Unlike Actual Insurance, Social Security “Insurance” Creates More Risk for the Future

From society’s perspective, then, Social Security acts as reverse insurance, leaving less for the future.

Gary M. Galles May 6, 2019

Every time the Social Security trustees issue their annual report, some people notice that the system’s huge unfunded liabilities (currently, a $42.1 trillion cumulative shortfall) are inherently unfair to future Americans. That threatens its status as the “third rail” of politics, which electrocutes anyone who tries to touch it.

So Social Security’s army of defenders goes on the attack. And one of their greatest weapons is that the program has been promoted as insurance program ever since it started, and taking away insurance sounds like a bad idea.

Retirement Benefits from Taxpayer’s Pockets

In a sense, Social Security does act as a form of mandatory old-age insurance for participants. However, rather than paying off with earnings from investments, as with private insurance, its taxes provide only promised future government benefits (though the Supreme Court long ago ruled in favor of the government’s claim that it did not need to provide the benefits promised).

From society’s perspective, then, Social Security acts as reverse insurance, leaving less for the future.

However, for Social Security to really be insurance, a group’s “premiums” would have to finance the benefits they receive. But that has not even remotely been true of Social Security. Older generations got far more in benefits than they paid. They may believe they deserve a massively subsidized deal (especially when it is falsely presented as if early recipients actually paid all the costs of their benefits), but that deal is dramatically unfair to younger generations forced to pick up the multi-trillion dollar bill to make good on program promises.

And this is where a key distinction must be noted. In real insurance, people pay more now so that they will have more assets in their future. But Social Security has transferred money in the opposite direction—giving more money to those currently older at the expense of subsequent generations. From society’s perspective, then, Social Security acts as reverse insurance, leaving less for the future.

Overpromised and Underfunded

At Social Security’s inception, and with each of its many expansions, those already retired paid no new taxes, and those near retirement paid more for only a few years, but both groups received increased benefits throughout retirement. That necessarily meant that those who were younger (including those not yet born) would have to pick up the remainder of their tab.

And the attempt to make good on the unfunded commitments of this massive income redistribution to earlier beneficiaries is the source of Social Security’s current financial problems, as well as why there is no fair way out of them—there is no way to make good on its over-promises but by being unfair to someone.

Social Security offered benefits by stealing a substantial part of what would be actuarially fair premiums from future generations.

Social Security’s reverse insurance accumulation of negative balances is also used to oppose any attempt to shift toward private retirement mechanisms. Under private insurance, current workers finance their own retirement benefits—and only their benefits. But if those younger could access such options to escape having Social Security’s huge unfunded liabilities imposed on them, someone else would necessarily be left holding the bag. So politicians instead pander to seniors—who are much more likely to be politically engaged and vote than the young—by demonizing any such move as threatening the status quo even though the status quo is unsustainable anyway.

Looking at Social Security’s finances as of a certain future date, while depressing, injects a similar bias in favor of the program. It means that trillions of dollars owed to those who have paid in, but who have not yet received all their promised benefits, can be made to disappear from public view. However, such arbitrary cut-off dates misleadingly make any private retirement mechanism, which produces no such “hidden” burden on later generations, look worse by comparison.

Social Security Is Unlike Actual Insurance

Assertions that Social Security is essentially just insurance, good to have in an uncertain world so that it should be politically untouchable, ignore the fact that benefits far exceeded “contributions” paid for earlier recipients every time it expanded. The great deal it offered them was provided by stealing a substantial part of what would be actuarially fair premiums from future generations. But that makes it a bad and unsustainable deal today, which will only get worse the longer we ignore that reality.

A program which leaves fewer resources for future Americans is the opposite of insurance, which doesn’t justify maintaining or expanding it on the backs of younger generations who are already big losers from the system. If we are to make rational policy in this area, we need to confront this government-sponsored “child abuse,” rather than letting a rhetorical cheat “insure” that it is overlooked.

Gary M. Galles is a professor of economics at Pepperdine University. His recent books include Faulty Premises, Faulty Policies (2014) and Apostle of Peace (2013). He is a member of the FEE Faculty Network.