The Role of Pensions in Pakistan s Social Security

The Role of Pensions in Pakistan’s Social Security Systems Omer Morshed 11 August 2005

Social Security Systems • Different countries define social security systems differently. A fairly comprehensive definition was that used in Japan by the Advisory Council on Social Security in a report of 1950. This is as follows: – "Social security systems mean the systems to enable every citizen to lead a worthy life as a member of cultured society. Social security systems provide countermeasures against the causes for needy circumstances including illness, injury, childbirth, disablement, death, old age, unemployment and having a lot of children by implementing economic security measures through insurance or by direct public spending. – Social security systems ensure the minimum level of living to the needy by public assistance, and they also promote public health and social welfare. "

Components of a Social Security System • Old-age, invalidity and survivors – Pensions or, more completely, Retirement Benefit Schemes • • Employment Injury Sickness and Health-care Unemployment benefits Family benefits

Where does Pakistand on Social Security ? Total social security expenditure (percentage of GDP) All Countries 14. 5% Europe 24. 8% Asia 6. 4% India 2. 6% Pakistan 1. 1% Large amount of individual philanthrophy – not documented Source of Table : ILO - Social Protection - Financial, Actuarial and Statistical Services Branch - 1996

Where Does Pakistan Stand ? Coverage ? Old-age, invalidity and survivors Employment Injury Some Sickness and Health-care Some Unemployment benefits None Family benefits None Some

Where Does Pakistan Stand ? Coverage ? Old-age, invalidity and survivors Employment Injury Some Sickness and Health-care Some Unemployment benefits None Family benefits None Some

Pensions - Where Does Pakistan Stand ? Contributors/ Labour Force Working Age Pop. (%) Country Covered Wage Bill/GDP (%) Pakistan 0. 6 3. 5 2. 1 India 3. 2 10. 6 7. 9 Malaysia 17. 4 48. 7 37. 8 89. 7 84. 5 UK

Where Does Pakistan Stand ? • Not currently at a desirable level with respect to our social security system including, more particularly, our arrangements for retirement benefits/ savings • Historically the social security “system” in the country (and, for that matter, in the region) has been largely family based, with the family stepping in in times of need – More particularly children support parents after retirement. • Is this system sustainable in the long run ? – Perhaps not as trends are beginning to change. – As family sizes shrink and the population ages there would be increased pressures on the working population which, almost certainly, will cause severe social strain unless supported by a credible social security system

Retirement Benefit Schemes – Role • The basic purpose of retirement benefit schemes is to provide financial resources after retirement – The prime role is, therefore, social – The requirement for the government/ employers to provide of retirement benefits is, therefore, often a part of social security legislation – There is also a savings element – deferring consumption of earnings for a time when earnings disappear but there is still a need to consume. • Various models for providing pensions exist throughout the world, ranging from full responsibility resting with the state (in socialist economies) to economies where very little is done by the state, with the exception of public servants • Systems are, however, becoming increasingly standardized, not least because of the intervention of international lending agencies, who are promoting a standard model for pension schemes, based on a “multi-pillar concept”

Pensions – The World Bank Model Objective Form Financing Redistribution Minimum Pension Tax Financed Mandatory State Pension Savings Occupational Pension Fully Funded & Regulated Mandatory Occupational Schemes Savings Individual Accounts Fully Funded & Regulated Voluntary Individual Ret. A/cs

Fitting the Standard Model to Pakistan Government/ Public Sector Large/Medium Private Sector Government Pension and Contributory Provident Fund EOBI Pension, Gratuity, PF VPS Small/Private/ Self Employed VPS Agricultural Workers ? Mandatory State Pension Occupational Schemes Individual Ret. A/cs

Issues • Large Implicit Debt re: Government Pensions • Do we have an effective first pillar ? • What is needed to strengthen and promote the second pillar ? • What impact will the VPS have ?

Govt Pensions – Implicit Debt • Government schemes (especially military) extremely generous relative to government pay • Coupled with benefits such as free medical benefits – government sector (again especially the military) the only one which has effective social protection • There is, however, a large cost for this, being paid by the rest of the country – including the very poor – More importantly there is a large deferred and unaccounted for liability being passed on to future generations • Government has examined the issue but a resolution appears to be elusive – Likely to be painful to those who have a vested interest – hence necessary decisions are not taken.

EOBI – The First Pillar ? • EOBI theoretically forms the first pillar • There are, however, some significant issues – Very limited coverage – Serious concerns about viability, especially following the withdrawal of the Government’s financial support • Significant issues with respect to administration of the scheme • In the past some suggestions have been made to convert the scheme into a defined contribution one – Misplaced concept as the first pillar must, almost by definition, have a target (defined) benefit structure

EOBI - Coverage • In 2002 Pakistan’s work-force was estimated by the Pakistan Labour Survey at 43 million 92% were deemed to be employed of the employed 64% worked in the agricultural or related sectors • EOBI’s coverage was under 2 million insured persons – Coverage is, therefore, minimal • Efforts at enhancing coverage have focused around redefining the employers covered by the scheme to include smaller employers • Most significant issue, however, is that there is no coverage for rural areas where the majority of Pakistan’s workforce resides – Protection taken in definition of this workforce as “self-employed”. – The most needy are, therefore, conveniently removed from even active consideration of how to bring them into the net.

EOBI – Financial Viability • EOBI’s financial viability continues to be an issue • Discussions on funding pattern have not led to any firm conclusion. EOBI continues to function on a partially funded basis with a large deferment of cost to future generations – Without really defining who in the future generations will pay this deferred cost • Even using the partially funded basis the scheme is not viable – No serious thought being given to sort out this issue

EOBI – Image and Systems • Large improvements made in last few years • Still continues to be a major problem • Still perceived as a “tax” • Corruption still prevalent at lower levels, leading to avoidance and, therefore, ineffectiveness • Need to continue the improvement brought around in the last few years

The Second Pillar - Occupational Schemes • Three major types – Gratuity (mandated by law for large employers) – Provident Fund – Pensions • Bulk of legislation/regulation focused around tax treatment – Very little available to ensure protection of benefit rights (other than Provident Funds) – Financial reporting largely focused on financial reporting of employer organization (IAS-19). Negligible reporting of funded position. – Almost nothing in the form of employee awareness • Current tax laws require a rigid approach to implementation of funded schemes – through employer administered trust funds • Regulation of provident fund schemes also lacks effectiveness (compare with India where the Employees Provident Fund Organization is exceedingly effective, operating through a network of Provident Fund Commissioners)

Occupational Schemes – Suggestions for Improvement • Suggest implementation of principles designed by the International Network of Pension Regulators and Supervisors (INPRS). In particular – Mandate the funding of schemes – Strengthen reporting and monitoring – focus more on viability reporting (IAS-26) rather than IAS-19 reporting • Need to introduce more implementation alternatives with possibility of third party providers for administration, asset management and risk coverage: • Need to seriously examine and reform the existing occupational pension framework and perhaps introduce a pensions law – Understand that an initiative is being taken under the auspices of the ADB

Occupational Schemes – Delivery Options • Schemes administered by the public sector, which can be subscribed to by private sector organizations. An example is the Employees’ Provident Fund Organization in India or the Central Provident Fund Board of Singapore. • Pension fund companies dedicated to administering pension schemes. This is prevalent especially in South America, where a number of countries have mandatory defined contribution pension schemes geared towards retirement savings. Such companies tend to be privately sponsored and managed, but are, per necessity, heavily regulated. • Insurance companies, who could offer services from providing annuity contracts to management of investments to complete management of schemes. • Multi-employer pension fund companies set up on a nonprofit basis by employers having similar benefit structures.

Occupational Schemes – Delivery Options • In addition there a number of options for partly outsourcing functions, including: – Third party administration of the schemes themselves, taken on by firms set up for the purpose as well as actuarial firms (Watson Wyatt, Towers Perrin and the like) – Asset management, which is outsourced to asset management firms, with the custody function being outsourced to custodians and sometimes even management of asset managers being outsourced to “gatekeepers”.

The Third Pillar - VPS • The VPS is an important addition to the pension framework in Pakistan. • Provides an opportunity for : – Individuals who have no retirement benefits to save for retirement in a tax efficient way – Topping up of retirement benefits provided by gratuity and provident fund schemes (existing members of pension schemes excluded) – A simple mechanism for implementing small occupational schemes – although the defined contribution nature may prevent larger schemes from using this mechanism • The impact which this will have will largely be based on a number of factors, including: – Ability to effectively market the scheme – Returns on managed assets achieved over time

VPS – Challenges & Impact • The major challenge of the VPS is that of effective marketing/ distribution – Charge structure will not allow compliant products to be marketed through a typical life insurance sales force – Products are more likely to be bought rather than sold • Impact is likely to be minimal from a social security viewpoint – Likely to be taken up by affluent individuals – Charge structure again will dictate fairly large average savings in order for providers to be able to absorb costs

Conclusion • A very long way still to go in making pensions effective as a form of social security provision in the country • The VPS, while being an important step in promoting retirement savings, is not really expected to contribute towards the social protection side • Much needs to be done to strengthen the EOBI scheme and also the occupational pension framework

Thank you