Companies considering new product launches often try out different beta versions of their products on focus groups. The practice is a sound one. No matter how attractive a concept may be, there is no telling whether you have a winner until it takes the form that the customer will see.
With such a process in mind, it is useful to pause for a moment to consider the practical appearance of the product that Social Security reformers are advocating. If optional personal accounts are available, they present choices and possibilities to citizens. How will these be conveyed? What will workers see? What will guide their decision making?
The logical place to start is with the official “Your Social Security Statement,” sent out by the Social Security Administration (SSA). Every covered worker receives an annual statement from the SSA that informs them of their estimated benefits under current law. Between the disclaimers that benefit levels could change due to changes in earnings patterns or Social Security law, the statement lays out past earnings, taxes paid, and estimates of likely benefits. For example, a statement might show that a typical worker would be eligible for retirement benefits of $19,600 a year if they retired at the normal retirement age.
If optional private accounts existed, this mailing would have to change. Instead of simply informing a worker what current law implies her benefit would be, the statement would reflect her choice about whether to participate in the accounts or remain in the traditional system. If she opts to stay in the current system, she would get a benefit calculation much like today’s. If she opts to place some of her payroll tax in an account, things would change.
The first way the form would change is that along with reporting what she could expect in traditional benefits (an amount that would be lower because she had shifted some of her funds into an account) it would have to report the current value of her accumulated contributions. Like a bank account or a mutual fund statement, the mailing would have to list the market value of existing assets.
As the current statement includes a projection about future benefits, the statements for account owners would also need to contain some type of projection about likely final balances at retirement in order to help participants with their retirement planning. This presents something of a design challenge. Financial returns are highly uncertain, and the presentation of a single expected return for a private account could be misleading. Moreover, the financial returns would depend on asset-allocation choices. Whereas the SSA could assume the same allocation over time, the more likely scenario is that the worker would shift more of her portfolio from stocks to bonds as she approached retirement.
Since returns can vary so much, it would be useful to present a representative expectation — but one should draw on the historical distribution of returns as well. In this case, and depending on reform specifics, a worker would see a form that tells them the following for each of the choices that they might make: (We base the numbers in this example on the benefit-adjustment proposal that has been floated by the administration, our own back-of-the-envelope calculations, and historical returns.)
If you’re an average wage worker entering the workforce today, you could retire at age 65 with a promised annual benefit of $19,600 (in today’s dollars). If you put one-third of your payroll taxes into a personal retirement account, your government payment would be reduced to around $12,600. However, your projected account balance at retirement would be $165,000.
There is significant uncertainty concerning the exact amounts. In particular, some percentage of the time, the account returns will be so disappointing that the account will not be able to finance a full replacement of benefits. It would be important to include a warning that includes something like a range of account values that might occur 95 percent of the time. Also, the base calculation might not be best based on historical returns, since most financial observers now agree that the equity premium has been declining over time. Our intent here is not to nail the best possible estimate of the numbers, but rather, to sketch what the typical worker might see.
We leave it to customer-service experts to decide whether such information is best delivered in words or a table, but it should be presented separately for a broad range of possible choices by the worker.
Finally, many proposals call for a forced annuitization of some or all of a private account. Should such a proposal become law, it would also be important to indicate what type of monthly payment could be expected from the annuity. There might be the need to include options for single and joint annuities depending on marital status.
The two types of statements would also help create a document to assist workers in making the initial decision about whether to open an account. If reform passes, workers will be faced with a choice to pass up some of the government benefit in exchange for more direct ownership of their assets. Seeing a comparison of government benefits to a hybrid benefit — some from the government, some from accounts under different returns assumptions — would assist with that decision.
It will be important that the new statements reflect both the likely scenario of what workers can expect in retirement and the information that returns can vary dramatically. Critics of personal accounts might use that variability as a reason to argue for steering clear of accounts and sticking to the current system. However, keep in mind there is significant risk in each of the systems; investment risk under an accounts-based system and the political risk that benefits will change under the current system. That is why page one of the current statement carries the warning that there won’t be enough younger people working to pay all of the benefits owed to those who are retiring and that changes will have to be made. Either way, there is no such thing as a risk-free system; the purpose of the Social Security statement should be to lay out the likely retirement benefit for a worker while reminding them there are no guarantees.
Viewed in this manner, it is almost difficult to see what all the fuss is about. Currently workers have no choices. Reform adds choices, including the possibility of sticking with the old system. If the old Social Security statement were compared to the proposed one in a focus group, it is our bet that a very large number of individuals of all ages and political persuasions would prefer the new statement.