6/28/2005

Personal Accounts, FDR, and a Modest Proposal

In the course of some work I did yesterday, I stumbled across the following quote by President Roosevelt from the initial debates on Social Security:
"In the important field of security for our old people, it seems necessary to adopt three principles: First, non-contributory old-age pensions for those who are now too old to build up their own insurance. It is, of course, clear that for perhaps thirty years to come funds will have to be provided by the States and the Federal Government to meet these pensions. Second, compulsory contributory annuities which in time will establish a self-supporting system for those now young and for future generations. Third, voluntary contributory annuities by which individual initiative can increase the annual amounts received in old age. It is proposed that the Federal Government assume one-half of the cost of the old-age pension plan, which ought ultimately to be supplanted by self-supporting annuity plans."
I am not about to argue, as some rather foolishly did, that this proves that FDR somehow would support President Bush's Social Security proposal on personal accounts; annuities are a whole different animal from a typical investment account. But the quote sparked an idea on one way to make personal accounts more palatable to some who presently oppose the plan.

I have seen two credible objections (to say nothing of the absurd objections) to the personal accounts plan as it is now formulated. The first is that money invested in the stock market is always subject to losses, which rather defeats the point of Social Security. (You could always invest 100% in bonds, but your rate of return will suffer.) The second is that even if an individual's personal account has excellent returns, it does nothing for the solvency of the system; people receiving benefits at the moment will still be paid out of the General Fund, which would be getting even less revenue than before because of the personal accounts.

A year or two ago, I saw a prospectus for a new model of annuity that allows policy holders to capture some of the benefit of a rising stock market, while protecting their principle. It was sold, I think, by The Hartford, though I cannot find it now on their site; the terms seemed too generous to me at the time, and they probably ended up losing money. Regardless, the model was interesting, and could work if the initial terms were tweaked a bit.

[UPDATE 7/3: My source in the financial planning business tells me that not only is The Hartford still selling this type of annuity, but so are most of the other major players. It has proven very, very profitable, which only makes the argument to follow more compelling.]

So, I propose that we add another option to personal Social Security accounts. This option would work as follows: funds paid in will grow along with the broad market, up to a cap established by the government (let's say 10% per year, for example). Any additional returns will be transferred to the General Fund, and will be used to pay current beneficiaries. In return, the government will guarantee that whatever the market does, participants will at minimum receive back what they put in. The principle will be protected, eliminating risk.

Furthermore, at periodic intervals the level of protected principle will be ratcheted up to more closely match the present value of the account. So for example, say I paid $100 into this program for my individual account. Over the next five years, say the fund grows to $180. At a given time, my guaranteed benefit would be recalculated upward (the exact amount would have to be decided on by the actuaries), so that I can protect my gains.

If this option is added to the personal-accounts proposal, it will allow for greater returns than an all-bond fund, and at the same time provide security for people's money. Moreover, when the stock market does well, returns in excess of the cap will be transferred to the General Fund, helping to guard against insolvency. This deals with the two objections put forward so far against personal accounts, as noted above.

If this were added to the table, I think we would see a lot more support from moderate Democrats for the idea of personal accounts, which is all to the good. And in any event, more flexibility in your options is always a good thing. We need to broaden the debate to include this hybrid model of annuities, to give people options that tap into the power of the market, yet give them some protection as well.

1 comment:

karen Codman said...

These annuities not only still exist (yes, it was Hartford Principal Guarantee that you saw) but are growing even better with guarantee step up and guaranteed income payouts. Most variable annuities now have some form of these guarantees on them.
By the way, an annuity is one form of invesment, one that is not as well understood and therefore has gotten some very undeserved bad press.