Social Insecurity: the annuity problem

Bush’s Social Insecurity plan means bringing back the good old days when old people worried about outliving their money.

Since Mr. Bush has made it a matter of principle not to explain just how he plans to replace Social Security with Social Insecurity until he’s finished terrifying the country with fairy tales about the current system’s impending “bankruptcy,” critics of the non-plan are reduced to asking questions and suggesting problems.

Here’s one I haven’t seen discussed: the problem of outliving one’s money.

Bush’s idea seems to be to convert Social Security into a defined-contribution plan like an IRA or a 401(k), where the fund would in some sense “belong” to the individual. But, unlike a defined-benefit plan such as the current Social Security system, there’s no automatic conversion from a defined-contribution program into an annuity: an annual stream of payments that continues as long as the beneficiary lives.

There is a private market in annuities, but the payouts are quite poor, for a reason well understood by students of insurance: adverse selection. Given a choice between keeping a lump sum to use during retirement and converting it into an annuity, those with healthy lifestyles, no life-threatening conditions, and grandparents who died at 90 will take the annuity, while those who don’t expect to live so long will take the lump sum. So the annuity market has to be priced to reflect the life expectancies of the very long-lived, making it reasonable for many people to take the lump sum.

Thus one of the freedoms the new plan will confer on retirees is the freedom to worry about outliving their money. That seems to me like a huge problem.

Note that this is a different problem from the decision to cut benefits by tying them, in effect, to the wage levels of the retirees’ own working lives rather than letting them rise along with wages post-retirement. But the two problems work together to ensure that large numbers of the very elderly will, once again, be among the very poor.

[I see that, like most of my good ideas, the idea of calling the Bush plan “Social Insecurity” has failed to catch on. But unless someone comes up with a better label, I’m sticking with it.]

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: