in OASDI covered employment was 1.0 percent over the 40 years 1955-94. However, the average annual rates of change over the 10-year periods varied considerably. The average annual rates of change for the 10-year periods 1955-64, 1965-74, 1975-84, and 1985-94 were 2.3 percent, 1.0 percent, 0.2 percent and 0.6 percent, respectively.

The ultimate annual increases in productivity for all sectors - wage-and-salary workers, self-employed persons, and the total economy - are assumed to be about 1.7, 1.4, and 1.1 percent for alternatives I, II, and III, respectively. The corresponding ultimate annual rates of change in the linkages for wage-and-salary workers are assumed to be declines of 0.2, 0.4, and 0.6 percent for alternatives I, II, and III, respectively. These linkages are made up of assumed annual decreases of 0.1, 0.2, and 0.3 percent in average hours worked per year, and 0.1, 0.2, and 0.3 percent annual declines in wages as a share of compensation, for alternatives I, II, and III, respectively. No ultimate change is assumed for the historically relatively stable ratio of employee compensation to GDP. The resulting ultimate real-wage differentials are 1.5, 1.0, and 0.5 percent for alternatives I, II, and III, respectively. Ultimate annual declines in the linkages for self-employed persons are smaller because the proportion of reported compensation that is considered earnings remains constant. As a result, ultimate average real-earnings growth rates for the self-employed are assumed to be higher than for wage-and-salary workers. The corresponding ultimate average real-earnings for wage-and-salary workers and self-employed persons, combined, are slightly higher than those assumed for wage-and-salary workers only.

Historically, the CPI has increased, on average, by 4.4 percent for the 40 years 1956-95, 5.3 percent for the 30 years 1966-95, 5.2 percent for the 20 years 1976-95, and 3.4 percent for the 10 years 1986-95. The ultimate average annual CPI increases of 3.0, 4.0, and 5.0 percent for alternatives I, II, III, respectively, were chosen to include a reasonable range of possible future experience. The GDP implicit price deflator has increased by 4.2 percent annually for the 40 years 1956-95, 5.0 percent annually for the 30 years 1966-95, 4.8 percent annually for the 20 years 1976-95, and 3.2 percent annually for the 10 years 1986-95. For this report, increases in the GDP implicit price deflator are assumed to be slower by about 0.1 percent, 0.3 percent, and 0.5 percent annually than increases in the CPI-W for alternatives I, II, and III, respectively, for the first 10 projection years 1996-2005. The assumed differential between the increase in the GDP implicit price deflator and the increase in the CPI-W reflects the anticipation of three trends for the first 10 projection years 1996-2005. These are: (1) relatively slower increases in computer prices, which are weighted more heavily in the implicit price deflator, (2) relatively faster increases in energy prices which are weighted more heavily in the CPI, and (3) relatively faster increases in health service prices, which are a larger component of the CPI. However, ultimate annual rates of increase in the GDP implicit price deflator are assumed to be the same, for each alternative, as for the CPI-W.

It should be noted that recent and expected changes in the methods for computing the CPI and the GDP price deflator are not reflected in the assumptions for this report. These changes will be reflected in next year's report.

The ultimate increases in average annual wages in covered employment are assumed to be 4.5, 5.0, and 5.5 percent, for alternatives I, II, and III, respectively. These were obtained, for each alternative, by adding the assumed annual percentage increase in the CPI to the assumed real-wage differential. Ultimate increases in average wages and earnings for the U.S. economy are very similar to those assumed for average wages in covered employment.

The interest rate considered in this report is the nominal interest rate, which is compounded semiannually, for special U.S. government obligations issuable to the trust funds in each of 12 months of the year. The real interest rate is defined to be the annual (compounded) yield rate for investments in these securities less growth in the CPI.

In developing a reasonable range of assumed future real interest rates for the three alternatives, historical experience was examined for the 40 years, 1955-94, and for each of the 10-year subperiods, 1955-64, 1965-74, 1975-84, and 1985-94. For the 40-year period, the real interest rate averaged 2.4 percent per year. For the four 10-year subperiods, the real interest rates averaged 1.5, 1.9, 0.9, and 5.2 percent per year, respectively. The assumed ultimate real interest rates are 3.0 percent, 2.3 percent, and 1.5 percent for alternatives I, II, and III, respectively. The projected interest rates are assumed to trend toward these ultimate interest rates, attaining the ultimate values after the tenth projection year.

4. Taxable Payroll and Taxes

In practice, the taxable payroll is calculated as a weighted average of the earnings on which employees, employers, and self-employed persons make contributions to the OASDI program. The weighting takes into account the lower tax rates, as compared to the combined employee-employer rate, which apply to multiple-employer "excess wages," and which did apply, before 1984, to net earnings from self-employment and, before 1988, to tips. For 1983 and later, taxable payroll also includes deemed wage credits for military service. Estimates of taxable earnings for employees, employers, and the self-employed were developed from corresponding estimates of earnings in the U.S. economy, by means of factors which adjust for various differences in these measures. The factors adjust total U.S. earnings by removing earnings from noncovered employment, adding earnings from various outlying areas which are covered by Social Security but are not included in published "U.S." data, and removing earnings above the taxable earnings base.

Decreases in the ratio of taxable earnings to earnings in OASDI covered employment since 1984, due to the higher proportion of total covered wages earned by very high wage earners, are projected to continue through the first 10 years of the projection. The ratio of taxable wages to wages in covered employment is projected to decline from a level of 0.883 for 1995 to ultimate levels of 0.879, 0.862, and 0.856, by the end of the tenth projection year for alternatives I, II, and III, respectively. These ultimate ratios of taxable earnings to OASDI covered earnings are about the same as were assumed for last year's report.

The projected levels of the taxable payroll for the intermediate cost alternative are lower than those projected for last year's report throughout the 75-year projection period. This results from revisions in the level of wages in the National Income and Product Accounts (NIPA) for 1994 and later and projected lower labor force than estimated for last year's report.

Estimates of taxes collected were developed from the estimates of taxable earnings by applying the employee, employer, or self-employed tax rate, and by taking into account the lag between the time the tax liability is incurred and the time the taxes are collected.

5. Insured Population

Projections of the percentage of the population that is fully insured were made by age and sex, from estimated distributions of workers by accumulated quarters of coverage based on past and projected coverage rates and amounts of earnings required for quarters of coverage. Currently insured status was disregarded for purposes of these estimates, because the number of cases in which eligibility for benefits is based solely on currently insured status is relatively small. Projections of the percentage of fully insured persons who are also disability insured were made by age and sex based on past and projected coverage rates, the requirements for disability insured status, and their historical relationships. Finally, the fully insured and disability insured populations were developed from the projected total population by applying the appropriate percentages.

Under this procedure, the percentage of the Social Security Area population aged 62 and over that is fully insured is projected to increase from its estimated level of 77.2 on January 1, 1993, to 90.7, 90.5, and 90.1 on January 1, 2070, based on alternatives I, II, and III, respectively. The percentage for females is projected to increase significantly, while that for males is projected to decrease slightly. Based on alternative II, for example, the percentage for males is projected to decrease during this period from 92.5 to 92.2, while that for females is projected to increase from 66.2 to 89.1.

The fully insured population by age and sex was further subdivided by marital status, using the variation in labor force participation rates by marital status to estimate the variation in coverage rates by marital status. These coverage rates were then used to estimate the variation in the fully insured rates by marital status.

6. Old-Age and Survivors Insurance Beneficiaries

For the short-range period, the number of retired-worker beneficiaries was developed by applying award rates to the aged fully insured population less those persons entitled to retired-worker, disabled-worker, or widow(er)'s benefits, and by applying termination rates to the number of persons already receiving retired-worker benefits. The fraction of entitled beneficiaries that would actually receive benefits was projected to increase at ages 65-69, due to the modifications in the retirement earnings test enacted in Public Law 104-121.

For the long-range period, the number of retired-worker beneficiaries not previously converted from disabled-worker beneficiary status was projected as a percentage of the exposed population, i.e., the aged fully insured population less persons entitled to or converted from disability benefits and insured persons entitled to widow(er)'s benefits. The percentage for ages 70 and over was assumed to be nearly 100, because the retirement earnings test and delayed retirement credit do not apply after age 70. The percentage for each age 62 through 69 was projected from observed historical and projected short-range trends, with an adjustment for changes in the portion of the primary insurance amount payable at each age of entitlement to the portion payable at age-70 entitlement. As the increases in the delayed retirement credit become effective and as the normal retirement age increases, the number of retired workers as a percentage of the exposed population is gradually adjusted downward at each age 62 through 69, reaching an ultimate level in 2030.

In addition, two other factors were applied. One was to adjust for the effect of projected changes in the proportion of other-than-legal aliens in the population. The other was to adjust for the effect of the earnings test provision of Public Law 104-121.

For the long-range period also, the number of retired-worker beneficiaries previously converted from disabled-worker beneficiaries was calculated as an extension beyond normal retirement age of the calculation of disabled-worker beneficiaries.

The number of aged-spouse beneficiaries was estimated from the population projected by age and sex. The benefits of aged-spouse beneficiaries are based on the earnings records of their husbands or wives, who are referred to as "wage earners." In the short-range period, a regression equation was used to project the number of aged-spouse beneficiaries, as a proportion of the aged uninsured female or male population. In the long-range period, aged-spouse beneficiaries were estimated from the population projected by age, sex, and marital status. To the number of spouses aged 62 and over in the population, a series of factors were applied, representing the probabilities that the spouse and the wage earner meet all of the conditions of eligibility - i.e., the probabilities that (1) the wage earner is 62 or over, (2) the wage earner is insured, (3) the wage earner is receiving benefits, (4) the spouse is not receiving a benefit for the care of an entitled child, (5) the spouse is not insured, and (6) the spouse is not eligible to receive a significant government pension based on earnings in noncovered employment. To the resulting number of spouses was applied a projected prevalence rate to calculate the estimated number of aged-spouse beneficiaries.

In addition, the same factors were applied to the number of divorced persons aged 62 and over in the population, with three differences. First, an additional factor is required to reflect the probability that the person's former wage-earner spouse is still alive (otherwise, the person may be entitled to a divorced widow(er)'s benefit). Second, a factor is required to reflect the probability that the marriage to the wage-earner spouse was at least 10 years in duration. Third, factor (3) was not applied because, effective for January 1985, a divorced person generally need not wait to receive benefits until the former wage-earner spouse is receiving benefits.

The projected numbers of children under age 18, and students aged 18, who are eligible for benefits as children of retired-worker beneficiaries, were based on the projected number of children in the population. In the short-range period, the number of entitled children was developed by applying award rates to the number of children in the population where both parents are alive, and by applying termination rates to the number of children already receiving benefits. The award rates were adjusted downward and the termination rates were adjusted upward to reflect trends expected to occur as a result of the stepchild provision of Public Law 104-121.

In the long-range period, the number of entitled children was projected separately by sex of the wage-earner parent. To the number of children in the population, factors were applied representing the probabilities that the parent is alive, aged 62 or over, insured, and receiving a retired-worker benefit. Another factor was applied representing the probability that the child is not entitled to a benefit based on the other parent's earnings. In addition, a factor was applied to reduce the number of beneficiaries to reflect the more restrictive requirements for entitlement of stepchildren that were enacted in Public Law 104-121. For children aged 18, a factor representing the probability that the child is attending a secondary school was also applied.

The number of disabled children aged 18 and over of retired-worker beneficiaries was projected from the adult population. In the short-range period, award rates were applied to the uninsured population, and termination rates were applied to the number of disabled children already receiving benefits. These award and termination rates were adjusted similarly to those for minor and student children to reflect trends expected to occur as a result of the stepchild provision of Public Law 104-121. In the long-range period, disabled children were projected in a manner similar to that for children under 18, with the inclusion of a factor representing the probability of being disabled since childhood.

In the short-range period, the number of young-spouse beneficiaries was projected as a proportion of the projected number of child beneficiaries who are either under age 16 or disabled. In the long-range period, young-spouse beneficiaries were projected as a proportion of the projected number of child beneficiaries of retired workers, taking into account projected changes in average family size.

The number of aged-widow(er) beneficiaries was projected from the population by age and sex. In the short-range period, insured aged-widow(er) beneficiaries were projected concurrently with the retired-worker beneficiaries. A regression equation projected the number of uninsured aged-widow(er) beneficiaries, as a proportion of the uninsured aged female or male population not receiving any type of benefit. In the long-range period, aged-widow(er) beneficiaries were projected from the population by age, sex, and marital status. Four factors were applied to the number of widow(er)s in the population aged 60 and over. These factors represent the probabilities that (1) the deceased wage earner was fully insured at death, (2) the widow(er) is not receiving a benefit for the care of an entitled child, (3) the widow(er) is not fully insured, and (4) the widow(er)'s benefits are not withheld because of receipt of a significant government pension based on earnings in noncovered employment. In addition, some insured widow(er)s who had not applied for their retired-worker benefits are assumed to receive widow(er) benefits. Also, the same factors were applied to the number of divorced persons aged 60 and over in the population, with additional factors representing the probability that the person's former wage-earner spouse is deceased and that the marriage was at least 10 years in duration.

In the short-range period, the number of disabled-widow(er) beneficiaries was estimated as a proportion of the uninsured female or male population aged 50-64. In the long-range period, the number was projected for each age 50 through 64 as a percentage of the widowed and divorced populations, adjusted for the insured status of the deceased spouse and the prevalence of disability.

The projected numbers of children under age 18, and students aged 18, who are eligible for benefits as survivors of deceased workers, were based on the projected number of children in the population whose mothers or fathers are deceased. In the short-range period, the number of entitled children was developed by applying award rates to the number of orphaned children, and by applying termination rates to the number of children already receiving benefits. The award rates were adjusted downward to reflect the trend expected to occur as a result of the stepchild provision of Public Law 104-121.

In the long-range period, the number of child-survivor beneficiaries was projected in a manner analogous to that for child beneficiaries of retired workers, with the factor representing the probability that the parent is aged 62 or over replaced by a factor that represented the probability that the parent is deceased.

In the short-range period, the numbers of mother-survivor and father-survivor beneficiaries were projected from the number of child-survivor beneficiaries who are either under age 16 or disabled. In the long-range period, mother-survivor and father-survivor beneficiaries were estimated from the number of child-survivor beneficiaries, taking into account projected changes in average family size.

The number of parent-survivor beneficiaries was projected based on the historical pattern of the number of such beneficiaries.

Table II.H2 shows the projected number of beneficiaries under the OASI program by type of benefit. Included among the beneficiaries who receive retired-worker benefits are some persons who also receive a residual benefit consisting of the excess of an auxiliary benefit over their retired-worker benefit. Estimates of the number of such residual payments were made separately for spouses and widow(er)s.

7. Disability Insurance Beneficiaries

The number of terminations was projected by applying assumed termination rates to the disabled-worker population. In the short-range period, the number of terminations was projected by applying assumed termination rates by reason - death, recovery, and all other - and by age and sex, to the entitled disabled-worker population. In the long-range period, the number of terminations was projected by applying assumed death rates and recovery rates, by age, sex, and duration of entitlement, to the entitled disabled-worker population. To this number of terminations was added, in both the short-range and long-range periods, the number of disabled-worker beneficiaries who would be automatically converted to retired-worker beneficiaries upon attainment of the normal retirement age (currently, age 65).

The projection of rates of incidence and termination in the DI program begins with an evaluation of historical trends in these rates. With respect to disability incidence, rates have varied dramatically over the past 20 years, declining from historically high levels in 1974-75 to a level about half as large by 1982. Since 1982, incidence rates have increased fairly steadily so that by 1995 the incidence rate had regained 50-60 percent of the decline experienced between 1975 and 1982.

Assumed future levels for disability incidence rates are determined in two stages: (1) rates are first projected from recent levels based on past trends and future expectations, as if the increases scheduled in present law for the normal retirement age (NRA) would not occur, and (2) for the year 2000 and later an adjustment is made to reflect the scheduled increase in the NRA; rates for persons aged 60 through 64 are assumed to increase, and rates for ages 65 and 66 are extrapolated. In an additional step for this report, the incidence rates were adjusted downward to reflect trends expected to occur as a result of the drug addiction and alcoholism provision of Public Law 104-121.

For the alternative II assumptions, gross incidence rates are projected to increase over the next 10 years due to the growing proportion of insured workers at the higher ages. Gross rates projected under the first stage increase from 1995 levels by about 12 percent over the next 10 years, reaching a level of about 5.9 per thousand persons exposed (approximated by the average number of persons who are disability insured and not currently entitled to disabled worker benefits).

Further increases in incidence rates over age 60, along with rates assumed for persons aged 66 and 67 due to the scheduled increase in the NRA, are reflected in the second stage for years 2000 and later. These adjustments contribute to the overall rise in the gross disability incidence rate from a level of 5.3 per thousand exposed for 1995 to 7.2 per thousand exposed by the year 2027, at which time the effects of the scheduled increase in the NRA on the DI program will be complete. This is very close to the ultimate rate of 7.3 per thousand, attained in 2047.

For alternative I, the gross disability incidence rate is assumed to decline by about 6 percent over the next 10 years. The 2027 gross incidence rate is assumed to be 5.8 per thousand exposed. For alternative III, the gross disability incidence rate is assumed to increase by about 30 percent over the next 10 years, to a level comparable to the peak experience for 1974-75. The gross incidence rate under alternative III is assumed to reach about 8.8 per thousand exposed by 2027.

In the short-range period, the age-sex specific termination rates were projected by reason - death, recovery, and all other. For alternative II, death rates are projected to remain relatively constant at roughly 1995 levels, while recovery rates are expected to increase over the next 5 years reflecting the anticipated increase in spending on continuing disability reviews authorized under Public Law 104-121. Termination rates due to all other reasons (except conversion to old-age benefits) are projected to exhibit a one-time increase in 1997 reflecting the effect of the elimination of drug addiction and alcoholism as a qualifying condition for entitlement to disability benefits under Public Law 104-121. For alternative III, the death rates decline by about 10 percent, while the rates for recovery and all other terminations increase more slowly and to lower levels. For alternative I, the death rates increase by about 10 percent, while the rates for recovery and all other terminations increase more quickly and to higher levels.

In the long-range period, the death rates and recovery rates were projected by age, sex, and duration of entitlement. For alternative II, death rates reach levels in 2070 approximately 43 percent lower for males and approximately 36 percent lower for females than those experienced by disabled-worker beneficiaries during 1977-80, the most recent period for which detailed data are available. The recovery rates, after their patterns during the short-range period, are assumed to increase until 2010, when they attain ultimate levels about 50 percent lower than those experienced during the period 1977-80. Projected increases in recovery rates reflect the estimated effect of the periodic reviews required by provisions of law first enacted in 1980, and amended in 1983, 1984, 1990, and 1996.

For alternative I, the death rates in 2070 are assumed to be roughly 27 percent lower for males and approximately 16 percent lower for females than those experienced by disabled-worker beneficiaries during 1977-80. Recovery rates are assumed to increase from current levels to levels that are about 1.6 times the 1995 level for both males and females. These ultimate recovery rates are 40 percent lower than those of the 1977-80 base period. For alternative III, the death rates in 2070 are assumed to be about 59 percent lower for males and 55 percent lower for females than those experienced during 1977-80, and recovery rates are assumed to be 60 percent lower than those experienced during 1977-80.

In the short-range period, the projected numbers of children under age 18, students aged 18, and disabled children aged 18 and over, who are eligible for benefits as children of disabled-worker beneficiaries, were projected by applying quarterly award and termination rates. Awards to the three categories of child beneficiaries were based on the number of awards to disabled-worker beneficiaries. As a result of anticipated trends due to the stepchild provision of Public Law 104-121, child awards were adjusted downward while child terminations were adjusted upward.

In the long-range period, the projected numbers of minor child and student beneficiaries were based on the projected number of children in the population by age. To the number of children were applied factors representing the probability that either of their parents is insured and disabled. In addition, a factor was applied to reduce the number of beneficiaries to reflect the more restrictive requirements for entitlement of stepchildren that were enacted in Public Law 104-121. The number of disabled children aged 18 and over was projected as a function of the number of disabled-worker beneficiaries and the size of the adult population.

In the short-range period, the number of young-spouse beneficiaries was projected by applying quarterly award and termination rates, where awards were based on the number of awards to child beneficiaries who are either under age 16 or disabled. Again, due to the stepchild provision of Public Law 104-121, terminations of young spouses were adjusted upward. The number of aged-spouse beneficiaries was also projected by applying quarterly award and termination rates, where awards were based on the number of awards to disabled-worker beneficiaries.

In the long-range period, the number of young-spouse beneficiaries was projected as a proportion of the projected number of child beneficiaries who are either under age 16 or disabled, taking into account projected changes in family size. The number of aged-spouse beneficiaries was projected as a proportion of the number of disabled-worker beneficiaries, based on recent experience and allowing for projected changes in marriage rates.

Table II.H3 shows the projected number of beneficiaries under the DI program by type of benefit.

8. Average Benefits

For several types of benefits - retired-worker, aged-spouse, and aged-widow(er) benefits - the percentage of the PIA that is payable depends on the age at initial entitlement to benefits. Projected ratios of average benefits to average PIAs for these types of benefits were based on projections of age distributions at initial entitlement.

9. Benefit Payments

Lump-sum death payments were calculated as the product of (1) the number of such payments, which was projected on the basis of the assumed death rates, the projected fully insured population, and the estimated percentage of the fully insured population that would qualify for benefits, and (2) the amount of the lump-sum death payment, which is $255 (not indexed in future years).

10. Administrative Expenses

11. Railroad Retirement Financial Interchange

The effect of the financial interchange with the Railroad Retirement program was evaluated on the basis of trends similar to those used in estimating the cost of OASDI benefits. The resulting effect was annual short-range costs of about $3-5 billion and a long-range summarized cost of 0.05 percent of taxable payroll to the OASDI program.

12. Benefits to Uninsured Persons

13. Military-Service Transfers

14. Income From Taxation of Benefits