More Than Cash: Social Security Buffers Longevity Risk

Research October 06, 2023 at 04:35 PM
Share & Print

Financial advisors who help their clients claim Social Security often base their analysis primarily on the projected cash value of expected benefits. This emphasis, though, misses a key aspect of the program's benefit to the American public: its value as de facto longevity insurance.

The approach also does a disservice to demographic groups with greater life expectancy uncertainty, including Black Americans and those with lower economic attainment. These groups face higher life expectancy uncertainty than white Americans as a whole and, as a result, may benefit from claiming analyses that put more focus on Social Security's ability to help curb longevity risk.

This is the topline finding of a new working paper published by the Center for Retirement Research at Boston College. Because of its progressive benefit structure, which helps those with lower lifetime earnings more, Social Security is the most important federal program for improving equity by race and socioeconomic status, the analysis found

The paper, authored by CRR research economists Karolos Arapakis, Gal Wettstein and Yimeng Yin, argues that the Old-Age and Survivors Insurance (OASI) component of Social Security greatly equalizes economic outcomes in retirement. 

While the nature of OASI as an annuity helps those with lower mortality probabilities, who tend to be white and higher-earning, the researchers show by leveraging a simple lifecycle model that all household types value OASI at least as much as their lifetime contributions to the program. Black households value OASI more highly than their white counterparts, both overall and in terms of excess valuation over expected benefits. Generally, they find, the valuation of OASI beyond expected benefits strongly correlates with the unpredictability of longevity.

Wealth Equivalence and OASI

At the heart of the analysis are projected estimates of the value of OASI, including the value of the program's longevity insurance by race, education and marital status.

The exercise involves calculating how much more wealth households would need in order to be as well off in a world with no OASI program as they are with the program — in other words, the "wealth equivalence" of OASI.

The analysis is based on a simple lifecycle model that features survival uncertainty, the researchers explain. The model also accounts for group-specific mortality rates, pension income, wealth and OASI benefits, which include survivor benefits.

The ratio of wealth equivalence to lifetime OASI contributions is then compared to OASI's "money's worth," a common measure in economic analyses that purposefully neglects the program's insurance value.

As the authors explain, the results show that the wealth equivalence of OASI is at least as large as the lifetime OASI payroll taxes paid for all household types, and that finding holds regardless of race, gender, education or household composition. According to the authors, this result strongly suggests they all prefer a world in which OASI exists to one in which it does not.

What's more, the authors find that Black households derive more longevity insurance value from OASI than their white counterparts, suggesting that OASI plays a more important role in equalizing retirement security across race than what is suggested by measures based solely on the cash value of expected benefits.

Finally, the authors find that singles derive more longevity insurance value than couples, as couples are already partially self-insured against longevity risk through intra-family resource pooling.

Why Insurance Perspective Matters

As the authors emphasize, earnings alone are insufficient for determining the racial effects of the OASI program because racial differences in mortality and other household resources persist even for households with similar earnings.

Furthermore, the authors argue, traditional analysis approaches that rely on the expected cash value of benefits neglect the insurance value of the program.

"OASI, being a life annuity, offers households protection against outliving their resources, and the value of this protection is commensurate with how unpredictable longevity is," they explain.

As the authors note, the standard method of assessing insurance value is through wealth equivalence: by asking how much wealth a household would be willing to give up to move from a world without insurance to one in which insurance is available.

"A large literature examines the insurance value of OASI using structural models," the authors point out. "The insurance value of OASI by socioeconomic status, however, has not been examined using the wealth equivalence method. This paper merges the literatures on money's worth and wealth equivalence approaches and uses a structural model to simultaneously examine OASI's insurance value and its money's worth by socioeconomic status and race."

Behind the Numbers

The researchers posit that their results show that the wealth equivalence of OASI is at least as great as the lifetime OASI payroll taxes paid for almost all household types, regardless of race, gender, education or household composition.

Looking by household types, singles of all racial and economic groups derive substantial longevity insurance value from OASI — with this being equivalent to about 80% of total payroll taxes paid on average — in a general reflection of their differential uncertainty in lifespan. In this way, Black men with high education benefit the most from an insurance value perspective by participating in the program.

Couples, on the other hand, generally derive much less insurance value from OASI, with that being worth about 10% to 20% of total payroll tax paid. As noted, this is essentially because couples are already partially self-insured against longevity risk.

"These results are essential for evaluating the disparate impact of OASI by race and socioeconomic status and can inform policymakers and academics about the distributional implications of any proposed changes to the program," the authors conclude. "In particular, across-the-board proportional reductions in generosity are likely to have particularly deleterious effects on Black and lower economic status households."

Credit: Shutterstock

NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.

Related Stories

Resource Center