How can the U.S. transition to personal public private social security saving accounts

How Can the U.S. Transition to Personal
Public-Private Social Security Saving
Accounts?
Options for “risk-averse” investors in a post-crisis
world
Matias H. Zelikowicz (Duke University)
+ =

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Table of Contents
I. Introduction
1. Overview of Problem and Context: Trouble in Paradise
II. Different Pension Arrangements in the United States
1. Types of Retirement Plans
2. Funding of Pension Plans
3. Organization of Pension Plans
III. Problems With Social Security and State Pensions
1. Demographic Challenges
2. The Numbers at the U.S. State Level: “State of Denial”
3. Diagnosis of the Problem: Government and Market Failure
A. Information Asymmetries: “My Financial Advisor Needs Advice”
B. Macroeconomic Dynamics: Hedge Funds Can Not Hedge Risk
C. Federal Reserve: “The Blind Leading The Blind”
D. Problems Inherent in Representative Democracy
4. Past Attempts to Solve the Problem

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IV. The Dilemma of Investment Choices
1. “To Risk or Not to Risk”
A. Low Interest Rates: Cash is Not King
B. Mutual Funds: Costs and Benefits
V. The Ryan Plan
1. Problems With The Ryan Plan
VI. Personal Public- Private Social Security Accounts (PPPSSS)
1. Market Linked CDs: Is Equity Investment Without Market Risk Possible?
A. Most Popular MLCD Structures
B. Performance of MLCDs: Historical Results
C. Drawbacks of MLCDs
D. Addressing the Drawbacks of MLCDs Inside PPPSSS Accounts
2. How Do PPPSSS Work?
VII. Final Remarks and Conclusion
VIII. Annexes
IX. Bibliography

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Abstract:
The main purpose of this paper is to provide an overview of the fiscal sustainability challenges and demographic
pressures that social security and state pension plans confront in the United States. The paper then describes a
specific plan for the partial privatization of the pay-as –you-go (PAYG) social security program, and a transition to
personal public-private social security saving accounts (PPPSSS). Finally it describes the specific investment choices
that would be available inside PPPSSS accounts.

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I. Introduction
1. Overview of Problem and Context: Trouble in Paradise
After the devastating effects of the Great Depression, the creation of the Social Security system
in 1935 made the prospects of a comfortable retirement a reality for most workers in the
United States and other industrial countries. Nonetheless, the latest financial crisis and
recession has further exposed the need for reform of a pension system that was already under
significant stress.
The main purpose of this paper is to provide an overview of the fiscal sustainability challenges
and demographic pressures that social security and state pension plans confront in the United
States. The paper then describes a specific plan for the partial privatization of the pay-as –you-
go (PAYG) social security program, and a transition to personal public-private social security
saving accounts (PPPSSS). Finally it describes the specific investment options that would be
available inside PPPSSS accounts. The paper is organized as follows. Section II describes the
different pension arrangements in the United States, beginning with its financing, and then
turning to their organization. Section III describes the problems and challenges with the PAYG
social security system, state pensions, and the past attempts to solve the problems. Section IV
discusses the problems with the current type of investments available in most retirement plans.
Section V discusses the Ryan Plan as one of the alternatives to reform the PAYG social security
system and some of the problems with it. Section VI makes the case for the partial privatization
of the social security system, discusses its implementation, and the investment options that
would be available inside the PPPSSS accounts. Section VII contains some concluding remarks.

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II. Different Pension Arrangements in the United States
1. Types of Retirement Plans
The objective of a pension system is to “create a mechanism for consumption smoothing, and a
means of insurance”1
. In the United States, pension provision is comprised not only by social
security, but also state pensions, private defined benefit (DB) pensions, traditional IRAs, Roth
IRAs, SEP-IRAs, employer based defined contribution (DC) pensions such as 401(k) and 403 (b)
plans, and non-qualified 457 plans for state employees, among others (see Annex 1 for a
description of the different retirement plans).
In a perfect world scenario, retirement needs will be met by voluntary arrangements; however,
due to social reasons (poverty relief) and investors’ shortsightedness, government involvement
has played a major role in the system not only through the establishment of social security, but
also by providing tax incentives for private and public retirement plans.
2. Funding of Pension Plans in the United States
Pensions in the United States are either fully funded or PAYG.
With a fully funded scheme, “pensions are paid out of a fund built over a period of years from its
members’ contributions. On the other hand, with a pay-as-you-go scheme, (most countries run their
public pensions on a PAYG basis) pensions are paid out of current income…From an aggregate
viewpoint; we simply are taxing one group of individuals and transferring the revenues to another.”2
1
Barr, Nicholas, and Peter Diamond. “The Economics of Pensions.” Oxford Review of Economic Policy 22.1 (2006): 15-39.
2
Barr, Nicholas, and Peter Diamond. “The Economics of Pensions.” Oxford Review of Economic Policy 22.1 (2006): 15-39.

7
Nevertheless, it is important to highlight that despite these polar opposites, notional or partial funding
structures are very much a part of the pension system.
3. Organization of Pension Plans
Within the two ways of financing pensions, there are three common ways to organize them:
Defined-contribution, defined-benefit, and notional defined-contribution. To begin with, in a
defined contribution scheme, members make fixed contributions into an account; these
contributions are accumulated in the account as well as the return on investments. In a defined
benefit scheme (they can be run by the government or a private employer), a worker’s pension
is based on his wage history and length of service. Lastly, a notional defined-contribution
scheme shares some characteristics of the fully funded and PAYG schemes. In this type of
scheme, benefits will on the hand depend on the accumulation of contributions, and on the
other hand, it is similar to a PAYG scheme since it is also unfunded. This is due to the fact that,
current contributions go to pay for the current benefit of pensioners. In the public sector,
tensions have derived from defined benefits plans due to the fact that the risk of adverse
outcomes falls on current taxpayers.
III. Problems with Social Security and State Pensions
The tension that has arisen from PAYG systems such as social security and some national
pension plans is born out of the fact that; pensions are paid out of current income, the taxing of
one group of individuals (currents workers) and the transferring of the revenues to another
(retirees) has to be balanced because if you tax the working population excessively, the risk of
“tax revolts” or political costs may be too high.

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1. Demographic Challenges
When President Franklin D. Roosevelt signed the Social Security Act in 1935, social security was
set up as a “pay-as-you-go” (PAYG) program in which today’s workers are paying for the
benefits to today’s pensioners and other beneficiaries through their payroll taxes. According to
statistics that describe the historical trends in the dependency ratio3
, “in 1940, there were 42
workers per retiree; in 1950, the ratio was 16-to-1; today, there are 3.3 workers per retiree,
and within 40 years, it’s projected that there will be just two workers per retiree.”4
This is a
significant development because the numbers of taxpayers that support the current system are
diminishing every year.
At the present rate, as life expectancies continue to rise, the system will not be able to sustain
itself into the future without major reform. Moreover, in the U.S., the share of population aged
65 or over accounts for 18.6% and “is projected to nearly double between 2000 and 2050… The
sharpest effects will generally be felt over the next two to three decades, as the baby-boom
generation reaches retirement age.”5
These demographic trends are very concerning because
age dependency ratios are a measure of the age structure of the population; consequently, as
the number of individuals that are likely to be “dependent” on the support of a smaller pool of
taxpayers increase, the system will be under an even bigger stress.
3
Age dependency ratios are a measure of the age structure of the population. They relate the number of individuals that are likely to be
“dependent” on the support of others for their daily living. OECD. "Society at a Glance: OECD Social Indicators 2006 Edition
http://www.oecd.org/dataoecd/4/24/38148786.pdf
4
“Age Dependency Ratios and Social Security Solvency.” CRS Report for Congress, 27 Oct. 2006. Web http://aging.senate.gov/crs/ss4.pdf.
5
Whiteford, Peter, and Edward Whitehouse. “Pension Challenges and Pension Reforms in OECD Countries.” Oxford Review of Economic Policy
22.1 (2006): 78-94. Print

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Today, “more than 30 million Americans depend on social security to provide a significant share
of their retirement income”6
and this number will continue to grow as the baby-boomer
generation retires in record numbers in years to come. As a result, social security will go into
deficit in 2017 (Graph 1 shows social security’s long term fiscal outlook).
Graph 1: Social Security from Surplus to Deficit
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Demographic pressures also threaten the fully funded system. In this scenario tensions arise
from the fact that life-cycle investment requires investment in risk free assets (usually
government bonds) toward the end of the lifecycle of a retiree, but when those bonds mature,
the government needs to tax current workers in order to redeem those bonds; thus, the system
in a way resembles the PAYG. The main difference is that in a fully funded system, tax increases
can be delayed for a few years until a large portion of the populations enters the last stages of
6
Ryan, Paul. A Roadmap For America's Future. http://www.roadmap.republicans.budget.house.gov/plan/#retirementsecurity
7
"State of the Union's Finances a Citizen's Guide." Peter G. Peterson Foundation Our America.

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the retirement investing cycle. In other words, it can only be delayed until investors allocate a
large portion of their savings into government bonds.
Moreover, many governments whether at the state or federal level not only have been ignoring
their explicit (formal) debt commitments and liabilities such as the bonds that they issue, but
they also have been reluctant to address the implicit unfunded liabilities (i.e. pensions) because
they depend on the social covenant agreed upon with the citizenry. According to the Peterson
Foundation, on January of 2008, the implicit liabilities of the U.S. to Medicare, Medicare and
Social Security account to 42.9 trillion dollars.8
This phenomenon will have to be reversed
because if the U.S. government does not take a proactive approach to dealing with its fiscal
imbalances, it runs the risk that markets and “bond vigilantes” will take the lead, and this will
be potentially devastating.
2. The Numbers at the U.S. State Level: “State of Denial”
On the state pension side, the trend is not very encouraging either; according to estimates
provided by Joshua Rauh from the Kellogg School of Business and Robert Novy-Mark from the
University of Rochester, “state’s pension shortfall may be as much as $3.4 trillion, and
municipalities have a hole of $574billion…If pension promises are kept, this will place immense
strain on taxes since several states have promised annual payments that will absorb more than
30% of their tax revenue”9
. Moreover, the enormity of this number has made some forecasters
8
States of the Union’s Finances A Citizen’s Guide. Print. Peter G. Peterson Foundation, March 2009
9
“A Golden-plated Burden.” The Economist Magazine 16 Oct. 2010: 95-96.

11
such as Meredith Whitney10
proclaim that the state’s troubled fiscal situation can potentially be
a source of systemic risk for the financial system in a not too distant future.
In response to this dire situation, “lawmakers and governors in many states, faced with huge
shortfalls in employee pension funds, are turning to a strategy that a lot of private companies
adopted years ago: moving workers away from guaranteed pension plans and toward 401 (k)
type retirement savings plans. For instance, Utah lawmakers voted last year to make a partial
change over to a 401 (k) plan, following in the footsteps of Alaska, Colorado, Georgia, Michigan,
Ohio and several other states, which offer at least some version of it. The push to switch to
401(k)-type plans comes overwhelmingly from Republicans, who see them as more
individualistic and free market. Democrats generally oppose the change, partly because their
union allies are eager to keep traditional plans.”11
However, some states have expressed concerns with the strategy of moving to fully funded
defined contribution plans. For instance, Georgia realized that having people solely in a 401(k)
plan could be a risky proposition. In this type of plan, “‘Investors have sole control and they
might lose a lot of money’, said Pamela L. Pharris, executive director of the Employees’
Retirement System of Georgia, adding that such people ‘eventually might become dependent
on the state. Many workers don’t know how to invest, many don’t contribute enough to their
401(k)s, and many cash out much of what’s in their 401(k) long before they retire, leaving them
too little to live on when they retire’.”12
10
Meredith Whitney is the CEO of Meredith Whitney Advisory Group, LLC, a macro and strategy-driven investment research firm.
11
Greenhouse, Steven. "Pension Funds Strained, States Look at 401(k) Plans." http://www.cnbc.com/id/41844284
12
Greenhouse, Steven. "Pension Funds Strained, States Look at 401(k) Plans." http://www.cnbc.com/id/41844284

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At the same time, many critics argue that the welfare state will not be able to maintain the
current pension systems in an era where high debt to GDP ratios, combined with low rates of
growth have alarmed financial market actors and ordinary citizens (see Graph 2 for a
description of GDP growth, debt to GDP ratios, and borrowing costs on sovereign issued debt
for the U.S. and other OECD countries).
Graph 2: The End of the Spending Road?
To make matters worse, due to the nature of pensions which promise to pay employees well
into the future, “such future liabilities have to be valued, using a discount rate to reflect what
they are worth in today’s money. The higher the discount rate the lower the present value. The
expected return on the assets is often around 8%...however; such returns will be hard to come
by in the future.”13
This approach presents ethical and financial problems because the proper
13
“A Gold plated Burden.” The Economist Magazine 16 Oct. 2010: 95-96. Print.

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practice for states would be to use the risk free rate when discounting liabilities. The common
practice by states; however, has been to erroneously use the average rate of returns on
equities (around 8 percent) as a discount rate. More importantly, “a state pension fund may
achieve the desired returns by investing in the stock market, but if it does not work out, the
state must still pay its pensioners.”14
This panorama is particularly worrisome because on
average, neither traditional nor more diversified portfolios reached 8 percent in the period that
goes from 1994 to 2010 (see Graph 7 for a description of stock market average returns).
3. Diagnosis of the Problem: Government and Market Failure
In the paradigm of pension economics it is difficult to make predictions. The presence of
macroeconomic shocks, “black swans” (outlier events that have an extreme impact),
demographic shocks, political risks, management risk and investment risk in private and public
schemes, the one certainty in the system is that current production and high levels of output in
the future must be preserved in order to support the fundamental structure of the system. The
basic characteristic of the retirement system whether it is PAYG or fully funded is that there are
“simply financial mechanisms for organizing claims on…future output.”15
When it comes to the diagnosis of the looming crisis in the social security system in the U.S, we
find a variety of government and market failures. To begin with, in the realm of market failures,
we encounter information asymmetries and macroeconomic dynamics. In the domain of
government failures, we encounter problems inherent in representative government.
14
“A Gold plated Burden.” The Economist Magazine 16 Oct. 2010: 95-96. Print.
15
Barr, Nicholas, and Peter Diamond. "The Economics of Pensions." Oxford Review of Economic Policy 22.1 (2006): 15-39. Print.

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A. Information Asymmetries: “My Financial Advisor Needs Advice”
Due to the existence of imperfect consumer information (information asymmetries), it is
difficult for consumers to know exactly how much to save or the performance overtime of
present investments.
The complexity of solving information asymmetries is difficult to address for the average
consumer because of the prevalent financial illiteracy. According to a study conducted by Orzag
and Stiglitz, “over 50 percent of Americans do not know the difference between a stock and a
bond.”16
Moreover, not only the most vulnerable in society suffer the adverse consequences of
market volatility, financial professionals also have a difficult time making sense of financial
events and macroeconomic developments; thus, this panorama helps explain the devastating
losses experienced in 2008 and the first quarter of 2009.
Moreover, the system does not provide any mechanisms to guide consumers in the selection
process of choosing financial advisors and portfolios. Thus, the process is heavily influenced by
biases that could end up being very costly for consumers. For example, a growing literature
shows that households are prone to behavioral biases in choosing portfolios, and although
financial advisors can in theory help mitigate these biases, especially given the competitive
market environment in which they participate; “advisor’s self-interest, may lead to them giving
faulty advice… Advisors encourage chasing returns, push for actively managed funds, and even
push them [on clients] who begin with a well-diversified low fee portfolio.”17
16
Barr, Nicholas, and Peter Diamond. "The Economics of Pensions." Oxford Review of Economic Policy 22.1 (2006): 15-39. Print.
17
Sendhil, Mullainathan. Markus, Noth. Antoinette Schoar. Scholarly Paper. “The Market for Financial Advice: An Audit Study”.

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B. Macroeconomic Dynamics: Hedge Funds Can Not Hedge Risk
The difficult task of achieving returns and maximizing alpha even escapes the most
sophisticated of investors and money managers; for example, “six in ten hedge funds lost
money in 2011, Asia-based funds suffered the worst performance, declining 5.70 percent.
European funds declined 2.45 percent. US funds lost 0.50 percent.”18
Even the hedge fund
legend John Paulson who is known in the industry for achieving large profits for shorting the
subprime mortgage market in 2007 had to apologize to his investors for his fund's poor
performance in 2011, which he characterized as "the worst in the firm's 17 year history.
Paulson Advantage Fund lost 32.57% and the Advantage Plus Fund, which uses leverage, was
down 45.35%.” 19
It is important to emphasize that these results were particularly unexpected
by investors in a year in which, despite the volatility, the S&P 500 ended flat.
Moreover, only “one in four managers beat the major stock indexes in 2011, as an intensely
volatile market environment drove an aversion from risk that left many dangerously exposed
during pullbacks and woefully flatfooted during rallies. As a result, only 23 percent of large-cap
managers beat the Standard & Poor's 500.”20
The aversion to risk in turn “helped drive up
correlation; or the tendency of different asset classes as well as individual stocks to move up
and down in tandem, making diversification and hedging more difficult and limiting returns.
18
Carney, John. "Six in Ten Hedge Funds Lost Money in 2011." http://www.cnbc.com/id/45930738
19
Rubin, Scott. "John Paulson Apologizes to Investors for Dreadful Year." http://www.benzinga.com/media/cnbc/11/11/2158762/john-paulson-
apologizes-to-investors-for-dreadful-year
20
Cox, Jeff. "Market Pros Had Bad Year, So Why Not Just Buy Index Fund?" http://www.cnbc.com/id/45524957

16
After coming through the Great Recession, most active managers are going to err on the side of
caution.” 21
On a historical basis, the argument that money managers and financial experts can consistently
outperform the market is not very encouraging either. For instance, “mutual funds have
underperformed benchmark portfolios both after management expenses and even gross of
expenses... Moreover, while considerable performance persistence existed during the 1970s
[among money managers], there was no consistency in fund returns during the 1980s”22
.
During the crisis of 2008, almost every asset class with the exception of low paying U.S.
Treasury bonds suffered losses. For instance, “of the almost 5000 U.S. mutual funds specializing
in stocks, only one was in the black (positive returns)… the average return for stock funds was
minus 39 percent.”23
As these numbers indicate, it was almost impossible in 2008 to avoid the
macroeconomic dynamics.
C. The Federal Reserve: “The Blind Leading the Blind”
The inability of retail investors, sophisticated institutional investors, money managers and
hedge fund managers to understand economic events, was also shared by members of the
Federal Reserve. For instance, Chairman Ben Bernanke and other top officials of the U.S. central
bank missed the nation's oncoming financial crisis, “believing as late as December 2006 that the
[housing] market was stabilizing. Policymakers were also far too sanguine about the potential
threat housing posed to financial markets. Six months before the first cracks began to appear in
21
Cox, Jeff. "Market Pros Had Bad Year, So Why Not Just Buy Index Fund?" http://www.cnbc.com/id/45524957
22
Burton, Malkiel. “Returns from Investing in Equity Mutual Funds 1971 to 1991”. Journal of Finance, Volume 50
23
Larry, Light. Book, “Taming The Beast”, 13

17
the financial system, the U.S. central bank appeared largely unaware of the severity of the risks
facing the economy. ‘We are unlikely to see growth being derailed by the housing market,’
Bernanke said in March 2006, presiding over his first meeting as Fed chairman. Later in the
year, when home sales and prices had already extended their drop, officials appeared to
believe the worst was over.”24
As shown above, the tentacles of complicated macroeconomic
dynamics can affect the most informed government officials and policymakers.
D. Problems Inherent in Representative Government
In democracies, “voting serves as the mechanism for combining the preferences of individuals
into social choices.”25
In the realm of pension economics, “Representatives often face the
dilemma of choosing between actions that advance their conception of the good of society and
actions that reflect the preferences of their constituencies.”26
Reforming the current social
security pension system could prove to be very costly for politicians who want to be reelected
to office or elected to it because the perception is that under any type of reform to the status
quo, they would have to oppose the interests of key stakeholders such as elderly voters, who
are one of the most responsive blocks of voters and are more likely to participate in elections
than younger voters.
It is precisely this panorama of high political risks which helps explain the perpetuation of the
bureaucratic paralysis when it comes to reforming social security.
24
Reuters. "Ahead of Crash, Fed Saw Little Threat from Housing." http://www.cnbc.com/id/45975123
25
Weimer, David, and Aidan Vining. Policy Analysis Concepts and Practice. Print., 157
26
Weimer, David, and Aidan Vining. Policy Analysis Concepts and Practice. Print., 164

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4. Past Attempts to Solve the Problem
A number of reforms have been enacted in the United States to alleviate the problems of the
pension system. To begin with, the full pension age was increased from 65 to 67. Furthermore,
changes in adjustment for early/late retirement and cuts in future public pension benefits have
also been enacted27
.
Secondly, there has been a shift toward defined contribution pensions. According to data
compiled by the U.S. Department of Labor, “defined benefit plan assets in 2005 accounted for
21 percent of private sector employer-sponsored plan assets, down from 32 percent in 1992-
1993, while defined contribution plan assets rose over the same period from 35 to 42 percent
of private sector retirement plan assets. At the end of 2006, defined benefit plans had grown to
2.3 trillion [dollars], but defined contribution plan assets and IRA assets totaled 4.1 trillion and
4.2 trillion [dollars] respectively.”28
However, there is no empirical data that provides conclusive
evidence that funding has a significant advantage over PAYG; furthermore, “its alleged
superiority in handling demographic and economic risk, as well as in signaling future pension
costs, is difficult to justify” 29
.
In 2005 the administration of George W. Bush put social security reform at the top of his
domestic policy agenda for his second term as president. His initiative was defeated and it
never gained public support.
27
Pearson, Mark. "A Decade of Pension Reforms: the Impact of Future Benefits." Social Policy Vision and Reality (2008): 1-35. Print.
28
Hubbard, Glenn R., Michael F. Koehn, Stanley I. Ornstein, Marc Van Audenrode, and Jimmy Royer. “The Mutual Fund Industry Competition
and Investor Welfare.” New York: Columbia Business School, 2010: 14. Print.
29
Hemming, Richard. "Should Public Pensions Be Funded?" International Social Security Review 52.2/99 (1999): 1-29: 3. Print.

19
Advocates of social security privatization typically note that if the average worker was allowed
to invest the Social Security payroll taxes paid by him and his employer in a 401(k) type of
account earning historically average returns, he or she would retire in a better position than
that afforded by social security. Moreover, they argue that even if the current system could be
sustained “the real rate of return for current workers is only about 1 percent to 2 percent per
year, and the expected rate of return for today’s children is expected to fall below 1 percent.”30
However, opponents of privatization point out that “the public looks at social security as the
foundation of retirement security. Its role is to be something that a worker can absolutely count
on to keep him out of destitution if all else fails. Its role is not to offer an upside, but to
eliminate the downside.”31
The supporters of the status quo also proclaim that “Social Security
is the ultimate low-risk retirement program. If a worker lives to be 125, it keeps paying. If the
price level doubles over five years, its benefits are fully indexed for inflation. And social security
is perceived to have no risk of default.”32
The arguments of the opponents of privatization do have some validity, for instance, while in
theory common stocks provide inflation protection, “a replay of the 17-year period between
1965 and 1982 during which the Dow lost more than 68% of its CPI-adjusted real value, [the
S&P 500 lost 133% of it CPI-adjusted real value] would bankrupt a retirement plan that
30
Ryan, Paul. A Roadmap For America's Future.
31
Woodhill, Louis. "Why Americans Are Skeptical about Private Social Security." http://www.forbes.com/sites/louiswoodhill/2011/04/13/why-
americans-are-skeptical-about-private-social-security-accounts/
32

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depended upon the stock market. A private retirement plan that aimed to directly replace
social security could not afford to take such a risk.”33
IV. The Dilemma of Investment Choices:
1. “To Risk or Not to Risk”
The “Great Recession” has caused output to dramatically fall and unemployment levels to rise
to unprecedented levels across the entire global economy. Moreover, around the world it
ravaged stock markets in which private pension funds actively participate. As a result, as
indicated by figures provided by the Pensions and the Crisis OECD report, “Private pension
funds in the United States suffered losses of 26.2% in 2008, worth a heady US$ 5.4 trillion”34
.
As Graph 3 indicates, investors have been subjected to a significant amount of volatility in
equity markets since the turn of this century, and as a result, many future and current retirees
have been left wondering if there is a better path to achieving their retirement goals.
33
34
OECD Report. “Pensions and the Crisis.” OECD (2009): 1-8. Print.

21
Graph 3: Performance of S&P 500 (1997-2010)
35
The group most affected by the recent financial crisis is the one that is nearing retirement (45
years or older) because of the fact that, in many cases, they have not engaged in the prudent
lifecycle investing. Lifecycle investing is a strategy that reduces exposure to risky assets i.e.
equities, as investors get closer to retirement. According to the OECD, when the crisis
materialized, “45 percent of 55-65 year olds held more than 70% of their assets inside their
private pension in equities.”36
To understand the magnitude of the problem that workers are facing, a survey by human
resources consulting firm Towers Watson published in early 2012, indicates that “about 39
percent of workers plan to delay retirement, and the majority of those delaying retirement
expect to work another three years. If you're 55 or older, you won't reach the full retirement
age for Social Security benefits until age 66 1/2 or 67... By retiring at age 70, you'd receive
35
"Guide to the Markets." J.P Morgan Asset Management
36
OECD. “Pensions and the Crisis.” OECD (2009): 1-8. Print.

22
nearly double the annual Social Security as you have received if you took early retirement at
age 62”. 37
Moreover, “the concept of a retirement age is becoming irrelevant, at least according to a new
study of middle-class Americans. Whether it is a desire to reach a certain nest-egg number,
dealing with rising health-care costs, or grappling with mortgage debt, more workers are
deciding to delay retirement. A quarter of middle-class Americans, defined as those earning
between $25,000 and $99,000 annually, say they will ‘need to work until at least age 80.
Furthermore, more than a quarter of people in their 20s and 30s expect no income at all from
social security during retirement years. On average, people in that age group expect social
security to cover only 20 percent of their retirement funding.”38
Also, as a result of population aging, the potential from upside returns from equity investing
might diminish in years to come. This is due to the fact that; “pension funds are expected to
reduce their exposures to equities and shift to fixed-income instruments and other low-risk
assets to preserve capital and provide guaranteed income streams.”39
However, several factors might slow the shift away from equities as investors approach
retirement. With longer life spans, “people now face 20 or 30 years of retirement, and the new
concern [of financial advisors] is that clients will exhaust their savings with many years left to
live. Even before the market crash of 2008 reduced portfolio values, members of the baby
boom cohort lacked adequate pensions or savings”.40
Now they have even greater needs for
37
Epperson, Sharon. "Delaying Retirement: Why 68 Has Become 'the New 65'." http://www.cnbc.com/id/46572257/
38
Leigh Parker, Jennifer. "80 Is the New 65 for Many Retirees." http://www.cnbc.com/id/45322079
39
Mc Kinsey Global Institute, December 2011 “The Emerging Equity Gap: Growth and Stability in the New Investor Landscape.”
40

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high returns. A study by the McKinsey Global Institute states that: “if Americans of all age
groups maintain the asset allocations they have today, the rising share of the population over
65 will drive down the overall share of household financial assets in equities from 42 percent to
40 percent over the next ten years. In 2030, when the last of the baby boomers reach
retirement, the US household allocation [in equities] would fall to 38 percent.” 41
In the realm of employer sponsored plans such as 401k; 403b and individual retirement
accounts such as Traditional IRA and Roth IRA the problems are numerous because a
substantial part of the contributions to these plans is invested in equities (either in individual
stocks, ETFs and or mutual funds), and other volatile asset classes such as gold, industrial and
agricultural commodities, high yield bonds and REITs etc. Therefore, all of them are exposed in
one way or another to market risk, economic risk, and interest rate risk. Moreover, over the last
10 years, traditional theories of portfolio diversification have been undermined due to the fact
that, there has been a great degree of correlation for almost all the different asset classes (see
Annex 2 to see a detailed account about the degree of correlation between different asset
classes).
Lastly, for those investors who elect a more conservative approach and are either fully or
predominantly invested in cash or cash equivalent instruments such as liquid money markets or
less liquid traditional CDs, they are exposed not only to inflation risk, but to “dollar weakness
risk”. As Graph 4 indicates, over the last two decades, the U.S dollar index has significantly
declined vis-a-vis a basket of major currencies.
41

24
Graph 4: The Rise and Fall of the U.S. Dollar (1992-2011)
42
In fact, holding U.S. dollars has been one of the worst investments when compared to other
asset classes; as Graph 5 indicates, over the last three decades the dollar has lost 72 percent of
its value.
Graph 5: Asset Class Performance 1978-2010
43
42
Guide to the Markets." J.P Morgan Asset Management
43
Franklin Templeton

25
1. Low Interest Rates: Cash is Not King
Retirees with low exposure to equities have also been negatively affected by the crisis. For
example, those who were not invested inequities in a significant way, and were instead heavily
invested in cash and cash equivalent liquid instruments as is recommended for people near or
well into retirement, the crises has also been problematic due to the historically low interest
rates in the United States on risk free government bonds and traditional certificates of deposit.
While low interest rates may help stimulate private sector borrowing and economic growth,
they have made it very costly for retired workers, savers and other risk-averse market
participants to generate secure incomes. As Graph 6 indicates, annual income generated on a
$100,000 investment in a 6 month CD declined from $5,240 in 2006 to $419 in 2011.
Graph 6: The End of Income
44
44

26
2. Mutual Funds: Costs and Benefits
Mutual funds are the primary vehicle used by individuals to invest in the stock and bond
markets, and they are the overwhelming choice in retirement plans, Thus, the effectiveness of
401 (k), 403 (b), 457, IRAs, and other pension plans depends upon the efficiency and the
competitiveness of the mutual fund industry.
Mutual funds “were introduced in the United States in the mid-1920s, growing from one fund
in 1924 to 19 funds in 1929, with approximately $140 million in assets. As of 2007, the industry
has approximately 12 trillion dollars under management distributed among 8,029 funds that
are owned by 55 million U.S. households and 96 million individuals. The most robust growth in
mutual funds has been in tax-deferred retirement accounts such as IRAs and 401 (k) where they
represent the primary investment vehicle of choice, comprising approximately 50 percent of
the total U.S. assets in self-directed retirement plans.”45
As of 2007, “together, IRAs and defined
contribution plans accounted for 52 percent of the total retirement assets.”46
Investing in mutual funds for retirement “expanded after the 1980s when traditional employer
defined benefit plans started to be phased out in favor of defined contribution plans.”47
Over
the last few decades, there has been a lot of discussion about excessive fees and
anticompetitive practices in the mutual fund industry; nonetheless, “the price elasticity of
demand for mutual funds (i.e. consumer sensitivity to the fees charged by different mutual
funds) shows that investors are very sensitive to the fees they face, and that price increases
45
Hubbard, Glenn R., Michael F. Koehn, Stanley I. Ornstein, Marc Van Audenrode, and Jimmy Royer. The Mutual Fund Industry Competition and
Investor Welfare. New York: Columbia Business School, 2010: 3. Print
46
Investor Welfare. New York: Columbia Business School, 2010: 13. Print.
47
Investor Welfare. New York: Columbia Business School, 2010: 3. Print.

27
above competitive levels lead investors to switch to lower priced funds. Consequently, there is
“no justification for laws…to control monopoly pricing in the mutual fund industry.”48
Nonetheless, the biggest issue with mutual funds and actively managed funds are their weak
and inconsistent performance, since on average “typically 70 percent of actively managed
portfolios fail to do better than the S&P 500”.49
Moreover, a study by Dalbar Inc., confirmed that many investors were not participating in long-
term mutual fund returns because of frequent switching among funds. Until this and other
studies were published, “everyone just assumed that whatever the large mutual fund firms
reported as returns were what investors got. However, these studies showed that many
investors were chasing hot returns in order to get better returns. In other words, they’d jump
from one hot fund to the other in hopes of increasing their return. But just the opposite
occurred.”50
These studies also show that the average investor has only been able to capture a
meager 2.6 percent average return over the same period (please see Graph 7). This
underperformance could be due to the fact that market volatility creates panic among investors
who tend to jump out of the market when markets perform poorly, thus preventing them in
many cases from capturing the upside of the market.
48
Investor Welfare. New York: Columbia Business School, 2010: xviii. Print.
49
Larry Light. Book “Taming The Beast”, 81
50
“Investors Still Lagging the Market.” http://www.investorsinsight.com/blogs/forecasts_trends/archive/2009/11/03/dalbar-update-investors-
still-lagging-the-market.aspx.

28
Graph 7: Average Return of Equity Portfolios 1994-2010 and the Average Investor
51
V. The Ryan Plan
The “Ryan Plan” also known as the Roadmap to America’s Future, has been pronounced by
many as the most comprehensive path to reform the current PAYG system.
This plan provides workers with the voluntary option of investing a portion of their payroll taxes
into personal savings accounts. By investing in equities and bonds, these accounts would allow
workers to build a significant nest egg for retirement that exceeds what the current social
security program provides. Each account will be the property of the individual, and fully
inheritable, which will allow workers to pass on any remaining balances in their accounts to
their descendants.
51

29
According to this plan, individuals 55 and older will remain in the current system and will not be
affected by this proposal in any way: they will receive the benefits they have been promised,
and have planned for, during their working years. All other workers will have a choice to stay in
the current system or begin contributing to personal accounts.
Those who choose the personal account option will have the opportunity to begin investing a
significant portion of their payroll taxes into a series of “life cycle” type mutual funds that
automatically adjust the portfolio’s risk based on the age of the beneficiary. These portfolios
would be managed by the U.S. government. To administer the savings fund there would be a
Board responsible for paying administrative expenses and regulating investment options
offered by nongovernment firms. The Board would consist of five members required to have
substantial experience, training, and expertise in the management of financial investments and
pension benefit plans. These individuals would be appointed by the President, two of whom are
appointed after consideration of the recommendations by the House and Senate.
Moreover, the expectation is that as these personal accounts continue to accumulate wealth,
they will eventually replace the funding that comes through the government’s pay-as-you-go
(PAYG) system. This will reduce the demand on government spending, lead to a larger overall
benefit for retired workers, and restore solvency to the Social Security Program.
The plan also guarantees the taxpayer’s contributions. Individuals who choose to invest in
personal accounts will be ensured every dollar they place into an account will be guaranteed,
even after inflation. The choice of personal retirement accounts is entirely voluntary. Even
those under 55 can remain in the current system if they choose. Further, those who choose to

30
enter the personal account system, they also have an opportunity to leave the system, and
those who initially opt out of the system of personal accounts can enter into it later on.
All individuals in the traditional system who meet certain working requirements will be ensured
that their minimum benefits are equal to at least 120 percent of the Federal poverty level, an
improvement from current law. Those in the personal account system will be guaranteed a
minimum of at least 150 percent of the Federal poverty level.
Lastly, there would be no taxation of personal account benefits. No tax will be paid on the
receipt of Social Security benefits generated from personal account payments either as a part
of an individual’s Federal income tax or estate tax.
1. Problems With The Ryan Plan
The problems with the “Ryan Plan” are numerous, and it is politically unfeasible. Firstly, the
idea that future retirees can invest in target date funds and just “set it and forget it” is naïve at
best. These funds are very volatile and future pensioners could end up losing a significant
portion of their nest-egg even when they are very close to retirement. For example, “the four
largest target date funds for people who were set to retire in 2010 lost an average of 25
percent in 2008, and one of them was down more than 40 percent.”52
Moreover, under the Ryan plan, future pensioners that participate in personal accounts are
guaranteed a minimum level of benefits of at least 150 percent of the Federal poverty level. In
other words, this plan resembles the PAYG system if the expected performance of the
52
Tim Garret, “Poor performance raises questions about automatic long-term investment”.

31
underlying investments is not achieved. Lastly, given the toxic and divisive political environment
in Washington D.C, it is unlikely that the plan will get any significant support from Democrats
who view the plan as too radical, and too similar to the failed plan that the Bush administration
attempted to pass without any success in 2005.
VI. Personal Public-Private Social Security Saving Accounts (PPPSSS)
PPPSSS accounts are an alternative that transforms the current pay-as-you-go (PAYG) social
security system into a partially privatized system.
This plan provides workers with the voluntary choice of investing the portion of the payroll
taxes that currently goes into the Social Security trust fund, into their own personal savings
accounts. Each account will be the property of the individual, and fully inheritable, which will
allow workers to pass on any remaining balances in their accounts to their descendants in the
form of a beneficiary PPPSSS account. All inherited PPPSSS accounts would be subject to annual
IRS minimum required distribution rules, but these would be based on the inheritor’s own life
expectancy. This enables continued investment without the impact of immediate taxes, so that
those who inherit the account can potentially maximize returns.
Under the PPPSSS plan, individuals 50 and older will remain in the current PAYG system. All
other workers will have a choice to stay in the current PAYG Social Security system or begin
contributing to personal public-private Social Security saving accounts.
The types of investments that would be available in PPPSSS accounts are “point to point”
market linked certificates of deposits, these financial instruments combine: FDIC insurance,

32
consistent outperformance relative to government bonds, and hedging mechanisms to help
preserve the savings of future pensioners. Moreover, in some instances, these products offer a
guaranteed minimum rate of return.
Those who choose the personal account option will have the opportunity to invest their payroll
taxes into principal protected market linked certificates of deposit (MLCDs) that range from 2 to
10 years in maturity or in U.S. government debt. For instance, savers could invest into longer
term U.S. Treasury-notes that range from 2 to 10 year maturities, and or Treasury inflation
protected bonds (TIPS) of longer maturities that hedge against the risk of cost of living
increases. For those who prefer to invest in risk free assets such as U.S.T-bills, they will be
better served by staying in the current PAYG system which ensures them a guaranteed defined
benefit.
1. Market Linked CDs: Is Equity Investment without Market Risk Possible?
Market linked certificates of deposit (MLCDs), also known as equity linked CDs or index-linked
CDs, are securities with interest rates based on the performance of a specified equity index
such as the S&P 500, the Dow Jones, UBS Commodity Index, or the price of an individual asset
such as gold. The MLCDs may vary by maturity (2 years, 5 years, etc.), and the minimum
required deposit varies from issue to issue.
Resembling traditional CDs, the MLCDs inside PPPSSS accounts provide the safety and security
of an FDIC insured return of principal when held to maturity. Also, MLCDs will provide future
retirees with diversification and a potential hedge against inflation without risking principal.

33
Unlike conventional CDs that pay a fixed rate of interest; MLCDs can potentially pay investors
inside PPPSSS accounts a specified fraction of the rate of return of an index; this upside
potential is known in the industry as a cap, which determines the investor’s upside potential.
Market linked CDs have several variants for example, in some instances these products offer a
guaranteed minimum rate of return should the market fall if investors are willing to settle for a
smaller capped return. Moreover, on the upside, the MLCD may offer, for example, 50 percent
of any market increase while protecting its holder from any market downside by guaranteeing
at least no loss.
Synthetic MLCDs consisting of a zero coupon bond and a stock index call option with the same
expiration as the time to maturity of the bond,53
were first introduced by Chase Manhattan
Bank of New York in 1987. According to the Structured Products Association, a trade group
representing issuers and vendors, “almost 50 billion of structured products were sold in
2005.”54
The average buyers of MLCDs are risk-averse investors that still need their assets to
grow in order to retire. Banks market MLCDs to investors as hybrid instruments that have the
safety of a traditional CD, with the potential to earn higher returns associated with more risky
stock market investments.
To understand MLCDs, PPPSSS investors must comprehend their composition. Inside a MLCD,
there is a “call option [that] provides the buyer with exposure to the underlying equity. The
zero coupon bond provides the buyer with principal protection. A zero coupon bond allows for
principal protection since it accretes from its discount value to its par value over a specified
53
A call option gives the right to purchase an asset for a specified price
54
Are Structured Products Suitable for Retail Investors

34
period of time…The discount from par value of the zero coupon bond can be used to purchase
the call option on the underlying equity”55
(see Graph 8 for an illustration of the workings of the
structure on a hypothetical $1000 investment in an MLCD). In other words, “if at maturity, the
underlying index (i.e. S&P 500) has increased, the investor indirectly (a bank operates as
intermediary) exercises the call option and earns a return on the capital gains portion of the
underlying index. If the index decreases, the investor does not exercise the option and receives
nothing for it. However, the investor still receives the face value of the bond thereby insuring
the original investment.”56
Graph 8: How Does an MLCD Work?
57
55
Lehman Brothers April 4, 2001. Equity Linked Notes An Introduction. http://homepages.math.uic.edu/~tier/Finance/equity-link-notes.pdf
56
Do equity-linked certificates of deposit have equity-like returns?
57
Deustche Bank PPT Presentation

35
A. Most Popular MLCD Structures
Two of the most popular MLCD structures are the “point to point” and the “quarterly cap”. The
returns on a market linked CD using the point to point method is based on the difference
between two points, or values. The starting point is the value of the index when the CD is
issued and the ending point is the value of the index at maturity. The return can be calculated
as the difference between these two points. In other words, the payout can be expressed in the
following calculation:
Point to Point Structure Return = (Final Closing Value-Initial Closing Value)
Initial Closing Value
It is important to emphasize that in this type of structure, if the indexed interest amount over
the period is greater than the cap, the capped indexed interest amount would apply.
On the other hand, a quarterly cap structure has payouts that are based on the sum of the
quarterly percentage changes in the underlying investment benchmark from the initial
quarterly index value to the final quarterly index value. Each quarterly percentage change is
calculated as follows:
Quarterly Cap Structure Return = (Final Quarterly Index Value – Initial Quarterly Index Value)
Initial Quarterly Index Value
It is important to highlight that, in this type of structure, quarterly percentage changes are
subject to a predetermined quarterly cap percentage, meaning that if any quarterly percentage

36
changes exceed the quarterly cap, the cap rate will apply as the return for that respective
quarter in the final payout calculation. The cumulative sum of the capped quarterly percentage
changes determines the indexed interest amount due upon maturity. Investors in this type of
MLCD structure must keep in mind that there is no limit, or floor, on the value of any negative
quarterly percentage change, and any positive quarterly percentage changes will be subject to
the quarterly cap. As a result, one or a limited number of negative quarterly percentage
changes could potentially eliminate all positive quarters of returns.
B. Performance of MLCDs: Historical Results
To provide PPPSSS account holders with the best investment options, the historical returns of
the following two popular MLCD structures were analyzed in a time series analysis:
The results show that MLCDs linked to the S&P 500 and gold between 1970 and 2010, and the
Dow Jones UBS commodity index between 1992 and 2010, under either structure, all
underperform a traditional index investing strategy. In other words, if an investor over this
period would have engaged on a “buy and hold” equity or commodity strategy, he or she would
have achieved a higher mean total returns than if they had invested in MLCDs provided that
they were able to withstand the higher volatility (see Graph 9 for a performance comparison
between a 2 year “point to point” MLCD vs. investing in gold).
2 year (8-quarter holding period) “point to point” MLCD with a 48% upside cap, and a 2 % guaranteed
minimum return
2 year “quarterly cap” MLCD structure with a 6 percent quarterly upside cap, which also has a 48%
potential upside (6% x 8 quarters), and a 2 % guarantee minimum return

37
Graph 9
2 Year Gold vs. 2 Year “Point to Point” MLCD 48% Upside Cap
(1970-2010)
The results described above, should not be surprising for at least two reasons. To begin with,
the most obvious one is that, by investing in an MLCD, whatever the structure, the PPPSSS
investor is agreeing to give up some potential upside in a bull market in order to protect
principal during times of weak or negative returns. This potentially represents a huge
opportunity cost in a bull market. The second reason for underperformance is due to the fact
that traditional equity and commodity investments carry a bigger risk than investing in MLCDs.
Investors expect a higher return by investing in an index or an asset such as gold than by
investing in an MLCD which has a lower standard deviation.
Nonetheless, according to the simulated historical returns between 1970 to 2010 for the three
asset classes, the good news for future PPPSSS investors is that the 2 year (8-quarter holding
period) “point to point” MLCD with a 48% upside cap, and a 2 percent guaranteed minimum
return, linked to the S&P 500 and gold outperformed Treasury-notes of the same maturity (see

38
Graph 10 to observe the outperformance of gold over T-notes). Moreover, the 2 year (8-quarter
holding period) “point to point” MLCD with a 48% upside cap, and a 2 percent guaranteed
minimum return, linked to Dow Jones UBS commodity index between 1992 and 2010, also
outperformed Treasury-notes of the same maturity. This is possible due to the fact that, “the
synthetic [MLCD] has a 0 beta in a down stock market and a beta close to 1 when there is a
healthy, positive market return.”58
The historical returns on the “point to point” structures and 2 year T-notes are as follows:
However, it must be emphasized that for the S&P 500, the Dow Jones UBS commodity index
and for gold, the above referenced “quarterly cap” MLCDs underperformed Treasury-notes
despite having a higher standard deviation.
58
Edwards, Michelle, Do equity-linked certificates of deposit have equity-like returns?
MLCD Type & Period (1980-2010) MLCD 2 Year Total Mean Return SD 2 (year period) 2 YEAR T-note SD (2 Year Period)
2 Year Point to Point S&P 500 MLCD 12.78% 19.20% 5.72% 7.26%
2 Year Point to Point Gold MLCD 9.52% 17.80% 5.72% 7.26%
Period 1992-2010 MLCD 2 YEAR TOTAL RETURN SD 2 (year period) 2 YEAR T-note SD (2 Year Period)
2 Year Point to Point DJUBS Commodity Index 7.80% 15.90% 3.78% 3.60%

39
Graph 10:
2 Year Gold “Point to Point” MLCD 48% Upside Cap Outperforms 2 Year T-note
(1980-2010)
However, despite the superior performance achieved by the “point to point” structures, it must
be emphasized that these instruments have more volatility than T-notes. Thus, for those
PPPSSS investors that do not feel comfortable with a higher level of volatility inside their
accounts, government bonds still are an attractive proposition. Nevertheless, features such as
principal protection and FDIC insurance may entice some investors to ignore the volatility to
capture potential higher returns. The MLCDs inside PPPSSS accounts are FDIC insured because
they will be sold to future pensioners by commercial banks.
The final question then becomes why anyone outside of PPPSSS accounts would invest in a
financial instrument like the “quarterly cap” MLCD given the alternative of the “point to point”
MLCD? One probable answer is that investors cannot easily estimate the return distributions of
the different [2-year] investment strategies (see Graph 11). Thus, in the absence of detailed
analysis, and the types of regulations found in the PPPSSS plan which forbids any MLCD
0%
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60% 1980
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2 year t-note MLCD 2 year gold

40
offerings that are not “point to point”, investors interpret the marketing literature that stresses
the safe return of principal with the opportunity to participate in positive market returns as a
win-win opportunity.
Graph 11:
2 Year Gold “Point to Point” MLCD 48% Cap vs. 2 Year Gold “Quarterly Cap” MLCD 48% Cap
(1970-2010)
In conclusion, in the period analyzed, the descriptive statistics show that although MLCDs can
capture a significant portion of market upside, they underperformed equity and commodity
returns during bull markets. Moreover, it was established that the 2 year “point to point
structure” in the three different asset classes that were analyzed substantially outperformed
Treasury-notes of the same 2 year maturity. On the other hand, the quarterly cap structures
not only displayed a higher standard deviation than T-notes, as expected, but their mean total
return underperformed that of 2 year Treasury-notes. It is however important to emphasize
that prior to purchasing MLCDs inside PPPSSS accounts, investors must understand all of the
0.00%
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1972
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MLCD 2 year return Point to Point MLCD 2 year return Quarterly Cap

41
terms and conditions; the percentage of the index return that will accrue to the investor’s
account, and the amount to be earned if the underlying index or asset declines in value.
C. Drawbacks of MLCDs
There are many considerations that must be taken into account when investing in MLCDs. For
instance, MLCDs do not provide any assurance of gains unless a minimum return is established.
MLCDs are riskier than regular certificates of deposit because there is the possibility of earning
nothing if the underlying index or commodity to which it is linked does not perform well. Thus,
the PPPSSS account depositor must be aware that when he invests in an MLCD, he or she trades
a sure payment on investing in a traditional in a government bond.
Secondly, the hybrid nature of the MLCD (zero coupon bond and call option) may make it
difficult for investors to understand the risk and return characteristics of the financial
instrument. Moreover, these instruments could be very expensive, with fees that could range
between 2 and 7 percent.
Thirdly, in terms of liquidity, MLCDs are not securities; consequently, they do not trade on a
securities exchange. Moreover, there is no secondary market for them at the moment. Also,
PPPSSS investors face penalties if the money is withdrawn before maturity; thus, this presents a
liquidity risk that investors must contemplate before investing in an MLCD.
Fourthly, unlike long term capital gains that are limited to a 15 percent tax rate, MLCD returns
are considered interest income and taxed at the holder’s ordinary income rate. Thus, these

42
instruments are not tax efficient for most consumers when purchased inside non-qualified
accounts.
Lastly, a PPPSSS investor purchasing an MLCD issued by a bank in excess of the FDIC- insured
amount ($250,000) will have credit exposure to the bank; thus investors could incur in credit
risk.
D. Addressing the Drawbacks of MLCDs Inside PPPSSS Accounts
In order to counter these drawbacks, policymakers and PPPSSS investors must consider the
following points:
Firstly, in order to minimize the complexities of investment selection and choices, under the
PPPSSS plan, the government would be in charge of providing information to future pensioners,
and the private sector (banks) would offer consumers through a competitive environment, the
best options for growth, diversification, and principal protection.
The PPPSSS plan guarantees the taxpayer’s contributions. Individuals who choose to invest in
personal accounts will be ensured every dollar they contribute into their account (MLCDs are
FDIC insured up to $250,000); nonetheless, only those who invest in TIPS will be fully hedged
against inflation.
Secondly, under the PPPSSS plan, the tax inefficiencies of MLCDs are eradicated since any gains
would accrue in a qualified tax deferred account.

43
Thirdly, the PPPSSS system charges no explicit fees to consumers. Under this plan financial
institutions (banks) would realize profits only after exercising the at the money call option once
the MLCD matures. Once exercised, banks will keep everything above the MLCD cap level that
was offered to consumers. Thus, although financial institutions will not realize a profit when
either markets perform poorly, or when the return of the MLCD is lower or equal to the cap
that is paid to consumers; during bull markets, banks will have unlimited upside potential.
Moreover, the banks downside potential would be limited to the expenses in which they have
to incur (i.e. labor hours) with those employees dedicated to the construction and management
of these financial instruments.
Politically this could represent an attractive proposition for politicians of both major parties. For
democrats, the protection of principal and FDIC insurance would be seen as positive features of
the plan. Moreover, the fee structure of the plan would allow politicians to claim that under the
PPPSSS plan “Wall Street does not get paid unless the people get paid”. Republicans will
support this plan because it reduces the involvement of government to the role of regulator
and provider of information, and potentially reduces the fiscal burden of future unfunded
implicit liabilities.
2. How Do PPPSSS Work?
The market linked CD offerings that would be available to consumers, would be constructed
and managed by domestic (U.S.) commercial banks of the highest credit quality, these banks
would compete with one another in an auction type system that together with economies of
scale would ensure the best available rates for consumers. After the bidding occurs, the bank

44
that offers the best rate to consumers would be ranked first; however, with the objective of
safeguarding consumers from exceeding the FDIC insurance of $250,000, savers would be able
to purchase MLCDs from other institutions that rank lower. (Please see Graph 12 for an
example on the market competition inside PPPSSS)
Graph 12: Market Competition between Financial Institutions
The role of the social security administration would be to ensure that offerings from banks
whose credit ratings are less than triple AAA are not allowed to compete on daily auctions. This
credit rating prerequisite, together with the safety and security of FDIC insurance significantly
minimize credit risks for future retirees. Moreover, under a PPPSSS system, the role of the
government would be to ensure that consumers receive the best available information about
bond and MLCD rates. In order to accomplish this goal, the Social Security Administration
would place MLCD rankings and issues into a website that could be accessed by consumers and
their financial advisors 24/7. Moreover, in order to minimize information asymmetries,
consumers will have at their disposal a government toll free number that would be open 24
hours. Also, consumers could call the issuers of MLCDs (banks) directly, and consult with

45
financial advisors regarding maturities, rates, and the type of index that the MLCD is linked to
(i.e. S&P 500).
The expectation is that as these PPPSSS accounts continue to amass wealth, they will eventually
replace the funding that comes through the government’s pay-as-you-go system. This will
reduce the demand on government spending, lead to a larger overall benefit for retired
workers, and restore solvency to the Social Security program.
For less risk-averse individuals with liquid or invested assets totaling $250,000 or more outside
or inside qualified accounts, the option of a trustee to trustee qualified non-taxable transfer will
be available. Under this plan, current payers to the Social Security system would be allowed to
channel their contributions into their 401 (k), 403 (b), IRA, or into a long term care insurance
policy. This transfer could be accomplished by completing a one page suitability analysis
provided by the trustee of the savers’ qualified plan. The private companies that receive the
assets transferred by the Social Security administration would be liable in case of loss if there
are irregularities found in the transfer process, or if the person who transferred the assets did
not meet the $250,000 threshold at the time of the transfer. The suitability analysis is not
intended as a bureaucratic hurdle, but as a way to ensure that those who completely transfer
out of the Social Security system have enough means to live during retirement, and do not
become dependent on the state if they were to lose those funds in more risky investments.
(Graph 13 provides a list of choices that will be available to consumers)

46
Graph 13: In the Future these will be Your Choices
Lastly for savers that select PPPSSS accounts, they will be eligible for tax free distribution of
benefits at age 67. On the other hand, for those individuals who select the option of a trustee
to trustee qualified non-taxable transfer, they will be eligible to take distributions at age 59 and
a half as it is customary inside these plans. Nonetheless, the portion of the distributions which
accounts for gains inside 401k, 403 b, IRA would be subject to long term a capital gain which
currently stands at 15 percent. It is also important to highlight that the contributions that
derive from payroll taxes would not be subject to double taxation. For accounting purposes, a
401 k or a 403 b administrator would have to disclose in quarterly statements the portion of the
contributions that are pre-tax, and those that derive from payroll taxes. Moreover, to simplify
matters further, investment companies would have to denote investments in mutual funds that

47
were purchased with contributions from payroll taxes with a new type of share class. This new
share class would be known as a Freedom share or “F share”.
VII. Final Remarks and Conclusion
Reforming social security is one of the biggest challenges that this country confronts in the
twenty first century. The sustainability of the welfare state not only depends on implementing
bold reforms, but in bringing together policymakers to design a new social contract with the
citizens of this nation.

48
VIII. Annexes
Annex 1: Description of Retirement Plans in the United States
Traditional IRA: In a Traditional IRA, you make contributions with money you may be able to
deduct on your tax return and any earnings potentially grow tax-deferred until you withdraw
them in retirement.
Roth IRA: In a Roth IRA, you make contributions with money you've already paid taxes on (after-tax)
and your money may potentially grow tax-free, with tax-free withdrawals in retirement, provided
certain conditions are met.
SEP-IRA-Simplified Employee Pension Plan: Simplified Employee Pension Plans (SEP-IRAs) help
self-employed individuals and small-business owners have access to a tax-deferred benefit
when saving for retirement.
Simple IRA: Savings Investment Match Plans for Employees (SIMPLE–IRAs) make it easier for
self-employed individuals and small businesses with 100 employees or fewer to offer a tax-
advantaged retirement plan, funded by employer contributions and elective employee salary
deferrals.
401K Plans: This is a private defined contribution (DC) plan that is available for small and large
businesses. Employees that participate in a 401(k) plan, tell their employer how much money they want
to go into the account (limits apply). The contributions come out before taxes are calculated.

49
403b Plans: A 403b plan is a retirement plan for university, civil government, and not-for-profit
employees. It has the same characteristics and benefits of a 401K plan since it shares many of the
withdrawals, contribution limits, tax rules, and investment choices.
457 Plan: A non-qualified, deferred compensation plan established by state and local governments and
tax-exempt governments and tax-exempt employers. Eligible employees are allowed to make salary
deferral contributions to the 457 plan. Earnings grow on a tax-deferred basis and contributions are not
taxed until the assets are distributed from the plan. 59
Social Security: This is a government sponsored plan in which benefits are based on the amount of
money you earned during your lifetime with an emphasis on the 35 years in which contributors earned
the most.
State Pension Plans: Most State pensions are plans are set up as fully funded schemes.
Private Defined Benefit Plan: This type of plan promises to pay a specified amount to each person who
retires after a set number of years of service. Such plans pay no taxes on their investments. Employees
contribute to them in some cases; in others, all contributions are made by the employer.
59
http://www.investopedia.com/terms/1/457plan.asp#axzz1pR3iSDgc

50
Annex 2: Correlation amongst different asset classes for the last 10 years

51
VIII. Bibliography
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strategy-driven investment research firm.

52
11. Greenhouse, Steven. "Pension Funds Strained, States Look at 401(k) Plans." Cnbc.com, n.d.
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53
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Vision and Reality (2008): 1-35. Print.
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Royer. The Mutual Fund Industry Competition and Investor Welfare. New York: Columbia
Business School, 2010. Print
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skeptical-about-private-social-security-accounts/>.

54
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52. Tim Garret, “Poor performance raises questions about automatic long-term investment”.
Print
53. A call option gives the right to purchase an asset for a specified price

56
54. McCann, Craig, and Dengpan Luo. "Are Structured Products Suitable for Retail Investors?" N.
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57. Deustche Bank PPT Presentation
58. Edwards, Michelle. "Do Equity-linked Certificates of Deposit Have Equity-like Returns?" N.
pag. Web. <http://www2.stetson.edu/fsr/abstracts2/V14-4%20A3.pdf>.

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