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Saturday, September 10, 2011

Is Social Security a "Pyramid Scheme"?

Recently, there has been much talk in the news -- including by potential candidates for the presidency -- about whether social security is a pyramid scheme. The SSA's official response is here; numerous folks on the internet say it is lying.

The readers of this blog should be able to tell the answer. There are similarities between pyramid schemes and social security: the main one being that money is paid to those who are earlier in the system from those who are latecomers. But this in itself, however, is not enough to make something a pyramid scheme! Consider a private medical insurance company: on the whole, it pays those who joined years ago (and are now older and need more medical care) from the income (the premiums) of those who joined later (and are thus still younger and need less medical care). Does this mean medical insurance is a pyramid scheme? No.

Why? because, like social security and unlike MLMs, there is no need for the number of insurers to grow exponentially. There is no need for the number of young insured every generation to double for the medical insurance company to remain viable. If the ratio of workers to retirees -- or older to younger medically insured -- remained constant, or at least didn't rise above a certain level, then both social security or the medical insurance company could continue to go on indefinitely.

Does this mean there's nothing to worry about? Not quite.

Again, imagine, if you will, a medical insurance company founded in 1935 (like social security) with the motto, "we insure everybody!". Assume there were 10% of the population that was sick at the time. In theory it is quite possible for them to have charged enough premiums to cover the expenses of treating those who are sick. There is no logical necessity for the number of sick people in the population to increase. So long as it remains the same, or decreases, the company will remain viable.

But suppose the number of sick people, for some reason, rises a lot. That instead of 10% who are sick, you have 20% or 30% of the population who are sick. Naturally in this case the company might well go bankrupt if it continues to charge the same premiums and give the same benefits. But would that mean it's a pyramid scheme? No.

Replace "sick people" with "retirees" and "healthy people" with "workers" you see social security's problem: the constant growth of the ratio of retirees to workers. The reason? The increasing life expectancy. So, yes, social security cannot be funded in its current form indefinitely. It will probably have to increase premiums, or cut benefits, much like a private insurance company might. Or, perhaps more reasonably, it might raise the eligibility age for benefits -- after all, in 1935, the average life expectancy was barely above 60, so the number of those getting benefits was quite small.

Will Social Security reform in such a manner? Maybe. A further problem -- not applicable to a private medical company -- is that this might be politically difficult to do; unlike a private company, where the stock holders have an interest in maintaining long-term viability, with social security, anybody suggesting reform of social security will be crucified, no matter how reasonable the suggestion is. Imagine, if you will, a private insurance company which, for religious or other reasons, considers it an unshakable dogma that the premiums must not be raised and benefits must not be cut under any circumstances.

But if social security eventually fails, it will not be due to its pyramid structure (it is not a pyramid in that sense), but due to these problems -- much like a medical company might well fail if it continues to charge the same premiums and give the same benefits when 30% of those it insures are sick, as it did when 10% were.

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At December 15, 2011 at 10:47 AM , Blogger Kasey Chang said...

Social security is failing because its eligibility age was never changed, and people it covers was increased vastly.

When SS debuted, eligibility age was 65. Guess what the life expectancy is in 1935?


That's right, you are NOT expected to survive long enough to use SS.

Not to mention like 50% of worker pool is NOT eligible for SS at its debut. Those are added later, much later.

Now, decades later, eligibility is STILL 65, but life expectancy is now what? 78?

NO WONDER it's going bankrupt.

it has nothing to do with the pyramid nature. All insurance are like that.

At February 8, 2012 at 1:15 PM , Blogger Bob Hurt said...

SS will not fail. Get used to it. To begin with SS tax is just another income tax. Congress raises the subject income level more than enough to keep up with inflation. It might go to $150,000 or $200,000 to capture more from high income earners. As for SSI, Congress keeps raising the retirement age because people live longer and have more work years available.

The problem with SS that needs fixing is what Congress does with the money. It should be forced to put it in a trust fund and invest it in foreign and domestic indexed securities. Florida earned 10.5% on its trust fund of nearly $150 billion in 2010, a BAD financial year, and has earned upwards of 18 0r 20% in past years. Generally, it beats inflation by a minimum of 7%. 15% of an income up to $150K per year earning compound interest of 7% annually will produce an enormous pile of money in 30 to 40 years of employment, more than enough for anyone's retirement, with money left over for society's irresponsible leeches.

At May 10, 2014 at 11:37 AM , Anonymous Anonymous said...

Must take issue with your contention that you were "not expected to survive long enough" to collect SS. The biggest reason for higher life expectancy noe is lower infant and child mortality; all those 0-year lifespans from infant deaths skewed the average lower. But infants also didn't pay into the system. By the time someone reached working age they were more likely than not to live to collect, because they'd survived all the typical child illnesses.

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