The authors point out in their paper that the debate surrounding the social security privatization issue is based on the idea that the traditional system is a “safe” defined benefit plan and creating individual accounts would change it to a “risky” defined contribution plan. The problem with that, they contend, is that the current system is not a defined benefit system and not safe.
The factor that differentiates the current social security system from a defined benefit plan, according to the authors, is that, in a defined benefit plan, participants do not bear the funding risk. If the plan becomes underfunded, the funding obligation is the employer’s or insurance entity’s. Not so, for our traditional social security system. The funding obligation is the taxpayers’ or participants’.
As far as the current system being safe, the authors argue that individual rates of return for social security are affected by demographic changes such as fertility rates, immigration rates, mortality rates, and the growth rate of real wages. Demographic changes create imbalances in the funding of the system and usually new legislation is passed to fix these imbalances. Participants’ benefits are cut by changes such as raising the normal retirement age and making part of benefits taxable, thus changing the individual’s long term rate of return.
The paper cites a previous study co-conducted by Shoven, that showed an individual account invested in a 60/40 stock/bond portfolio produces an average lifetime rate of return of 6.2% with standard deviation of 2.03%, while a system like social security where benefits are affected by demographic and law changes produces an average lifetime rate of return of 1.02% with standard deviation of .55%.
The authors conclude that, “Once the riskiness of traditional Social Security is recognized, then the discussion of funded individual accounts should become one of asset diversification.”