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Monday, 27 September 2010
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Social Security Is Not Insurance

So last week, I attempted to explain how comparing Social Security to a Ponzi Scheme isn't that far off. One of the bloggers who doesn't like the comparison is Jay Bullock, who calls myself, and others out. He says that we're wrong, because Social Security is just like your auto insurance policy... and you don't think insurance is a Ponzi Scheme do you?

Every six months, I send a big chunk of dough to American Family to insure my car. That money doesn't go into a safe with my name on it. Instead, that money goes into 1) a set of investments designed to increase AmFam's long-term financial stability and 2) the settlement payouts of other clients found to be at fault. Someday, I will (sadly, not too long ago, I did) need AmFam to pay for an accident myself. When that happens, the payout will come from the immediate cashflow of the company--the premiums their other customers are paying at that moment.

The only problem is... Social Security is not insurance. Insurance is a risk pooling system which depends on many people paying into the pool and never drawing out of the pool so that others can pay less into the pool than they draw out. In other words, it's a way of hedging your bet that you'll never get into an accident. If you don't buy insurance, and your car gets wrecked, then you're out a ton of money to replace it. If you do buy insurance, and you never get into an accident, then you've actually lost money on the deal. But by paying a small amount (relative to the value of your car) every 6 months, you can hedge on the bet that you'll never get into an accident, and also allow you so budget for that bet over time.

Put simply, when you buy insurance, you're hoping that something doesn't happen, but if it does, you're protected. People actually want to be on the losing end of insurance payments because it means you've never gotten into an accident... or if you have... the cost of paying repairs was still less than what you've paid in during a lifetime of paying premiums. There are very few people out there who deliberately crash their cars and total them, just so that they can get "their money's worth" out of their car insurance. And of course, those who do destroy their cars deliberately to collect insurance are prosecuted for insurance fraud.

In the world of car insurance, actuaries are constantly looking at statistics and demographics in order to determine how much to charge individual members of the pool, based on how many people they figure to pay out that year. But the system depends... and this is a key point... on more people paying in than paying out.  If everyone demanded that they "get their full money's worth out of their insurance" than insurance would cease to exist. As a small aside, this is essentially the problem that "Universal Health Insurance" has, which is why it is also not insurance, as I've argued before.

So my question is... do people hope they never turn 65? Is that the "unexpected event" that we're hedging against? Of course not. This is why Social Security is not insurance either, but rather an entitlement. You pay into the program a given amount on the expectation that you'll get a payout. Moreover, while your payout formula is somewhat based on your earnings while you worked, it is not directly tied into the amount you paid in. In fact, not only does your actual lifespan make a difference, whether you are married or not makes a huge difference. The Urban Institute compiled statistics on net benefits paid (the amount received over a lifetime minus FICA taxes taken in) and found that being married could lead to a $300,000 net benefit increase in payout! This of course has nothing to do with how long you'd live (as most people would assume in a "Social Security is Insurance" argument), but simply because they payment system has been rigged to favor those who get married. As another small aside, this is another good reason why banning Homosexual Marriage creates a conflict under the "Equal Protection Under the Law" clause of the 14th Amendment... above and beyond the fact that homosexual survivors aren't due spousal benefits under Social Security either.

Ironically, Jay ends his post by saying:

For this, I defer to erstwhile Republican Charlie Crist, who makes a salient point: "There are other ways we can help fund it, by creating a pathway to citizenship. [...I]f we have those 11 to 14 million people productively participating in the American economy and paying the payroll taxes that would be attended to it, that would help Social Security." There is a labor force in this country willing and waiting to contribute to our financial health--and Nick's financial future--but the same forces scaring the pants off of you about the safety of Social Security are also busy scaring you about the Brown Menace because, you know, that too makes a good election issue. What's good for the country is bad for electoral fortunes.

It's ironic, because this is the exact same sort of thing you hear from people who run Ponzi and Pyramid Schemes. In a typical Pyramid Scheme, some of your earnings are paid to whoever recruited you, and also whoever recruited that person.  But of course, you then get some of your recruits earnings... so new recruits into the scheme are encouraged to enroll even more people. The higher you are in the pyramid, the more levels of earning you get... which makes the base of the pyramid a very lonely and poor place. Jay is essentially acting in the role of a Pyramid Scheme manager by saying that those of us who are currently at the bottom of the pyramid, unsure of how we'll get any money, should go out and recruit new members into the scheme so we can get paid! But remember, it's just insurance!

Democrats, and Social Security Administrators, simply blame this "pyramid like structure" on the nature of demographics in a "pay as you go" system. But of course, the demographic trends of the Baby Boom generation have long been known. While one can argue that this changes the negative moral implications of creating this particular Ponzi Scheme, it doesn't change the Scheme itself, or its future implications on payment over time.

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