The Role of Pensions in Pakistans 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 Pakistan stand on Social Security ?

Total social security expenditure (percentage of GDP) All Countries Europe 14.5% 24.8%

Asia
India Pakistan

6.4%
2.6% 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 Sickness and Health-care Unemployment benefits Family benefits Some Some Some None None

Where Does Pakistan Stand ?

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

Pensions - Where Does Pakistan Stand ?

Country Covered Wage Bill/GDP (%) Contributors/ Labour Force (%) Contributors/ Working Age Pop. (%)

Pakistan India Malaysia UK

0.6 3.2 17.4

3.5 10.6 48.7 89.7

2.1 7.9 37.8 84.5

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

Redistribution

Savings

Savings

Form

Minimum Pension

Occupational Pension

Individual Accounts

Financing

Tax Financed

Fully Funded & Regulated

Fully Funded & Regulated

Mandatory State Pension

Mandatory Occupational Schemes

Voluntary Individual Ret. A/cs

Fitting the Standard Model to Pakistan

Government/ Public Sector

Government Pension and Contributory Provident Fund

Large/Medium Private Sector

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 Governments 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 Pakistans 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 EOBIs 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 Pakistans workforce resides
Protection taken in definition of this workforce as selfemployed. The most needy are, therefore, conveniently removed from even active consideration of how to bring them into the net.

EOBI Financial Viability

EOBIs 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 are 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