The sustainability of a private sector pension scheme

7 December 2015 03:10 am Views - 1701

Last week, many unions and politicians were protesting against the proposed Employees’ Provident Fund (EPF)-Employees’ Trust Fund (ETF) reforms covering the private sector employees. The proposal was to introduce a mechanism to improve the quality of management of the current trust fund and the provident fund and also to deliver a pension for life. Sadly, many of those who protested did not really know what was going on. The government also failed because they did not know how to sell the idea to the key stakeholders. 

Furthermore, none of the investigations done so far on the pump and dump deals, involving the EPF, have been fully investigated. If the investigations are complete, the government should go public with the findings. Many people like the idea of the EPF being taken out of the Central Bank. Now the Prime Minister says the proposal has been put on hold. A private sector pension scheme is now on the cards. It is a pity that the original proposal has now been put on hold because all the elderly people in Sri Lanka should have access to at least one reliable, affordable and a livable pension. A proper pension is essential to ensure income security for the elderly.


Better governance
In Sri Lanka, 85 percent of the population between the ages of 20 and 59 are not covered by a pension scheme and only 30 percent of the population above the age of 60 get a pension that helps them to make ends meet. Any new pension scheme must be contributory and sustainable as the public sector pension system is mostly unfunded. The EPF or ETF in its current form cannot be considered a pension scheme. Therefore, if both funds are going to be merged to provide a pension for life, the fund needs major reform and must be taken out from the Central Bank. Moreover, the pension amount should help to keep a person out of poverty. If that cannot be achieved it is best the funds are left alone, but at least ensure there is better governance and 
more transparency.


Current situation
According to my research, there are 24 income support schemes, which include the state’s Public Service Pension Scheme (PSPS) and the private sector’s EPF. There are also contributory pension schemes for the informal sector workers, which include the Farmers Pension and Social Security Benefit Scheme (FMPS), Fishermen’s Pension and Social Security Benefit Scheme (FSHPS) and the Self-employed Persons Pension Scheme (SPPS). Other than for these there is a Public Assistance Monthly Allowance (PAMA), which provides an allowance to households whose monthly income falls below a minimum amount. The pension system in the public sector is mostly unfunded and public sector wages are lower than the private sector. As a result, the public sector pensions are therefore very low. 

Furthermore, because the public sector schemes are mostly unfunded, current and future taxpayers bear the burden of the current non-contributory pension system we have. On the other hand, the EPF is the largest social security scheme in Sri Lanka, with a current asset base of 1.35 trillion rupees and 2.5 million active accounts. But it cannot be considered a pension scheme as it is not an annuity, however, it could be converted into an annuity if recipients use the proceeds in that manner. In Sri Lanka pension anomalies are seen not only in the state sector but also in most schemes in the country, while the access to pensions is also not uniform.


International experience
In many countries, pension provision is covered by a mandatory public scheme that is often supplemented by occupational pension schemes - Defined Benefit (DB) Defined Contribution (DC) schemes. The extent to which occupational pension schemes supplement public schemes varies substantially among advanced economies. In emerging economies, the access to any form of pension coverage among the working population is limited. Among public pension schemes, some are funded, i.e. the pension liabilities are backed by pension assets, others are unfunded and referred to as pay-as-you-go schemes, i.e. the current pension payments are financed from contributions or payroll taxes paid by the current employees. In advanced economies, when the pension assets relative to gross domestic product (GDP) are low, it usually implies that a large share of pension liabilities is tied to future government revenues.


Options
Occupational pension schemes (DB) offer the employees more measurable post-employment income benefits but they lack the transferability that DC schemes offer employees when they switch employers. In a DC plan, the amount of money that has to be contributed to the fund is specified but the benefits payout will be known only at the time of retirement. The design of retirement plans can have influences on labour markets because they have important economic incentives associated with them that affect employment contracts and terms.


Objective of a pension scheme
The principal objective of any pension scheme is to provide beneficiaries with an adequate income stream during the post-employment period. For funded schemes, this requires assessment of what the appropriate contribution rates (as a percentage of salaries) into the pension fund should be, to deliver the expected retirement income stream. For DB schemes, any asset shortfall arising from poor investment returns on pension assets becomes a liability of the schemes’ sponsor. For DC schemes, employees bear the risk that the post-employment income can be lower than what they had planned for.

For both unfunded DB schemes and occupational DB schemes, the contractual commitments that underpin the promised retirement income will serve as inputs to the actuarial calculations used to estimate the present value of pension liabilities. In addition to this, the actuarial calculations will involve a number of assumptions about the future value of economic, demographic and financial variables and risks. Because of the inherent uncertainties involved in estimating these variables over the long term, investment decisions that deliver the contractual commitments with minimum risk to the pension sponsor for funded pension schemes can be extremely challenging. 

The regulatory restrictions on investments and compliance with pension-related accounting standards, often add to these challenges. Yet, the state and public awareness of these challenges and the costs they impose on the pension champion from these contractual commitments is limited and relatively unknown. Therefore, in the final analysis, the government needs to engage the right people to structure the pension scheme if they are serious about launching a pension scheme for the private sector - that is doable and also marketable.

(Dinesh Weerakkody was a former Chairman of the ETF)