Actuarial Deficit Details

Although we could apply the term "actuarial deficit" to any investment instrument, it's usually used to describe a government social security fund. The US Social Security Administration regularly summarizes the actuarial status of Social Security trust funds. The statistics they publish are projections about the financial status of the trust funds 75 years in the future, based on the current position. The statistics reveal that, in the United States, there will be an actuarial deficit of 2.78% in 2094, rising to 3.21% in 2095. These figures reveal that, at current contribution rates, there will not be enough money in the reserve to meet pension obligations in the future.

Thirty years ago, pension funds generally showed a surplus but, in the 21st century, most pension funds are dealing with potential actuarial deficits. The reason for the deficit lies in demographics. In 1960, life expectancy in the United States was a little under 70 years old. Life expectancy has risen steadily and now stands at over 78 years. Although most people consider 65 the average retirement age, it is actually 64. People are living longer and using pensions for a longer time.

Half of all retirees expect to continue working, either full-time or part-time, after their retirement to maintain their standard of living. Clearly, even if there were no actuarial deficit, provision for retirement is not sufficient. Whether governmental or private, pension funds tend to be careful investors who look for an acceptable level of return at an acceptable risk level. For example, the Social Security Administration trust funds invest exclusively in United States Treasury securities.

Actuarial Deficit Example

Ruritania has an actuarial deficit in its state pension fund. The country faces problems common to many governments: people live longer, and the birth rate is dropping. So, while more and more people are claiming pensions for longer periods, fewer people are replacing them in the workforce. This is causing a drop in contributions as demand increases.

Administrators and relevant government officials call a meeting to discuss possible solutions. They draw up a list that highlights the following options:

  • An increase in payroll taxes. This will boost contributions but will be deeply unpopular as citizens believe that they pay too much in taxes as it is.
  • Sales tax increase on luxury goods. The government will use the extra revenue from this to top off the state pension fund. This idea gains some support, but some are worried that it will be misused.
  • Raise the retirement age. This seems logical to many. Nobody had expected such a dramatic increase in life expectancy when pensions were first introduced. However, again this will be unpopular.
  • Increase the workforce by encouraging immigration.
  • Encourage investment in private pension plans.

Eventually, the Ruritanian government decides to implement all of these measures at the same time. They hope that people will support unpopular measures if the government tells them why their introduction is necessary.