The DoD can Further Optimize its Retirement System

BLUF: The DoD could probably save money, increase servicemember compensation, and better optimize talent management if it further increased TSP contributions while reducing 20-year retirement pensions.

Introduction to the Military Retirement: For decades, the DoD had a retirement system where after 20 years of active-duty service (and upon leaving the service) a servicemember (SM) was entitled to an immediate annuity based on years of service and basic pay using a 2.5% multiplier. For instance, after 24 years of service, a SM essentially earned 2.5% * 24 = 48% of their base pay for the rest of their life.  In 2016, Congress created a new system called the Blended Retirement System (BRS) that reduces the base pay multiplier to 2.0% but adds two new components: 5% matching Thrift Savings Plan (TSP) contributions and continuation pay (CP) (a few month’s pay for signing and continued service obligation for 8-12 year SMs).

The traditional 20-year retirement model (T20R) served as a powerful retention tool.  It takes a lot of time and resources to develop a senior Non-Commissioned Officer (NCO) or a field grade officer, and the T20R is a strong incentive for retaining talent who often have lucrative civilian career options. The problem with the T20R is that it is expensive to the Department of Defense (DoD), accounting for about $52 billion of its budget annually.[1]

The BRS was developed in the interest of saving money while also strengthening talent management.  Costs are initially higher under the BRS because of expenditures for CP and TSP matching contributions, but costs will eventually lower due to the lowered retirement pensions.[2]

The BRS promotes talent management because it improves incentivizes for short-term and mid-term service as well as long-term, 20+ year service.  Some individuals who would be valuable assets to the DoD are not necessarily careerists, and matching TSP-contributions is an incentive to attract them. Additionally, too many servicemembers tend to leave at 20 years; the BRS would better incentivize additional service.

My Argument: The military/Congress decided on a matching contributions rate of only up to 5% of base pay, but I argue that a higher percent of matching contributions, such as 10%, can further save the DoD money over its T20R system, increase average SM compensation, and increase talent management by offering more optimal incentives for SM retention.

Current Retirement System Example: A typical compensation scenario under the traditional retirement system: If an officer retires at a paygrade of O-5 at 20 years of service, it will cost the DoD an additional $10,278 per year compared to the BRS model which has a pension set at 40% of final base pay.  With future improvements in medical care, 20-year retirees (approximately 42 years old) might very well live up into their 90s, which may be 50 years after their retirement. Under the T20R, this 50-year pension would cost the DoD $2,569,530, and under the BRS, this would cost $2,055,624. Out of this $513,906.00 in savings comes the TSP matching contributions and continuation service pay in the new BRS.

Blended Retirement System Example:  Under the BRS, the military plans to match up to 5% of a SM’s contribution to their TSP. Over a 20-year career where a SM chose to donate at least 5% of their base pay to the TSP, this would cost the DoD $75,573.80 over the 20 years.  Continuation pay, an additional retention incentive, costs the service 2.5*base pay. For an O-4 with 12 years in service, this would cost the DoD $18,075.45. Under the new BRS, the military is not spending approximately $513,906 due to the difference in pensions (at 50 years after retirement), while additional expenditures for a 20-year officer retiree would generally only amount to $93,649.254.  Just as the DoD is saving $420,256.74, SMs who transfer to the BRS lose approximately this much income over their lifetime due to smaller monthly pensions (assuming they would have donated the TSP matching contributions themselves).

Proposal: While the DoD ought to save money and cut costs, I argue that it is even more important to offer competitive incentives for the sake of talent management and retention.  To illustrate a point, if the military were to maximize TSP contributions (limit of $18,500) for a 20-year career officer, this would cost the DoD $370,000. This is still less than the $420,256 in savings the DoD makes under the new BRS. This would allow the SM to open up a private investment account like a Roth IRA, which one would expect to match the returns of the TSP.  While the DoD would still be saving $50,256, the SM still investing $18,500 a year could now reasonably expect to earn an additional $550,894 over 20 years assuming a market growth of 4% over inflation. If the SM did not touch this money and stopped contributing to the Roth IRA after retiring at 20 years TIS, they could expect to have both their TSP and Roth IRA each worth $3,915,032 after 50 years.

This is an extreme argument to exemplify a point: the DoD can save money and increase SM compensation by utilizing market forces and compounding interest.  Only about 17% of SMs end up serving 20 years and retiring [3], so it would be very costly to the DoD if it were paying everyone an additional $18,500 a year for their TSPs. The military, however, is interested in increasing short-term service incentives for talented individuals who know a 20-year career is not for them.  The military also may be interested in reducing the incentive for mid-career (8-15 years) SMs to force themselves to continue service (out of fear of walking away with no retirement benefits; this the military does not want to retain members who really are ready to go). Additionally, the military is interested in reducing the overly strong incentive for talented senior SMs to get out shortly after 20 years of service.[3] See Appendix A for a chart of officer retention.[3]

To balance these incentives and the cost behind them, the DoD can increase matching TSP contributions to, say, 10%, while paying for this through reducing the pension percentage of base pay after 20 years to say, 35%.  For an officer who allots the full $18,500, and would allot the extra 10% of their Base Pay saved by the DoD’s 10% matching contributions, this would yield an extra $55,089.45 after 20 years.

According to my model (detailed below), a SM will always have less total compensation than the T20R until after 24 years after retirement at 20 years (assuming a RR < .5).  After 24 years, BRS retirees will see their total compensation surpass that off T20R retirees. If a BRS retiree is most interested in maximizing their lifetime compensation (perhaps for the sake of setting up a trust for a good cause) and they are willing to bear the lower pension up until their 24th year after retirement (approximately 66 years old), they are actually best off with a lower RR.  The best RR for that frame of mind is actually 0.

Model

Problem: Find an optimal TSP matching contributions rate and pension rate (as a final percentage of final base pay) to maximize lifetime earnings of service-members (SMs) without increasing costs to the DoD.

Variables:
        RR, the new 20 year retirement rate to optimize ;
LSEn, lifetime service earnings at year n ;
        TBPn, total base pay, the summation of base pay earned in all ranks prior to year n ;
        BPn, base pay at year n ;
        TCn=MCR*BPn ;
        RDn, retirement pay difference n years after being retired ;
        TSPn, value of TSP account at year n after starting account ;
        TSPr, value of TSP at exit from government service ;
       Yr, year of military retirement ;
        Yc, year of cessation of benefits ;
        n, years (of service or retirement) ;

Parameters:
         SMBRS, the number of service members (SMs) in the BR ;
         I, inflation rate of the US dollar, assumed to be 2% ;
         MRR, market return rate and rate a balanced TSP portfolio is predicted to grow.  For a particular solution, I assume 6% annual growth (1.06) ;
         MCR, the BRS matching TSP contribution rate ;
         AYURD, Average number of years lived until from retirement to death

Assumptions: For simplicity’s sake, I assume the TSP index fund growth will remain constant.  I also ignore future rises in the cost-of-living with the presumption that the military will continue to make cost-of-living-adjustments to its pay and retirement system.  I am also speculating an increased rate of SM retirement from 17% to 20%.

Model
General model for lifetime service earnings at year n due to TSP account growth:
             LSEn= TBPn – n * TCn + TCn * ( 1 – MRRn ) / ( 1 – MRR )

 Model for TSP account growth after retirement:
            TSPn = TSP*  MRR * ( Yd – Yr )

Additional cost of the BRS to the DoD compared to T20R for an individual SM:
           MCR * BP* n + 2.5 * BP12

Savings to the DoD compared to T20R:
           ( .5 – RR ) * BPr * 12 * ( Y– Y)

Cost of BRS:
           ( MCR * BP* n + 2.5 * BP12 ) * SMBRS( .5 – RR ) * BPr * 12 * AYURD

The general solution to find the optimal solution is:
RD(RR, n) = 6BPr + 12nRRBPr – 6nBPr -(3nRRBPry(1 – nMRR))/(25*(1 – MRR))

The particular solution:
RD(RR,n)= 13896nn + 129504nRR – 64752.2n – RR 27792nn

Importantly, we should set realistic constraints on RR and n:
           .2 < RR < .5   ;   0 < n < 50

The constraints are chosen because the markets could fail and SMs should still have a safety net of 20% of their final base pay.  A 50-year cap is chosen because of the assumption that retirees will want to eventually utilize their TSP accounts (at this age, perhaps setting up a trust).

Rather than try to save the DoD money in this model, I am routing all the money from the savings from the reduced pension payouts back into the TSP matching contributions for all service members. Because there are now 5 SMs to provide matching TSP contributions for instead of just 1 SM to provide a pension for, the savings from a reduced payout will be divided by 5, and this will be the amount of money the DoD can pay out to each SM over their careers.

Normally, rank determines compensation, but to simplify this model, everyone will receive the same amount of matching contributions over their careers. Thus, this model divides the amount of TSP matching contribution money available to each SM by 20 and provides this as the maximum amount of matching contributions available to each SM every year.

See Appendix B for an Excel sheet that uses Solver to optimize for the pension and matching contributions rate.  What we find is that the function is non-convex in the domain defined by our constraints, so there are no relative maxima.  There is only an optimum RR for any given n (and vice versa).

Further Discussion: If one is willing to wait over 24 years after retiring to touch their TSP accounts, it seems that my current model is better than the T20R. However, what I have failed to account for is how much money extra money a SM retired under the T20R could invest in private investment accounts.  This amount is modeled by the expression:

(.5 – M) * BP* (1 – MRR*n) / (1 – MRR)

For example, an O-5 SM retiring under T20R and investing the difference between the two pensions could expect to have more money regardless of RR (as long as it is the same as the TSP) up until year 36.  The BRS only surpasses 36 years after military retirement due to the 20 years of earlier TSP contributions that would finally catch up and make the difference.

While it takes a long time for lifetime compensation for my modeled BRS SMs to surpass the T20R SMs, the benefit of this really seen elsewhere.  Now, every SM, regardless of how long they stay in the DoD, has a retirement benefit. Not only does this help millions of individuals financially, but it also will considerably promote talent management.

Appendix A

appendix2BRS

Appendix B

appendix3BRS

Link to Google Sheets File

Sources

[1] https://budget.house.gov/hbc-publication/364048/

[2] https://www.rand.org/pubs/research_reports/RR1373.html

[3] https://warontherocks.com/2015/03/military-retirement-too-sweet-a-deal

A Singleton Government is not as Dangerous as Omnicidal Agents

Back in November of 2018, I had a brief discussion with the economist (polymath, really) Robin Hanson on Twitter and inspired him to write a blog post.  We were discussing essentially whether a strong, central government or free individual agents are going to pose a greater threat to future society.  He wrote that a strong, centralized government is riskier, and he did so for interesting reasons.

While his argument is persuasive, I still think that individual agents will pose a greater threat in the future.

Society is going to face these two risks in the future, and they are in contention with each other.  An advanced monitoring system and highly capable police is the only way to prevent omnicidal agents from carrying out their plan. These should not sound far fetched:

 The Likelihood of a Future Strong, Central Government

Artificial intelligence will enable strong, central governance more than we have ever seen. Just look at China and their social credit program.  Additionally, a central government is likely one of the few solutions to our Mutually Assured Destruction deadlock, which probabilistically is a recipe for doom.

The Likelihood of Omnicidal Agents

A number of individuals motivated by religious arguments, ecology preservation, anti-natalism, hate, or other motives have longed to destroy humanity, all sentient life, or even the whole world. Technology is progressing at unprecedented rates and dangerous technology is gradually becoming more accessible to individuals and small groups. While it still takes a nation-state to even make a single nuclear weapon, it only takes one biologist to engineer a pandemic that can potentially kill millions. There is no reason to think a more deadly technology will not eventually be discovered and fall into the hands of the public that gives small groups the ability to destroy significantly more value than ever before.
As it turns out, we are going to have to, to a degree, choose our risk here.  If we go with unlimited liberty, depending on technological development, we face nearly certain destruction; until human psychology changes, someone is going to act to destroy the world should they have the opportunity.  A strong, central government has the risk of enforcing highly sub-optimal values at scale. This is a real problem, but I believe that only a powerful state has the power to prevent omnicidal agents from fulfilling their plans.

Of all possible future worlds, I bet you see relatively fewer fully libertarian societies in the far future because they do not survive past a certain point of technological development. Societies with a strong, central government carry the risk of misgovernance, but at least there is a better chance at surviving into the long future. Yes, there are fates worse than death, but I don’t think most far future strong governments are actually going to be as Orwellian as we traditionally suspect.

I have not ironed out all my ideas about this yet, so I want to hear your feedback!

To learn more about this line of reasoning and related arguments, see Nick Bostrom’s paper The Vulnerable World Hypothesis. Just so one knows, I had formulated these ideas before reading Bostrom’s paper, so I am not just rehashing his ideas here.

We Should Have Prevented Other Countries from Obtaining Nukes

Ever since nuclear weapons fell into the hands of the USSR and other countries beyond the United States, human civilization has been under tremendous risk of extinction. For decades now, the Doomsday clock has been perilously close to midnight; we continue to flirt with disaster which could strike once any nuclear leader falls into a suicidal mindset, which breaks the calculus of Mutually Assured Destruction. There is no solution in sight: we will only continue to avoid the destruction of all that we care about insofar as a handful of world leaders value living more than winning or being right. Perhaps down the road, some institution will emerge which will lead denuclearization to non-extinction levels, but even navigating this transition will be risky.

Given the dilemma of this current state of affairs, we messed up. We should have had the strategic foresight to prevent this from happening, and done nearly everything in our power to prevent it from happening. We should have negotiated more fiercely with the Soviet Union to make them stand down their nuclear development, and we should have backed up our words with the threat of bombs. Further, moral philosophy messed up by not laying the groundwork for this to happen at the time: as undesirable as it would have been to target a research lab in Siberia or even a populated city, this pales in comparison to the hundreds of millions, billions, or even all future people (we are talking trillions+) who remain under significant, perpetual risk in the current nuclear environment we created.

We should have never allowed more than one state to develop the Bomb. “But this one state might abuse their power and try to dominate the world” one might counter. This could be the case, but I would venture that one state enforcing its values on another would probably not have been as bad as extinction. Further, this one nuclear state would have an incentive to be good stewards of their power to discourage others’ pursuit of nuclear development; insofar as non-nuclear states are not desperately unsatisfied with their lives, it does not make sense to pursue nuclear development under the threat of annihilation should the one nuclear state find out before they had amassed an arsenal big enough for Mutually Assured Destruction.