Jane the Actuary Retirement

Forbes post, “The Chicago Park District’s 30% Funded Pension Plan – And More Tales Of Illinois’ Failed Governance”

Originally published at Forbes.com on June 7, 2021

 

The Illinois legislature ended its regular legislative session on May 31, in a flurry of legislation passed late into the night. One of those bills was a set of changes to the 30% funded pension plan of the Chicago Park District. Were these changes long-over due reforms, or just another in the long line of legislative failures? It’s time for another edition of “more that you ever wanted to know about an underfunded public pension plan,” because this plan illustrates a number of actuarial lessons.

To start with the basics, the Chicago Park District is a separate entity than the city of Chicago, although its commissioners are appointed by the mayor. Its liabilities are not included in the city’s accounting; if they were it would be a small sliver, only 3%. But that’s still over $800 million in debt.

Some history

The Chicago Park District pension, as with the other city pensions, has its benefit provisions fixed by state law. In addition, also by state law, it has a dedicated property tax levy sufficient to contribute to its pension 110% of employee contributions, which themselves are set at 9% of pay. Just as was the case for other state and local pensions, legislators created a Tier 2 pension benefit for those hired after 2010. And just as there were reductions to other state and state-legislated pensions for Tier 1 workers and retirees, the same was true here: regarding COLA, the retirement age, and disability benefits, as well as an increase to the required employee contribution, which the court struck down in 2018. (This was later than the ruling for other state and city pensions, because the reform legislation was passed later and park district workers waited until the court decision on the other reforms was finalized before filing their lawsuit.)

That reform legislation also contained changes to pension funding. However, unlike the other plans, those changes did not set a funding target, neither using the public-pension concept of Actuarially Determined Contribution, nor the approach of other Illinois pensions, setting a target date 30, 40, or 50 years into the future and setting contributions as that percent of payroll that would reach full (or mostly-full) funding at that date. Instead, the law merely prescribed new multipliers, in which the district would have to pay 2.9 times employee contributions until the plan was sufficiently funded.

In any case, that new funding requirement was lost when the reform law was struck down, and the plan has been on a path to insolvency in 2027 since then.

Some deeper history

In many respects, the history of this plan is similar to the Municipal Employees’ pension. In both cases, this woeful level of debt was not always so. As recently as 2001, according to actuarial reports, the plan was essentially fully funded.

This chart looks very similar to that of my 2019 Municipal Employees’ pension analysis, in which the early 2000s full funding is actually a peak after a steady climb from 45% in the early 70s. In that case, the path to full funding was explained in part by an increase in the funding valuation interest rate from 5% to 8%, and likely as well not just increases in interest rates but a shift to equities from a prior traditional fixed-income investment strategy. In the case of the Park District, older reports are not available online, so we don’t know whether the same pattern held true, and whether that near-100% funding level was a consistent one in the past or a one-time aberration due to the confluence of favorable investments and demographics.

In any case, it’s been downhill since then. What happened?

The easy answer is that the city did not make its Actuarially Required Contributions, or Actuarially Determined Contributions — the label changed in 2014 to reflect that this is merely a standardized method of calculating contributions that amortizes debt over a fixed number of years, not an amount required by law. By the time the city started making the temporarily-higher contributions as prescribed by the reform law, it was too late.

Pension plans, of course, grow in liabilities regardless of what the law says should happen regarding contributions. In fact, here’s what’s happened over the past 20 years:

Believe it or not, this twenty-year doubling of the liability is actually less steep than for the municipal plan, indicating that the bonanza of benefit provision increases in the latter plan did not take place here to the same degree.

But, again, the actuarial math remains unforgiving.

And thus we have Lesson 1:

A pension plan which promises guaranteed benefits to its recipients must be willing to make all prescribed contributions. There is no getting around this math. A plan which is not firmly committed to these contributions, however much they may swing due to market changes and demographics, or which does not have the ability to make this commitment, simply must have some flexibility in its plan design.

This is made all the worse with a disproportion of retirees. That’s true with multiemployer pensions, and that’s true with public pensions, whether that’s due to a generous early retirement age or a declining population. In the case of the Chicago park district, there are virtually identical numbers of retirees/beneficiaries and active workers.

Consider, too, this rather dramatic change in fortunes:

The 2013 pension reform’s increased multipliers did not provide any guarantees that the pension would reach full funding. However, in 2014 and 2015, actuaries calculated that the plan would reach 90% funding in 2048. But in 2016, it was a different story. At that time, the court had ordered that one of the reform changes, reductions to COLA, be un-done, even though the entirety of the law was not yet struck down. This change in itself was enough to set the pension on a path towards insolvency, declining to a 6% funded status in the last year of the report’s projection, in 2055.

And, again, to say that public pensions must be funded seems fairly obvious, but, regrettably, some people who hold themselves out as experts and gain attention as such, still manage to claim the opposite, that it’s acceptable to leave public pensions un- or under-funded as long as they can be deemed “sustainable,” with future pension payments projected to be a tolerable level of the state or local budget. That’s the claim made by Brookings scholars James Lenney, Byron Lutz, Finn Schuele, and Louise Sheiner, which has been picked up by such media as Reuters and MarketWatch.

But the speed with which a public pension can find itself in such a serious hole means that it simply is not reasonable to shrug off debts as tolerable as long as a projection determines it to be so under ideal circumstances.

And that’s not the only issue. Here’s lesson 2: a pension plan is not sustainable without proper governance and actuarial analysis.

Let’s revisit that 1.1 multiplier: this was the property tax levy prescribed by the Illinois state legislature. But the Chicago Park District was never restricted to only this contribution level. At any point, the city could have chosen to use its operating budget for higher contributions, and, in fact, in fairness, the city has done so at times. Even after the legislative mandates were ended, in 2019, the park district contributed an extra $13.1 million beyond the designated property tax levy, and in 2020, the park district had budgeted a supplemental contribution of $20.6 million. Pension funding was also an issue in a narrowly-averted park district union strike in 2019, though the specifics were never made public, except with the implication that the district was constrained in the amount of increases it could offer due to its need to fund the pension.

But at the same time, in 2004 and 2005, the Illinois state legislature authorized the park district to cut back its pension contributions, siphoning off $5 million in each year from the dedicated tax levy to ongoing operating expenses. (”Parks ‘06 budget raises flag,” Chicago Tribune, Dec. 1, 2005).

Can any local entity be trusted to fund its pension plan, when other groups are clamoring for money right now, pension benefits must be paid in the future, and the risks of population decline or other issues feel so intangible?

At the same time, the legislature’s reform attempts repeatedly fall short.

Consider, again, the Tier 2 reform, in which state and local pensions in Illinois provide lower benefits for those participants hired after 2010. I’ve discussed in the past the issues facing the Illinois Teachers’ Retirement System, in which the Tier 2 changes pared away benefits so much that the state likely faces a lawsuit in the future for failing to provide benefits even at the level of Social Security itself for some teachers.

For the Chicago Park District, the Tier 2 benefits are, for the workers as a total group and based on all the plan assumptions, pretty much equal to the contributions the workers pay. The sole benefit those workers receive is due to the guaranteed nature of the benefit, in the form of, basically, a guaranteed 7.25% investment. But benefits are highly unequal; because all workers must have 10 years of service to receive Tier 2 benefits, based on the plan’s valuation assumptions, only about 30% of Tier 2 workers will ever collect a retirement benefit at all. In fact, turnover in the first few years is so high that even for Tier 1 workers, nearly half aren’t eligible for retirement benefits — and in either case, all they get back is their employee contributions without even earning any interest on them.

No actuary would have designed a plan like this. And no private-sector plan would be legally allowed to have such a strict vesting requirement as 10 years; ERISA requires the private-sector DB plans vest after 5 years, and 401(k)s after 3 years.

And now, finally, we get to the last-minute legislative changes, with the legislative text filed on the 19th, passed by the State Senate on the 27th, and passed by the State House on the 31st, the last day of the session. There are three major provisions: a new funding schedule, authorization of pension bonds, and a new Tier 3 group of participants. None of these appear to have been based on actuarial analysis (inquiries to the Pension Board and to the office of sponsoring state senator Robert Martwick were not responded to).

Most egregiously, the Tier 3 benefit simply increases employee contributions by 2 percentage points, from 9% to 11%, and reduces the retirement age two years, from 67 to 65. As it happens, this is similar to the Tier 3 for the Chicago Municipal Employees’ pension, but there are two key differences: first, employees in the latter system only pay contributions at this higher rate until funded status improves, and, second, employees are guaranteed to pay a contribution rate that is no higher than the normal cost (annual benefit accrual) rate, so that they are not obliged to subsidize other employees. This new Tier 3 has no such provisions, and it is wholly unknown whether new employees will benefit or merely subsidize the system.

Second, the plan provides for a new contribution schedule: the amounts necessary to reach 100% funding in the year 2058. For the years 2021, 2022, and 2023 (in each case, paid a year later), there is a “ramp” in which only 1/4, 1/2, and 3/4 of the amount otherwise due must be paid. In addition, not later than November 1, 2021, another $40 million must be paid, though the law specifies that this sum “shall not decrease the amount of the employer contributions required under the other provisions of this Article.” (Does that mean that the projected employer contributions to 2058 must be done as if this $40 million didn’t exist?) This, it turns out, is a lot of money — approximately the equivalent of 60% of payroll or 25% of the total budget (making some estimates based on valuation data). It is the inevitable consequence of past failures to fund and of poor plan design — but I wonder how many of the legislators who cast their votes truly knew what they were voting for.

And, finally, the bill authorizes pension obligation bonds, in the amount of $250 million in total, or $75 million in any one year, and, like the additional $40 million in 2021, the law specifies that “Any bond issuances under this subsection are intended to decrease the unfunded liability of the pension fund and shall not decrease the amount of the employer contributions required in any given year under Section 12-149 of the Illinois Pension Code.” Does this mean that the park district would be required to make contributions on a schedule as if the bonds didn’t exist, so that they would accelerate the funded status of the plan to a point earlier than 2058, while being paid off outside the plan? It is again wholly unclear, and this legislation was passed without any discussion on how these pension bonds would actually work.

This is not how to pass pension legislation. Regardless of whether it’s the $230 billion in liability of the five Illinois state systems ($137 billion unfunded) or the comparatively small $1.2 billion in liability here, no such legislation should be passed without actuarial analysis laying out the impact of the changes, and without making this available to the public.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Prediction: Biden’s Answer To The Medicare Trust Fund Insolvency Is Hidden In His Budget Proposal”

Originally published at Forbes.com on June 1, 2021

 

According to the most recent report, from 2020, the Medicare HI (Hospital Insurance, or Part A) Trust Fund is projected to be emptied in the year 2026. That’s well before the Social Security Trust Fund’s projected insolvency in 2034, and when that happens, Medicare will only be able to pay 90% of Part A benefits, dropping down to 80% in 2038.

So why aren’t our elected officials, and why aren’t Americans themselves, more concerned?

When it comes down to it, I’ll suggest to readers that they don’t really believe that it matters. And with the Biden administration’s 2022 budget proposal comes a fairly strong indication that this is their point of view as well, that they expect, when the Trust Fund well comes dry, to simply tap general federal revenues for the necessary funds, in exactly the same manner as is done for Parts B (doctors) and D (drugs).

Here’s the key sentence:

“The President supports providing Americans with additional, lower-cost coverage choices by: creating a public option that would be available through the ACA marketplaces; and giving people age 60 and older the option to enroll in the Medicare program with the same premiums and benefits as current beneficiaries, but with financing separate from the Medicare Trust Fund.”

To be sure, this is more aspirational than concrete, and wholly lacks a cost estimate. But previous proposals from Biden or other Democrats had been unclear about the nature of the proposal and its financing, with various iterations suggesting that the near-retirees would pay “at cost,” benefitting from Obamacare subsidies as well as the lower cost of a buy-in, relative to private insurance, due to the low provider reimbursement rates fixed by Medicare.

This single sentence makes it clear that’s not the case: the only premiums paid by Medicare recipients are partial-cost payments for Parts B and D. For Part B, this is 25% of the cost for most retirees; for those with income above $85,000/$170,000 single/married, premiums are higher, reaching as much as 85% of the total cost for the highest earners. For Part D, the premium is set to cover 25.5% of the standard drug benefit, plus any extra costs charged by particular private providers for enhanced benefit levels, and an extra flat charge for higher earners. The remaining cost, 75% of Part B and 74.5% of Part D, is funded by the federal government through its general revenues.

What’s more, Part A is premium free, paid for by the contributions of workers through their Medicare FICA taxes. (There’s a small exception, in the form of workers with so little work history in the US, either on their own or by their spouses, that they do not qualify for any Social Security benefits, who must pay either $259 or $471 per month to receive Part A, depending on the number of quarters of coverage earned by the individual or his/her spouse.)

To declare that Medicare Parts B and D will be funded from general revenues for individuals ages 60 – 64, is simply to expand existing government-funded benefits.

To provide Medicare Part A, premium-free, to those ages 60 – 64, likewise funded from general revenues, is to create a path, whether intended or not, towards the funding of Part A from general revenues, for everyone, to the extent that the dedicated FICA revenues fall short. It is simply inconceivable that Congress could establish a system in which hospital charges are handled differently for the two groups of ages 60 – 64 and 65+, and apply a cap or alternate reimbursement rates for the second group. The only way this proposal makes sense is if is paired with a plan, or, less concretely, at least an intention, generally speaking, to meet future shortfalls in Part A, with general tax revenues, rather than any more elaborate cost-control and dedicated tax revenues approach.

And that’s not necessarily a bad thing. Given the complexity of Medicare funding as it stands, and the intertwining of Medicare expenditures with ordinary public health spending, perhaps the entire concept of a Trust Fund and fixed, dedicated, funding for one, but only one, part of Medicare, doesn’t really continue to make sense. (For example, the fact that it is Medicare that funds the hospital residency system for the training of new doctors, and that there is a cap on the numbers of residencies, may be contributing to a shortage of physicians. Does this make sense?) It will continue to be crucial that the government find a way to pay the medical costs of the elderly in a manner that maximizes their well-being while being financially prudent and responsible, but that does not necessarily mean that the artificial construct of a “Trust Fund” should be an ongoing part of this effort.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Chicago Firefighters Pension Update: Why Did Pritzker Boost Benefits?”

Originally published at Forbes.com on May 10, 2021.

 

About a month ago, Illinois governor JB Pritzker signed legislation that boosted pension benefits for a group of Chicago firefighters, despite the urging of Chicago mayor Lori Lightfoot not to do so, because of the cost to the already-woefully-underfunded plan. As I wrote back in January, this change could drop the funded status from 18% funded down to an even-worse 16%. Each dollar that is spent on this benefit improvement is a dollar that must be extracted from taxpayers or found by cutting other needs.

As the Chicago Sun-Times reported,

“A Wall Street rating agency that alone gave Chicago a junk bond rating on Friday branded as ‘credit negative’ a bill Gov. J.B. Pritzker signed over Mayor Lori Lightfoot’s objections boosting pensions for thousands of Chicago firefighters.

“’The legislation is credit negative for the city of Chicago,’ said the advisory from Moody’s Investors Service, ‘because it will cause the city’s reported unfunded pension liabilities, and thus its annual contribution requirements, to rise.’

“With pension contributions consuming 17% of the city’s operating revenue and total liabilities pegged at $46.6 billion in 2019, pensions are the ‘largest credit challenge facing Chicago,’ Moody’s said.”

Why, then, did Pritzker sign this bill?

In his press release, Pritzker claimed that “HB 2451 creates a system that gives all firefighters certainty and fair treatment.”

And the promoters of this bill, most notably State Senator Robert Martwick, had claimed that, despite all appearances, the bill was actually prudent and responsible, because it removed a “birth date restriction” that, as the Sun-Times reported, “Martwick has . . . already has been moved five times as a way of masking the true cost to the pension fund.”

And Martwick’s own statement at the time?

“If we ever hope to right our financial ship, we must finally put an end to the irresponsible behavior that put us here in the first place . . . . This law simply ensures that the city confronts the true costs of its pension obligations and makes the difficult decisions it needs to make today.”

But, again, as I explained back in January, this is misleading, to put it nicely. This restriction was imposed in 1982 and changed in 1995 and 2004 — then the benefit boosts stopped as the city and the state both finally recognized that pension funding mattered, with Tier 2 benefits implemented in 2011 and an attempted reform in 2013. Only in 2017, in a bill sponsored by Martwick himself, as a state representative, was the benefit boosted again by a further moving of the birthdate restriction, and after he succeeded in getting this bill passed, he set about getting the birthdate restriction eliminated, with a bill in 2018 which died in 2019, before re-introducing it for its final passage now. For Martwick to point to this past history to claim that the moving of the birthdate restriction is somehow inevitable and out of anyone’s control is, well, chutzpah at its finest.

But why, then, would Pritzker have signed into law a bill when the central claim of its advocate — that the state had an unalterable practice of benefit boosts that needed to be recognized honestly — was demonstrably not true, with the barest amount of research required to understand this?

Plainly, there are three possibilities.

First, that Pritzker truly believed Martwick’s claim that the legislature would always boost benefits, so the only option was to recognize this fact.

Second, that Pritzker was unwilling to stand up to legislators who, themselves, did not hesitate to support this bill, because, after all, no one is going to blame an individual legislator for going along with the rest of the party, with the safety in numbers it affords. “Fiscal responsibility” offers a plausible cover for what is, in the end, the action of a coward.

Or, third, that he knows full well that Martwick’s claim is absurd, but simply doesn’t care, because he himself, however much he claims otherwise, doesn’t particularly care about pension funding, and will take any opportunity available to boost benefits in an environment in which this is otherwise out-of-the-question. A statement becomes a purposely misleading, even if others think it’s the truth, if you have access to information to the contrary.

Does it matter?

Pritzker signed this bill a month ago. In the meantime, immediate fiscal crises in Illinois and Chicago have been lightened by the $7.5 billion in American Rescue Plan funds to the state and $1.8 billion to the city. Pritzker announced that, as a result, the state’s contribution to public schools would increase by $350 million and state Comptroller Susana Mendoza announced that the state’s bill backlog had shrunk down to $3.5 billion. Lawmakers are working on budget negotiations, with a May 31 deadline. The redistricting battle is also underway, with its own June 30 deadline, and with the Illinois GOP accusing Pritzker of breaking a campaign promise to support an independent redistricting commission. And Pritzker, as well as new House Speaker Chris Welch, want Illinoisans to believe that, regardless of the state’s past history of corruption that gave it its second-most-corrupt ranking, the state is “under new management” and is now being ethically and responsibly governed.

Can Pritzker be trusted? Can legislators and their leadership be trusted? Not only is the Democratic party in full control of the state, but there are no factions within the party arguing for different directions; bill after bill is passed wholly on a party-line basis, because legislators are expected to simply vote as they’re told to.

Actions like Pritzker’s decision in the firefighters’ bill seem small, but they add up, one signature after the next. And each decision matters, each one is a decision in favor of good governance and fiscal responsibility, or against it. This decision, and countless others like it, matter, even if Pritzker may choose to believe otherwise.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Expand Medicare In The American Families Act? Not So Fast”

Originally published at Forbes.com on April 30, 2021.  While the legislation never passed, I think the background/context for “Medicare expansion” is still relevant.  

 

The American Families Act — Biden’s new spending proposal covering paid leave, child benefits, childcare subsidies, tuition-free community college, and more, but lacks one component progressives had been calling for: an expansion of Medicare, in terms of benefits provided and age eligibilities.

Here’s an excerpt from yesterday’s Washington Post:

“Congressional Democrats are planning to pursue a massive expansion of Medicare as part of President Biden’s new $1.8 trillion economic relief package, defying the White House after it opted against including a major health overhaul as part of its plan. . . .

“They specifically aim to lower the eligibility age for Medicare to either 55 or 60, expand the range of health services the entitlement covers and grant the government new powers to negotiate prescription drug prices. . . .

“Roughly 100 House and Senate Democrats led by Rep. Pramila Jayapal (Wash.) and Sen. Bernie Sanders (I-Vt.) publicly had encouraged Biden in recent days to include the overhaul as part of his latest package, known as the ‘American Families Plan,’ which proposes major investments in the country’s safety net programs. . . .

“Sanders said Wednesday he would ‘absolutely’ pursue a Medicare expansion as lawmakers begin to translate Biden’s economic vision into legislation. Sen. Ron Wyden (D-Ore.), the chairman of the tax-focused Finance Committee, similarly pledged that he would ‘look at every possible vehicle’ to lower drug costs.

“And Sen. Richard J. Durbin (Ill.), the Democrats’ vote-counter in the chamber, said he planned to push for Medicare reforms he saw as a ‘game changer.’”

Democrats and, to a lesser degree, Republicans have been on a quest to reduce prescription drug costs for years, and even in the waning months of the Trump administration, there had been efforts to implement a “most favored nation” pricing model, in which Medicare would pay drug prices equivalent to those paid by other developed countries; an executive order mandating this for Part B drugs was issued in September, published as a rule in November, and halted via injunction from a lawsuit in January. Proposals to expand this concept to Part D drugs are still pending, but have bipartisan approval; more extreme proposals such as the promise to seize patents and produce drugs via compulsory licensing, of course, do not.

But what exactly is the plan, when it comes to demands to expand Medicare eligibility? There have been two versions floated about: the first offers a “buy in” to otherwise-uninsured near-seniors, and the other simply offers the benefit under the same terms as for those already age 65. The letters from Sen. Sanders and Senate Democrats and from House Democrats do not spell out precisely their intention when they call for eligibility expansion alongside benefits expansion. Can it be inferred from their claim that Medicare would save $500 billion over 10 years with prescription drug price-control and the money could be used to “expand and improve Medicare,” that they intend for their pre-65 Medicare to be exactly as “free” as 65+ Medicare? Politico reports that merely to add dental, vision, and hearing benefits would cost $350 billion, but that Sanders, when asked, declined to discuss the costs of his proposals:

“He said he doesn’t want to just pick a target; he wants to check off as much as can be done to help people across the country and then figure out just how much that would cost.”

What is the actual cost of Medicare expansion? Even in a moderate form down to age 60, one estimate is between $40 billion to $100 billion per year, which, at the higher end, or with a further eligible drop down to age 55, would be far, far more than the projected savings from drug price controls, even without the addition of the benefit enhancements.

As to the various buy-in proposals, Kaiser evaluated several of the proposals being floated as of 2018. These proposals keep the Medicare benefit design, with its Part A, B, and D benefits, calculate the cost of benefits plus administrative expenses, and use the ACA structure to provide premium subsidies. The proposals would also require that all existing Medicare providers accept new patients at the same, low, Medicare reimbursement rates as for existing over-65s, and it is this low-reimbursement mandate, not superior management or reduced administrative costs, which would reduce the cost of this coverage to recipients. And for any iteration of “buy-in,” or any of the “Medicare for All” proposals from the various Democratic candidates, the ultimate impact of including far more medical care into the “Medicare rates” is something that generates a lot of worry, without much of a sense, even from experts, as to what would happen when providers are squeezed and cannot cost-shift from Medicare to private-insurance patients.

One analysis from 2019 attempted to model the effects of some sort of Medicare expansion, based on a hypothetical non-profit hospital system, in which private-sector insurance rates are double those of Medicare. This hypothetical did not include doctors’ practices, only hospitals. It found that its current 2.3% profit margin would drop to a 1.6% margin, in the case of a voluntary buy in for those age 50 and above, where employers could not shift coverage to Medicare; if employers did have the ability to move their older employees to Medicare, the hospitals would have a 5.3% loss; for a public option for all ages, that hospital system would have an 8.4% loss. (I was unable to find a similar analysis of doctors’ revenues.)

It stands to reason, then, that, however much the United States may be overpaying when it comes to drug costs, there is no such simple answer when it comes to costs for healthcare, in general, where expanding the number of recipients of care at Medicare rates (or, even more extreme, the Medicaid rates), would open up a can of worms. Proposals exist to reduce the cost of medical care, far more broadly speaking than simply forcing down reimbursement rates or expanding the number of people eligible for the lowest rates, but this is a far greater challenge than sloganeering, or simply declaring a new form of government benefit.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary General Interest, Retirement

Forbes post, “Why Biden’s American Family Plan’s Family Leave – Reportedly – Gets Social Insurance Completely Wrong”

Originally published at Forbes.com on April 22,2021.  The legislation has failed in the meantime, but the issue of Family Leave has not gone away.

Earlier this week, the Washington Post reported on some initial details on the American Families Plan, the third of the Biden administration’s massive spending bills, expected to be unveiled next week, and following on the American Rescue Plan already passed and the American Jobs Plan of infrastructure and social spending. The proposal is expected to include

  • $225 billion for child-care funding;
  • $225 billion for paid family and medical leave;
  • $200 billion for universal prekindergarten;
  • Hundreds of billions in education funding, including his “free community college” campaign promise; and
  • An extension of the expanded child tax credit/child allowance through 2025.

The plan is intended to be funded by tax increases on “wealthy Americans and investors, in addition to beefing up enforcement at the Internal Revenue Service.”

The Post did not provide details on the time frame over which these costs would be incurred or funded. (Recall that the “jobs plan” spends over 8 years and funds over 15.) But one might assume that his proposal for family and medical leave would be based on his campaign promise, that is,

“Biden will create a national paid family and medical leave program to give all workers up to 12 weeks of paid leave, based on the FAMILY Act. Workers can use this leave to care for newborns or newly adopted or fostered children, for their own or family member’s serious health conditions, or for chosen family; or to care for injured military service members or deal with “qualifying exigencies arising from the deployment” of a family member. During their time away from the job, workers will receive at least two-thirds of their paycheck up to $4,000 so they can better afford to take leave — with low- and middle-wage workers receiving larger shares of their paycheck.”

Now, the FAMILY Act is an existing legislative proposal which would provide 12 weeks of leave at 66% of pay, paid for by 0.2% of pay (employer/employee) contributions. And as it turns out, this proposal has been around since at least 2013, when on another platform I critiqued the bill not just for its egregious acronym (the bill title is the Family and Medical Insurance Leave Act, which ought to be the FAMIL Act, and even then “insurance leave” rather than “leave insurance” doesn’t even make sense, but it’s rearranged to get the acronym) but for the fact that the contribution level appear to have been chosen as a politically palatable tax rate rather than based on any actuarial analysis of the cost of running such a program. In fact, in January 2020, the Social Security Chief Actuary provided an analysis of the bill’s cost, and found that rather than the proposed payroll tax rate of 0.4% would be insufficient and instead 0.62% would be required to fund benefits — and that under a surprisingly low set of assumptions around use of the benefits, that only 35% of new parents would take advantage of the program, that 4% of workers would have medical conditions of their own and 0.4% of workers would need to care for a family member, and that, on average, they would receive benefits for only two rather than three months. Yet nowhere in the legislation is there any means of adjusting the payroll tax to meet actual financing needs, nor adjusting benefits to meet the revenue available.

Financing issues aside, however, this approach is a reasonable form of social insurance provision. Quite simply, this is how social insurance works. We, collectively, want a means of collectively providing funds to people as circumstances require — retirement, disability, unemployment, family leave needs — and the mechanisms of social insurance deliver: universal payroll taxes with rates set as needed to fund these payments.

Consider a few international examples, based on the data available at the International Social Security Association website (and highly simplified):

France provides sickness benefits and maternity/paternity/adoption leave, for up to 10 weeks after birth, funded with a 13.3% payroll tax, plus family allowances funded with a 3.45% payroll tax, which include both cash benefits, childcare subsidies, and benefits for reduced work hours, paid for 2 years, more or less.

Netherlands provides a maternity leave benefit for up to 16 weeks, funded through its unemployment insurance program (2.85% payroll tax).

Sweden’s benefits have a parental benefit-specific payroll tax of 2.6% of pay as well as a 4.35% payroll tax for sick leave.

Germany provides maternity and sick leave with a payroll tax that’s combined with the costs for medical benefits, at 7.3% for each of employees and employers, for up to 8 weeks. Additional benefits, including a child benefit and a one-year 67% parental leave benefit, are funded out of general revenues.

And — as a reminder — when other “western” countries do fund their benefits from general revenues, this means they fund them from income taxes in which there is no special effort to “soak the rich” but instead their top tax bracket applies, generally speaking, to everyone middle-class (or upper-middle-class) and above.

This means that Biden’s proposal to fund family leave through a tax hike on the wealthy is not just ill-conceived but far from the international norm. And it won’t get us where its supporters want us to be. If we define social insurance not as something we all pay for and benefit from, but as government benefits “paid for by other people,” it will create a dead-end that will impact the prospects for social insurance, generally speaking — including reform of Social Security itself.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.