(UM09-03) - Adjusting Social Security Unfunded Liability for Risk
Laurence J. Kotlikoff
This proposal would apply what are now standard modern asset-pricing techniques to determine the current market value of Social Security’s liability to current retirees and workers assuming the future prevalence of current policy. The arbitrage pricing theory (APT) demonstrates how to value non-traded, risky securities, including claims to future Social Security benefits and obligations to pay future Social Security taxes. In providing an APT valuation of Social Security’s net benefit obligations to current retirees and workers we will be adjusting for risk based on the prevailing market price of risk. In contrast, the Trustees Report makes no adjustment for risk in assessing the system’s unfunded liability. To be sure, the Trustees Report does engage in sensitivity analysis with respect to Social Security trust fund ratios and cost rates, but this does not tell us how to value in the present the constellation of future net income streams that the system may generate.