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Editorial: I See Longevity Risk

Editorial: I See Longevity Risk

by Alan Parikh

Like Haley Joel Osment in "The Sixth Sense," we actuaries sometimes see things that others can't. As Social Security reform moves through Congress, and as the topic gets hashed out in the editorial pages of our daily newspapers, many of us actuaries find ourselves muttering over our morning coffee about the ignorance of the non-actuarial community. In fact, just this morning I overheard one such actuary at my local coffee shop. He seemed agitated, as he chugged down his second venti latte. The Wall Street Journal's editorial page trembled in his hands.

"Social Security is longevity insurance," he grumbled. "Private accounts eliminate the pooling of longevity risk–so every dollar you shift from the current system to a personal account will no longer purchase this insurance. Sure, some will be better off–but the program wasn't created to build wealth, it was created to insure against old-age poverty."

He continued. "Rate of return comparisons are meaningless. The notion that the median participant will get a lousy rate of return from their Social Security contribu-tions isn't a 'flaw' in the system–it's the reason the system exists. Those extra few hundred basis points are being shifted towards those who live longer than the media

n, so that they won't have to be burdens on their family, their communities or the state when they are least able to care for themselves."

He looked around at the other customers, but nobody was paying attention. Except me, and I quickly looked down at my notebook to avoid his accusatory gaze.

"I get a miserable 'return' on my car insurance–in fact, I usually 'lose' 100 percent of my premium every six months. And when my neighbor totaled his Subaru, I didn't congratulate him on his great 'investment.' But auto insurance is mandatory, and it should be. By making it mandatory, we protect everyone on the road. How is Social Security any different?" He pounded the table in frustration. A brown coffee splotch appeared on his tie. Unperturbed, he continued.

"In fact, as insurance, Social Security is a pretty great program. Administrative expenses are less than 1 percent–that's ridiculously low, but of course they don't need to pay agents to sell the stuff. The benefit is complicated, sure, but it is uniformly applied–so you don't have to worry that the contract you're signing is a better deal than what your neighbor got. Coverage is mandatory, which sidesteps the anti-selection costs that drive premiums higher for annuities and life insurance.

"And the design sidesteps many of the problems of the private employer-sponsored defined benefit system. The lack of pre-funding, in fact, may not be a flaw. In effect, the elderly retirees of failed companies and shrinking industries have their income protected by workers in surviving companies, and industries that didn't even exist when these retirees were working. So unlike our employer-sponsored defined benefit system, Social Security isn't weakened by capitalism's 'creative destruction'–in fact, it's strengthened. Why can't people see that?"

He put down the paper and thought for a minute. He leaned back in his chair and took a breath. He nodded.

"But if you dismantle a huge, efficient system that delivers longevity insurance very cheaply, you've created a huge unmet need. Won't the markets compel insurance companies and private employers to fill at least some of that gap? In a system this huge, even a small fraction would represent a giant increase to our business. People talk about how much the mutual fund companies are going to reap from privatization. I bet we actuaries get some of that too."

For the first time, a smile crept across his face. He went on. "While privatization may be politically possible now, it may not be politically sustainable in the long term. As interest rates and equity indexes inevitably rise and fall, annuity payouts from account balance arrangements experience huge swings. When they do, politicians may want to buy a new kind of insurance, one that the current system already provides. Call it...political insurance against the electoral wrath of the elderly."

He stood up, stretched and grinned. As he headed toward the door, he murmured, "Now how would I price that out?"