6

The Origins and Nature of the Railroad Retirement System

The railroad retirement system was created by the Railroad Retirement Act of 1935. It is the only federally-administered pension plan for the workers of a single private industry. As a major heavy industry and a strongly unionized one, railroading has long been a leader in providing benefits for its workers. Railroad company and union pension plans grew on a substantial scale until they ran into financial difficulties early in the Great Depression of the 1930's. Then the railway labor organizations began to look to the Congress for a more satisfactory solution.

The Congress first acted in 1934 with a plan calling for federallyadministered pensions supported by contributions from the workers and the employers and administered by an independent Railroad Retirement Board. This Act was declared unconstitutional by the Supreme Court in 1935 under the narrow construction then accorded the authority of the Federal Government to regulate interstate commerce. The Railroad Retirement Act of 1935 was largely similar to its predecessor, except that it took its authority from the general welfare clause of the Constitution and the taxing power of the Federal Government. Benefit provisions under this second Act were separated from taxing provisions. The latter were simultaneously enacted in the Carriers' Taxing Act. In June 1936 the carriers won a District of Columbia District Court judgment that the new legislation, too, was unconstitutional. However, the Railroad Retirement Board started payment of benefits to former company pensioners on July 13, 1936. The following December President Franklin D. Roosevelt took a hand and secured a formal, signed agreement between the representatives of the unions and of management on February 18, 1937.

The 1937 agreement provided in principle that: (a) the carriers and the employees would support the retirement system on an "equal tax burden" principle and the parties would not depart from this arrangement; (b) both sides would support the existing legislation and would not contest the constitutionality of legislation putting the plan into operation; (c) beneficiaries on the rolls of private pension plans would be transferred to the new system; and (d) railroad employment would be excluded from coverage under the Social Security Act. The 50/50 cost sharing has been preserved for the regular Railroad Retirement Account, but in 1966 the carriers agreed to pay the full cost of certain supplemental benefits for long-term employees through a separate Railroad Retirement Supplemental Account. The present. total railroad retirement "package" costs the employees 46% of total contributions, the employers, 54%.

The Railroad Retirement Act of 1935 removed railroad employment from the coverage of the Social Security Act of 1935, then two weeks old. One reason was that the railroad labor and management wanted immediate payment of benefits to retired railroad workers, and monthly social security payments were not originally scheduled to begin until 1942. In historical perspective, this step established a precedent of exemption from social security coverage and led to the mixing of social insurance and private pension principles which created many of the problems that confront the railroad retirement system today. The Development of the Railroad Retirement System, 1935–1971

At the outset the railroad retirement system was almost solely a career emplovee retirement program and this emphasis remains the

7

primary thrust of the system to this day. The main emphasis was on retirement and disability benefits. The retirement benefit formula was structured primarily to reward length of career service in the railroad industry; benefits were computed on average covered lifetime wages. Computation was by a formula in which a basic amount (derived by three different percentage factors applied to wages) was multiplied by years of service. Except for a joint-and-survivor option and certain temporary death benefits under the 1935 Act, there was no protection for survivors.

The social security system has developed along lines which emphasize social adequacy rather than career service. Its benefit formulas provide a significantly higher replacement ratio for lower wages. New start provisions have enabled many workers to qualify for relatively full benefits after coverage of only a portion of their careers. Benefits have been extended not only to the aged retired, but to their dependents, to survivors, later to the disabled, and then to their dependents. Thus, family protection has become an important function of the system.

As the social security system grew in scope and adequacy, the railroad retirement system has been adjusted to keep abreast. In 1939 social security added survivor benefits; in 1946 the railroad retirement system followed suit. In the early years railroad retirement benefits were several times larger than their OASDI counterparts. However, the Social Security Amendments of 1950 raised OASDI benefits by an average of about 77% and greatly broadened the coverage of the system by blanketing-in millions of new workers and simplifying eligibility requirements. This action was followed by the Railroad Retirement Amendments of 1951 which raised railroad retirement benefits and made other very important changes in the system. Thereafter, whenever social security benefits were raised, railroad retirement amendments soon followed.

All told, the Congress has enacted 12 major amendments to the Railroad Retirement Act since 1935, mostly in response to social security amendments that broadened the scope of the benefit protection and increased the benefit levels substantially. Benefits for retired railroad workers have increased substantially faster than the cost of living. For example, from 1951 to 1970 the average monthly benefit for a retired single worker has increased from $90 to $194, or 116%. Adjusted for inflation, the real purchasing power of the benefit for the unmarried retiree has improved 44% since 1951. For a worker and wife, the average monthly benefit has increased from $141 in 1951 to $310 in 1970, or 120%. In constant purchasing power terms, the improvement has been 47% for the couple.

The Interlinking of Railroad Retirement and Social Security

The numerous amendments in the railroad retirement and social security programs in the last 35 years have had several important effects on the character and status of the railroad retirement system.

First, the nature of the system has been fundamentally changed. Significant amendments in 1951 provided that all railroad retirement benefits were to be at least equal to those payable under OASDI based on combined railroad and social security service, and further amendment in 1959 raised this guarantee to 110%. This changed the railroad retirement system into a family income maintenance program by establishing the entire social security benefit structure as a floor within the

8

railroad retirement system while retaining all its earlier staff pension elements.

Railroad workers who spend a full career in the industry receive benefits that are about twice as high as social security benefits. They also pay taxes which are about twice as high as social security taxes. In 1972, the railroad worker and his employer each pay 9.35% of the first $750 of covered monthly wages, or a maximum of $841.50 a year. This tax is divided 4.6% ($414.00) for OASDI and 4.75% ($427.50) for the Railroad Retirement Account. In addition, the carriers finance the entire cost of a supplementary benefits program for career employees enacted temporarily in 1966 and made permanent in 1970.

Second, the railroad retirement system has become administratively and financially interwoven with social security in a number of extremely complex ways. It is almost impossible for the Railroad Retirement Board to make a final award today without first checking with the Social Security Administration. Many of the benefits awarded, particularly for survivors, are based on combined railroad and social security service and wages; also, many railroad benefit awards must be computed by a different formula if the beneficiary receives an additional benefit directly from OASDI.

A close linkage also results because of the financial interchange, enacted in 1951. The statutory purpose of the interchange is to place the social security system in the position in which it would have been if there had been no separate railroad retirement system and railroad workers had always been covered by social security. On the revenue side, the Railroad Retirement Account transfers to the social security trust funds the taxes which social security would have collected directly from railroad workers and their employers. On the benefit side, the social security system transfers to the Railroad Retirement Account that portion of the railroad retirement benefits that social security would have paid for combined railroad and social-security-covered service, minus the sum of any OASDI benefits paid directly by the Social Security Administration to railroad retirement beneficiaries. The net effect of this offset is that the Railroad Retirement Account bears the excess cost of dual benefits. This excess cost is a large and increasing amount because of the large and growing number of dual beneficiaries. It is a cost that could have been avoided by full coordination of railroad retirement with social security. The financial interchange settlement is now carried out annually on a current pay-as-yougo basis, except for an average 18-month lag between accrual and transfer, which is covered by an adjustment for interest.

Had it not been for the financial interchange, the Railroad Retirement Account would be entirely exhausted today. Retroactive application of the 1951 financial interchange from 1937 on has resulted in a net flow to the Railroad Retirement Account from 1937 through June 30. 1971 of $5.9 billion. Even so, the Railroad Retirement Account is seriously underfunded.

The formal exclusion of railroad workers from regular social security coverage has led to costly structural problems. Because railroad employment is not covered by social security, and because social security permits qualification for substantial benefits after relatively short service, many railroad workers are able to get both social security and railroad retirement benefits. In 1971 38% of the railroad bene

9

ficiaries were receiving benefits from both systems. Typically, these dual benefits involve an excess or windfall element. They are weighted in favor of low earnings and are disproportionate to contributions and to length of social security service.

Under the financial interchange, the excess cost of these dual benefits is charged to the railroad retirement system-estimated at an average annual level cost of $480 million a year for the years 19702000. Although short-service railroad workers qualify for dual benefits more frequently than full career workers, all railroad workers must pay taxes that help finance these excess costs.

BASIC TRENDS AFFECTING RAILROAD RETIREMENT

The financial condition of the Railroad Retirement Account depends directly on railroad employment trends which, in turn, result from the forces affecting the economic situation of the industry. Because pension commitments are intergenerational in nature and extend from a worker's job entry to his or his wife's death, it is necessary to look many years ahead to assess fully the system's actuarial solvency, even though long range projections involve much uncertainty. The Commission made many projections for periods up to 75 years ahead. Projections of annual receipts and expenditures year-by-year are also necessary to diagnose cash flow problems that are not revealed by conventional actuarial present-value calculations. Inasmuch as the critical problems of this system lie in the next 30 years, the Commission has analyzed projections of receipts and outlays to the year 2000 with particular care.

The Commission carried out two major in-depth studies. One analyzed and projected the future of railroad employment against the backdrop of total transportation and GNP prospects through the year 2000, using alternative assumptions. The second study developed and programmed a dynamic computerized actuarial model of the railroad retirement system which projected its receipt and benefit flows in considerable detail for periods up to 75 years and also made the conventional actuarial present-value calculations under alternative sets of assumptions regarding economic and benefit trends. All the projections confirm the finding that the present system is in financial trouble and will soon go broke, unless immediate corrective action is taken to increase the tax rate and/or the wage base or reduce benefits.

These studies were supplemented by eight additional related projects. The Commission's reports provide a comprehensive array of data and other information for assessing the status of the railroad retirement system.

Declining Railroad Employment

Levels of railroad employment running as far back as 50 years determine the present and future number of retirees and other beneficiaries. Present and future railroad employment and payrolls also determine current and future tax collections to support the system.

Past funding methods did not provide for the accumulation of sufficient reserves to tide the system over its coming peak outlay period. The need for such funding was not brought out in the published actuarial reports. The valuation methods used relied very heavily on future

10

tax collections to pay the benefits, and calculated the costs on a level basis "in perpetuity". These past actuarial studies have usually assumed that railroad employment would continue indefinitely at a level close to the actual employment at the time. Their results have therefore been consistently over-optimistic and the system was not funded adequately for its period of peak costs in relation to covered payroll. Through its studies of past trends and its projections of possible future trends in railroad employment the Commission has reached two principal findings:

(1) Railroad employment has trended almost steadily downward for the past 25 years; and,

(2) Employment will probably continue to decline.

The general trend in railroad employment for the last 25 years, despite minor fluctuations, has been almost steadily downward. Indeed, the all-time peak of railroad employment occurred more than 50 years ago, during World War I. When the railroad retirement system was established in 1937 there were 1.28 million railroad workers (average of mid-month monthly counts). The number rose again to 1.68 million during World War II, and thereafter declined almost steadily. Average railroad employment in calendar year 1971 was only 611,000, only 43% of the 1950 level. In the first quarter of 1972 it was 582,000, compared with 616,000 in the first quarter of 1971.

This trend has occurred despite a doubling in the real GNP and an increase of nearly 30% in ton-miles of intercity freight carried by the railroads during the last twenty years. Two significant forces account for this reduction of railroad employment in a growing economy. Technological improvements in the railroad industry and changes in the composition of the freight carried have increased output per worker and enabled growing amounts of freight to be moved by sharply decreasing numbers of employees. In addition, increased competition since the 1940's from highway, pipeline, waterway and air transportation have cut into the share of intercity freight and passenger traffic moved by the railroads. In 1940, for instance, railroads accounted for 61% of all freight ton-miles, but in 1970 their share was 40%.

Passenger service has also declined sharply. At their all-time peak in 1944, railroads carried 75% of the intercity public transport load, airlines about 2%. In 1969 railroads carried about 8% of these passengers, airlines about 73%. (These figures do not include the large proportion carried by private automobiles.)

The likelihood of continuing future decline in railroad employment is suggested by projections made for the Commission by the National Planning Association (NPA). Of several alternative projections, the one deemed most probable indicates that between 1970 and 2000 in a growing economy the revenue traffic units (largely freight ton-miles) carried by railroads will rise from 784 billion to 1,396 billion. This is a 78% increase in 30 years, or 1.9% a year. In this span of years it was assumed that output per employee will increase by 4.8% yearly at first but will gradually fall off-to a rate of 3.6% by 2000. This compares with a 4% increase in the 1950's and a 5.8% increase in the 1960's, calculated without adjustments for the changing mix of traffic.

82-813 O 72 10