Quiz 15: Social Security and Medicare: How Secure Is Our Safety Net for the Elderly


Private insurance is a scheme by which a private company sells policies to the public, which are essentially contracts that guarantee a payment by the private company to the customer if some particular event should occur. The company earns a profit from this scheme by setting the premiums , or the price of the insurance policies, so that they continuously bring in more money than they have to pay out. Social insurance is offered by a government rather than a private company. Similar to private insurance, social insurance makes payments to individuals when certain events occur. Unlike private insurance, however, social insurance plans typically include all of the citizens in a country, and are funded by taxes. The government does not necessarily have the profit motive of a private insurance company, but nevertheless there is an incentive to ensure that money coming in exceeds money going out in order to keep the program sustainable. When considering whether any good or service should be more public or more private, the key consideration depends on the characteristics of the good, or rather, its desired characteristics. A public good is meant to be available to anyone at the same benefit level and should not be denied to anyone. Thus, if the insurance service represents something that provides something with these qualities, it would be better provided as social insurance than as private insurance. Whether or not this is the reality depends on expectations of government, which varies by culture. Health insurance is a good example. Some may argue that health is a fundamental requirement of everyone in a society. Consequently, health insurance should be offered as a form of social insurance to ensure that at least basic needs are met. Most developed countries offer nationalized health insurance plans to their citizens. However, the United States only provides such a program (Medicare) to the elderly, because there is a different expectation of the level of services to be provided by government. While there is much difference of opinion on the subject, the idea that each citizen should bear the costs of their own needs has been the dominant view, and thus the health insurance market for the non-elderly consists of private companies.

Fully funded insurance scheme: The fully funded insurance scheme is designed to provide benefits that are accrued from the interest income earned on accumulated payments. Initially, the social security program was designed as a fully funded insurance program. However, it never operated as a fully funded insurance program. The main reason was that during the period of great depression, elderly workers who had lost their savings made an immediate pressure to provide their benefits. Due to this action, the system did not get enough time to make an adequate investment fund. Pay-as-you-go insurance scheme: Due to the financial crisis in the fully funded insurance scheme, in 1939, the social security scheme was converted as a 'pay-as-you-go insurance scheme'. Under this scheme, the funds from the current contributions are used to finance the annual benefits expenditures. That is, the current recipients earned the social security benefits from the tax contributions of the current workers. Therefore, the economic effects of a fully funded insurance program are different from those of the pay-as-you-go system.

A statement that Social Security transfers wealth from one generation to another, that is, from the younger generations to the older ones, depends on whether payments into the system from some members are used to make the payments out of the system for other members. Social Security is neither a "fully funded" with funds for individual members handled independently, or a "pay-as-you-go" system where all funds are pooled together, but a hybrid system somewhere between the two. A fully funded system would have no intergenerational transfer while a pay-as-you-go system would be almost completely comprised as intergenerational transfer. In the early days of Social Security, the system was set up to make immediate payments for retirees who had lost their savings in the Great Depression. That money came from taxes paid by younger members. In that circumstance, the system was certainly an intergenerational transfer of income from the younger to the older generations. However, over time, the amount of payments into the system gradually increased so that this became less true. When the baby boomer generation entered working age, the money flowing into the Social Security trust fund exceeded the spending outward. The difference was saved, so the system became more fully funded. Because that age group outnumbered older generations by a good margin, the money they contributed was more likely to be paid back to them in retirement than contribute to older generations' Social Security payments. However, as the baby boomer generation enters retirement, the system will regress back to one of wealth transfer from the young to the old. Since subsequent generations are smaller in size, there will be a smaller ratio of those paying in to those drawing out, eventually leading to the exhaustion of the fund if there are no changes to the system.