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According to most Washington observers, debate on how best to reform or restructure the Social Security system will soon begin. No doubt it will be a lively discussion, for the mythology and lack of understanding of how the system works is very pervasive. Hopefully, one result will be a better understanding of the program by lawmakers and the public.

As I understand the major proposal, the objective is to produce a better return on the deposits of future retirees. At the outset, it should be noted that this is a specious assumption and the reason can be found on the bottom of many Coke bottles: “No DepositNo Return.” There is no deposit, or fund, standing to the credit of any individual at the present time and therefore there is also no “return.” The often maligned trust funds, which do earn interest, are simply a mechanism to balance the inflow of revenue and outflow of benefits in years when they do not match. Changing the system to create individual accounts is a major shift in both economics and philosophy.

Because such a proposal is a dramatic change, the debate needs to address important and difficult questions. In many respects, questions are more important than answers. If you ask the wrong question, even if it is answered correctly, you are still on the wrong track. In that spirit, I would like to lift up a few questions that should be asked and hopefully the answers will be forthcoming.

When you move from a plan that has no vested individual accounts to one that provides them, there is a cost. It is somewhat analogous to a person converting a term life insurance policy to whole life. Costs for converting the Social Security system, creating individual accounts with some of the revenue, range from $1 trillion to $2 trillion, by some estimates. Therefore, the big question to be answered iswho pays for this?

Will taxes be raised for participants with special accountsmuch like converting from term to permanent insurance? If taxes remain the same, will participants trade part of their survivor and disability benefits for better retirement benefits? If neither of these options are acceptable, then that leaves the general fund footing the bill. Where will that money come from?

In the event individual accounts within Social Security become a reality, then equally vexing questions arise in regard to their management. Accounting and administrative costs associated with millions of small accounts would likely absorb much of the gain that might be achieved. Therefore, it is most likely these accounts would be pooled much like a 401(k). And how would that work?

We have 23 years experience with 401(k)s managing $1.9 trillion in assets providing some guidance in this area. In the Dec. 1 edition of The Wall Street Journal, the lead article paints a rather gloomy picture of the record thus far. In general, the article reveals the many unwise decisions employees have made with respect to their individual accounts. Many, if not most, employees feel uncomfortable making investment decisions they are not qualified to make, the article claims.

The Journal points out that a number of major employers have become so concerned over this issue that they are shifting this responsibility away from employees and placing such decisions in the hands of professional investment companies. Impetus for this has been the result of comparing performance of 401(k)s with professionally managed pension plans. The article cites figures generated by Watson Wyatt that show $100,000 in a pension plan would generate $88,000 more than a like amount in a 401(k) over 30 years. It will, I believe, be hard for the debaters to ignore the experience of 42 million employees presently covered by 401(k)s.

Assuming that some central administrative fund will be created, there also is experience in that area that may be helpfulbut at the same time raises serious questions. The largest institutional investor at present is the “California Public Employees Retirement System” (CalPERS), managing $177 billion for its participants. My understanding is CalPERS has been successful as an investor, but often criticized for its activist role in corporate governance and other issues. Because of the large stake it holds in many companies, it has not been shy in injecting the fund into the internal affairs of such companies. The president of CalPERS board was, as I write this, ousted for being overzealous in throwing CalPERS weight around.

A similar Social Security fund will quickly dwarf the size of CalPERS and will hold shareholder stakes in many major corporations. What are the ramifications of a federal agency owning large blocks of corporate America? Is this flirting with socialism? Socialism is defined as government ownership of a nations productive resources. It is worth noting that the reason the present Social Security trust funds only can invest in government obligations is to prevent government from acquiring these same productive resources.

There are other questions. Will the plan be optional or mandatory? Can an employee opt in or out as the market for stocks and bonds changes? If so, can the movement of large amounts of savings in and out of the market accelerate a boom or bust?

I dont profess to know the answers to the foregoing questions, but I believe the questions are valid and the debaters should have the correct answers before decisions are made.


Reproduced from National Underwriter Edition, December 10, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.