1.
How does a worker become fully insured under Social Security? What benefits are fully
insured workers entitled to?
2.
Explain the concept of arriving at AIME. How do you compute the PIA?
3.
How does the earnings test affect Social Security benefits?
4.
Social Security benefits are financed largely through payroll taxes. The more you earn (up
to the maximum earnings base), the more tax you pay. Income benefits, however, favor
lower-income workers. Explain why lower-income people are favored.
5. What is the difference between Medicare Part A and Medicare Part B?
6. Explain the concept of Medicare Part D.
7. Medicare costs have turned out to be much greater than expected when the program was first
enacted. The number of people eligible for Medicare and the benefit amounts have
increased through the years. For example, Medicare covers not only medical expenses for
eligible retirees but also kidney dialysis and kidney transplants for persons of all ages.
a. Why does Medicare have deductibles, coinsurance, and limitations on benefits that create gaps
in coverage for insureds?
b. Considering the fact that many older people worry about what is not covered by Medicare, do
you think the gaps should be eliminated?
8. Do you think Social Security coverage should be voluntary? Explain.
9. Would you favor privatization of the Social Security retirement program, as other countries have
done? Explain.
10. What solutions, other than privatization, would alleviate some of the funding problems of
Social Security in the United States?
Chapter 18
Social Security
The mandatory coverage for life cycle events risk is Social Security. As noted in Chapter 16 "Risks Related
to the Job: Workers’ Compensation and Unemployment Compensation", Social Security is a major social
insurance program that was created in 1935 as an outcome of the Great Depression. Originally, this
program was a compulsory pension plan known as Old Age Insurance (OAI). Later, survivors’ benefits
were added and the program became known as Old Age and Survivors’ Insurance (OASI). When disability
benefits were added, it became Old Age, Survivors’, and Disability Insurance (OASDI), and, with the
addition of hospital and medical benefits, it became the Old Age, Survivors’, Disability, and Hospital
Insurance (OASDHI) program. Social Security is not need-based and depends on a person’s employment
history. Its objective is to provide a “floor of protection” or a “reasonable level of living.” Figure 18.1 "The
Links between Life Cycle Risks and Social Security Benefits" illustrates the idea of a “floor of protection.”
Social Security is the foundation on which retirement, survivors’, and disability benefits should be
designed. In addition, the program is the foundation for health benefits for the retired population under
Medicare Part A (hospitals), Part B (doctors), Part C (managed care medicine), and Part D (the new drug
program). The discussion of Social Security is positioned here, in this chapter of the text, to emphasize the
importance of Social Security as the foundation for employer-provided benefits, such as group life,
disability, and health insurance and retirement programs.
Most U.S. workers—full-time, part-time, self-employed, and temporary employees—are part of the Social
Security program. Every employer and employee is required to contribute in the form of payroll taxes.
Social Security provides income in the event of retirement, disability, or death. It also provides medical
expense benefits for disabled or retired persons and their specified dependents.
[1]
The 2008 Social
Security Trustees reported that income to the combined OASDI Trust Funds amounted to $785 billion in
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2007. During that year, an estimated 163 million people had earnings covered by Social Security and paid
payroll taxes, and the trust funds paid benefits of more than $585 billion to almost 50 million
beneficiaries.
[2]
The Medicare program is the second largest social insurance program in the United States, with 44.1
million beneficiaries and total expenditures of $432 billion in 2007.
[3]
This chapter includes the following discussion points:
1.
Links
2. Definition of social insurance, eligibility, benefits, financing, and program administration
3. Medicare
4. Social Security issues and global trends in social security
Figure 18.1 The Links between Life Cycle Risks and Social Security Benefits
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Links
At this point in our study, we get into the foundation of different types of coverage for many of the life
cycle, injury, and illness risks. InChapter 19 "Mortality Risk Management: Individual Life Insurance and
Group Life Insurance" to Chapter 20 "Employment-Based Risk Management (General)" we will talk about
the risk management of all life cycle risks, but in this chapter, we will discuss a basic mandatory package
of coverages that is tied to belonging to the work force in the United States. Social Security’s mandatory
coverages comprise the first step in building the pyramid of coverages to ensure our complete holistic risk
management process. Figure 18.1 "The Links between Life Cycle Risks and Social Security
Benefits" depicts Social Security as the basic foundation of coverages for life cycle risks, which are part of
our holistic risk picture.
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As before, for our holistic risk management we need to look at all sources of coverage available.
Understanding each component of the coverages from the various sources is critical to completing the
picture and ensuring that we have adequately managed all our risks. Social insurance programs (including
workers’ compensation and unemployment compensation discussed in Chapter 16 "Risks Related to the
Job: Workers’ Compensation and Unemployment Compensation") play an important role in financial
planning and should be considered when assessing the risk of economic loss due to premature death,
disability, or retirement. The amount each individual must save for such situations is effectively reduced
by the expected benefits from social insurance programs. The Social Security Administration (SSA) sends
an annual statement to all workers that includes earnings history and projected future benefits. Table 18.1
"Estimated Average Monthly Benefits Payable as of December 2008"provides the estimated average
income by beneficiary category as of December 2008.
Table 18.1 Estimated Average Monthly Benefits Payable as of December 2008
Estimated Effect of a 5.8% COLA on Average Benefits
Type of Benefit or Family
Benefit
type
All retired workers
$1,090
All disabled workers
Aged couple
Surviving child(ren) only
Before 5.8%
COLA
[4]
Widowed mother and 2 children
Family type Aged widow(er) alone
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After 5.8%
COLA
$1,153
Increase
$63
1,006
1,064
58
1,773
1,876
103
936
991
55
2,268
2,399
131
1,051
1,112
61
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Estimated Effect of a 5.8% COLA on Average Benefits
Disabled worker, spouse, and one or more
children
1,695
1,793
98
Note: The above estimates are based on actual benefit data through September 2008.
Source: Social Security Administration, October 16, 2008, Accessed April 5,
2009, http://www.ssa.gov/OACT/COLA/colaeffect.html.
[1] All statistics in this chapter are from the Social Security Administration (http://www.ssa.gov)
and the Department of Health and Human Service’s Medicare site (http://www.medicare.gov).
[2] OASDI Board of Trustees, “Status of the Social Security Program: A Summary of the 2008
Annual Social Security,”http://ssa.gov/OACT/TR/TR08/II_highlights.html#76455 (accessed April
4, 2009).
[3] Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical
Insurance Trust Funds, 2008, Annual
Report,http://www.cms.hhs.gov/ReportsTrustFunds/ (accessed April 4, 2009).
[4] Family with one or more children excludes surviving parent or guardian who is ineligible to
receive benefits.
18.1 Definition, Eligibility, Benefits, and Financing of
Social Security
L EA R N IN G O B JEC T IV ES
In this section we elaborate on Social Security, one of the three social insurance
programs in the United States:
x
x
Who is eligible to receive benefits under Social Security
The old age, survivors’, and disability benefits provided by Social Security
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x
x
x
How benefit amounts are computed
How the Social Security system is funded
Administration of the program
Definition of Social Insurance
Many governmental programs are designed to provide economic security for individuals and families.
Both public assistance (also referred to as welfare programs) and social insurance programs are organized
and undertaken by the government and have the broad social purpose of reducing want and destitution.
However, social insurance is different from public assistance: social insurance is an insurance program
that is compulsory for nearly all Americans, eligibility criteria and benefits are specified by law, and
financing is wholly or partially covered by the employer. Unlike public assistance, employers and
employees pay into the social insurance system to earn their rights to benefits. Some examples of social
insurance programs include workers’ compensation and unemployment compensation, which were
covered in Chapter 16 "Risks Related to the Job: Workers’ Compensation and Unemployment
Compensation", as well as Social Security.
Welfare benefits are financed through general revenues that come from both federal and state funds.
Benefits received from welfare are not based on contributions made by or on behalf of the recipients.
Medicaid is an example of a welfare benefit based solely on need. While public assistance programs have a
role in providing economic security, they are not insurance programs. The insurance principles of
assessing and pooling risk do not apply to welfare programs.
The types of benefits available from Social Security are apparent from the acronym OASDHI: old age (or
retirement), survivors’, disability, and health (or Medicare) benefits, which include hospital insurance and
supplemental medical insurance. The program can be separated into two broad parts. The first part of
OASDHI is the old-age, survivors’, and disability (OASD) insurance program known as Social Security.
The second part of the OASDHI program is Medicare (HI).
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We will begin the discussion about Social Security and Medicare with a description of each social
program, its benefits, and its eligibility requirements. Following the general discussion is an explanation
of how the programs are financed. We will introduce the two programs separately because there are many
differences between Social Security and Medicare. We begin with the eligibility requirements and then
discuss the benefits available to eligible employees.
Coverage and Eligibility Requirements
Today, nearly all employees in private industry, most self-employed persons, and members of the armed
forces are covered by Social Security. Coverage is compulsory for more than 90 percent of all workers in
the United States, meaning that Social Security taxes must be paid on their wages. The major exceptions
are railroad workers, who are covered by the Railroad Retirement Act, and federal government
employees, who were covered by other programs before 1984. Prior to 1984, state and local government
bodies could elect not to cover certain employees under Social Security. With few exceptions, this option
is no longer allowed. Municipal governments that elected out prior to 1984 do have the option to join the
Social Security program voluntarily. Ministers are covered automatically unless they request a waiver on
religious grounds. Members of religious sects whose beliefs prohibit acceptance of benefits are exempt.
Eligibility
To be eligible to receive benefits, a worker must achieve insured status. There are three levels of insured
status: fully insured, currently insured, or disability insured. If the worker’s status is fully insured, most
types of Social Security benefits are payable. If the worker does not have enough work tenure to be fully
insured, he or she may be currently insured or disability insured, which still allows eligibility for some
survivor benefits or disability benefits.
A person must be in the work force for a minimum number of quarters during which his or her earnings
meet minimum criteria. The required earnings per quarter in 2008 was a minimum of $1,050, and in
2009 that amount increased to $1,090. The amount is adjusted every year. An employee can earn a
maximum of four credits per year, even if he or she did not work the full four quarters, as long as he or she
made enough even in one month (4 × $1,050). A Social Security beneficiary is fully insured once forty
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credits of coverage are earned, or when the beneficiary has a minimum of six credits of coverage and, if
greater, at least as many quarters of coverage as there are years elapsing after 1950 (or after age twentyone, if later). For example, a person age twenty-five who has six credits of coverage is fully insured,
whereas a person age forty needs nineteen credits to be fully insured. Currently insured status is
achieved if the Social Security beneficiary has at least six credits in the thirteen-quarter period ending
with the quarter of death. Disability insured status is gained by the Social Security beneficiary having
twenty credits in the ten years before disability begins. Less rigorous disability requirements apply to a
beneficiary who is under age thirty-one or blind.
Types of Benefits
As noted, Social Security pays four types of benefits: old-age (or retirement), survivors’, disability, and
Medicare. Following is a more detailed description of each of these benefits.
Retirement (Old-Age) Benefits
A fully insured worker is eligible to receive benefits, including retirement income benefits. A spouse or
divorced spouse of a retired worker is entitled to a monthly benefit if he or she is (1) at least age sixty-two,
or (2) caring for at least one child of the retired worker (under age sixteen, or disabled if disability began
before age twenty-two). A dependent child, grandchild, or great-grandchild of a retired worker who is (1)
under age eighteen; (2) a full-time student between the ages of eighteen and nineteen; or (3) disabled, if
disability began before age twenty-two, is also entitled to a benefit. Table 18.2 "Who Gets Monthly
Benefits If a Fully Insured Worker Retires?"summarizes these benefits.
Table 18.2 Who Gets Monthly Benefits If a Fully Insured Worker Retires?
x
x
Retired worker who is at least sixty-two years old
Spouse of retired worker who either (1) has a child under age sixteen or a disabled child in his
or her care or (2) is at least sixty-two years old; applies also to divorced spouse if the
x
marriage lasted at least ten years
Dependent child of retired worker, either under age eighteen, under nineteen if a full-time
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student, or disabled before age twenty-two
Normal retirement age for the purposes of Social Security ranges from sixty-five (for people born
before 1938) to sixty-seven (for those born in or after 1960). A fully insured worker is entitled to receive
full retirement benefits at the normal retirement age for Social Security, or reduced benefits as early
as age sixty-two. A schedule of the new retirement ages is shown in Table 18.3 "Schedule of Normal Social
Security Retirement Ages".
Table 18.3 Schedule of Normal Social Security Retirement Ages
Year of Birth
Age
1937 and prior
65
1938
65 and 2 months
1939
65 and 4 months
1940
65 and 6 months
1941
65 and 8 months
1942
65 and 10 months
1943–1954
66
1955
66 and 2 months
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Year of Birth
Age
1956
66 and 4 months
1957
66 and 6 months
1958
66 and 8 months
1959
66 and 10 months
1960 and later
67
Notes:
1. Persons born on January 1 of any year should refer to the normal retirement age for the previous year.
2. For the purpose of determining benefit reductions for early retirement, widows and widowers whose
entitlement is based on having attained age sixty should add two years to the year of birth shown in the table.
Sources: Processed by the authors from the American Academy of Actuaries CSO Task Force Report, June
2002,http://www.actuary.org/life/CSO_0702.asp (accessed April 4, 2009); 2001 CSO Ultimate Table.
Early Retirement
Early retirement benefits are permanently reduced in amount because the expected benefit payout period
is longer than it would have been starting from normal retirement age. In the case of early retirement,
a benefit is reduced 5/9 of 1 percent for each month before the normal retirement age for Social Security
benefits. The earliest a person can retire, with benefits, is age sixty-two. Beyond thirty-six months, the
benefit is reduced 5/12 of 1 percent per month.
For example, assume that the normal retirement age is exactly age sixty-seven and that a person decides
to retire at exactly age sixty-two. There are a total of sixty months of reduction to the worker’s expected
benefit. The reduction for the first thirty-six months is 5/9 of 1 percent times 36, or 20 percent. The
reduction for the remaining twenty-four months is 5/12 of 1 percent times 24, or 10 percent. Thus, in this
example, the total benefit reduction is 30 percent.
Late Retirement
Likewise, postponing retirement past Social Security’s normal retirement age—late retirement—results
in a permanently increased benefit amount to compensate for the shortened length of the payout period
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and to encourage older workers to continue working full-time. No delayed retirement credit is granted for
retiring past age sixty-nine.
Survivors’ Benefits
Social Security survivors’ benefits protect the surviving dependents of a fully or currently insured
deceased worker. The surviving spouse is entitled to monthly income payments if caring for a child who is
under age sixteen or a child who is disabled by a disability that began before age twenty-two. A child of a
fully or currently insured deceased worker is entitled to benefits if he or she (1) is under age eighteen, is
disabled by a disability that began before age twenty-two, or is age eighteen or nineteen and a full-time
student attending an elementary or secondary school; (2) was dependent on the deceased worker; and (3)
is not married. Table 18.4 "Who Gets Monthly Benefits If a Fully Insured Worker Dies?" summarizes who
gets monthly benefits if a fully insured or currently insured worker dies.
Table 18.4 Who Gets Monthly Benefits If a Fully Insured Worker Dies?
x
x
x
x
x
Dependent child of deceased worker
Aged widow(er) who is at least sixty years old
Young widow(er) caring for a dependent child under age sixteen or a disabled child
Disabled widow(er) who is disabled and fifty years or older (converted to aged widow[er] on
attainment of age sixty-five)
Parent who was a dependent of the deceased worker and is at least sixty-two years old
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A widow or widower of a fully insured deceased worker is qualified for benefits at age fifty if disabled, and
otherwise at age sixty. A divorced spouse also qualifies if he or she was married to the worker for at least
ten years and has not remarried. A parent of a fully insured deceased worker is entitled to benefits if he or
she (1) is at least age sixty-two, (2) was receiving at least half of his or her support from the child, (3) has
not remarried since the child’s death, and (4) is not entitled to a retirement or disability benefit equal to
or larger than this survivors’ benefit.
In addition to these monthly benefits, a small lump-sum death benefit of $255 is paid upon the death of a
worker who is fully or currently insured. It is paid to the spouse living with the worker at the time of
death, or a spouse otherwise entitled, or children entitled as described above. In the absence of a spouse
or children, the death benefit is not paid. It is the only benefit that has not increased since the Social
Security legislation was passed in 1935.
Disability Benefits
A fully insured worker who has a medically determinable physical or mental condition that prevents any
substantial gainful work is entitled to monthly disability benefits after a waiting period of five full
months if he or she is under age sixty-five and has been disabled for twelve months, is expected to be
disabled for at least twelve months, or has a disability that is expected to result in death. A spouse or child
of a disabled worker is entitled to a monthly benefit upon meeting the same qualifications as those
previously listed in connection with retirement benefits. Table 18.5 "Who Gets Monthly Benefits If a Fully
Insured Worker Is Disabled?" shows who gets monthly benefits if a fully insured worker is disabled. Note
that, to receive benefits, the worker must be eligible by being fully insured or meeting the disability
insured status. A nonblind person earning more than $980 in 2009 is considered to be engaging in
substantial gainful activities and is not eligible for Social Security benefits. The amount of earnings
allowable if the person is blind is $1,640 in 2009. These amounts are indexed annually to increases in the
national wage index.
[1]
It is extremely difficult to qualify to receive Social Security disability benefits.
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Disability benefits may be stopped if the disabled worker refuses to participate in rehabilitation. They may
be reduced if disability benefits are received from workers’ compensation or under a federal, state, or local
law. As reported in the 2008 Trustees Report, “On December 31, 2007, about 850,000 persons were
receiving monthly benefits from the OASI Trust Fund because of their disabilities or the disabilities of
children. This total includes 25,000 mothers and fathers (wives or husbands under age sixty-five of
retired-worker beneficiaries and widows or widowers of deceased insured workers) who met all other
qualifying requirements and were receiving unreduced benefits solely because they had disabled-child
beneficiaries (or disabled children aged sixteen or seventeen) in their care. Benefits paid from this trust
fund to the persons described above totaled $7,293 million in calendar year 2007.”
[2]
Table 18.5 Who Gets Monthly Benefits If a Fully Insured Worker Is Disabled?
x
x
Disabled worker who had been working recently in covered employment prior to disability
Spouse of disabled worker who either (1) has a child under age sixteen or a disabled child in
his or her care or (2) is at least sixty-two years old; applies also to divorced spouse if the
x
marriage lasted at least ten years
Dependent child of disabled worker
Primary Insurance Amount
The primary insurance amount (PIA) is the basic unit used to determine the amount of monthly
Social Security benefits. PIA is computed from a person’s average indexed monthly earnings. In the
calculation of average indexed monthly earnings (AIME), workers’ earnings for prior years, up to
the maximum Social Security wage base (see Table 18.12 "OASDI Annual Wage Base for Tax Purposes" for
the OASDI annual wage base), are adjusted to what they would have been if wage levels in earlier years
had been the same as they are now. This is the indexed amount.
The Social Security Administration provides an illustration of retirement benefits using examples. Table
18.6 "Benefit Calculation Examples for Workers Retiring in 2009" shows the examples of two workers
retiring in 2009—one at age sixty-two, the earliest age possible, and the other at age sixty-five, the normal
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retirement age. It is important to note the differences in the application of the PIA formula to the worker
retiring at age sixty-two. If a worker retires at normal retirement age, the PIA benefits are calculated as if
the person retired at age sixty-two and are modified with cost of living adjustments.
Table 18.6 Benefit Calculation Examples for Workers Retiring in 2009
Earnings before and after indexing
Case A, Born in 1947
Indexing
Factor
Indexed
Earnings
Nominal
Earnings
Indexing
Factor
Indexed
Earnings
1969 $5,511
6.8556
$37,781
$4,803
5.7798
$27,761
1970 5,802
6.5315
37,896
5,434
5.5066
29,923
1971 6,113
6.2190
38,017
6,023
5.2431
31,579
1972 6,733
5.6639
38,135
6,906
4.7751
32,977
1973 7,177
5.3304
38,256
7,612
4.4940
34,208
1974 7,627
5.0313
38,374
8,327
4.2418
35,322
1975 8,223
4.6815
38,496
9,208
3.9469
36,343
1976 8,817
4.3793
38,612
10,102
3.6921
37,297
1977 9,374
4.1317
38,730
10,964
3.4833
38,191
1978 10,150
3.8277
38,851
12,097
3.2271
39,038
1979 11,072
3.5198
38,971
13,426
2.9675
39,841
1980 12,106
3.2290
39,090
14,918
2.7223
40,611
1981 13,365
2.9337
39,208
16,718
2.4733
41,349
1982 14,144
2.7806
39,328
17,941
2.3442
42,058
1983 14,878
2.6514
39,448
19,121
2.2353
42,742
1984 15,800
2.5042
39,566
20,559
2.1112
43,405
1985 16,523
2.4019
39,686
21,752
2.0250
44,047
1986 17,064
2.3326
39,804
22,715
1.9666
44,671
1987 18,207
2.1928
39,924
24,491
1.8487
45,276
1988 19,161
2.0899
40,044
26,033
1.7619
45,868
1989 19,978
2.0103
40,161
27,403
1.6948
46,443
1990 20,963
1.9215
40,281
29,016
1.6200
47,005
Year
Nominal
Earnings
Case B, Born in 1943
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Earnings before and after indexing
1991 21,809
1.8525
40,401
30,449
1.5618
47,555
1992 23,000
1.7617
40,519
32,380
1.4853
48,093
1993 23,266
1.7467
40,638
33,016
1.4726
48,619
1994 23,961
1.7010
40,758
34,262
1.4341
49,135
1995 24,994
1.6355
40,877
36,003
1.3788
49,642
1996 26,293
1.5592
40,997
38,142
1.3145
50,139
1997 27,908
1.4733
41,116
40,761
1.2421
50,628
1998 29,453
1.4000
41,234
43,301
1.1803
51,108
1999 31,185
1.3261
41,354
46,136
1.1180
51,580
2000 33,004
1.2566
41,473
49,126
1.0594
52,044
2001 33,888
1.2273
41,591
50,740
1.0347
52,502
2002 34,326
1.2151
41,710
51,689
1.0244
52,953
2003 35,266
1.1861
41,830
53,396
1.0000
53,396
2004 37,011
1.1334
41,950
56,336
1.0000
56,336
2005 38,474
1.0934
42,069
58,866
1.0000
58,866
2006 40,356
1.0454
42,187
62,054
1.0000
62,054
2007 42,307
1.0000
42,307
65,369
1.0000
65,369
2008 44,051
1.0000
44,051
68,383
1.0000
68,383
Highest—35 total 1,415,637
Highest—35 total 1,677,907
AIME 3,370
AIME 3,995
Source: Social Security Administration, October 16, 2008, Accessed April 4,
2009,http://www.ssa.gov/OACT/ProgData/retirebenefit1.html.
We will use the examples provided by the Social Security Administration as a learning tool here. First, we
focus on the calculation of the AIME. For each case, we see the columns labeled “nominal earnings.”
Indexing brings nominal earnings up to near-current wage levels. For each case, the table shows columns
of earnings before and after Indexing. The highest thirty-five years of indexed earnings and the
corresponding average monthly amounts of such earnings are used for the benefit computation. The
result is the AIME. The indexing requires some special computation. Consequently, there is no easy way
to make an estimate of one’s PIA. It is not as simple as finding average wages and consulting a table. The
Social Security Administration has computerized wage histories for all workers, and the PIA calculation is
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made when an application for benefits is processed. The Social Security Administration furnishes
annually the calculation of each insured’s PIA. If a person has not received the statement, the Social
Security Administration will furnish a record of the historical Social Security earnings and PIA upon
request. The Social Security Administration Web site also has an online calculator.
After the AIME is determined, an individual’s PIA in 2009 would be determined by the formula in Table
18.7 "PIA Formula for an Individual in 2009". The formula shows that Social Security benefit levels,
expressed as replacement ratios, are weighted in favor of lower-income workers. Here, a replacement
ratio is defined as the Social Security benefit divided by the AIME.
Table 18.7 PIA Formula for an Individual in 2009
For an individual who first becomes eligible for old-age insurance benefits or disability insurance
benefits in 2009, or who dies in 2009 before becoming eligible for benefits, his or her PIA is the sum
of
x
x
(a) 90 percent of the first $744 of his or her average indexed monthly earnings, plus
(b) 32 percent of his or her average indexed monthly earnings over $744 and through
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x
x
$4,483, plus
(c) 15 percent of his or her average indexed monthly earnings over $4,483.
Round this amount to the next lower multiple of $0.10 if it is not already a multiple of $0.10.
Source: Social Security Administration, October 16, 2008, Accessed April 4,
2009, http://www.ssa.gov/OACT/COLA/piaformula.html for 2009.
The three AIME ranges represented in the formula are known as bend points. The bend points represent
the dollar amounts at which the primary insurance amount formula for Social Security benefits changes.
The bend points increase as average wages in the economy increase. This is shown in Table 18.8
"Examples of PIA Calculations for the 2009 Retirement Cases Illustrated in ". The bend points in 2009
are $744 and $4,483, as you can see in Table 18.7 "PIA Formula for an Individual in 2009". These bend
points apply to workers who become eligible for benefits (at age sixty-two) in 2009. A table of bend points
for past years is available at http://www.ssa.gov.
Table 18.8 Examples of PIA Calculations for the 2009 Retirement Cases Illustrated in Table 18.5 "Who
Gets Monthly Benefits If a Fully Insured Worker Is Disabled?" Case A—Retirement at Age Sixty-Two and
Case B—Retirement at Age 65
Formula Bend Points
Case
AIME
First Second
Formula Applied to AIME
A
$3,370
$744 $4,483
í $1,509.92
B
3,995
627
í í $1,605.34
3,779
Source: Social Security Administration, October 16, 2008, Accessed April 5,
2009,http://www.ssa.gov/OACT/ProgData/retirebenefit2.html.
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Table 18.8 "Examples of PIA Calculations for the 2009 Retirement Cases Illustrated in " illustrates the
straightforward calculation for the worker in Case A who retires at age sixty-two. For the worker who
retires in 2009 at age sixty-five, the bend points are the same as those in 2006 (as if he or she retired at
age sixty-two). Thereafter, the benefits are adjusted to reflect the COLA of 3.3 percent, 2.3 percent, and
5.8 percent, respectively. The resulting PIA is $1,605.34.
Other Factors Affecting Benefit Amounts
As described above, the AIME determines the PIA of a retired or disabled worker; the benefit levels for
other beneficiaries are a percentage of the PIA. If an individual qualifies as both a worker and as the
spouse of a worker, the beneficiary will receive whichever PIA is greater, but not both. Other factors may
also affect the benefit amount.
The maximum family benefit is the maximum monthly amount that can be paid on a worker’s earnings
record. The formula for the maximum family benefit, shown in Table 18.9 "The PIA Formula for
Maximum Family Benefit, 2009", is based on the worker’s primary insurance amount (PIA). The
maximum PIA for the family is computed based on the bend points shown in Table 18.9 "The PIA
Formula for Maximum Family Benefit, 2009". When the family reaches its maximum family benefit, the
worker’s benefit is not reduced but the benefits of the survivors or dependents are reduced
proportionately. There is also a minimum PIA for very-low-wage workers who have been covered by
Social Security for at least ten years. This attempts to address the broad social purpose of Social Security:
reducing want and destitution by providing an adequate income to insured workers.
[3]
Table 18.9 The PIA Formula for Maximum Family Benefit, 2009
For the family of a worker who becomes age sixty-two or dies in 2009 before attaining age sixty-two,
the total amount of benefits payable is computed so that it does not exceed
x
x
150 percent of the first $950 of the worker’s PIA, plus
272 percent of the worker’s PIA over $950 through $1,372, plus
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x
x
x
134 percent of the worker’s PIA over $1,372 through $1,789, plus
175 percent of the worker’s PIA over $1,789.
This total amount is then rounded to the next lower multiple of $0.10 if it is not already a multiple of
$0.10.
Source: Social Security Administration, October 16, 2008, Accessed April 5,
2009, http://www.ssa.gov/OACT/COLA/familymax.html.
Cost of Living Adjustment (COLA)
Social Security benefit amounts are increased annually by automatic cost-ofliving adjustments (COLAs) linked to increases in the consumer price index (CPI). In addition,
workers receiving Social Security disability income may have Social Security benefits reduced to offset
other disability benefits received from governmental programs, such as workers’ compensation, to reduce
the moral hazard of malingering. Legislation enacted in 1973 provides for automatic cost-of-living
adjustments (COLAs). The theory is to prevent inflation from eroding the value of Social Security and
Supplemental Security Income (SSI) benefits. The COLA for 2008 is 5.8 percent for both Social Security
benefits and SSI payments, as you can see in Table 18.10 "Automatic Social Security Cost of Living
Adjustments (COLAs)".
Table 18.10 Automatic Social Security Cost of Living Adjustments (COLAs)
Social Security Cost-of-Living Adjustments
Year
COLA
Year
COLA
Year
COLA
1975
8.0%
1990
5.4%
2005
4.1%
1976
6.4%
1991
3.7%
2006
3.3%
1977
5.9%
1992
3.0%
2007
2.3%
1978
6.5%
1993
2.6%
2008
5.8%
1979
9.9%
1994
2.8%
1980
14.3%
1995
2.6%
1981
11.2%
1996
2.9%
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Social Security Cost-of-Living Adjustments
1982
7.4%
1997
2.1%
1983
3.5%
1998
1.3%
1984
3.5%
1999
2.5%
1985
3.1%
2000
3.5%
1986
1.3%
2001
2.6%
1987
4.2%
2002
1.4%
1988
4.0%
2003
2.1%
1989
4.7%
2004
2.7%
[4]
Source: Social Security Administration, October 16, 2008, Accessed April 5,
2009, http://www.ssa.gov/OACT/COLA/colaseries.html.
Many people retire before or after the normal retirement age, which affects the PIA for those individuals.
For an individual retiring past the normal retirement age, the final benefit amount is higher than the PIA
formula reveals, as illustrated in the example of Case B in Table 18.8 "Examples of PIA Calculations for
the 2009 Retirement Cases Illustrated in ".
The Earnings Test
The Social Security retirement benefit may be reduced for a retiree who is younger than normal
retirement age and whose annual earned income exceeds the retirement earnings exempt amount; this
provision is called the earnings test. Its purpose is to limit monthly cash benefits for retirees who have
earned income and to reduce the cost of the Social Security program. As Table 18.11 "Annual Retirement
Earnings Test Exempt Amounts for Persons Under the Normal Retirement Age" shows, a beneficiary
attaining the normal retirement age after 2002 is exempt from reduction of Social Security benefits
regardless of the amount of earned income. The earning test applies only to early retirement.
Table 18.11 Annual Retirement Earnings Test Exempt Amounts for Persons Under the
Normal Retirement Age
Annual Retirement Earnings Test Exempt Amounts
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Annual Retirement Earnings Test Exempt Amounts
[5]
Year Lower Amount
Higher Amount [6]
2000
$10,080
$17,000
2001
10,680
25,000
2002
11,280
30,000
2003
11,520
30,720
2004
11,640
31,080
2005
12,000
31,800
2006
12,480
33,240
2007
12,960
34,440
2008
13,560
36,120
2009
14,160
37,680
Source: Social Security Administration, October 16, 2008, Accessed April 5,
2009, http://www.ssa.gov/OACT/COLA/rtea.html
In 2008, a beneficiary under the normal retirement age would lose $1 of benefits for every $2 earned
above $13,560. The beneficiary would also lose $1 for every $3 above the higher exempt amount, $36,120.
Financing of Benefits
Taxation
Social Security benefits are financed through payroll taxes paid by employers and employees and by a
special tax on earnings paid by the self-employed. The tax rate for employers and employees is 6.2 percent
for OASDI, up to a maximum amount of earnings called the wage base level, as shown in Table 18.12
"OASDI Annual Wage Base for Tax Purposes", and 1.45 percent for HI (Medicare Part A) on all earnings.
The tax rates scheduled under current law are shown inTable 18.13 "Tax Rates Paid on Wages and
Earnings". Those who elect Medicare Part B coverage pay monthly premiums via deductions from their
Social Security benefits checks.
Social Security taxes, sometimes called FICA taxes (after the Federal Insurance Contributions Act of
1939), are automatically withheld on wages up to a set amount and are adjusted annually for inflation.
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Any wages earned over this wage base are not taxed for Social Security, although Medicare Part A taxes
are still deducted.
The tax rates are intended to remain constant (the last hike was in 1990), but the taxable wage base is
adjusted annually to reflect increases in average wages. As you can see in Table 18.12 "OASDI Annual
Wage Base for Tax Purposes", the 2008 annual wage base was $102,000, and it is $106,800 in 2009,
meaning employers, employees, and the self-employed paid OASDI taxes on individual wages up to the
wage base. If wages increase 5 percent the following year, the tax rates would remain the same but the
taxable wage base would increase by 5 percent, thus increasing total Social Security tax revenue (all else
being equal). Wages beyond the threshold are not subject to the OASDI tax, but they are subject to the
Medicare Part A tax.
Social Security benefits are subject to income taxes. More specifically, taxes are payable on 50 percent of
the Social Security benefit by single persons whose taxable incomes (including 50 percent of Social
Security benefits and any interest on tax-exempt bonds) are between $25,000 and $34,000 (between
$32,000 and $44,000 for married couples filing joint returns). If income exceeds $34,000 for single
persons (or $44,000 for married couples filing jointly), up to 85 percent of the Social Security benefit
received at retirement as income is taxable.
Table 18.12 OASDI Annual Wage Base for Tax Purposes
Contribution and Benefit Bases, 1937–2009
Year(s)
Amount
Year(s)
Amount
Year(s)
Amount
1937–1950
$3,000
1981
$29,700
1996
$62,700
1951–1954
3,600
1982
32,400
1997
65,400
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Contribution and Benefit Bases, 1937–2009
1955–1958
4,200
1983
35,700
1998
68,400
1959–1965
4,800
1984
37,800
1999
72,600
1966–1967
6,600
1985
39,600
2000
76,200
1968–1971
7,800
1986
42,000
2001
80,400
1972
9,000
1987
43,800
2002
84,900
1973
10,800
1988
45,000
2003
87,000
1974
13,200
1989
48,000
2004
87,900
1975
14,100
1990
51,300
2005
90,000
1976
15,300
1991
53,400
2006
94,200
1977
16,500
1992
55,500
2007
97,500
1978
17,700
1993
57,600
2008
102,000
1979
22,900
1994
60,600
2009
106,800
1980
25,900
1995
61,200
Note: Amounts for 1937–1974 and for 1979–1981 were set by statute; all other amounts were determined
under automatic adjustment provisions of the Social Security Act.
Source: Social Security Administration, January 15, 2009, Accessed April 5,
2009, http://www.ssa.gov/OACT/COLA/cbb.html.
Table 18.13 Tax Rates Paid on Wages and Earnings
Tax Rates as a Percentage of Taxable Earnings
Calendar Years Tax Rate for Employees and Employers, Each Tax Rate for Self-Employed Persons
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Calendar Years
2000 and later
Tax Rates as a Percentage of Taxable Earnings
OASI
DI
Total
OASI
DI
Total
5.300
0.900
6.200
10.6000
1.8000
12.400
Tax Rates as a Percentage of Taxable Earnings
Calendar Years
1990 and later
Rate for Employees and Employers, Each
Rate for Self-Employed Persons
OASDI
Medicare A
Total
OASDI
Medicare A
Total
6.200
1.450
7.650
12.400
2.900
15.300
Trust Funds
The funds collected from payroll taxes are allocated among three trust funds. One trust fund is for
retirement and survivors’ benefits; the second is for disability insurance; and the third is for hospital
insurance, or Medicare Part A. Medicare Parts B and D, supplementary medical benefits, are financed by
monthly premiums from persons enrolled in the program, along with amounts appropriated from the
general revenue of the federal government. These funds are deposited in a fourth trust fund, the
supplementary medical insurance trust fund.
The Social Security system is primarily a pay-as-you-go system, meaning that current tax revenues are
used to pay the current benefits of Social Security recipients. This is quite different from financing with
traditional, private insurance, where funds are set aside in advance to accumulate over time and benefits
are paid to those who contributed to the fund.
Income to the trust funds consists of the following:
x
x
x
x
Employment taxes paid by employees, their employers, and self-employed persons
Income from the taxation of benefits
Interest on investments made by the program
Other income such as donations and Treasury reimbursements
Administration
The Social Security program is administered by the Social Security Administration, an agency of the
United States Department of Health and Human Services. Local service is provided by offices located in
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the principal cities and towns of the fifty states and Puerto Rico. Applications for Social Security numbers
and the various benefits as well as enrollment for the medical insurance plan (discussed next) are
processed by the district office. The administration is set up to help beneficiaries in catastrophic times, as
was evident following Hurricane Katrina. Because so many people were displaced, the Social Security
Administration created emergency offices and stations to continue immediate payments to the
evacuees.
[7]
Disability determination—the decision whether or not an applicant for disability benefits is disabled as
defined in the law—is made by a state agency (usually the vocational rehabilitation agency) under
agreements between the state and the secretary of the Department of Health and Human Services.
Qualification for hospital and medical benefits is determined by the district office, but claims for such
benefits are processed through private insurer intermediaries under contract with the Social Security
Administration.
The first decision concerning a person’s qualification for benefits under the various parts of the program
is made at the local level. Simple, effective procedures exist for appeal by any applicant for whom the
decision is unsatisfactory. There is no charge for such appeals, and the agency strives to provide courteous
assistance to the claimant.
K E Y TA K EA WAYS
In this section you studied the features of Social Security, a compulsory social
insurance program paying old age, survivors’, and disability (OASD) benefits:
x
A person must be in the work force a minimum number of quarters, during
which earnings must meet minimum amounts to be eligible for Social Security
x
benefits.
The level of benefit depends on a worker’s status as fully insured, currently
insured, or disability insured.
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x
Fully insured workers, their aged spouses, and dependent children are eligible
to receive retirement (old-age) benefits beginning at the worker’s retirement
x
x
age (which depends on birth year) and disability benefits.
Benefits are reduced in the case of early retirement and increased in the case
of late retirement.
A fully insured worker under age sixty-five with a medical condition that
prevents substantial gainful work can receivedisability benefits after a waiting
period if he or she has been disabled for twelve months, is expected to be
x
disabled at least twelve months, or has a disability expected to result in death.
Survivors (aged spouses, disabled spouses, and dependents) of deceased fully,
currently, or disability insured workers are also eligible to receive old-age
x
survivors’ or disability benefits.
The primary insurance amount (PIA), computed from average indexed
monthly earnings (AIME) up to the Social Security wage base, is used to
x
determine the amount of monthly benefits.
The PIA formula is weighted to help lower-income workers at three different
bend points—the sum of these amounts equals the monthly benefit, with
x
COLAs made annually.
Benefits are subject to (1) a monthly maximum that can be paid on a worker’s
earnings record, at which survivors’ benefits are reduced proportionately, and
(2) an earnings test, whereby benefits are reduced for retirees whose earned
x
income exceeds the retirement earnings exempt amount.
Social Security benefits are financed through payroll taxes on employers and
employees at 6.2 percent (OASDI) and 1.45 percent (HI) up to the wage base
x
level (adjusted annually).
Benefits are paid through the Social Security trust fund, which is made up of
employment tax revenues, benefit income tax revenues, interest on
investments, and other income.
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x
The Social Security program is a pay-as-you-go system administered by the
Social Security Administration (part of the Department of Health and Human
Services), with offices to handle applications in each state.
D I SCU S S ION Q UE ST IO N S
1. How does a worker become fully insured under Social Security? What benefits are
fully insured workers entitled to?
2. Explain the concept of arriving at AIME. How do you compute the PIA?
3. How does the earnings test affect Social Security benefits?
4. Social Security benefits are financed largely through payroll taxes. The more you
earn (up to the maximum earnings base), the more tax you pay. Income benefits,
however, favor lower-income workers. Explain why lower-income people are
favored.
5. The Baylor Crane Construction Company is a Virginia-based builder with
1,750 full-time and 300 part-time employees. The company provides all the
social insurance programs required by law and most standard employee
benefits plans. Last year, Baylor Crane suffered a high severity of losses
when the top five floors of a high rise collapsed in Virginia Beach during
strong winds. Luckily, most workers escaped injuries, except six workers
who stayed to secure the building. Three of them sustained severe injuries
and Johnny Kendle, the sixty-four-year-old supervisor, was killed. The
injured workers are back at work except for Tom Leroy, who is still on
disability. His prognosis is not good.
a. What social insurance programs are provided by the company?
b. Compare the benefits provided by each of the social programs.
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Dan Wolf, Duncan Smith, and Jim Lavell are employees of the Happy
Wood Company. Fifteen months ago, Dan Wolf was injured when a log fell
on him and hurt his back. He has not been able to work since. Duncan
Smith, who had fifteen years of service with the company, was killed in that
accident. He left a wife and five children. About a month later, Jim Lavell
injured his back at home and he, too, has been unable to work since the
accident.
a. Based on the benefits of the social insurance programs you
described above, compare the type of benefits Dan, Duncan, and
Jim (or their families) are receiving.
b. What are the eligibility conditions that must be met to receive
these benefits?
[1] Social Security Administration, “If You Are Blind or Have Low Vision—How We Can Help,”
SSA Publication No. 05-10052, January 2009, ICN
462554, http://www.ssa.gov/pubs/10052.html (accessed April 4, 2009).
[2] Social Security Administration, The 2008 OASDI Trustees Report, Section VI(G): Analysis of
Benefit Disbursements from the OASI Trust Fund with Respect to Disabled Beneficiaries, June
11, 2008, Accessed April 4, 2009,http://ssa.gov/OACT/TR/TR08/VI_OASIforDI.html#97986.
[3] To be eligible for “special minimum” benefits, a worker must earn at least a certain portion
(25 percent in years 1990 and before, and 15 percent in years following 1990) of the “old law”
contribution and benefit base.
[4] The COLA for December 1999 was originally determined as 2.4 percent based on CPIs
published by the Bureau of Labor Statistics. Pursuant to Public Law 106-554; however, this
COLA is effectively now 2.5 percent.
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[5] Applies in years before the year of attaining NRA.
[6] Applies in the year of attaining NRA for months prior to such attainment.
[7] Social Security Administration, “Social Security Responds to Hurricane Katrina, Agency Issues
More Than 30,000 Emergency Checks to Date,” Social Security Press Release, September 9,
2005, Accessed April 5, 2009,http://www.ssa.gov/pressoffice/pr/katrina-pr.html.
18.2 Medicare
L EA R N IN G O B JEC T IV ES
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In this section we elaborate on the portion of the Social Security program known
as Medicare:
x
x
x
x
x
Medicare Part A—hospital insurance
Medicare Part B—supplementary medical insurance
Medicare Part C—managed care medical insurance
Medicare Part D—prescription medication insurance
Beneficiary costs under all Medicare parts
Medicare Part A: Hospital Insurance Program
Anyone who is eligible for Social Security or railroad retirement benefits at age sixty-five is also eligible
for Medicare Part A—hospital insurance benefits. No premium is required because workers have already
paid Medicare A taxes. A worker does not have to retire to be covered for hospital benefits; however,
Medicare is the secondary payer for persons who continue to work between ages sixty-five and sixty-nine
and have medical coverage through their employers. Individuals age sixty-five and over who are not
eligible for Social Security or railroad retirement benefits may enroll in Medicare Part A by paying
premiums. The Medicare Part A plan provides the following hospital-related benefits:
x
x
x
In-patient hospital services
Posthospital home health services
Hospice care
For Medicare Part A, the deductible paid by the beneficiary was $1,068 in 2009, up $44 from the
deductible of $1,024 in 2008.
Medicare Parts B, C, and D: Supplementary Medical Insurance
Program
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Anyone eligible for Part A, the basic hospital benefits plan, and anyone age sixty-five or over is eligible for
Medicare Part B—medical benefits, Medicare Part C—managed care benefits, and Medicare Part D—drug
benefits. Those receiving Social Security or railroad retirement benefits are enrolled automatically unless
they elect not to be covered. The monthly premium paid by beneficiaries enrolled in Medicare Part B,
which covers physician services, out-patient hospital services, certain home health services, durable
medical equipment, and other items, is $96.40 in 2009, the same as in 2008.
Charges that are not covered through Medicare parts A and B include routine physical examinations;
routine care of the eyes, ears, and feet; prescription drugs; most immunizations; and cosmetic surgery.
Coverage for such options may be available through Medicare Part C, discussed below. Doctors must bill
Medicare directly, rather than having patients file Medicare claims. Some physicians and surgeons accept
as full payment the amount that Medicare considers reasonable, but others charge patients an additional
fee. However, doctors are limited in the additional amount they may charge patients.
Medicare Part C, also known as Medicare+Choice, was authorized by the Balanced Budget Act of 1997.
Through Medicare Part C, eligible participants can elect to receive the benefits of Medicare Parts A and B
through private health plans, in addition to certain items not covered by Medicare Parts A and B. These
supplemental benefits might include dental care, vision care, and health club memberships. Medicare Part
C may also cover routine physical examinations, unlike Parts A and B, thereby encouraging preventive
care. Medicare+Choice became known as Medicare Advantage plans with the addition of prescription
drug coverage through the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.
Medicare Part C enrollees are limited to a network of benefit providers, a feature similar to managed care
health plans (discussed in ). Going outside the network causes some expenses to be passed on to
participants.
Medicare Advantage plans are offered to eligible persons through managed care, preferred provider
organization (PPO), private fee-for-service, and specialty arrangements. You will learn about all of these
concepts in . Membership cards are issued to Medicare Part C participants by plan providers. Because the
range of covered services varies among Medicare Advantage providers, premiums for Medicare Part C
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benefits are not fixed by the Social Security Administration. Participants typically pay an amount equal to
Medicare Part B premiums plus an additional charge for the added benefits of Medicare Part C. Medicare
Advantage providers who choose to cover less for certain benefits than would be paid by Medicare Parts A
and B typically lower out-of-pocket costs for plan participants so that they do not pay more for
proportionately less coverage. Providers are compensated by the government. Additionally, benefit
formulas that overpay providers of Medicare Advantage plans relative to traditional Medicare benefits
result in a net extra benefit value for participants.
Medicare Part D is the Medicare Prescription Drug, Improvement, and Modernization Act of 2003
(P.L. 108–173), enacted December 8, 2003. It requires the Social Security Administration to undertake a
number of additional Medicare-related responsibilities. Under Medicare Part D, the Social Security
Administration and the Centers for Medicare & Medicaid Services (CMS) work together to provide
persons with limited income and resources with extra help paying for their prescription drugs. The start
date of this program was January 1, 2006. Insurance companies and other private companies work with
Medicare to provide a choice of plans that cover both brand-name and generic drugs. To enroll, a
beneficiary must have Medicare Part A and/or Medicare Part B. The combination of Part C Medicare
Advantage plans with Part D prescription drug benefits are known as Medicare Advantage Prescription
Drug (MAPD) plans.
Medicare D premiums are not set in stone. For example, the Center for Medicare and Medicaid Services
released the following in September 2005: “The average Part D monthly premium will be $32, about 14
percent lower than had been projected, with plans in virtually all areas of the country available for a
premium of under $20 or even less. The drug benefit will provide help with prescription drug costs that
for many beneficiaries will exceed the premium cost.”
[1]
details how the drug card works. For those with limited income and resources, there is a way to qualify for
extra help that will cover between 85 and almost 100 percent of drug costs. Most people who are eligible
for this extra help pay no premiums, no deductibles, and no more than $5 for each prescription. The
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amount of extra help depends on income and resources. In the beginning of 2006, the help promised was
not in place, so the states helped those in need.
Table 18.14 How Does Medicare Part D—the “Drug Card”—Work?
1.
1.
You pay the first $250 per year for your prescriptions—the “deductible.” (It is paid on an
annual basis.)
2. After you pay the $250 yearly deductible, you pay 25 percent of your yearly drug costs, from
$250 to $2,250, and the plan pays the other 75 percent of these costs, then
3. You pay 100 percent of your drug costs from $2,251 until your out-of-pocket costs reach
$3,600, then
4. You pay 5 percent of your drug costs (or a small copayment) for the rest of the calendar year
after you have spent $3,600 out-of-pocket and your plan pays the rest.
Here is an example:
$250
Deductible
$250–$2,250
$2,251 Until You Reach $3,600 in
Out-of-Pocket Cost
After $3,600 in Out-ofPocket Costs
What you pay
$250
25% up to
$500
$2,850*
5%
What your plan
pays
$0
75% up to
$1,500
$0
95%
Total drug
spending
$250
$2,250
$5,100
*$250 deductible + $500 (25% of $250 to $2,250) + $2,850 = $3,600 out of pocket cost.
Source:http://www.medicare.gov/MPCO/Static/Resources.asp#HowPlansWork
The benefits provided under all Medicare parts are listed in .
Table 18.15 All Medicare Parts (A to D)
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Medicare has four parts:
1.
Hospital insurance (Part A) helps pay for in-patient hospital care and certain follow-up
services.
2. Medical insurance (Part B) helps pay for doctors’ services, out-patient hospital care, and
other medical services.
3. Medicare Advantage plans (Part C) are available in many areas. People with Medicare Parts A
and B can choose to receive all of their health care services through a provider organization
under Part C.
4. Prescription drug coverage (Part D) helps pay for medications doctors prescribe for medical
treatment.
Source: Social Security Administration, SSA Publication No. 05-10024, January 2009, ICN 454930,
Accessed April 5, 2009,http://www.ssa.gov/pubs/10024.html#aboutbenefits.
K E Y TA K EA WAYS
In this section you studied the features of Medicare, a compulsory social insurance
program paying hospital insurance (HI) benefits:
x
Anyone eligible for Social Security benefits at age sixty-five is also eligible for
Medicare Part A, which provides hospital-related benefits: in-patient hospital
x
service, posthospital home health service, and hospice care.
Anyone age sixty-five and older who is eligible for Medicare Part A is also
eligible for Medicare Part B, which provides physician, out-patient hospital,
some home health services, and more. Medicare B requires premiums and is
x
voluntary.
Medicare Part C (Medicare Advantage) offers coverage of Medicare Parts A
and B plus supplemental services through private health plans. Medicare Part
C requires premiums and is voluntary.
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x
Medicare Part D, effective in 2006, was an enhancement to the Medicare
program and provides assistance in paying prescription drug costs and
x
x
discounts. Medicare D requires premiums and is voluntary.
No premium is required for Medicare Part A because workers pay for it
through employment taxes, but premiums are required for Parts B and D
Annual deductibles apply to all parts of Medicare
D I SCU S S ION Q UE ST IO N S
1. What is the difference between Medicare Part A and Medicare Part B?
2. Explain the concept of Medicare Part D.
3. Medicare costs have turned out to be much greater than expected when
the program was first enacted. The number of people eligible for Medicare
and the benefit amounts have increased through the years. For example,
Medicare covers not only medical expenses for eligible retirees but also
kidney dialysis and kidney transplants for persons of all ages.
a. Why does Medicare have deductibles, coinsurance, and limitations
on benefits that create gaps in coverage for insureds?
b. Considering the fact that many older people worry about what is
not covered by Medicare, do you think the gaps should be
eliminated?
[1] “Medicare Premiums and Deductibles for 2006,” CMS Office of Public Affairs, September 16,
2005,http://www.cms.hhs.gov/apps/media/press/release.asp?Counter=1557, Accessed April 5,
2009.
18.3 Issues and Global Trends in Social Security
L EA R N IN G O B JEC T IV ES
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In this section we elaborate on the following:
x
x
x
x
Reasons for funding gaps in Social Security and Medicare
Current actuarial projections
International views on social insurance
The trend toward privatization
Issues in Social Security
During the 2000 presidential election campaign, Social Security financing was the most heated issue, with
the debate focusing on privatization and moving away from the pay-as-you-go system. When the stock
market was booming and everyone believed they could do better by investing their own funds, the idea of
moving away from the current system became very appealing; however, their tune changed after the large
decline in the stock market. The immediate big issue in early 2006 was how to help those who could not
pay the deductibles and coinsurance for the new drug program. The major funding problems are still at
issue.
Social Security and Medicare were originally designed to operate with advance funding, but for many
years they have operated on an unfunded, pay-as-you-go basis. As a result, this generation of workers is
paying for the benefits of current beneficiaries. Social Security taxes have increased much faster than the
general level of prices and even faster than the cost of health care during the past two decades.
As described in the box “Does Privatization Provide a More Equitable Solution?” and depicted in Figure
18.2 "Number of Workers per OASDI Beneficiary", the number of retired workers has increased faster
than the number of those working. In 1945, there were forty-two workers per retiree. Currently, this has
decreased to approximately three workers per retiree and is expected to decline to two by 2020. The
Social Security funding burden is being borne by a shrinking sector of society because birth rates have
declined and longevity has increased. This trend will continue as the baby boomers move out of the work
force and into retirement. Retired workers are concerned about the certainty of their benefits and future
required tax rates. The current generation of taxpayers has serious doubts about the ability of the Social
Security system to deliver benefits at current inflation-adjusted levels.
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Such doubts are understandable, considering recent problems of the OASI program, which is by far the
largest part of the system. Each year, the trustees of the Social Security and Medicare trust funds report
on the funds’ status and their projected condition over the next seventy-five years. The 2008 Annual
Reports continue to show that both Social Security and Medicare need serious reform.
[1]
Both programs
face a long-term financing gap. Closing the gap between monies going into the Social Security and
Medicare funds and monies coming out of the funds will be a challenge. It will force the government to
come up with innovative solutions to fixing the long-term deficits.
As Figure 18.3 "Long-Range OASI and DI Annual Income Rates and Cost Rates (as a Percentage of
Taxable Payroll), Trustees Report 2008" shows, the OASDI and HI trust funds are expected to be
adequately financed for only the next ten years (depending on the actuarial assumptions).
[2]
Figure 18.4
"OASDI and HI Income Shortfall to Pay Scheduled Benefits, and the 75 Percent General Fund Revenue
Contribution to SMI (Percentage of GDP), Trustees Report 2008" shows the deficits of the Medicare Parts
B and D trust funds. The deficits are expected to grow rapidly.
Figure 18.2 Number of Workers per OASDI Beneficiary
Source: OASDI Trustees Report,http://www.ssa.gov/OACT/COLA/CBB.html.
Figure 18.3 Long-Range OASI and DI Annual Income Rates and Cost Rates (as a
Percentage of Taxable Payroll), Trustees Report 2008
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Source: Social Security and Medicare Board of Trustees, “A Summary of the 2008 Annual Reports,”
April 22, 2008,http://www.ssa.gov/OACT/TRSUM/trsummary.html (accessed April 5, 2009).
Figure 18.4 OASDI and HI Income Shortfall to Pay Scheduled Benefits, and the 75
Percent General Fund Revenue Contribution to SMI (Percentage of GDP), Trustees
Report 2008
Source: Social Security and Medicare Board of Trustees, “A Summary of the 2008 Annual Reports,”
April 22, 2008,http://www.ssa.gov/OACT/TRSUM/trsummary.html (accessed April 5, 2009).
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Whether the objective of the Social Security program should be to provide a “floor of protection” or a
“reasonable level of living” remains debatable. Reform will require agreement, however, by politicians and
the public on not only what benefits citizens are entitled to, but what benefits taxpayers are willing to
fund. See the box “The Future of Social Security,” for a discussion of this topic.
Global Trends in Social Security Systems
In many countries, financing the government social security system has become increasingly difficult for
several reasons. Benefit levels have increased in many nations, to the point where the tax rates necessary
to support benefits are at an all-time high. For example, free or very-low-cost medical care may be
available to everyone, disability benefits may require little proof of inability to work, and generous
disability payments may result in the moral hazard of malingering. Demographic trends in other
industrialized nations mirror those in the United States: the population is aging, so fewer workers finance
the pay-as-you-go system for retirees. The declining birth rate suggests that this trend is unlikely to be
reversed. In addition, other governments also face the problem of growing budget deficits. Governments
in some developing countries may be perceived as unable to administer the social security system fairly
and efficiently.
Experts anticipate a shift from public sector social insurance plans to private sector plans, especially for
retirement benefits. Private sector organizations, particularly insurance companies, have successfully
managed retirement savings and income for decades and are in a position to improve management and
funding practices. Several countries have already begun to privatize the social security system, namely,
Chile, Peru, Mexico, Italy, and Japan. In Chile (beginning in 1981) and Peru (in 1993), for example,
workers are required to contribute to their own retirement fund, and contributions are invested by a
private pension fund manager selected by the worker. In both these countries, the prefunded privatized
system appears to be working well. Some countries also are moving toward privatized medical care
systems.
The trend toward privatization is worldwide, including both industrialized and developing countries. The
potential for market expansion for insurers and other financial institutions is tremendous.
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Does Privatization Provide a More Equitable Solution?
The threat to the stability of Social Security has been apparent for decades. For years,
political leaders have agreed that something must be done…. We can postpone action no
longer. Social Security is a challenge now; if we fail to act, it will become a crisis. We must
save Social Security and we now have the opportunity to do so.
With these words, on May 2, 2001, President George W. Bush established the Presidential Commission to
Strengthen Social Security.
The crisis President Bush was referring to is the declining numbers of new workers paying into the Social
Security system. Fewer births and longer life expectancies are causes. In 1940, when the first benefits
were paid, there were more than forty workers paying for each retiree receiving benefits. In 1960, there
were five workers for each retiree. Today, there are 3.4 workers paying for each beneficiary. With the baby
boom generation set to retire over the next few decades, that number is expected to fall even further. The
Presidential Commission’s report estimates that the ratio will be 2.2:1 in 2025 and just 2:1 by 2050.
These demographic changes mean that the burden of paying for Social Security will fall ever more heavily
on the younger generation of workers. When polled, 41 percent of young people (ages eighteen to thirtyfour) said that they do not expect to receive Social Security benefits at today’s level when they retire, while
31 percent expected to receive no benefits at all.
Certainly, current benefit levels cannot be maintained without raising Social Security withholding taxes or
extending the normal retirement age. But is it fair to tax younger workers more heavily to pay for their
parents’ retirement? Will there even be any money left for their own retirement? One solution that has
been proposed is individual investment accounts that would allow individuals to invest a percentage of
their Social Security savings themselves. Proponents of privatization argue that it would allow greater
returns than the traditional Social Security system.
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In the heady days of soaring stock prices and budget surpluses, just before President Bush created the
commission, privatization was a popular solution. Workers, it was argued, could invest their Social
Security funds in the stock market and see great returns. Low-wage workers would become shareholders
in the U.S. economy and be able to accumulate wealth. Money would flow into the economy.
With the economic recession that began in 2008, privatization has lost momentum. But even when the
plan was first proposed, it faced opposition on a number of grounds. The pay-as-you-go system is a
guaranteed benefit. With many retirees depending on Social Security as their main source of income, this
guarantee is crucial. But what happens if an individual invested unwisely? Proponents of a private system
argue that an education campaign, along with requirements for diversification and safeguards against
high-risk investments, should prevent such losses.
Another argument against privatization is the distortion it could cause in the stock market. With a large
number of funds flowing into mutual funds from Social Security investors, prices might be driven up
artificially. Government-approved mutual funds would receive a huge windfall in fees.
Most young people, who politicians have argued would benefit the most from privatization, do not
support changing the Social Security system but would rather see the existing system strengthened. A
majority polled say that “making sure that people receive a decent, guaranteed monthly retirement
benefit” is a higher priority than “making sure that people receive a better rate of return.”
Questions for Discussion
1.
Who should be responsible for the welfare of the retired population? The current workers or the
retirees (who should save for it)?
2. Is it appropriate for the government to mandate forced savings in private accounts in lieu of the
pay-as-you-go Social Security system? Would this action change the nature of the requirements
from taxes to private saving?
3. If part of the individual accounts would be administered by the government, is it ethical for the
government to essentially become a major shareholder in private companies?
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Sources: Key findings from Hart Research Poll, July 24, 1998; “Young Americans and Social Security: A
Public Opinion Study Conducted for the 2030 Center by Peter D. Hart, Research Associates,” July 1999,
accessed April 5, 2009,http://www.commondreams.org/pressreleases/july99/072299a.htm; President’s
Commission to Strengthen Social Security, “Final Report: Strengthening Social Security and Creating
Personal Wealth for All Americans,” December 21, 2001 (this document includes all appendixes and
Estimates of Financial Effects for Three Models Developed by the President’s Commission to Strengthen
Social Security, prepared by the Office of the Chief Actuary, Social Security Administration, May 2, 2001);
Gary Burtless, “Social Security Privatization and Financial Market Risk,” Center on Social and Economic
Dynamics, Working Paper No. 10, February 2000; Social Security Administration, “Little Change in Social
Security Solvency (Trustees Recommend Timely Action),” March 23, 2005, accessed April 5,
2009,http://www.ssa.gov/pressoffice/pr/trustee05-pr.htm.
The Future of Social Security
A quick glance at Figure 18.3 "Long-Range OASI and DI Annual Income Rates and Cost Rates (as a
Percentage of Taxable Payroll), Trustees Report 2008" shows that the costs of Social Security are rising
faster than the payments into the system. In the 2008 Annual Report to Congress, the Trustees
announced the following:
x
x
x
x
The projected point at which tax revenues will fall below program costs comes in 2011
The projected point at which the trust funds will be exhausted comes in 2041
The projected actuarial deficit over the seventy-five-year, long-range period is 3.54 percent of
taxable payroll
Over the seventy-five-year period, the trust funds require additional revenue, equivalent to $4.3
trillion in today’s dollars to pay all scheduled benefits.
Figure 18.3 "Long-Range OASI and DI Annual Income Rates and Cost Rates (as a Percentage of Taxable
Payroll), Trustees Report 2008" and Figure 18.4 "OASDI and HI Income Shortfall to Pay Scheduled
Benefits, and the 75 Percent General Fund Revenue Contribution to SMI (Percentage of GDP), Trustees
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Report 2008"are from the 2008 OASDI Trustees Report on the current and projected financial condition
of all the Social Security programs. (The six trustees of the board are the Secretary of the Treasury, the
Secretary of Labor, the Secretary of Health and Human Services, the Commissioner of Social Security, and
two members appointed by the president.) The programs are financed through four separate trust funds:
the Old-Age and Survivors Insurance (OASI) Trust Fund, Disability Insurance (DI), and two for Medicare.
To project future effects on the bottom line, the trustees review available evidence and gather expert
opinion about all the factors that affect income and expenditures: demographic (birth rate, mortality,
immigration); economic (unemployment rates, inflation); and program-specific (retirement patterns,
disability incidence). The trustees make both short-range (ten-year) and long-range (seventy-five-year)
predictions.
Traditional solutions to the looming Social Security and Medicare budget crisis have focused on
increasing these taxes and cutting benefits. President G. W. Bush, in his State of the Union address on
January 31, 2006, called for a bipartisan committee to find a solution to the impending major shortfall as
the baby boom generation begins retirement. President Bush and many members of Congress believed the
answer was privatization—allowing workers to invest some or all of their own (private) Social Security
funds in the stock market, which historically yields greater returns over long investment periods than
Treasury securities do. Beliefs in an ownership society and personal responsibility lie behind this
objective. After Chile’s successful move to privatization in 1981, almost every South American country has
followed suit, with positive results. Countries from Singapore to Hungary have also converted
successfully. With the economic recession of 2008 and the arrival of a new administration, focus has
shifted from Social Security as a major political issue. But there are many arguments on both sides, and it
remains to be seen how the Social Security system will be preserved.
Sources: Merrill Matthews, Jr., “A 12-Step Plan for Social Security Reform,” National Center for Policy
Analysis, June 4, 1998,http://www.ncpa.org/ba/ba267.html (accessed April 4, 2009); Social Security
Administration, the 2008 OASDI Trustees Report, June 11,
2008, http://ssa.gov/OACT/TR/TR08/trTOC.html(accessed April 4, 2009).
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K E Y TA K EA WAYS
In this section you studied problems with the Social Security program in the United
States and examples of global trends in administering social insurance:
x
x
During the past two decades, Social Security taxes have increased faster than
the general level of prices and the cost of health care.
Extended life expectancies and lower birth rates have resulted in the funding
burden being borne by a shrinking sector of society (three workers per
x
retiree).
Seventy-five-year actuarial projections issued annually by the Social Security
and Medicare trustees show long-term funding deficits, with the program
x
x
x
running out of money in the next thirty-two years.
Global problems with social insurance institutions mirror those of the United
States.
Privatization of social security has worked well in Chile and Peru.
The trend toward at least partial privatization and prefunding is worldwide.
D I SCU S S ION Q UE ST IO N S
1. Do you think Social Security coverage should be voluntary? Explain.
2. Would you favor privatization of the Social Security retirement program, as
other countries have done? Explain.
3. What solutions, other than privatization, would alleviate some of the funding
problems of Social Security in the United States?
4. Should Medicare be expanded to cover everyone for a broad array of medical
services, without regard to age or work history? Do you favor expanding
Medicare into a national health insurance plan?
[1] Social Security and Medicare Board of Trustees’ Summary of the 2008 Annual Reports on
the status of the Social Security and Medicare Programs. The goal of the public trustees is to
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approach the current state of Social Security and Medicare in a nonpartisan way. They aim to
ensure the integrity of the reports, both in methods of preparation and in the credibility of the
information they contain. Realizing that numerous assumptions must be made to predict the
future condition of the funds, the trustees prepare these reports because they believe the
reports paint the most reliable picture available today. This summary is available online
athttp://www.ssa.gov/OACT/TRSUM/trsummary.html.
[2] 2005 OASDI Trustees Report, Section II:
Overview,http://www.ssa.gov/OACT/TR/TR02/II_highlights.html#76460.
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18.4 Review and Practice
1.
How is Social Security financed?
2. From time to time, you may hear that Social Security is in financial trouble and that you may not
receive the benefits you expect. Do you think this is true? If it is true, what should be done about it?
3. C. J. Abbott worked hard all his life and built up a successful business. His daily routine involves
helping with management decisions in the business, even though the majority of it is now owned and
managed by his sons. He continues to draw a salary from the company sufficient to cover his expenses
each month. C. J. is fully insured under Social Security and applied for benefits at age sixty-two.
However, he does not presently receive, nor has he ever received, Social Security benefits. He
celebrated his sixty-fourth birthday last May.
a.
Why hasn’t C. J. received any Social Security benefits? Does this tell you anything about
how much he is earning at the business?
b. Why do you think C. J. continues to work?
c.
Will C. J.’s benefits be increased for his work beyond age sixty-five? (Assume that he
starts drawing benefits at age seventy.)
d. What is the logic behind the provision in the Social Security law that leads to a fully
insured individual like C. J. not receiving Social Security retirement benefits after age
sixty-five?
Your father-in-law was employed by a state agency for forty years before his retirement last year.
He was not covered by Social Security on his state job. During the last five years of his career with the
state government, however, you employed him on a part-time basis to do some surveying work on a
housing development for which you had an engineering contract. You withheld Social Security tax
from his wages and turned his share, plus yours as his employer, over to the government.
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When your father-in-law retired, he applied for Social Security retirement benefits. Several
months later, he was notified that he was not entitled to benefits because the work he did for you was
in the family and not bona fide employment. The implication in the notice he received was that the job
you gave him was designed to qualify him for Social Security benefits rather than to provide him with
real employment.
a.
What should your father-in-law do?
b. How can you help him?
Does the economic recession beginning in 2007 tell you anything about the merits, or the risks, of
shifting Social Security funding to individual private accounts?
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