oversight

Social Security Reform: Experience of the Alternate Plans in Texas

Published by the Government Accountability Office on 1999-02-26.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to the Chairman and Ranking
                 Minority Member, Subcommittee on
                 Social Security, Committee on Ways and
                 Means, House of Representatives

February 1999
                 SOCIAL SECURITY
                 REFORM
                 Experience of the
                 Alternate Plans in
                 Texas




GAO/HEHS-99-31
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Health, Education, and
      Human Services Division

      B-279337

      February 26, 1999

      The Honorable E. Clay Shaw
      Chairman
      The Honorable Robert T. Matsui
      Ranking Minority Member
      Subcommittee on Social Security
      Committee on Ways and Means
      House of Representatives

      In 1981, the employees of three Texas counties—Galveston, Matagorda,
      and Brazoria—withdrew from Social Security.1 The counties replaced
      Social Security with a system of individual accounts that provided
      retirement, survivor, and disability benefits. Social Security faces a
      long-term financing shortfall, and some reformers have suggested that the
      experience of these three counties demonstrates the advantages of
      individual accounts as an element of Social Security financing reform.

      Under a system of individual accounts within the Social Security program,
      participants would be either required or allowed to build up savings,
      depending on the reform proposal. The accounts and the earnings they
      accrued would belong to the individuals at retirement. In contrast, under
      the current system, employees and their employers pay into the program,
      and benefits are calculated using a formula that takes into account lifetime
      earnings, age, number of years worked, marital status, and other factors.
      Social Security is largely financed on a pay-as-you-go basis under which
      payroll tax revenues collected from today’s workers are used to pay
      benefits for today’s retirees. While individuals have “claims” on Social
      Security in the sense of promised benefits, under the current program
      design, changes to the program’s revenues, benefits, or both will be
      necessary to ensure the program’s future financial balance and
      sustainability.2

      At your request, we studied the benefits provided by the plans—known as
      the Alternate Plans—created for the employees of the three Texas


      1
       Before the Social Security Act was amended in 1983, state and local governments that had previously
      participated in Social Security were permitted to opt out.
      2
       The Social Security trustees estimate that either revenues will need to be increased or benefits
      reduced by an amount equal to 2.19 percent of taxable payroll (above the current 12.4 percent rate), if
      the system is to pay all promised benefits over the next 75 years. Any delay in taking action will result
      in an increase in the required revenue increase or benefit reduction to ensure the financial solvency of
      the program over the next 75 years. This estimate is based on Social Security’s intermediate actuarial
      assumptions.



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counties.3 We agreed to (1) compare the principal features and benefits of
these plans with those of Social Security and (2) simulate the retirement,
survivor, and disability benefits that individuals in varying circumstances
might receive under the Alternate Plans and under Social Security. While
not all possible scenarios can be simulated, our examples cover a range of
likely experiences. To put both systems on an equal footing, we simulated
outcomes for individuals who would have spent their working careers
under either one or the other system. We assessed benefits for individuals
retiring today and for those who went to work for the counties at the time
the Alternate Plans went into effect in 1981. We examined outcomes for
individuals with 35-year and 45-year working careers with the counties.
Because the Alternate Plans are relatively new, we had to make some
assumptions about how the plans’ investments would have performed
before 1981 because those retiring today would have started working for
the counties before 1981. We assumed that the Alternate Plans’ funds
would have earned returns equivalent to those of similar
portfolios—government and corporate bonds and preferred stocks—at the
time. We estimated outcomes for workers with low, median, and high
incomes on the basis of the distribution of earnings for Galveston County
employees. Our low earners are those at the bottom 10th percentile of the
wage distribution for Galveston County employees nearing retirement age,
and our high earners are those at the 90th percentile.4 We also assumed
that workers retire at 65, the age at which full Social Security benefits are
available. In reality, many workers elect to receive reduced benefits at age
62, and many Texas workers may retire even earlier. Finally, our
calculations assumed that future Social Security retirement benefits will
not be reduced in order to help solve Social Security’s long-term financing
problem, although we did take into account the scheduled increase in the
normal retirement age.

The data we used in our analysis were derived from U.S. government data
systems, the three Texas counties, administrators of the Alternate Plans,
and insurance industry sources. We analyzed the cost and benefit
structures of the Alternate Plans as they existed in 1998. We performed
our work between October 1997 and December 1998 in accordance with
generally accepted government auditing standards. For a more detailed
discussion of our methodology, see appendix I.


3
 The Alternate Plans receive deferred tax treatment under sec. 457 of the Internal Revenue Code.
4
 The earnings distribution of Galveston County employees is somewhat narrower than that of the
nation at large. The median income for Galveston County employees was $25,596 in 1998—about
82 percent of the national median wage. However, incomes for low-wage earners were one-third higher
than those reported for the 10th percentile of Social Security-covered workers, and high-wage earners’
incomes were 68 percent of the 90th percentile of wages nationally.


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                   In general, while Social Security and the Alternate Plans offer retirement,
Results in Brief   disability, and survivor benefits to qualified workers, there are
                   fundamental differences in the purpose and structure of the two
                   approaches. Social Security is a social insurance program designed, in
                   part, to provide a basic level of retirement income to help retired workers,
                   disabled workers, and their dependents and survivors stay out of poverty.
                   Social Security benefits are tilted to provide relatively higher benefits to
                   low-wage earners, and the benefits are fully indexed to protect against
                   inflation. The program also provides significant ancillary benefits to
                   workers’ dependents. Social Security is a pay-as-you-go system that is
                   projected to produce a negative cash flow in 2013 and become insolvent
                   by 2032. To restore the program’s financial balance over the next 75 years,
                   either annual program revenues would have to rise beginning in 1999 by
                   16 percent or annual benefit payments would have to fall beginning in 1999
                   by 14 percent across the board. In contrast, the Alternate Plans are
                   advance funded plans; that is, the contributions made by workers and their
                   employers, which total 13.915 percent of workers’ pay,5 and the earnings
                   made on those invested contributions are used to fund retirement benefits.
                   The Alternate Plans’ benefits are directly linked to contributions, so that
                   retirement income is based on accumulated contributions and the earnings
                   thereon. At retirement, the worker can take the money in the account as a
                   lump sum or select from a number of monthly payout options, including
                   the purchase of a lifetime annuity. Like Social Security, the Alternate Plans
                   also offer insurance protection for the disabled and survivors.

                   Our simulations of how workers for the three Texas counties and their
                   dependents might fare under the two systems revealed that outcomes
                   depend generally on individual circumstances and conditions. In general,
                   we found that certain features of Social Security, such as the progressive
                   benefit formula and the allowance for spousal benefits, are important
                   factors in providing larger benefits than the Alternate Plans for low-wage
                   earners,6 single-earner couples, and individuals with dependents. For
                   example, our simulations showed that low-wage earners retiring today
                   after a 35-year career generally would have qualified for higher retirement
                   incomes had they been under Social Security (that is, on the basis of
                   promised benefit levels) instead of the Alternate Plans. Many median-wage
                   earners in our simulations, while initially receiving higher benefits under
                   the Alternate Plans, would also have received larger benefits under Social

                   5
                    Like Social Security, contributions to Alternate Plans are also capped.
                   6
                    Low-wage earners, in the 10th percentile of the wage distribution in the three Texas counties, earned
                   $17,124 per year. Median earners had wages of $25,596 per year, and higher earners, in the 90th
                   percentile of the wage distribution, had wages of $51,263 per year.



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Security after between 4 and 12 years after retirement, because Social
Security benefits are indexed for inflation. The Alternate Plans provide
larger benefits for higher-wage workers than Social Security would, but in
some cases, such as when spousal benefits are involved, Social Security
benefits could also eventually exceed those of the Alternate Plans. Even
Social Security’s cost-of-living adjustment feature would not lift higher
earners’ benefits beyond those of the Alternate Plan participants until very
late in retirement. Survivor benefits often would be greater under Social
Security than under the Alternate Plans, especially when a worker died at
a relatively young age and had dependent children. With regard to
disability benefits, all workers in our simulations would receive higher
initial benefits under the Alternate Plans. These higher disability benefits
can be traced primarily to the annuitization of the existing account
balances at the time of disability and to the fact that the Alternate Plans
replace 60 percent of wages at the time the disability occurs. Low-income
workers with dependents and some median-income workers with
dependents would qualify for 60-percent income replacement under Social
Security. Although the presence of dependents would narrow the
difference somewhat between Social Security and the Alternate Plans in
initial disability benefits, the Alternate Plans’ initial disability benefits
would still likely exceed those from Social Security because of the added
value of the annuity.

It is important to note that the Alternate Plans’ performance is not
necessarily indicative of how well a proposed system of individual
accounts within Social Security might perform. We looked at the two
approaches in isolation, whereas many Social Security reform proposals
that include individual accounts involve a “two-tiered system” that
combines a base defined benefit element with supplemental individual
accounts, whereby total retirement income would come from the
combination of these two tiers. The Alternate Plans have also followed a
very conservative investment strategy that has precluded investing in
common stocks. By restricting investments to bonds and preferred stock,
the Alternate Plans avoided the higher risks associated with equity
investments but also gave up the opportunity for potentially higher
returns. Proposed reforms that allow for individual accounts envision
investment in equities. Finally, the sum of employer and employee
contributions under the Alternate Plans is somewhat higher than Social
Security’s payroll taxes. On the other hand, the Alternate Plans’ benefits
are fully funded, while Social Security’s promised benefits cannot be met
without increasing program revenues.




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                              Social Security is largely a pay-as-you-go, defined benefit system under
Background                    which taxes collected from current workers are used to pay the benefits of
                              current retirees.7 Social Security is financed primarily by a payroll tax of
                              12.4 percent on annual wages up to $72,600 (in 1999) split evenly between
                              employees and employers or paid in full by the self-employed.8 Since 1940,
                              Social Security has been providing benefits to the nation’s eligible retired
                              workers, their dependents, and the survivors of deceased workers. In
                              addition, since 1956, the program has provided income protection for
                              disabled workers and their eligible dependents. Today, the Social Security
                              program covers over 145 million working Americans—96 percent of the
                              workforce. It is the foundation of the nation’s retirement income system
                              and an important provider of disability benefits. Currently, 44 million
                              individuals receive Social Security benefits.9


Social Security Benefit       Social Security retirement benefits are calculated using the worker’s 35
Eligibility and Calculation   years of highest earnings in covered employment. However, benefits are
                              not strictly proportional to earnings. A progressive benefit formula is
                              applied so that low-wage workers receive, as a monthly benefit, a larger
                              percentage of their average monthly lifetime earnings than do high-wage
                              workers. The benefit is adjusted for the age at which the worker first
                              begins to draw benefits. To receive Social Security retirement benefits,
                              employees must be at least 62 years old and have earned a certain number
                              of credits for work covered by Social Security. Retirees are eligible for full
                              benefits at age 65—the normal retirement age—and those retiring at 62
                              currently receive 80 percent of their full benefit. The age for full benefit
                              eligibility is scheduled to incrementally increase to age 67 for those born
                              between 1938 and 1960.10 Since 1975, benefits have been automatically
                              adjusted each year to compensate for increases in the cost of living.




                              7
                               Revenues that exceed current expenditures are credited to the Social Security Trust Fund to be used
                              for future expenditures.
                              8
                               In 1997, payroll taxes accounted for 88.7 percent of Social Security’s revenue. Interest income from
                              the Treasury bonds in the Social Security Trust Funds generated another 9.6 percent of Social
                              Security’s revenue. Taxes on Social Security income accounted for the remaining 1.7 percent.
                              9
                               Of those receiving Social Security benefits in 1996, 61.5 percent were retired workers, 24.7 percent
                              were family members and survivors of retired workers, 10.1 percent were disabled workers, and
                              3.9 percent were family members of disabled workers. (Numbers exceed 100 percent because of
                              rounding.)
                              10
                               When the age for full benefits reaches 67, those retiring at 62 will receive only 70 percent of their full
                              benefits.



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Additionally, benefits are adjusted when recipients aged 62 through 69
have earnings above a certain threshold.11

Individuals may be eligible for Social Security benefits on the basis of their
spouses’ earnings. For example, a married person who does not qualify for
Social Security retirement benefits may be eligible for a spousal benefit
that is worth up to 50 percent of the primary earner’s retirement benefit.
Spouses who do qualify for their own Social Security retirement benefit
but whose retirement benefit is worth less than 50 percent of the primary
earner’s benefit are eligible for both their own retirement and certain
spousal benefits. Specifically, benefits for such dually eligible individuals
are calculated so that their retirement benefit and their spousal benefit
could add up to 50 percent of the primary earner’s benefit. In practice,
spouses receive either the value of their individual benefit or the value
equivalent to 50 percent of the primary earner’s benefit, whichever is
higher.

Under Social Security, retirement benefits can be paid to ex-spouses if
they were married to the worker for at least 10 years, are not remarried,
and are at least 62 years old. A deceased worker’s survivors are eligible for
benefits if the survivor is a spouse at least 60 years old or a disabled
spouse at least age 50, a parent caring for an eligible child under age 16, an
eligible child under the age of 18, or a dependent parent.12 Ex-spouses are
eligible for survivor benefits if they do not remarry before age 60 and meet
other qualifications for surviving spouses.

Social Security’s Disability Insurance program provides cash benefits to
disabled workers and their dependents. To qualify for disability benefits,
the worker must be unable to engage in any substantial gainful activity
because of a medically determinable physical or mental impairment that is
expected to result in death or to last for a continuous period of at least 12
months. Disability benefits are available after a 5-month waiting period
beginning at the onset of the disability. To be eligible, the employee, if
over age 30, must have worked in Social Security-covered employment for
at least 20 of the 40 quarters immediately preceding the disability’s onset.
If under 31, the disabled worker must have had earnings in at least
one-half the quarters worked after he or she reached age 21, with a
minimum of six quarters. Disabled worker benefits are automatically

11
 In 1996, the earnings limit for those under age 65 was $8,280 a year, and the earnings limit for those
aged 65 through 69 was $12,500 a year. For earnings above these amounts, recipients under age 65 lose
$1 in benefits for every $2 earned, while recipients aged 65 through 69 lose $1 for every $3 earned.
12
 Children aged 18 or older can also qualify for survivor benefits if they became disabled before
attaining age 22 or if they are full-time elementary or secondary school students under the age of 19.



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                        converted to retired worker benefits when the disabled worker reaches
                        the normal retirement age.


Coverage of State and   Workers for state and local governments were originally excluded from
Local Government        Social Security because many were already covered by a state or local
Workers Under Social    government pension plan, and the federal government’s constitutional
                        right to impose a tax on state and local governments was uncertain. In the
Security                1950s, the Social Security Act was amended to allow state and local
                        governments the option of covering their employees. Those state and local
                        governments that elected coverage were allowed to opt out later if certain
                        conditions were met. However, the Congress amended the Social Security
                        Act in 1983 to prohibit state and local governments from opting out of the
                        program once they joined.

                        In 1981, Galveston County officials, citing expected future increases in the
                        Social Security tax rate and wage base, notified the Social Security
                        Administration of the County’s intent to withdraw from the program.
                        County employees voted two to one in support of withdrawal. The
                        neighboring counties of Brazoria and Matagorda followed Galveston’s lead
                        and also withdrew from Social Security. Rather than simply eliminate the
                        Social Security payroll taxes and the coverage provided, the three Texas
                        counties continued to collect these amounts to create the Alternate
                        Plans—deferred compensation plans that include retirement, disability,
                        and survivor insurance benefits.13 The Alternate Plans are designed to
                        replicate many of the features found in the Social Security program.
                        Creators of the Alternate Plans, however, wanted to replace Social
                        Security’s benefits package with one that offered potentially higher
                        returns, while still providing a high level of benefit security. Today, about
                        3,000 employees of the three Texas counties are covered by these plans.14




                        13
                         Under deferred compensation plans, income that is invested is not taxed when earned but rather
                        when benefits are paid in retirement, when, it is assumed, the individual’s marginal tax rate will usually
                        be lower.
                        14
                         The Alternate Plans are a secondary source of retirement income for the workers in the three Texas
                        counties. Their primary retirement benefit is provided under the Texas County and District Retirement
                        System, another defined contribution plan, which also provides disability and survivor benefits.



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                        While Social Security and the Alternate Plans offer a similar package of
Important Differences   benefits, there are a number of important differences between the two
Exist Between Social    approaches in the calculation of benefits and scope of coverage. The
Security and the        Alternate Plans’ benefits are advance funded, while Social Security’s
                        promised benefits are not. As a defined benefit plan, Social Security
Alternate Plans         calculates benefits by formula, whereas the Alternate Plans—defined
                        contribution plans—determine benefits largely by the accumulations in
                        the beneficiary’s retirement account. Retirement benefits under the
                        Alternate Plans are thus based on contributions and investment returns
                        and are not adjusted to provide proportionately larger benefits to
                        low-income workers, as is the case with Social Security. Survivor benefits
                        under the Alternate Plans are not lifetime benefits, but a one-time life
                        insurance payment made to the worker’s designated beneficiaries, along
                        with the worker’s account balance; there are no additional benefits for
                        dependents. Disability benefits under the Alternate Plans are equal to
                        60 percent of the employee’s wage at the time of disability, up to a
                        maximum benefit of $5,000 a month. Workers are eligible to receive the
                        value of the employee’s account at the time he or she becomes disabled. At
                        that time, a new retirement account is established that pays an amount
                        equivalent to the employee and employer’s contributions at that time. The
                        Alternate Plans’ disability benefits make no allowances for dependents.
                        Social Security’s disability benefits are based on a modified benefit
                        formula and include additional benefits for the dependents of disabled
                        workers.


Funding and Coverage    As is the case with Social Security, the Alternate Plans are funded by
                        payroll taxes collected from employers and employees. Galveston County
                        employees, for example, contribute 6.13 percent of their gross earnings
                        toward their deferred compensation account. The County contributes
                        7.785 percent of a worker’s gross compensation. Total contributions to the
                        Alternate Plans in Galveston County today are 13.915 percent—somewhat
                        higher than the 12.4 percent contributed by employers and employees to
                        Social Security. A portion of the County’s contribution goes to pay for the
                        employee’s life and disability insurance premiums (4.178 percent in 1998).

                        The Alternate Plans were designed to give the employees a guaranteed
                        nominal annual return on their contributions of at least 4 percent.
                        Therefore, the Alternate Plans’ managers contracted with an insurance
                        company to purchase an annuity that guaranteed the minimum return. The
                        portfolios holding the plans’ contributions are invested only in fixed-rate
                        marketable securities (government bonds, corporate bonds, and preferred



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                      stocks) and bank certificates of deposit. Rates of return on the portfolios
                      for all of the Alternate Plans have ranged widely over the years but
                      currently are around 6 percent in nominal terms.

                      Social Security, on the other hand, is mostly a pay-as-you-go program, but
                      when revenues exceed outlays, as they currently do, the surplus is
                      credited to the Trust Funds in the form of nonmarketable Treasury
                      securities. The funds earn interest but, unlike the Alternate Plans, the
                      interest income does not influence the amount of Social Security benefits
                      paid to retirees.

                      Because virtually all work in the United States is covered by Social
                      Security, benefits are fully portable if the worker changes jobs. If
                      participants in the Alternate Plans leave county employment, they can
                      either take their account balances with them or leave the account, which
                      will continue to earn the portfolio’s rate of return. The Alternate Plans are
                      tax-deferred plans, so if the employee elects to cash out the account, he or
                      she must pay income taxes on the proceeds, although there is no penalty
                      involved. All distributions of deferred compensation accounts are taxed at
                      the employee’s marginal tax rate at the time of distribution. Social Security
                      income is not taxed as long as an individual’s income does not exceed
                      certain thresholds.


Retirement Benefits   There are also a number of significant differences in how retirement
                      income benefits are determined under the two approaches. Because Social
                      Security is a defined benefit plan, it calculates benefits by formula. The
                      Alternate Plans are defined contribution plans, so benefits are directly
                      related to the capital accumulations in the beneficiaries’ retirement
                      accounts. In addition, retirement benefits are available at younger ages
                      under the Alternate Plans than under Social Security. Moreover, unlike
                      Social Security retirement benefits, which are based on the 35 years of
                      highest covered earnings and weighted to replace a larger share of a low
                      earner’s wages, retirement income benefits under the Alternate Plans
                      depend solely on contributions to the individual’s account and the
                      earnings on the plans’ investments. Also, Social Security provides a
                      separate spousal benefit, and the Alternate Plans do not. (See table 1.)




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Table 1: Principal Differences Between
Social Security and the Alternate        Feature                      Social Security                        Alternate Plans
Plans’ Retirement Benefits               Minimum eligibility          Employees must have at least           Employees are immediately
                                         requirements                 40 quarters of work in covered         vested and may take the
                                                                      employment. At age 65                  balance of their deferred
                                                                      employees are eligible for full        compensation accounts, which
                                                                      benefits, and at age 62, for           are subject to taxation, when
                                                                      reduced benefits. The age for          leaving county employment.
                                                                      full benefits is scheduled to          Employees may retire when
                                                                      rise to 67 for those born after        their combined years of age
                                                                      1959.                                  and service equal 75 or at age
                                                                                                             60, with at least 8 years of
                                                                                                             service.
                                         Benefit determination        The progressive formula used           The value of the employee’s
                                                                      is based on the 35 years of            account at the time of
                                                                      highest indexed earnings.              retirement is based on the
                                                                      Low-wage workers have a                contributions of the employee
                                                                      higher proportion of lifetime          and employer and interest
                                                                      earnings replaced. Married             income on the Plan’s
                                                                      couples are eligible for a             investments. There are no
                                                                      spousal benefit of up to 50            benefits for dependents.
                                                                      percent of the worker benefit.         However, married couples may
                                                                      Dependent children also                use the value of the account to
                                                                      eligible for benefits.                 purchase a joint annuity.
                                         Benefit period               The benefit is a lifetime annuity      The retiree has the option of
                                                                      that includes a benefit for a          purchasing an individual or a
                                                                      surviving spouse after the             joint and survivor annuity.
                                                                      principal annuitant dies.              Alternatively, the retiree may
                                                                                                             take a lump sum benefit that
                                                                                                             lasts until the account is
                                                                                                             depleted.
                                         Cost-of-living               Adjustments are automatic and There are no adjustments,
                                         adjustments                  tied to the Consumer Price    although retirees may
                                                                      Index.                        purchase a graduated annuity.

                                         The Alternate Plans do not ensure the preservation of retirement benefits.
                                         While Social Security provides retirees with a lifetime annuity, the
                                         Alternate Plans allow retiring employees to choose between taking a lump
                                         sum payout or purchasing an annuity with one of several different payout
                                         options. If the worker chooses to receive income from the plan over his or
                                         her remaining lifetime or over that of a spouse, he or she must purchase
                                         either an individual annuity or a “joint and survivor” annuity.15 But
                                         annuities generally are not inflation-protected as they are under Social
                                         Security, so the purchasing power of this retirement income could decline
                                         over time. To protect against future inflation, the retiree can arrange to

                                         15
                                           A joint and survivor annuity pays benefits for the remainder of both the worker and his or her
                                         beneficiary’s lifetime. There is a probability that payments will need to be made over a longer period,
                                         so the monthly income from such an annuity is less than if the annuity were only for the lifetime of the
                                         individual worker.



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                    schedule the annuity payouts so that they are higher in the later years, but
                    this means accepting smaller benefits in the early years. In 1998, the plan
                    for Brazoria County was modified to allow employees to place their share
                    of the contributions in equity funds. It is too soon to judge how this change
                    would affect our comparisons.


Survivor Benefits   Unlike Social Security, the Alternate Plans’ survivor benefits can be a
                    one-time payment or a series of payments over a finite period of time.
                    Under the Alternate Plans, if an employee dies, the surviving beneficiary
                    (anyone named as beneficiary by the worker) receives the value of the
                    employee’s account at the time of death, plus a life insurance benefit. The
                    life insurance benefit for a beneficiary of an employee who dies while
                    under age 70 is 300 percent of the deceased worker’s salary, with a
                    minimum benefit of $50,000 and a maximum of $150,000. Beneficiaries of
                    employees who die between the ages of 70 and 74 are entitled to insurance
                    proceeds up to 200 percent of the covered employee’s annual earnings,
                    with a minimum of $33,330 and a maximum of $100,000. Beneficiaries of
                    employees who die at age 75 or older are entitled to 130 percent of the
                    employee’s annual earnings, with a minimum of $21,665 and a maximum of
                    $65,000.16 These lump sum payments can be used by the beneficiary to
                    purchase a lifetime annuity. Social Security survivor benefits, on the other
                    hand, are based on the worker’s benefit at the time of death, adjusted for
                    the number of beneficiaries. The benefit is paid as an annuity, not a lump
                    sum distribution, and is paid generally to surviving spouses who are 60
                    years old or older or who have dependent children. (See table 2.)




                    16
                     These benefits are for full-time workers. For a part-time worker, survivor benefits can range from
                    65 percent of the worker’s annual earnings to 150 percent, and the amount payable can range from a
                    minimum of $10,832 to a maximum of $75,000. Survivor benefits for workers differ slightly for
                    employees of Matagorda County.



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Table 2: Principal Differences Between
Social Security and the Alternate        Feature                      Social Security                      Alternate Plansa
Plans’ Survivor Benefits                 Eligibility                  A survivor is a widow(er) at   A survivor is any person
                                                                      least 60 years old or a parent named as a beneficiary.
                                                                      caring for an eligible child
                                                                      under age 16 or a dependent
                                                                      child under 18. Surviving
                                                                      disabled children, widows, and
                                                                      widowers are also eligible.
                                         Method of payment            A beneficiary receives a             The beneficiary has the option
                                                                      lifetime annuity after age 60 or     of taking a lump sum
                                                                      until children reach age 16.         distribution or purchasing an
                                                                                                           annuity.
                                         Benefit calculation          The benefit is based on the          Survivors of workers who die
                                                                      worker’s benefit at the time of      before reaching age 70
                                                                      death and adjusted for the           receive three times the
                                                                      number of beneficiaries.             deceased worker’s annual
                                                                                                           salary with a $150,000
                                                                                                           maximum, as well as the value
                                                                                                           of the individual account at
                                                                                                           time of death.
                                         a
                                          Full-time employees who have 8 years of service and retire at age 65 or older will also receive a
                                         “retired life reserve” benefit, which is a paid-up death benefit worth $50,000.




Disability Benefits                      Under the Alternate Plans, workers are considered to be disabled if they
                                         cannot work in their occupation for at least 24 months. Social Security, in
                                         contrast, requires that the individual not be able to perform any
                                         substantial gainful activity because of a physical or mental impairment for
                                         at least 12 months to qualify for benefits. After an initial 180-day waiting
                                         period, the Alternate Plans’ disability insurance pays 60 percent of an
                                         individual’s base salary until age 65 or until the individual returns to work.
                                         The amounts provided by Social Security’s disability insurance vary, but
                                         they follow the same formula as retirement benefits. Of the first $505 of
                                         monthly earnings, 90 percent is replaced, but the replacement rate falls off
                                         rapidly after that. Only 32 percent of monthly earnings between $505 and
                                         $3,043 are replaced, and only 15 percent of earnings above $3,043 are
                                         replaced. Few disabled workers who do not have dependents, therefore,
                                         would receive as much as 60 percent of their wage or salary. A totally
                                         disabled employee can receive a minimum monthly benefit payment of
                                         $100 under the Alternate Plans, up to a maximum benefit of $5,000 a
                                         month. At the time the worker ceases employment because of a disability,
                                         he or she can purchase an annuity with the account balance. A separate
                                         account is then set up by the disability insurance provider, and the insurer
                                         pays an amount into that account equivalent to the employer and




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                                         B-279337




                                         employee contributions at the time the employee stopped working.
                                         Payments are made until the employee reaches age 65.17 Unlike Social
                                         Security, the Alternate Plans provide no dependent benefits. (See table 3.)

Table 3: Principal Differences Between
Social Security and the Alternate        Feature                      Social Security                      Alternate Plans
Plans’ Disability Benefits               Eligibility                  If over 30, the beneficiary must     Workers are immediately
                                                                      have been in covered work 20         qualified under long-term
                                                                      of the last 40 quarters; if 30 or    disability and term life
                                                                      younger, the beneficiary must        insurance policies and the
                                                                      have been in covered work at         group annuity contract
                                                                      least half of the quarters since     disability rider.
                                                                      age 21, with a minimum of 6
                                                                      quarters.
                                         Definition of disability     Person must be unable to             Person must be unable to
                                                                      perform substantial gainful          perform his or her usual
                                                                      work because of a physical or        occupation for 24 months
                                                                      mental impairment expected to        because of a physical or
                                                                      last at least 12 months.             mental impairment. Thereafter,
                                                                                                           the person must be unable to
                                                                                                           work in any occupation for
                                                                                                           which he or she is fit or
                                                                                                           becomes reasonably fit by
                                                                                                           education, training, or
                                                                                                           experience.a
                                         Waiting period               5 full calendar months               180 days
                                         Calculation of benefits      The benefit is determined            The benefit is 60 percent of the
                                                                      using a modified retirement          worker’s salary at the time of
                                                                      benefit formula, and additional      disability, up to $5,000 per
                                                                      benefits are available for           month, plus the value of the
                                                                      eligible dependents.                 individual account at the time
                                                                                                           of disability. In addition, the
                                                                                                           insurer makes monthly
                                                                                                           deposits into a separate
                                                                                                           retirement account equal to the
                                                                                                           worker and county’s
                                                                                                           predisability contributions.
                                         a
                                          Monthly income benefits for mental impairments may be limited to a total of 12 months.




                                         17
                                           A provision of the Alternate Plans requires the insurance company to make monthly contributions to
                                         a new retirement account after the worker becomes disabled. The fixed contribution amount is based
                                         on an average of the employee and employer contributions during the 18-month period before the
                                         onset of the disability. In addition, counties pay life insurance premiums for workers who are totally
                                         disabled before the age of 59.



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                             Our comparisons of retirement, survivor, and disability benefits under the
Benefits Under the           two approaches show that outcomes generally depend on individual
Two Plans Vary With          circumstances and conditions. For example, certain features of Social
Individual                   Security, such as the tilt in the benefit formula and the allowance for
                             spousal benefits, are important factors in providing larger benefits than
Circumstances                the Alternate Plans for low-wage earners, single-earner couples, and those
                             with dependents. The Social Security benefit formula replaces a larger
                             share of the wages of a low earner than of a high earner. As a result,
                             low-wage earners with relatively shorter careers in the three Texas
                             counties would have received larger initial benefits from Social Security
                             than from the Alternate Plans. Social Security benefits also are adjusted
                             for inflation so their purchasing power is stable over time. Thus, the longer
                             the period of retirement, the more likely it is that Social Security will
                             provide higher monthly benefits than a fixed annuity purchased with the
                             proceeds from the Alternate Plans. The Social Security spousal benefit
                             also can significantly raise the retirement incomes of couples when one
                             partner had little or no earnings. Under the Alternate Plans, workers have
                             assets that they may pass on to designated beneficiaries. Conversely, a
                             worker has no assets from Social Security to bequeath to his or her heirs.
                             Finally, the fact that Social Security takes into account the number of
                             dependents in calculating survivor and disability benefits means that
                             individual family circumstances will be important in determining whether
                             Social Security or the Alternate Plans provides larger benefits.


Social Security Provides     Our simulations comparing the retirement benefits for employees of the
Higher Retirement Benefits   three Texas counties show that the benefits from Social Security and the
for Most Low Wage            Alternate Plans depend on the employee’s earnings, the number of years in
                             the program, the presence of a spouse, the length of time in retirement,
Earners                      and the year the worker retires. In general, low-wage workers and, to a
                             lesser extent, median-wage earners would fare better under Social
                             Security. High-wage earners can generally expect to do better under the
                             Alternate Plans, although if spousal benefits are included, even high-wage
                             workers could eventually receive higher retirement income benefits from
                             Social Security.

                             Low-wage workers retiring at 65 today after a 35-year career in county
                             employment would receive a higher initial monthly benefit under Social
                             Security. If the family is eligible for a Social Security spousal benefit or if a
                             joint and survivor annuity is elected under the Alternate Plans, the gap
                             increases. Social Security provides a spousal benefit of up to 50 percent of
                             a worker’s benefit (for a spouse with a record of little or no earnings of his



                             Page 14                           GAO/HEHS-99-31 Alternate State and Local Pensions
                                         B-279337




                                         or her own), while the Alternate Plans’ spousal coverage through the
                                         purchase of a joint and survivor annuity actually reduces the couple’s
                                         monthly income. Low-wage earners with 35-year careers retiring in 2016
                                         are projected to receive roughly the same individual initial monthly
                                         benefits under Social Security and the Alternate Plans. The Alternate
                                         Plans’ benefits are relatively better for those retiring in the future than for
                                         those retiring today because earnings on the plans’ investments were
                                         relatively low in the ’60s and early ’70s as compared with the ’90s. (See
                                         table 4.)

Table 4: Initial Monthly Retirement
Benefits at the Social Security Normal               Social Security         Social Security                        Alternate Plan
Retirement Age Under Social Security                      individual           with spousal      Alternate Plan joint and survivor
and the Alternate Plans, 35-Year Work    Earner              benefit                 benefit individual annuity            annuity
History, 1998 Dollars                    1964-1998
                                         Low                      $750                  $1,125                    $617                        $542
                                         Median                    992                   1,488                      923                        810
                                         High                    1,283                   1,984                    1,848                   1,621
                                         1981-2016a
                                         Low                       947                   1,420                      946                        830
                                         Median                  1,260                   1,891                    1,414                   1,241
                                         High                    1,737                   2,605                    2,771                   2,431
                                         a
                                          Period is 36 years, reflecting the increase to 66 in the Social Security normal retirement age by
                                         2024.



                                         Nevertheless, because Social Security benefits are indexed for inflation,
                                         they would grow larger over time and would eventually exceed the
                                         retirement benefits from the Alternate Plans, as the latter remained
                                         constant. (See figs. 1 and 2).




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Figure 1: Influence of Indexation on
the Relationship Between the Value of
                                                                                     Low Earners
Social Security and Alternate Plan
Monthly Retirement Benefits for            $4,500
Workers Who Begin Receiving
                                           $4,000
Benefits in 1999 After a 35-Year
                                           $3,500
Career, 1999-2017
                                           $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
                                             $500
                                                     99

                                                     00

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                                                   20
                                                                                  Social Security    Alternate Plans



                                                                                    Median Earners


                                           $4,500
                                           $4,000
                                           $3,500
                                           $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
                                             $500
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                                                                                   Social Security   Alternate Plans


                                                                                      High Earners

                                          $4,500
                                          $4,000
                                          $3,500
                                          $3,000
                                          $2,500
                                          $2,000
                                          $1,500
                                          $1,000
                                            $500
                                                 99

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                                               20




                                                                                  Social Security    Alternate Plans




                                        Note: An inflation rate of 3.5 percent is assumed.




                                        Page 16                                     GAO/HEHS-99-31 Alternate State and Local Pensions
                                        B-279337




Figure 2: Influence of Indexation on
the Relationship Between the Value of
                                                                                       Low Earners
Social Security and Alternate Plan
Monthly Retirement Benefits for            $4,500
Workers Who Begin Receiving                $4,000
Benefits in 2017 After a 35-Year           $3,500
Career, 2017-2035                          $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
                                             $500
                                                     17

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                                                   20
                                                                                   Social Security    Alternate Plans




                                                                                     Median Earners


                                          $4,500
                                          $4,000
                                          $3,500
                                          $3,000
                                          $2,500
                                          $2,000
                                          $1,500
                                          $1,000
                                            $500
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                                                                                  Social Security     Alternate Plans



                                                                                       High Earners

                                          $4,500
                                          $4,000
                                          $3,500
                                          $3,000
                                          $2,500
                                          $2,000
                                          $1,500
                                          $1,000
                                            $500
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                                                                                   Social Security    Alternate Plans




                                        Note: An inflation rate of 3.5 percent is assumed.




                                        Page 17                                     GAO/HEHS-99-31 Alternate State and Local Pensions
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                                         The picture for low-wage workers changes somewhat if a 45-year career is
                                         assumed. Because all contributions and the investment earnings on them
                                         determine the size of an Alternate Plan account, more years of earnings in
                                         jobs covered by Alternate Plans lead to higher account balances and,
                                         therefore, higher monthly benefits from the annuity. Social Security
                                         benefits, by contrast, are based on a formula using the 35 years of highest
                                         earnings from all jobs. With the longer work history, initial individual
                                         benefits for low-wage workers would be higher under the Alternate Plans
                                         than under Social Security, although, if spousal benefits and joint and
                                         survivor annuities were considered, Social Security benefits would again
                                         be larger. (See table 5.)

Table 5: Initial Monthly Retirement
Benefits at the Social Security Normal               Social Security         Social Security           Alternate Plan     Alternate Plan
Retirement Age Under Social Security                      individual           with spousal                individual joint and survivor
and the Alternate Plans, 45-Year Work    Earner              benefit                 benefit                  annuity            annuity
History, 1998 Dollars                    1964-2008
                                         Low                      $872                  $1,308                    $982                        $861
                                         Median                  1,157                   1,735                    1,469                   1,289
                                         High                    1,575                   2,363                    3,024                   2,653
                                         1981-2026a
                                         Low                     1,028                   1,542                    1,366                   1,198
                                         Median                  1,367                   2,050                    2,024                   1,775
                                         High                    1,898                   2,847                    4,089                   3,587
                                         a
                                          Period is 36 years, reflecting the increase to 66 in the Social Security normal retirement age by
                                         2024.



                                         Even the higher individual benefits would not be permanent, as indexation
                                         would ultimately close the gap. For low-wage workers retiring in 2008,
                                         however, the gap would be closed in 4 years, while for those retiring in
                                         2026, the gap would be closed in 9 years. Thereafter, Social Security
                                         monthly benefits would be higher. (See figs. 3 and 4.)




                                         Page 18                                     GAO/HEHS-99-31 Alternate State and Local Pensions
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Figure 3: Influence of Indexation on
the Relationship Between the Value of
                                                                                      Low Earners
Social Security and Alternate Plan
Monthly Retirement Benefits for            $4,500
Workers Who Begin Receiving
                                           $4,000
Benefits in 2009 After a 45-Year
                                           $3,500
Career, 2009-2027
                                           $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
                                             $500
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                                                                                   Social Security     Alternate Plans



                                                                                   Median Earners

                                           $4,500
                                           $4,000
                                           $3,500
                                           $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
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                                                                                     High Earners


                                           $4,500
                                           $4,000
                                           $3,500
                                           $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
                                             $500
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                                                                                  Social Security     Alternate Plans




                                        Note: An inflation rate of 3.5 percent is assumed.




                                        Page 19                                     GAO/HEHS-99-31 Alternate State and Local Pensions
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Figure 4: Influence of Indexation on
the Relationship Between the Value of
                                                                                     Low Earners
Social Security and Alternate Plan
Monthly Retirement Benefits for
                                           $4,500
Workers Who Begin Receiving
                                           $4,000
Benefits in 2027 After a 45-Year
                                           $3,500
Career, 2027-2045
                                           $3,000
                                           $2,500
                                           $2,000
                                           $1,500
                                           $1,000
                                             $500
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                                                                                  Social Security   Alternate Plans



                                                                                   Median Earners


                                          $4,500
                                          $4,000
                                          $3,500
                                          $3,000
                                          $2,500
                                          $2,000
                                          $1,500
                                          $1,000
                                            $500
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                                                                                    High Earners

                                          $4,500
                                          $4,000
                                          $3,500
                                          $3,000
                                          $2,500
                                          $2,000
                                          $1,500
                                          $1,000
                                            $500
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                                                                                  Social Security   Alternate Plans




                                        Note: An inflation rate of 3.5 percent is assumed.




                                        Page 20                                     GAO/HEHS-99-31 Alternate State and Local Pensions
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For median-wage earners, Social Security initial benefits are higher when
spousal benefits are included. Individual benefits—even when they start
out lower—eventually catch up to the Alternate Plans’ benefits, but it does
take longer for median-wage earners than for low-wage earners. After 7
years of retirement Social Security benefits would catch up to Alternate
Plan benefits for median-wage earners retiring in 2008 after a 45-year
career with the county assuming Social Security was indexed at
3.5 percent. For those with 45-year careers retiring in 2026, it would take
about 13 years for Social Security individual retirement benefits to
overtake those of the Alternate Plans. High-income workers, in general,
would probably do better under the Alternate Plans, although
consideration of spousal benefits or coverage also could lead to higher
benefits under Social Security through indexation of benefits—at least for
those with 35-year careers.

We used 35- and 45-year work histories to approximate working careers.
We recognize that many people have shorter or less continuous careers.
For example, in 1993 the average 62-year-old woman spent only 25 years in
the workforce, compared with 36 years for the average 62-year-old man.
Both men and women leave the workforce temporarily for a variety of
reasons, such as to return to school or to raise children. Fewer years and
less continuity would influence the pattern of benefits under both plans.
We simulated outcomes for workers who left the labor force for either 5 or
10 years early in their careers (at age 25). Under both Social Security and
the Alternate Plans, retirement benefits were reduced. However, the
reduction was larger under the Alternate Plans because the size of the
accounts at retirement is sensitive to when the contributions are made.
Monies not contributed early in the worker’s career lose the benefits from
compounding, leading to a significantly lower account balance at
retirement. Social Security benefits are also reduced, but because they are
based on the earners’ 35 years of highest income and are not affected by
compounding, the impact on retirement income is less.

This simulation shows that the relative “superiority” of the two approaches
depends on individual circumstances. These simulations are not meant to
portray a “typical” worker, but rather to demonstrate the importance of
particular factors in determining relative benefits from the two
approaches. For example, currently only about 7 percent of Social
Security benefits are spousal benefits, and that percentage is expected to
decline over time as more women become eligible for benefits on the basis
of their own earnings. It is also true that Social Security benefits are
reduced on the death of the retired worker, while the joint and survivor



Page 21                         GAO/HEHS-99-31 Alternate State and Local Pensions
                                         B-279337




                                         annuity under the Alternate Plans could be structured to provide constant
                                         benefits. Nonetheless, for some county workers Social Security retirement
                                         benefits would probably have exceeded those available from the Alternate
                                         Plans.


Presence of Dependents                   With respect to survivor benefits, our simulations indicated that, in cases
Affects Comparisons of                   in which the surviving spouse was left with two dependent children under
Survivor Benefits                        age 16, benefits would usually be higher under Social Security because
                                         Social Security takes the number of dependents into account when
                                         computing the total family monthly benefit. For example, if a low-wage
                                         worker died at age 45, our simulations indicate a surviving spouse with
                                         two dependent children would receive $1,602 per month, while under the
                                         Alternate Plans, the family would receive only $831 per month on the basis
                                         of annuitizing lump sum benefits. (See table 6.)

Table 6: Initial Monthly Survivor
Benefits Under Social Security and the                                           Worker’s age at time of death
Alternate Plans for a Worker Beginning   Earner            21a        25        30       35          40      45      50        55        60b
a Career at Age 21, in 1981 in 1998
                                         Initial Social Security benefits with two dependents
Dollars
                                         Low                  0 $1,271 $1,366 $1,408 $1,550 $1,602 $1,664 $1,720 $1,013
                                         Median               0    1,686    1,818     1,877        2,069   2,138   2,219    2,292       1,348
                                         High                 0    2,373    2,535     2,589        2,832   2,922   3,043    3,160       1,869
                                                                                c
                                         Alternate Plan survivor benefits
                                         Low              $477       559      635       582         680     831    1,011    1,225       1,494
                                         Median            713       837      948       869        1,017   1,243   1,512    1,831       2,219
                                         High            1,427     1,628    1,830     1,697        2,036   2,490   3,029    3,667       4,471
                                         a
                                         Assumes worker dies 12 months after beginning first job for pay.
                                         b
                                             Benefits at age 60 assume no children under age 16.
                                         c
                                          Assumes life insurance and individual account proceeds are used to purchase individual life
                                         annuities.



                                         On the other hand, if there were no dependent children, the surviving
                                         spouse would not be eligible for survivor benefits under Social Security
                                         until age 60, whereas under the Alternate Plans, the surviving spouse
                                         would immediately be eligible to receive three times the worker’s salary
                                         plus any dollar amounts in the worker’s retirement income account. The
                                         Alternate Plans’ survivor benefits would also be higher in cases in which
                                         the worker died late in his or her career. The survivor of a low-wage
                                         worker who died at age 60 with no dependents would receive $1,013 per




                                         Page 22                                     GAO/HEHS-99-31 Alternate State and Local Pensions
                             B-279337




                             month under Social Security, whereas the survivor could receive a lifetime
                             monthly benefit of $1,494 under the Alternate Plans if he or she chose to
                             use the proceeds to buy an annuity. Again, in about a dozen years,
                             increases in benefits due to cost-of-living adjustments would lead to larger
                             monthly benefits under Social Security than under the Alternate Plans. In
                             those cases in which the worker died before working enough quarters to
                             qualify for Social Security benefits, the surviving spouse would not be
                             eligible for survivor benefits. Under the Alternate Plans, however, the
                             survivor is immediately eligible to receive three times the employee’s wage
                             and any account accumulations regardless of how long the employee
                             worked.


Alternate Plans Provide      Because the Alternate Plans replace 60 percent of a disabled worker’s
Higher Disability Benefits   wage or salary and because disabled workers can also annuitize their
                             account balances at the time of disability, the Alternate Plans often
                             provide substantially better disability benefits than Social Security. This is
                             especially true when no dependents are involved. Indexation of Social
                             Security benefits for inflation can eventually close the gap, but it could
                             take over 20 years to do so. For example, a 26-year-old low-income worker
                             with no dependents would receive $711 monthly under Social Security, but
                             $1,086 from the Alternate Plans. It would take a dozen years for indexation
                             (at 3.5 percent per year) to raise the Social Security initial benefit to that
                             received under the Alternate Plans. For a high-income 26-year-old, it
                             would take more than 25 years to close the gap.

                             Although the Alternate Plans still provide a larger initial monthly benefit in
                             all the cases we simulated, the differences were narrowed when
                             dependents were involved. Nevertheless, for high earners, even those with
                             dependents, the Alternate Plans provided larger benefits, and indexation
                             would not close the gap for 15 to 20 years. (See table 7.)




                             Page 23                          GAO/HEHS-99-31 Alternate State and Local Pensions
                                       B-279337




Table 7: Disability Benefits for
21-Year-Old Workers Entering the       Benefit                              Worker’s age at time of disability
Labor Force in 1981 Under Social       type             21         25        30        35         40        45        50        55         60
Security and the Alternate Plans, in
                                       Low earner
1998 Dollars
                                       Social
                                       Security           0     $711      $752      $788       $877      $912      $951       $983 $1,013
                                       Social
                                       Security
                                       with
                                       dependent          0    1,067     1,128      1,183     1,316     1,367      1,426     1,475     1,520
                                       Alternate
                                       Plans         $829      1,086     1,242      1,346     1,473     1,620      1,771     1,926     2,106
                                       Median earner
                                       Social
                                       Security           0      941       996      1,048     1,169     1,216      1,268     1,310     1,348
                                       Social
                                       Security
                                       with
                                       dependent          0    1,412     1,494      1,573     1,753     1,824      1,902     1,965     2,022
                                       Alternate
                                       Plans         1,237     1,625     1,856      2,012     2,201     2,421      2,648     2,879     3,147
                                       High earner
                                       Social
                                       Security           0    1,335     1,409      1,459     1,608     1,666      1,739     1,806     1,869
                                       Social
                                       Security
                                       with
                                       dependent          0    2,003     2,113      2,189     2,412     2,499      2,608     2,708     2,804
                                       Alternate
                                       Plans         2,479     3,253     3,718      4,030     4,409     4,850      5,302     5,766     6,304

                                       The type of disability a worker has also influences how he or she fares
                                       under the two systems. Benefits for workers with “mental or nervous
                                       disorders” are limited to 12 months under the Alternate Plans. Workers
                                       with such disabilities would receive higher benefits under Social Security
                                       if their condition lasted over 12 months because Social Security does not
                                       limit benefits on the basis of impairment.18


                                       Given the inherent differences between the two systems, our results
Observations                           suggest that benefits primarily depend on individual circumstances. Social
                                       Security was designed, in part, to protect low earners and their families,
                                       and indeed low-wage earners generally would do better under Social

                                       18
                                        In 1997, over 30 percent of disabled workers receiving Social Security benefits had some sort of
                                       mental disorder, including mental retardation.



                                       Page 24                                     GAO/HEHS-99-31 Alternate State and Local Pensions
                   B-279337




                   Security. Moreover, while individual circumstances play a role, particular
                   features of Social Security, such as the spousal benefit and automatic
                   cost-of-living adjustments, often result in larger Social Security benefits to
                   recipients than the benefits available under the Alternate Plans. In
                   addition, when dependent children are involved, survivor benefits can be
                   higher under Social Security. Because the Alternate Plans do not tilt
                   benefits in favor of low-wage earners, they can provide better benefits for
                   high-wage workers. In terms of disability benefits, the Alternate Plans
                   generally provide higher initial monthly benefits, especially for
                   high-income workers.

                   It is important to keep the results of our analysis in perspective. Our
                   results reflect the specific features and conditions of the Alternate Plans
                   and should not be construed as an analysis of the potential for individual
                   accounts in general. For example, in an effort to mirror the “safety” of
                   Social Security, the Alternate Plans have followed a conservative
                   investment strategy wherein investments in common stocks are avoided.
                   As a result, the Alternate Plans’ investments have had low
                   returns—especially relative to those from the equities markets. Also, our
                   projections of future Social Security benefits assume the benefits available
                   today will be available in the future. Social Security benefits in the future
                   could certainly be less than those we simulate depending on the reforms
                   that are implemented to address the system’s long-term shortfall. Finally,
                   many of the proposals for individual accounts do not call for the complete
                   replacement of Social Security but rather provide for a two-tier system
                   that combines the safety net, social insurance aspect of Social Security
                   with the promise of higher returns from individual accounts.

                   Overall, our analysis suggests that several of Social Security’s features
                   make an important difference to the relatively less well-off, to
                   single-earner married couples, and to families with dependent children.
                   How these features are treated in any changes to Social Security could
                   have important implications for these groups.


                   We shared a draft of this report with Social Security personnel familiar
Agency and Other   with the program’s benefit structure, outside retirement income
Comments and Our   specialists, and individuals responsible for administering the Alternate
Response           Plans. We received technical comments from several reviewers and
                   incorporated the comments as appropriate. Administrators for the
                   Alternate Plans also provided us with updated figures, which we used in
                   calculating benefits. In addition, these administrators pointed out that we



                   Page 25                          GAO/HEHS-99-31 Alternate State and Local Pensions
B-279337




should use the annuitized values of the accounts at the time of the
disability to calculate the Alternate Plans disability benefits. We
incorporated those changes.

The administrators also noted that they were in the process of introducing
a number of changes to the Alternate Plans that would improve benefits.
They told us that they were introducing an annuity that provided for a 2- to
3-percent annual adjustment to protect against inflation. The
administrators also said they were in the process of adding new benefits
for surviving spouses and dependent children. The spouse would receive a
lifetime benefit of 30 percent of the deceased worker’s income, and
dependent children would receive an additional 30 percent. How much
these benefits would cost had not been determined, and it was not clear
how they would affect our comparisons.

Finally, the Alternate Plans administrators told us that, in their view, we
should have used the average returns that the plans’ investments made in
the past 17 years in projecting future returns. We disagree. Returns on
fixed income portfolios have declined significantly since the 1980s, and
forecasts of future returns on the assets in fixed income portfolios do not
envision a return to those higher levels. The projections we employed
were for an asset whose performance has closely mirrored the
performance of the Alternate Plans’ investments. We believe that is a more
accurate estimate.


We are providing copies of this report to the Commissioner of Social
Security, officials of organizations and state and local governments that
we worked with, and other interested congressional parties. Copies will
also be made available to others upon request. Please contact me at
(202) 512-7215 if you have any questions about this report. Other major
contributors to this report are listed in appendix III.




Barbara D. Bovbjerg
Associate Director, Income Security Issues




Page 26                         GAO/HEHS-99-31 Alternate State and Local Pensions
Page 27   GAO/HEHS-99-31 Alternate State and Local Pensions
Contents



Letter                                                                                                  1


Appendix I                                                                                             30
Scope and
Methodology
Appendix II                                                                                            33
Social Security
Trustees’ Intermediate
Cost Assumptions
Appendix III                                                                                           36
Major Contributors
Tables                   Table 1: Principal Differences Between Social Security and the                10
                           Alternate Plans’ Retirement Benefits
                         Table 2: Principal Differences Between Social Security and the                12
                           Alternate Plans’ Survivor Benefits
                         Table 3: Principal Differences Between Social Security and the                13
                           Alternate Plans’ Disability Benefits
                         Table 4: Initial Monthly Retirement Benefits at the Social Security           15
                           Normal Retirement Age Under Social Security and the Alternate
                           Plans, 35-Year Work History, 1998 Dollars
                         Table 5: Initial Monthly Retirement Benefits at the Social Security           18
                           Normal Retirement Age Under Social Security and the Alternate
                           Plans, 45-Year Work History, 1998 Dollars
                         Table 6: Initial Monthly Survivor Benefits Under Social Security              22
                           and the Alternate Plans for a Worker Beginning a Career at Age
                           21, in 1981 in 1998 Dollars
                         Table 7: Disability Benefits for 21-Year-Old Workers Entering the             24
                           Labor Force in 1981 Under Social Security and the Alternate
                           Plans, in 1998 Dollars


Figures                  Figure 1: Influence of Indexation on the Relationship Between                 16
                           the Value of Social Security and Alternate Plan Monthly
                           Retirement Benefits for Workers Who Begin Receiving Benefits in
                           1999 After a 35-Year Career, 1999-2017




                         Page 28                         GAO/HEHS-99-31 Alternate State and Local Pensions
Contents




Figure 2: Influence of Indexation on the Relationship Between               17
  the Value of Social Security and Alternate Plan Monthly
  Retirement Benefits for Workers Who Begin Receiving Benefits in
  2017 After a 35-Year Career, 2017-2035
Figure 3: Influence of Indexation on the Relationship Between               19
  the Value of Social Security and Alternate Plan Monthly
  Retirement Benefits for Workers Who Begin Receiving Benefits in
  2009 After a 45-Year Career, 2009-2027
Figure 4: Influence of Indexation on the Relationship Between               20
  the Value of Social Security and Alternate Plan Monthly
  Retirement Benefits for Workers Who Begin Receiving Benefits in
  2027 After a 45-Year Career, 2027-2045




Abbreviations

GDP        gross domestic product


Page 29                       GAO/HEHS-99-31 Alternate State and Local Pensions
Appendix I

Scope and Methodology


             In order to compare potential retirement, survivor, and disability benefits
             under the Alternate Plans and Social Security, we simulated the work
             histories of county employees who had relatively low, median, or high
             earnings. We classified employees as low earners if they were at the 10th
             percentile of the wage distribution and as high earners if they were at the
             90th percentile. Median earners are in the middle of the distribution (half
             earn more and half earn less). We used the 1998 wage distribution of
             Galveston County employees nearing retirement to determine low,
             median, and high earnings: $17,124, $25,596, and $51,263, respectively.
             Nationally, low, median, and high earnings were $13,000, $31,200 and
             $75,000. Low earners in Galveston County, therefore, had wages nearly
             one-third higher than those in the 10th percentile nationally, but the wages
             of high earners in Galveston were about 68 percent of those of the 90th
             percentile earners nationally; median wages of the Galveston County
             workers were 82 percent of the national median.

             In order to calculate Alternate Plans and Social Security benefits for our
             illustrative employees, we created earnings and contributions histories for
             these workers. We used a model of earnings growth over workers’ careers
             to reflect the fact that wage income does not grow linearly over a working
             lifetime, but rather that wage growth resembles an “s”-shaped curve. This
             curve reflects more rapid growth during the years when an individual’s
             productivity grows fastest and slower wage increases as the worker nears
             the end of his or her career. We used the earnings for workers nearing
             retirement in 1998 to project the nominal wages of such workers back to
             the beginning of their careers. We also used the model to project earnings
             experiences for those retiring in the future. We projected earnings at age
             65 for workers retiring in the future in the three income classes by taking
             the wage distribution for 1998 earnings and inflating the earnings by
             nominal wage growth to the future retirement years, using the Social
             Security Trustees’ Intermediate Cost Assumptions (see app. II). We
             applied the model to create the wage histories. The coefficients used to
             create the earnings histories were developed and reported in T.
             Hungerford and G. Solon, “Sheepskin Effects in the Returns to Education,”
             Review of Economics and Statistics, 69(1), 1987. While actual earnings
             histories may have greater diversity over time than the wages produced by
             this model, this methodology allowed us to provide illustrative earnings
             patterns.

             To compute expected retirement, survivor, and disability benefits under
             the Alternate Plans, we calculated the expected balances in the accounts
             at the time of retirement, death, or onset of disability. Account balances



             Page 30                         GAO/HEHS-99-31 Alternate State and Local Pensions
Appendix I
Scope and Methodology




depend on earnings, contributions, and investment income. We used the
actual contribution rates that were in effect when the Alternate Plans
began (Social Security payroll tax rates at the time) and adjusted the rates
as they changed over time. Similarly, in projecting what the contributions
would have been if the Alternate Plans had been in effect before 1981, we
used the corresponding Social Security payroll tax rate. The contribution
rates for the three counties differ only slightly, so we used the Galveston
County contribution rates in generating our estimates. For future years, we
assumed that current contribution rates would remain in effect.

To arrive at the investment income, we obtained data on the interest rates
earned on assets purchased by the Alternate Plans since 1981. To calculate
the potential account balances for workers who entered county
employment before 1981 or for future periods, we had to make some
extrapolations. For the period 1963 to 1980, the funds’ portfolio manager
was able to provide us with the investment income on similar types of
investment vehicles offered by the firm. In projecting future earnings, we
found that Social Security special Treasury securities were another fixed
income asset whose earnings closely paralleled the experience of the
Alternate Plans’ portfolios. The special Treasury securities issued to the
Social Security Trust Funds closely mirrored the Alternate Plans’
investment earnings history. We used Intermediate Assumptions’ interest
rate forecasts for the special Treasury securities developed for the Social
Security Trustees 1998 Annual Report. To calculate Social Security
benefits, we employed the Social Security Benefit Estimate Program for
Personal Computers, known as the ANYPIA program, which is available
on-line at www.ssa.gov.

Finally, to calculate retirement and survivor benefits under the Alternate
Plans, we calculated the monthly benefits that retirees or survivors would
receive if they took their lump sum distributions and purchased either an
individual life or a joint and survivor annuity. To estimate the monthly
benefits, we obtained the annuity factors from the Alternate Plans’
insurance and annuity providers. We also received annuity factors from
the Social Security Administration to calculate the lifetime monthly
retirement benefits.

Our simulations made a number of simplifying assumptions. We do not
represent the simulations we undertook to be “typical,” but rather as
illustrative of how workers and their families might fare under a range of
circumstances. We assumed that individuals work continuously at one job
for their entire working lives. We simulated 35-year and 45-year working



Page 31                         GAO/HEHS-99-31 Alternate State and Local Pensions
Appendix I
Scope and Methodology




lives and assumed that people retire at the normal Social Security
retirement age. In reality, many individuals have very discontinuous work
histories, work at many different places, and retire before the normal
retirement age. Many people elect to take Social Security benefits when
they first become eligible at age 62. We also assumed that Alternate Plan
beneficiaries annuitized their lump sums, although currently very few elect
life annuities. We made this assumption in order to put the two systems on
an equal footing for benefit comparability.




Page 32                         GAO/HEHS-99-31 Alternate State and Local Pensions
Appendix II

Social Security Trustees’ Intermediate Cost
Assumptions


                                                 Average annual percentage change
                                Average                                                      Average               Average
                          annual wage in                                      Average          annual               annual
Calendar                        covered     Consumer          Real-wage annual interest unemployment          percentage in
year          Real GDPa     employment     price indexb      differentialc        rated          ratee          labor forcef
1998                2.5              3.3              1.4            1.9              5.8              4.8               1.0
1999                2.0              3.4              2.4            1.0              5.4              5.0               0.9
2000                2.0              3.8              2.6            1.3              5.6              5.3               1.0
2001                2.0              3.6              2.7            0.9              5.9              5.5               1.0
2002                1.9              3.7              2.8            0.9              6.0              5.7               0.9
2003                1.9              4.1              3.1            1.0              6.1              5.8               0.7
2004                1.9              4.4              3.2            1.2              6.2              5.9               0.7
2005                1.9              4.4              3.4            1.0              6.3              5.9               0.8
2006                2.0              4.4              3.5            0.9              6.4              6.0               0.9
2007                2.0              4.4              3.5            0.9              6.3              6.0               0.9
2008                1.8              4.5              3.5            1.0              6.3              6.0               0.6
2009                1.8              4.5              3.5            1.0              6.3              6.0               0.6
2010                1.8              4.5              3.5            1.0              6.3              6.0               0.6
2011                1.7              4.5              3.5            1.0              6.3              6.0               0.6
2012                1.6              4.5              3.5            1.0              6.3              6.0               0.4
2013                1.5              4.4              3.5            0.9              6.3              6.0               0.3
2014                1.5              4.4              3.5            0.9              6.3              6.0               0.3
2015                1.4              4.4              3.5            0.9              6.3              6.0               0.3
2016                1.4              4.4              3.5            0.9              6.3              6.0               0.3
2017                1.4              4.4              3.5            0.9              6.3              6.0               0.2
2018                1.3              4.4              3.5            0.9              6.3              6.0               0.2
2019                1.3              4.4              3.5            0.9              6.3              6.0               0.2
2020                1.3              4.4              3.5            0.9              6.3              6.0               0.1
2021                1.3              4.4              3.5            0.9              6.3              6.0               0.1
2022                1.2              4.4              3.5            0.9              6.3              6.0               0.1
2023                1.2              4.4              3.5            0.9              6.3              6.0                0
2024                1.2              4.4              3.5            0.9              6.3              6.0               0.1
2025                1.2              4.4              3.5            0.9              6.3              6.0               0.1
2026                1.2              4.4              3.5            0.9              6.3              6.0               0.1
2027                1.3              4.4              3.5            0.9              6.3              6.0               0.1
2028                1.3              4.4              3.5            0.9              6.3              6.0               0.2
2029                1.4              4.4              3.5            0.9              6.3              6.0               0.2
2030                1.4              4.4              3.5            0.9              6.3              6.0               0.2
2031                1.4              4.4              3.5            0.9              6.3              6.0               0.3
2032                1.4              4.4              3.5            0.9              6.3              6.0               0.3
                                                                                                                 (continued)

                                       Page 33                             GAO/HEHS-99-31 Alternate State and Local Pensions
                                     Appendix II
                                     Social Security Trustees’ Intermediate Cost
                                     Assumptions




                                              Average annual percentage change
                             Average                                                        Average                 Average
                       annual wage in                                        Average          annual                 annual
Calendar                     covered       Consumer          Real-wage annual interest unemployment            percentage in
year       Real GDPa     employment       price indexb      differentialc        rated          ratee            labor forcef
2033             1.5              4.4               3.5               0.9              6.3              6.0               0.3
2034             1.4              4.4               3.5               0.9              6.3              6.0               0.3
2035             1.4              4.4               3.5               0.9              6.3              6.0               0.2
2036             1.4              4.4               3.5               0.9              6.3              6.0               0.2
2037             1.4              4.4               3.5               0.9              6.3              6.0               0.3
2038             1.4              4.4               3.5               0.9              6.3              6.0               0.3
2039             1.4              4.4               3.5               0.9              6.3              6.0               0.3
2040             1.4              4.4               3.5               0.9              6.3              6.0               0.2
2041             1.4              4.4               3.5               0.9              6.3              6.0               0.2
2042             1.3              4.4               3.5               0.9              6.3              6.0               0.2
2043             1.3              4.4               3.5               0.9              6.3              6.0               0.2
2044             1.3              4.4               3.5               0.9              6.3              6.0               0.2
2045             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2046             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2047             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2048             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2049             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2050             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2051             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2052             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2053             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2054             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2055             1.2              4.4               3.5               0.9              6.3              6.0               0.1
2056             1.2              4.4               3.5               0.9              6.3              6.0               0.1
2057             1.2              4.4               3.5               0.9              6.3              6.0               0.1
2058             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2059             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2060             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2061             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2062             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2063             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2064             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2065             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2066             1.3              4.4               3.5               0.9              6.3              6.0               0.1
2067             1.3              4.4               3.5               0.9              6.3              6.0               0.1
                                                                                                                  (continued)



                                    Page 34                                 GAO/HEHS-99-31 Alternate State and Local Pensions
                                     Appendix II
                                     Social Security Trustees’ Intermediate Cost
                                     Assumptions




                                               Average annual percentage change
                             Average                                                            Average                           Average
                       annual wage in                                            Average          annual                           annual
Calendar                     covered        Consumer             Real-wage annual interest unemployment                      percentage in
year       Real GDPa     employment        price indexb         differentialc        rated          ratee                      labor forcef
2068             1.3              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2069             1.3              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2070             1.3              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2071             1.3              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2072             1.2              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2073             1.2              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2074             1.2              4.4                 3.5                  0.9                  6.3                   6.0                     0.1
2075             1.2              4.4                 3.5                  0.9                  6.3                   6.0                     0.1

                                    a
                                     The real gross domestic product (GDP) is the value of total output of goods and services
                                    expressed in 1992 dollars.
                                     b
                                      The Consumer Price Index is the annual average value for the calendar year of the Consumer
                                     Price Index for Urban Wage Earners and Clerical Workers.
                                    c
                                     The real-wage differential is the difference between the percentage increases, before rounding,
                                    in (1) the average annual wage in covered employment and (2) the average annual Consumer
                                    Price Index.
                                     d
                                      The average annual interest rate is the average of the nominal interest rates, which, in practice,
                                     are compounded semiannually, for special public-debt obligations issuable to the Trust Funds in
                                     each of the 12 months of the year.
                                    e
                                     Through 2007, the rates shown are unadjusted civilian unemployment rates. After 2007, the rates
                                    are total rates (including military), adjusted by age and sex on the basis of the average labor
                                    force for 1996.
                                    f
                                     The labor force is the total U.S. workforce (including military personnel); it reflects the average of
                                    the monthly numbers of people in the workforce for each year.




                                    Page 35                                       GAO/HEHS-99-31 Alternate State and Local Pensions
Appendix III

Major Contributors


               Francis P. Mulvey, Assistant Director, (202) 512-3592
               Hans Bredfeldt
               James Lawson
               Christy Bonstelle Muldoon
               Barbara Smith
               Ken Stockbridge
               Bill Williams




(207011)       Page 36                         GAO/HEHS-99-31 Alternate State and Local Pensions
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