And Forgive Us Our Debts, Part 1 - Insurance Thought Leadership



August 1, 2013

And Forgive Us Our Debts, Part 1


This is part 1 of a 2-part series on the national debt and social insurance (including health care financing). The series was first written twenty years ago, but its principles are still valid today. Part 2 of the series will be published soon.

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Dear Jackson:

This is a difficult letter for an actuary and grandfather to write to his grandson. Your life will be much more difficult than mine has been, and for that I am sorry. Yes, this is an apology, although “others,” of course, are far more to blame for your plight than I, or my colleagues. But placing blame is less important than understanding the problem and deciding how to deal with it.

Your country is in actuarial ruins. An actuarial ruin can still stand and may even be a thing of beauty, but the termites have done their job. Without restoration, collapse is inevitable, sooner or later. Today, it might take a few hurricanes to blow down the house — but tomorrow, it will take only the big bad wolf. Sadly, it appears that no restoration is underway, or even on the horizon. To the contrary, the termites are still chomping away.

Who are these termites that are to blame for the gloomy picture of actuarial reality that I am compelled to paint? For the most part, they’re politicians. All politicians want to get elected, of course — and then stay elected. The ward-hellers of old used ill-gotten gains to buy votes, but modern liberals and many conservatives gather and dispense money more efficiently by catering to special interest groups such as the AARP, the NEA, the AMA, and many, many others.

But such politicians are not necessarily termites. The political termite dispenses more than he has gathered, relying either on biased analyses of costs and benefits, or often on inflated benefit polemics to the exclusion of any analysis of cost whatsoever. Wilbur Mills was a liberal and a politician, but he was no termite. Unfortunately, for the country and for you, the majority of politicians over the past generation or so have been termites. The predictable result is that the country now stands in actuarial ruin.

I say “predictable” and enclose as Exhibit A the letter I wrote to the Los Angeles Times shortly after your mother was born. In it, I warned of an eventual “trillion-dollar deficit” in the national social insurance program. The letter was published in full, with just one editorial change: “trillion-dollar” was changed to “huge.” The termites, meanwhile, started chewing in earnest.

Exhibit A
A Trillion Dollar Deficit

{Letter to the Los Angeles Times, October 12, 1964

Millions of Americans are counting on two monthly checks to pay for their retirement years, one from their company pension plans and one from the Social Security system. The current funds under the former, together with expected future contributions, are sufficient to provide the benefits promised. The current funds under the latter, together with expected future contributions, are inadequate to provide the benefits promised. The current amount of this inadequcy, which is increasing all the time, is roughly equivalent to the national debt. Given a few more years, plus the inevitable liberalizations to Social Security, there will be a trillion-dollar deficit to sweep under the rug. Apparently our leaders feel that, if it’s only big enough, a pyramid club need not fail. They are wrong.

— Frederick W. Kilbourne

Now, a generation has passed, and editors as well as astronomers use the word “trillion” with ease. Attached in Exhibit B is my estimate of the size of the pile of termite leavings by the time of your birth in 1990. Roughly half the $25 trillion debt shown is in our national social insurance pgoram, with a portion of the total being the familiar actuarial quantity. It represents the excess of the present value of future benefits and expenses, over the present value of future contributions and interest. In other words, much more has been promised than has been provided for.

Exhibit B
The Real National Debt
Public Debt Component $ Trillions
Social Insurance Programs
  • Medical insurance
  • Hospital insurance
  • Old age, survivors, disability
Total 13
Acknowledged Government Debt
  • Federal
  • State and local
Total 4
Other Government Debt
  • Off-book programs
  • 1990s increment
Total 8
The Real National Debt in 1990 25

Only about 15% of the termite droppings are generally acknowledged by politicians and journalists (termites are crafty creatures, as well as voracious), most of it in the form of the recently discovered, so-called national debt. Another several trillion dollars must be added for the unfunded, off-book liabilities of programs such as military pensions and federal employee retiree health benefits, and for federal guarantees such as the Federal Deposit Insurance Corporation and the Pension Benefit Guaranty Corporation. Finally, I have added an estimated $5 trillion for the apparently inescapable deficits of the 1990s, expressed as a present value in your year of birth. If you could read and understand the newspaper, you’d see that the termites are still chewing.

Share of National Debt: $100,000
But how does this affect you, and why do I expect your life to be difficult because of it? Turn to Exhibit C, where I’ve tried to apply arithmetic, and other skills of my trade, to develop a rough lifetime financial plan for you. You’ll see that you share of the real national debt, on a strictly pro rata basis, is about $100,000. This is a 1990 present value, however, which you’ll have to amortize over your working lifetime. It’s very much like a mortgage on the house you could have owned but for the debt you inherit — except that you can’t move in for another 65 years. Amortized, it will cost you about $6,000 per year, if social insurance projection assumptions are used.

Exhibit C
The Average American’s Share
Your Financial Plan Amount
Your Share of the Public Debt
  • Total public debt
  • U.S. population
  • Your pro-rata share
Your Annual Budget
  • Government debt payment
  • Federal Tax
  • State and local taxes
  • Social insurance contributions
  • Poverty-level necessities
  • Discretionary spending and saving

The assumptions underlying the social insurance programs in Exhibit B are the so-called intermediate set of assumptions as set forth in the annual reports of the Board of Trustees. The $13 trillion social insurance debt you inherited will prove to be $23 trillion if the worst-case scenario proves correct, but only $3 trillion if the optimistic assumptions prove correct. The real problem for you is that the pessimistic assumptions may be more realistic.

For example, consider the intermediate fertility assumption that the average woman will have 1.9 children. This assumption is very important for estimating costs of social insurance, since it projects the number of adults who’ll be around to help you clean up the actuarial debris that accumulated during the last quarter of the twentieth century. The fertility rate has dropped by one-half since “the pill” was first offered, so that, by ten years ago, it was down to 1.8 children. It has apparently increased slightly in more recent years, but this is due substantially to postponed babies, rather than any real trend reversal. It seems unlikely to me, and to many others more knowledgeable about demographics, that a fertility rate of 1.9 will be sustained in the future.

Consider, next, the productivity assumption: that labor output per hour will increase 1.7% annually into the future (and the related assumption that real wages will increase 1.3% annually). This is supported by the fact that the average annual productivity increase rate over the past two generations has been about 1.7%. Over the past generation, however, the rate has been about 1.4%, and over the past decade no more than 1.0%. There is obviously an adverse trend at work, which has apparently been dismissed in spite of the ongoing political and societal forces that continue to debase — and thus to depress &mdash productivity.

But it’s not only the assumptions of the social insurance programs that are unsupportedly rosy. Consider my allocation of the national debt among the total population. Some are already too old to contribute, and if, as is likely, the exterminator is not called until the millennium, we youngsters in my generation will be too old to help. Some won’t be of much help throughout their lives, and others, perhaps many others, will be unwilling to do so. Unfortunately, you will have to make up this shortfall.

Furthermore, there’s the question of support for you during your unproductive years. With luck, you’ll be able to count on your parents before you start working, and on the government after you retire. But note carefully that government neither has, nor generates, any real money; all it can do is redistribute the earnings of others. The social insurance projections cited above look ahead 75 years, to 2065. The trust funds will be depleted by then (or most likely, sooner, owing to the demographic bulge of the baby boomers). Any further payments to you will be entirely dependent on the productivity (and population size) of future generations.

Working To Pay Taxes
There are other productivity problems that go beyond social insurance financing. The gross national product (GNP) depends not only on people’s willingness to work as they have in the past but also on capital formation to create jobs. When I was born, people worked about one hour per day to pay their taxes; when you were born, that was up to nearly three hours every day. This trend impairs the incentive to produce and save.

While government policy has damaged productivity, the media has also — through attacks on business and producers &mdash done more than its share of harm. The work ethic is alive in the country, but it isn’t well, and social insurance projection assumptions are in jeopardy as a result. Furthermore, for all the negative focus on high incomes, it is generally portrayed as even worse to accumulate lots of capital. But without capital formation, your job may well disappear, and the difficulties you will face are, therefore, greatly understated in Exhibit C. Even if you keep your job, it’s hard to see any solid basis for sustainable productivity increases, or real-wage increases in the foreseeable future.

Now, a word about those difficulties you face. When I say that your life will be more difficult than mine, I’m not concerned about the fine wines I’ve enjoyed that you will not. And it’s not just financial matters that trouble me, but rather something more fundamental; that living in actuarial ruins makes it difficult to maintain a decent standard of living, and to keep up a good attitude about your neighbor and vice versa. And it’s not just you I worry about — it’s your entire generation. All 100 million of you are very likely going to be transported over a time span of a few decades into a Third World country of the future, potentially losing your freedoms no less than your comforts as you go. No country has flown so high as ours — and none has so far to fall if it crashes.

But let’s return to Exhibit C and your financial plan, insupportably optimistic though it may be. Let’s assume you work those 40 years as an average wage earner, with an annual income of $25,000 in 1990 dollars, and with no real wage increases over the years. Over the course of your working lifetime, therefore, you’ll earn about $1 million. But you, the average working American, will be no millionaire, as you’ll see when you look at your annual budget.

About 25% of your $25,000 gross annual income will be consumed in mopping up the termite droppings — that is, to retire the real national debt bequeathed to you by prior generations. Another 40% will go to sustain government in its current operations, including current projected contributions needed to support current benefit promises under current social insurance programs.

That leaves amost $9,000 annually for you to spend or save as you see fit. But paying for poverty-level necessities, as defined by the federal government in 1990, will cost you about $7,000. That leaves you with less than $2,000 to spend on not-so-fine wines, and not-so-fine everything else. Obviously, life will be difficult, for you will be only marginally above the 1990 poverty level. But we must return to the assumptions, to learn why things are really much worse than they appear in Exhibit C (and for reasons beyond infertility and unproductivity).

Consider again the social insurance assumptions. There is a painless (for me, at least) solution to the retirement financing problem. It is to have you, and your parents’ generation, work beyond the retirement age you were promised by the termites. (On the grounds of expected increases in longevity, this can be somewhat justified.)

However, there’s no easy quick fix for health care financing problems. It appears at this writing that the mid-1990s will see significant changes in the health care financing and delivery systems of the country. Universal access to the delivery system seems assured, based on concern for the 15% of the population now without health insurance. Simple arithmetic leads to an approximate $100 billion annual cost, if the uninsured are moved from exclusion from the health care system to full inclusion at average costs of care. Cost savings are asserted by some, on the grounds of administrative savings and profit reductions under various health care reform proposals. However, the history of government involvement in health care, including increased utilization, and the costs to employers for regulatory compliance, provides little reason for optimism in this regard. Various price and practice controls are major features of most proposals, in spite of &mdash from Washington to Moscow — a dismal record of failure on this point.

It is true, on the other hand, that heavy-handed price controls could substantially reduce the health care debt of our social insurance program. The quality of medical care will decline, though, with reduced incentives to work and invest in the health care delivery system. You may be better off financially, but perhaps at the cost of your health.

Three of my assumptions that may be insupportably optimistic are that government will operate with balanced budgets after this decade, that fiscal integrity will be restored for the new century, and that the new millennium will be termite-free. I further assume that all levels of government combined will be able to function with just 40% of your earnings to cover their current operations. In the year you were born, government spent $2.2 trillion out of the $5.5 trillion GNP — so there’s no room in my assumption for any liberalizations beyond the years of the enacted, the financial picture for you, the average wage earner, will worsen accordingly.

My assumptions also leave no room for increased government regulation. Termites prefer to spend other people’s money directly but, if necessary (e.g., in the face of a tax revolt), they are willing to require business or lower levels of government to spend for them, and then take credit for the asserted benefits, real or imagined. In some cases, such as the workers’ compesnation legislation enacted several generations ago, real benefits do trickle down. But in other cases — for instance, much of the environmental legislation enacted in recent years — few if any real benefits to people (or the environment) are discernible.

In all cases, there are actuarial costs to be reckoned with, and future costs to be analyzed. (As demonstrated in Exhibit C, plus current federal budget documents.) Unfortunately, actuaries are seldom called upon, and are generally otherwise occupied.

I’m sorry that my profession, and I, have done so little to shine a bright spotlight on the termites who have been destroying your home. We are so few, I might argue, but so are they. A better argument, when sizing up our competing armies, is that we are hopelessly outclassed in terms of camp followers and throw-power, and that is why we’ve run for cover. Yet we haven’t always stayed covered, and few among us can claim never to have followed a camp or two.

While I know few actuaries who have actively aided the termites by generating biased estimates of the long-term costs of proposed legislation (and none when it comes to our national social insurance programs), I know many, including myself from time to time, who have labored mightily at tax-avoidance and other compliance work. Such work is legal, it’s more or less honest, and I suppose it can even be called productive, in the sense that it makes up a part of the GNP. But it sure doesn’t put a chicken in anyone’s pot — except the actuary’s. It doesn’t even put a chicken in the pot of the client who is just trying to keep some scraps of meat on the chicken she produced.

I wish I could say that this scenario for your future was just a worst-case harbinger of what could happen if we let down our guard, but it is not. The big bad wolf is at the door, dressed in the sheep’s clothing of compassion, but lusting for pork and power. The industrious little pig who built our home is still with us and still productive. Given his freedom, he can provide for himself, his needy brother, his greedy sister, and still have some table scraps for the wolf. But alas, he’s no match for the termites.

In my next letter, I’ll do my best to suggest some ways for you to deal with a difficult future.

Love, Grandpa

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