Proposals to bolster the Social Security trust fund by allowing it to invest in private equities have stirred controversy for more than a decade, but the experience of a retirement plan for railroad workers offers a glimpse at the pitfalls and how they could be avoided, a Center for Retirement Research brief found.
The political and financial risks associated with such investments have long been enough to keep the Social Security fund from getting the nod to invest in equities. The Railroad Retirement program, which is similar to Social Security’s pay-as-you-go model, started investing in equities in 2001.
Social Security would need to do two things to follow the path of the Railroad Fund, the center, based at Boston College, said. First, to keep political influence out of the management process, it recommended a “highly circumscribed investment program using index funds.” Second, an automatic mechanism to absorb market risks would need to be put in place.
Keeping politics out of investment decisions has been one of the arguments against allowing Social Security to invest in equities, an idea first considered during the Clinton administration. The Railroad Fund met that problem by creating the National Railroad Investment Trust, a non-government organization, which makes only periodic reports to Congress.
Steven Sass, a research economist at the center, that in 1999 the railroad plan executives and the labor unions started to negotiate a plan to invest some of the fund in equities. Using historical data, they calculated that when they started investing in equities, payments to the fund would decrease to 18 percent from 21 percent of all employee’s salaries. Of that 18 percent, employees would pay 13 percent and management would pay 5 percent.
Congressional approval was needed to make the change. The plan included an automatic mechanism to absorb shocks in financial markets. The Railroad Retirement mechanism adjusts the amount paid to the fund based on whether the pension fund's total assets are up or down.
The report found that the mechanism has worked, though slowly. Despite the 2008 market crash, Sass said the railroad fund had increased in value enough so that contributions were cut to 16 percent of workers’ salaries, 11 percent of which came from employees. That’s because the value of bonds skyrocketed as interest rates fell. Only this year, 2013, did contributions rise to 17 percent. So employees are paying less now than they did when the program started.
The railroad fund had $23.7 billion in assets at the end of last year.