Social Security and the Stock Market: How the Pursuit of Market Magic Shapes the System
Eisen, Roland, Journal of Risk and Insurance
Social Security and the Stock Market: How the Pursuit of Market Magic Shapes the System, edited by A. H. Munnell and S. A. Sass, 2006, Kalamazoo, MI: W.E. Upjohn Institute for Employment Research, ix + 171 pages
Reviewer: Roland Eisen, Goethe University, Germany
This is a timely and most interesting book about Social security reform strategies, discussed in the mid-1990s when the 1994-1996 Social security Advisory Council (SSAC) attempted to fix the problem of closing the funding deficit in the United States. At that time, the SSAC was caught in a trilemma. Should it attempt to restore balance by raising taxes and/or cutting benefits only, or by resorting to a new source of revenue, the higher expected return on equity investment?
In the Introduction, the authors very clearly state the focus of their book: to examine how the use of equities may help solve the Social security financing problem, while being aware of "a host of new and difficult challenges" which "could dramatically change the structure of Social security in the United States" (p. 2).
The second chapter provides a short history of the creation of modern retirement income systems, pointing to the difference between the Bismarckian programs of the nations on the European continent1 and the "Anglo-Saxon" models. It is clear from the beginning that the book deals with reform strategies for these latter models, even when it is obvious that all nations face the common challenge of "how best to maintain the poverty reduction and income smoothing achievements of current system(s) while minimizing burdens on the active population" (p. 40).
The third chapter describes the evolution of the U.S. public and employer-sponsored retirement system since 1980, the reforms undertaken since that time, and the problems still ahead. The authors mention the three primary options for reforming the U.S. Social security program, as put on the table by the SSAC: investing a portion of trust fund assets in equities, adopting "add-on" individual accounts invested in equities, and using "carve-out" individual accounts invested in equities, redirecting a significant portion of current payroll taxes while sharply reducing the guaranteed social insurance benefit (cf. p. 63).
In addition to political considerations (i.e., which political group prefers which options), practical considerations should also influence the equity decision, for example, how an increased role for equities may shape the current retirement income system, how incorporating equities may affect the cost of administering programs, and how to deal with the increased risk in equity investment. The authors stress, correctly in my opinion, the risk management side. "As the experience of employer defined-benefit pension plans clearly shows, the risk that comes with equity investment can radically upset a retirement income program" (p. 64). Furthermore, the radical shift from defined-benefit to defined-contribution plans (in the sense of 401 (k)s) also has placed more risk on the shoulders of individual employees.
To shed more light on the equity proposals noted above, in the next three chapters the authors "explore the experience of (three) countries that have systems like that of the United States and have introduced equities into their public pension system in each of these three ways" (p. 128). They examine the United Kingdom's use of "carving-out" individual accounts; Australia's mandated "add-on" individual account approach; and Canada's introduction of equity investments using the "trust fund investment" approach.
The authors note that "Britain's decision to sharply cut out social insurance programs and increase reliance on individual initiatives has returned the nation to a welfarebased solution to the old-age income problem" (p. …