Testimony by James B. Lockhart III
Deputy Commissioner, Social Security Administration
Hearing before the House of Representatives
Social Security Subcommittee
Protecting and Strengthening Social Security
June 23, 2005
I would like to thank Chairman McCrery and the Members of the Subcommittee for holding this series of hearings on protecting and strengthening Social Security and for inviting me to discuss the administration of voluntary personal retirement accounts.
My remarks today are based on the work that has been done by many groups as well as over 30 years of off and on personal experience with corporate pensions. My experiences range from serving on the pension committee of one of the largest corporations in the country, to starting a 401(k) plan for a small business, to serving as the Executive Director of the Pension Benefit Guaranty Corporation.
Over the past decade, the idea of creating a system of personal accounts as part of reforming Social Security has received much attention, including proposals developed by the 1994-96 Social Security Advisory Council and the 2001 President's Commission to Strengthen Social Security. As a result, SSA has looked at the issues involved in administering such a program. We have also studied the Federal Thrift Savings Plan (TSP) and met with their staff and their systems contractor to discuss pertinent issues and draw on their experience. I have also seen SSA successfully implement other large projects such as our new electronic disability system and the rollout of the new application for extra help with prescription drug costs under Part D of Medicare.
A number of models for administering a system of personal accounts have been discussed. Over the last several years, most personal account proposals envision a voluntary program with a centrally administered system modeled on the TSP.
Assuming this approach, Social Security's independent actuaries reduce their estimate of real investment returns of 4.9% by an ultimate annual cost of 0.3% (30 basis points) of assets under management for personal accounts. A basis point is 1/100th of one percent, so 30 basis points would equal $3 per $1,000 of assets. This cost seems reasonable and, in my opinion, may fall as the system matures and gets larger.
There would be significant challenges, but I believe that over a reasonable implementation period of perhaps three years, we could produce an efficient, equitable, and accurate system of personal retirement accounts.
I want to note that I have not been talking about a small business corporate 401(k) plan model, which some critics of personal accounts do. 401(k) plans are expensive for small businesses to administer because of their small scale and because of the regulatory burden. Nor am I using a large employer 401(k) model that has lots of choices, although some do have annual fees less than 30 basis points. To the contrary, I am focusing on a centralized model using the Social Security Administration's existing annual wage reporting (Form W-2) system and the proven TSP model. I believe that this approach is the key to successful and timely implementation of a personal account system.
Social Security personal accounts could quickly become the largest defined contribution plan in the world and achieve very large economies of scale. Assuming a two-thirds participation rate, the Social Security actuaries project that under the President's personal account framework, which phases in personal accounts from 2009 to 2011, there would be about 120 million personal accounts with assets totaling $602 billion (in constant 2004 dollars) at the end of 2015.
As a centralized system of personal accounts is developed, its business processes should reflect a coherent set of underlying design principles. The goal should be to enable the pieces of the new system to fit together in a seamless manner, keep administrative costs to a minimum, speed implementation, and boost public acceptance. There are 7 basic processes in a personal account system, which are:
- Education - The process of providing plan information at various points in time and to distinct categories of individuals, enabling them to make informed decisions.
Initially, the general public would need to be educated about the plan's structure, operation, and participation benefits so that workers could decide whether or not to enroll. Subsequently, those who enroll would need more detailed information about investment opportunities and the status of their accounts. Finally, those about to retire and beneficiaries of deceased participants would need information that outlines options available for accessing account assets.
In addition to the initial, one-time education of the general public about the account plan, a continuous educational program would need to be in place for the over 4 million new workers a year who would need to make an enrollment decision.
- Enrollment - The process of obtaining a worker's consent and supporting information to create a personal account. The supporting information includes the person's identifying information, investment fund selections, beneficiary data, and contact information.
A plan could enroll workers via the Internet and machine readable paper forms. Enrollment could be done by "opting-in" or "opting-out". The latter means that a worker would have to fill out a form stating that he or she did not want to volunteer for personal accounts. In the corporate 401(k) world, opting-out has successfully raised enrollment rates. No matter which enrollment option was chosen, the administrator would likely need to mail out confirming "welcome" packages to enrollees that acknowledge receipt of the applications and provide more detailed educational materials about the plan.
This process entails a large, initial start-up process to establish accounts for current workers and then a continuing process to create accounts for new workers.
- Contribution - The process of collecting, verifying, and crediting wage information and money from approximately 6.5 million employers and 15 million self-employed workers.
The most efficient method for collecting the contributions would be through the current payroll deduction process, as it would demand the least change for employers. However, other options exist that would entail more frequent employer reporting, electronic reporting, direct employer reporting to the account administrator, or use of other reporting/collection avenues, such as the State workforce agencies.
- Investment - The process of quickly and accurately investing contributions in funds chosen by the participants.
This process involves setting the plan's investment policies, establishing available funds for participant investment, selecting investment managers, making timely fund purchases, and updating account balances based on fund performance.
- Recordkeeping - The process of maintaining account information and providing service to participants.
The process would need to provide participants with periodic account statements and the ability to update account records as personal situations change; for example, as addresses, marital status, or beneficiary selections change. It would also need to allow participants to modify how their contributions are invested and to reallocate their assets between funds.
In addition, the plan would need to provide the means to answer account or plan-related questions from participants, beneficiaries, employers, and the general public. This would entail a large internet/website operation as well as a large teleservice component.
- Compliance - The process for monitoring the program to ensure that workers, employers, beneficiaries, and fiduciaries comply with statutes and regulations.
A plan would need to develop procedures to monitor transactions and audit financial records, and make corrections to account records where errors are detected. In addition, the plan would need to have an appellate process that could hear worker or employer requests for reconsideration of the corrective actions.
- Payout - The process for dispersing account assets to participants during retirement or to beneficiaries of workers who die prior to retirement.
Many proposals envision that workers would annuitize to remain above a poverty level-related threshold. Options for releasing the remaining assets above the threshold include paying them out as lump sums or as phased withdrawals.
Included in this process would be making various types of annuities available to retirees and their spouses, and possibly the administration of the entire annuitization program. Moreover, the process would need to have procedures in place to locate beneficiaries and deal with abandoned accounts.
There are proven, low cost models for each of these processes. As others point out, there are also proven, expensive models. In designing a personal account system, Congress should take care to choose options that follow the low cost model. Over time, more flexibility and options could be added as needed.
Many proposals suggest a new independent government agency with an independent board similar to the TSP that would have primary responsibility for most of these activities, with the strong support of the Social Security Administration. In particular, SSA could play a key role in the front-end education, enrollment and contribution phases and potentially in the payout phase. The education process in particular could involve many government agencies building on the Financial Literacy and Education Council as well as business and not-for-profits ongoing financial education efforts.
The TSP is a very good, low cost role model for personal accounts. It has 3.4 million participants and $157 billion of assets under management. It offers 5 investment alternatives including a Treasury bond option and four very low cost indexed funds, which are invested to replicate the returns of broad market indexes. These four TSP funds are very comprehensive and include a corporate bond fund, a Standard and Poor's 500 fund, a U.S. smaller companies fund covering U.S. stocks not in the S&P 500, and an international equity fund.
In addition, by September 2005, TSP plans to add lifecycle funds using a combination of investments in each of the 5 funds in their system. These lifecycle funds gradually and automatically move assets into less volatile investments as the participant gets closer to retirement. For instance, the TSP lifecycle fund for younger workers will have 85 percent invested in equities and by retirement age the equity percentage would be reduced to 20 percent. The idea, which President Bush has endorsed, is to lessen investment volatility as one reaches retirement age. Life cycle funds are especially appealing to persons who do not wish to make a fund selection or actively manage their accounts. At payout or retirement, TSP offers lump sums, monthly payouts, or annuities.
The TSP does all of that with only 90 people plus approximately 400 contract employees and a net cost of $95 million in FY 2005, or 6 basis points of the assets under management. Almost all of this cost is administrative fees. The fees of Barclays Global Investors, the TSP investment managers, represent a very small portion of those 6 basis points.
The TSP recordkeeping system would be an excellent model for the administration of personal accounts even though it has more capabilities than would be needed initially for a Social Security personal account system. TSP and its contractor have told us that their computer system could be adapted to Social Security personal accounts.
Some people have suggested that the TSP is not an appropriate model because there are about 6.5 million employers in the United States while there are only about 130 government agencies providing payroll information to the TSP. While this is true, I believe the existing SSA wage reporting process could provide a similar single interface between eligible employees and self-employed individuals and the program's central record keeper.
Using the existing wage reporting system would provide a low cost and efficient way to collect contribution information. Social Security processes 240 million W-2s annually for approximately 149 million workers. We have a major push under way to increase electronic filing. Over the last six years, electronic filing has grown from 7 percent to 65 percent and we are targeting 82 percent by 2008, and 95 percent by 2012. By law, employers with over 250 employees must report electronically.
Social Security begins receiving W-2s in January for the previous year. We begin processing immediately with 82 percent processed by April 30th and 99 percent by September. Because of the lag in reporting, the President's Commission on Strengthening Social Security suggested that there could be a "holding" fund where contributions would be deposited until individual accounts could be reconciled. This reconciliation would occur once the individual's W-2 information was processed and the personal account would receive the amount contributed plus interest.
As you look at the design of a personal account system, you may want to consider basic principles that would facilitate a simple, efficient process that minimizes administrative burdens and participant costs. These include:
- Utilize existing and proven processes. As previously discussed, the TSP and Social Security's annual wage reporting system provide an excellent foundation for a timely, low cost and effective implementation of a Social Security personal account program.
- Minimize worker and employer burden. The public would most likely prefer a system that causes little additional work for workers and employers. Significant reporting responsibilities for employers could raise business costs, and may adversely impact employment.
- Minimize the use of paper processes. Building a new system would allow the unique opportunity to develop processes based on new and innovative methods where cost-effective processes do not already exist. Developing electronic-based means for collecting, storing, and releasing information would be consistent with e-Government concepts, could potentially reduce administrative costs, speed processes, and allow smoother interface with other administrative systems.
- Limit investor-initiated changes. Limiting investors initially to a few investment allocation changes per year would reduce administrative costs.
- Limit account reporting. Providing investors with quarterly account statements would help to keep reporting costs low and investor inquiries to a minimum. Reducing investor non-electronic inquires about account statements would also help to reduce investor support costs.
- Prevent pre-retirement account access. By preventing access to accounts before retirement, administrative costs could be kept to a minimum, the process would be simpler, and the governing rules would be more understandable to participants.
- Limit distributional alternatives. Unlike the TSP, which has multiple annuity and payout options, the personal account program should limit distributional options in order to minimize administrative costs. As the first retirees under a personal account plan would retire 10 years from enactment, there would be the opportunity to develop low cost, flexible payout alternatives.
In conclusion, while specific issues and costs related to the administration of personal accounts would vary with the specifics of the plan, a strengthened Social Security program that includes personal accounts that provide individual Americans with ownership and more personal control over their retirement income is feasible. Using the model of the Federal TSP along with systems already in place, costs could be kept to an acceptable minimum. And as the assets under management and account sizes grow, allowing additional economies of scale, more choices and flexibilities can be added at a reasonable cost.
As President Bush said in his 2005 state of the Union Address, "The goal here is greater security in retirement, so we will set careful guidelines for personal account." He also said, "We'll make sure there are good options to protect your investments." That is very doable and I would add that a properly designed personal account plan could ensure a better deal for younger workers.
Commissioner Barnhart and I are committed to strengthening and protecting Social Security and to making sure that SSA is ready to assist the Administration and Congress in doing so. Given sufficient time and resources, SSA could successfully implement and administer our share of a personal account program. I will be happy to address any questions you may have.