American Academy of Actuaries on Social Security

Who would be in a better position than the American Academy of Actuaries to evaluate a benefit plan like Social Security? I suggest reading this report on Social Security from the Academy, which explains why a safety net program like this needs to be a defined benefit plan instead of a defined contribution plan. From the abstract:

As originally conceived, Social Security provided monthly benefits for life to covered workers who ceased employment after attaining age 65. Benefits were calculated by a formula based on each worker’s employment history and were payable for life, regardless of how long the worker lived or the amount of taxes paid on his or her behalf while working. Thus, there was at best an indirect relationship between taxes paid and benefits received.

Plans such as this, where the benefits are determined according to a formula and generally paid for life, are called defined benefit plans. By contrast, plans that pay benefits based on amounts accumulated in an individual’s account are called defined contribution plans (or individual account plans).

Much has changed since Social Security was created. The program has expanded to cover new classes of beneficiaries, such as spouses of retired workers, surviving spouses and other family members of deceased workers, and disabled workers and their families. Many U.S. workers have also earned benefits under employer-sponsored defined benefit plans. These developments account, in part, for the fact that the elderly now have the lowest poverty rate among all age classes.

However, over the past 25 years, many employers have dropped sponsorship of their defined benefit plans in favor of defined contribution plans. Many Americans are now saving for their own retirements through employer-sponsored 401(k) plans (a type of defined contribution plan), individual retirement accounts, and personal savings. Some people believe that Social Security would also work better if converted, in whole or in part, to a defined contribution structure.

After careful study of the issues involved, the Social Insurance Committee of the American Academy of Actuaries has concluded that the defined benefit structure is preferable to the defined contribution structure for providing basic retirement benefits under Social Security. Because of its ability to tailor benefits that meet the needs of beneficiaries in different circumstances and its inherent risk-sharing attributes, the defined benefit structure is more efficient at providing the floor of retirement and disability protection needed by U.S. workers, particularly those least able to supplement their Social Security benefits from other income sources. This conclusion is only strengthened by the trend toward defined contribution structures among employer-sponsored retirement plans, since this leaves Social Security as the only remaining defined benefit plan for many workers. This is not to suggest that a defined contribution approach should not be a part of Social Security reform, but this committee would support it only as a supplement to the benefits provided under a basic defined benefit program.