I am amazed that I still hear people claiming that social security is insurance. Yes, the government says that social security is insurance, and the government bases your benefits on the amount you paid, but that does not make it insurance. If a mafioso asked you for protection money would you call it insurance as well, just because you make monthly installments and he calls it insurance? Calling something a name does not make it so. Just because the government calls paying subsidies with tax dollars "investment" does not mean it is anything like a real private sector investment. Nor do the plans to re-dub taxes "dues" make them anything other than taxes.

Likewise, just because the government calls social security "insurance" does not make it so.

I think I have written on this before, but as I cannot find the link, I will just start from scratch.

Let us begin by looking at insurance. Insurance is based, very basically, on accepting premiums against some future calamity. Those premiums are invested and the eventual earnings are used to offset the cost of compensating the customer against that future mishap. In general, if the insurer plans well, he will end up with more earnings from investment than he pays out over the life of the policy. If not, then he will lose money on that account.

The reason that insurance works is risk pooling. By putting together a large number of customers, he can offset the statistically likely losses against more likely gains to turn a net profit. Of course, for risk pooling to work, he must either be able to deny coverage or adjust premiums, or both. If premiums are fixed, then he must be able to deny those who are at such a probability of payout that investment will not cover the payout. If not, then he must be able to charge risky customers a higher premium in order to cover their costs. In reality, most insurance carriers use a bit of both, adjusting premiums for low and moderate risks, while denying coverage to high risks.

And all of this is done because of one other essential feature of insurance. Insurance underwriting is a profitable venture, designed to make money for the owners.

Which leaves us with the essential features of insurance. It operates by pooling risks, requires either the right to deny coverage or adjust premiums, that the premiums are invested to earn money for future payouts, and it is a profit-making venture. The other features (payout proportionate to pay in, being called 'insurance", requiring regularly timed payments) are not essential to the definition. In fact, one could easily imagine an insurance scheme wherein the payout was fixed for all investors, the word "insurance" was never used, and payments were made in one lump sum up front, so those are certainly not essential to calling a plan insurance.

Unfortunately for those who believe social security is insurance, it is only in these non-essential features that social security resembles insurance. In terms of the three essentials, social security falls far short of being insurance.

First, let us deal with two features at once, everything having to do with risk pooling, as these show most clearly that social security is not insurance.

There is simply no risk pooling in social security. The plan is open to all working Americans except those few excluded by statute. Not only open to them, but mandatory*. Nor are the premiums adjusted for risk. In fact, there is no risk pooling at all. Everyone pays in the same percentage of wages up to the cap, and the payout is proportional to the amount paid in.

When we speak of "risk", from the insurer's perspective, the risk is that the worker will survive to retirement age. Should the worker do so, payout will occur. The point where profit turns into loss, is where the amount paid out exceeds the amount paid in plus the income from investing those premiums.  With the addition of payments to disabled workers or orphaned children there are other risks than longevity, but longevity is the most common.

Now, were this truly an insurance plan, premiums would increase as the worker's age rose, as he would be ever closer to retirement, and the risk is proportionately greater. Likewise, those with children who could be orphaned, or spouses who could collect in the event of death would also pay higher premiums, as would those whose habits or profession greatly increased the probability of disability. A real insurer would also refuse coverage to those who started working far too close to retirement age, or had a preexisting condition likely to result in disability*.

The government does none of this. They accept all comers with a  uniform premium schedule. They do not deny coverage for anyone who has ten qualifying quarters and they do not adjust premiums. That is not an insurance plan.

Nor does the government really invest the money in any real sense. An insurer will invest money actively, to maximize profits. In fact, whole life insurance was once the investment vehicle of choice for Americans, serving the same purpose as mutual funds do today. As insurers were professional investors, it was assumed they would remain solvent and manage money well. Of course, whole life insurance did not have all the benefits of mutual funds, as the payout was fixed, not variable, but it did provide a relatively high return investment with little risk, similar to the benefits most mutual funds claim now. Even today, many annuities and other investment vehicles are still offered by insurers, so they maintain this financial function.

Needless to say, no one is entrusting their nest egg to the social security administration. When the social security administration receives funds, they do not invest them in a diversified portfolio, nor dot hey hand them over to a money manager. Socials ecurity funds are put one place, government debt. It is why those who claim to want a "lockbox", as Al Gore did once, are so deluded. Even if the government no longer formally borrowed money from social security, the administration would have to put money somewhere, so they would "buy" government debt, which would make the money as available to the federal government as if they had borrowed it more directly. The only other alternative (as private investment is not an option) would be to leave the money lying about earning no returns, which makes no sense at all.

But how social security should invest its funds is not my subject in this essay. My point is a simple one. The money is not really invested. Yes, it is in the form of government bonds and they do pay some return, but it is hard to call a massive sum of money all invested in the same thing an "investment" in any meaningful sense. In reality, money sent to social security is simply handed over to the general fund until needed, though the mechanism obscures that somewhat. In short, there is no real "investment" as there would be if it were truly insurance.

All of which brings me to my final point, that social security is not a profitable enterprise.

Now, some will be objecting to my arguments so far saying something like "Well, OK, it isn't a real 'insurance' plan, but it is still an investment plan, I am just getting back what I put in." And that serves as a perfect lead in to my remaining argument. The truth is, it is unusual for a beneficiary to have paid enough to cover what they receive.

The social security administration itself admits this, saying on their web site :

Social Security is largely a "pay-as-you-go" system with today's taxpayers paying for the benefits of today's retirees. Money not needed to pay today's benefits is invested in special-issue Treasury bonds.

If that is true, it is evident that the venture is loosing money. If I am paying for today's retirees, then they have obviously spent up the money they put in some time ago.

And if you think about it, this is inevitable. First, there are a number of situations where the benefits paid will inevitably exceed the amount paid in. Let us start with my personal case. Were my situation to worsen, I would be able to collect disability payments. I have been paying in close to the maximum in social security for some time, but there is no way that that amount would cover the payments I would likely receive over the next forty years or so, even if we ignore inflation. And the same is true of widow and orphan benefits, especially for those who have paid in for just slightly more than those 10 qualifying quarters.

Another problem is the ever increasing lifespan. When it was conceived, 65 was a relatively old age, now it is unusual for someone not to make it to retirement. And it was easier to remain solvent when the average retiree collected for maybe one or two years rather than the 15 or so common today. Not to mention the 20 or more years likely in the near future. Obviously, adjusting the age span upward would help, but it still would not resolve the problem. The amount being collected, and the retirement age being set, is always based on the lifespan of today, but the beneficiaries will be surviving based on the lifespan int he future. In short, we are always planning twenty or thirty years in the future based on what conditions prevail today. It is a losing game.

And, of course, there is also inflation. A reasonable premium in the 1950's amounts to pocket change today, yet that amount is being used to support retirement payments in today's dollars. As the funds wee "invested" in low yield loans to the treasury, there was no real appreciation, so we are basically paying retirees as if they had contributed many times what they did. Now, hopefully, we won't have any carter sized inflation in the future to make my retirement as costly as that of this generation, but I doubt we will revert to the gold standard either. So, as long as we have managed currency, we will have inflation, and with that will come a depreciation of the amount paid in, making it unlikely any retiree will "pay his own way" unless he dies at a very early age.

I suppose I would be remiss if I missed the favorite reason of the press, the baby boomers. It is a big reason that social security is suffering now, rather than later, but I think the press favors the "baby boomer" explanation as it allows them to say social security is broken without mentioning any of the other causes, or addressing the problems inherent in the system. It is easy for them to say "We have too many people retiring at once" and ignore the fact that even without those old people, social security would still fail.

So, yes, the number of retiring baby boomers will severely tax the system, especially as a part of their earnings were in pre-Carter dollars which are virtually worthless now. On the other hand, they did earn their best incomes after the Carter years, so they have paid in some substantial amounts. Were social security real insurance or even an investment scheme, there would probably be no problem. but, as it is a "pay as you go" Ponzi scheme, and as the retirees will being to equal those actually working, the stress on the system will begin to show soon. So, yes, the press is right in saying the boomers will be a problem, but to focus on the boomers alone is to ignore the bigger issues.

To summarize, social security does not pool risks, it does not deny coverage or adjust premiums relative to risk, tit does not invest premiums, and it does not turn a profit, or even break even**.

Hopefully I have made my case this time, and everyone can agree that there is nothing in social security which resembles insurance. It is a welfare scheme, pure and simple. Yes it pays the benefits to those who previously paid in, so it is not quite like other welfare schemes, but those getting benefits will still most likely get out much more than they paid in, so it is still a wealth transfer, no matter what one calls it. But ignoring the question of whether it should be called welfare or something else, there is one truth we cannot dispute:

However you choose to describe it, social security is not insurance.

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* Should any commenter fell the need to tell me about the long running myth that you can opt out of social security or income tax, please save your breath. Even in the early twentieth century nanny state planners were smart enough to prevent citizens from opting out of schemes developed "for their own good".

** The fact that there is a surplus does not mean social security is profitable. To truly judge profit, one must judge past premiums against matching current liabilities, or current assets against predicted future liabilities. As future predictions here are difficult, we should judge the current beneficiaries against the amounts they paid in and the returns on the investments supported by those premiums. As we are in a "pay as you go mode", obviously current retirees spent up the amount they paid in some time ago, and we are using present premiums to pay present liabilities. In a private insurer that would be considered the sign of an unhealthy business.