Muhammad Ashraf
Pakistan’s public sector pension system relies heavily on state-sourced unfunded annuities, which are unsustainable in the long term. Additionally, existing funded pension schemes, such as the Employees' Old-Age Benefits Institution (EOBI) and the Voluntary Pension System (VPS) in the private sector, have struggled to provide adequate post-retirement income due to a lack of effective policy frameworks and management structures. Despite attempts to align with international best practices, EOBI and VPS have yet to meet expectations, raising concerns about their ability to support public sector pensions.
Notwithstanding the above, the government plans to shift public sector pensions onto the VPS framework, like 401k in the USA, with AML-2 license companies operating as fund managers and the Security and Exchange Commission of Pakistan (SECP) acting as the regulator.
Sustainability Concerns
The looming pension crisis in Pakistan underscores projections indicating a substantial increase in pension expenditure by 2030, surpassing available state resources. The impending strain on public finances necessitates immediate action to address the pension system's sustainability. The challenge facing policymakers is two-fold: mitigating the risk of a pension blowout caused by escalating expenditure on existing and future pensioners and creating fiscal space to accommodate the growing burden of state contributions for new entrants into the system. However, the proposed transition of public sector pensions to the VPS framework, while a step in the right direction, may exacerbate the existing challenges without comprehensive reforms.
The SECP rules have been adequate to the extent that none of the 22 VPS Funds in Pakistan have filed for bankruptcy. However, their revenues have been marginal and far below those of the world's pension funds, including the Indian National Pension System (NPS). The low annualised profits of VPS may only lead to sustainable pensions for the public sector if they are restructured through significant reforms that conform to contemporary best practices.
The Dilemma
The challenge, therefore, is threefold: How to avert an imminent pension blowout by taking measures to curtail the rise in pension expenditures due to the existing pensioners and present employees retiring soon, i.e., in the next 15 - 20 years, creating the fiscal space necessary to cater growing additional expenditure on account of state contributions to annuity for future enrollments which are expected to be 15-20% of basic salaries and the investments by the pension funds generating revenues that start meeting pension expenditure partially in the mid-term perspective of 10-20 years and take pension expenditure off budget in a timeframe of 25-30 years.
The Planning Parameters
Policy Framework – The future-funded pension system based on contributions from the state and employees must be aligned with contemporary trends and best practices, which are certainly not our VPS and EOBI.
Pension Funds must be designed for long-term sustainability, high profitability, and provision of adequate benefits for pensioners. In doing so, large-scale investments of pension funds play a leading role in a country's economic growth. This can be seen in 76% ownership of the US Stock Market by the pension funds. Pension funds generate high profits. Usually, 3-4 times the interest rates. The annualised revenue growth in the case of Indian NPS during the past decade was 63%. Such high returns are essential for pension funds to be sustainable. Pension funds can only perform with an autonomous and effective regulatory framework for development and oversight. Likewise, an autonomous Investment Board is pivotal in generating high profits. The Pension Fund Regulatory and Development Authority in India and the Canada Pension Plan Investment Board (CPPIB) are the models worth considering instead of pursuing VPS, which needs more statutory status, autonomy, and authority.
Creating Fiscal Space Needed for Reforms: The challenge of averting the imminent collapse of our public sector pensions while accommodating the additional cost of state contributions for new entrants can only be managed by creating desperately needed fiscal space over the next 15-20 years.
The Regulatory and Management Framework
The Central Pension Funds Regulatory and Development Authority (CPFRA) in Pakistan could play a pivotal role in ensuring the country's stability, growth, and protection of pension funds. Here are some essential functions and roles it could undertake.
Regulatory Oversight - The CPFRA regulates pension funds and related activities and ensures compliance with laws, regulations, and standards. This includes setting guidelines for fund management, investment practices, disclosure requirements, and risk management.
Development of Pension Sector - It could facilitate the development of the pension sector by promoting initiatives that enhance pension coverage, increase public awareness about pension benefits, and encourage employers to establish pension schemes.
Investment Guidelines - CPFRA could establish prudent investment guidelines for pension funds to safeguard pensioners' interests while ensuring optimal returns. These guidelines aim to diversify investments, manage risks effectively, and promote transparency in investment practices.
Consumer Protection - It would ensure consumer protection by monitoring pension funds' operations, addressing complaints, and taking appropriate actions against misconduct or malpractices within the pension industry.
Capacity Building: CPFRA could conduct training programmes and workshops for pension fund managers, trustees, and other stakeholders to enhance their knowledge and skills in pension fund management, governance, and regulatory compliance.
Research and Analysis: The authority could conduct research and analysis on pension-related issues, market trends, and international best practices to inform policymaking and enhance the effectiveness of pension regulations and programmes.
Promotion of Innovation - CPFRA could encourage innovation in pension products and services, such as introducing new retirement savings options, annuity products, or technology-driven solutions to improve pension delivery and accessibility
Coordination and Collaboration - It would collaborate with other regulatory bodies, government agencies, industry associations, and international organisations to harmonise regulations, share best practices, and foster cooperation in the development of the pension sector.
Monitoring and Evaluation - CPFRA would monitor the performance of pension funds, assess their compliance with regulatory requirements, and evaluate the effectiveness of pension policies and programmes in achieving their objectives.
Overall, the CPFRA would play a crucial role in ensuring the sustainability and effectiveness of pension funds in Pakistan, thereby contributing to the financial security and well-being of retirees and beneficiaries.
A Two-tier Pension Fund for the Public Sector
Adopting a two-tier funded pension system for the public sector in Pakistan, supported by a comprehensive regulatory framework and an independent investment board, will enhance retirement security for employees and ensure the sustainability of pension schemes.
Tier 1 - Basic Pension Scheme - The first tier should include a basic pension scheme, providing a minimum guaranteed pension to all public sector employees upon retirement. Mandatory contributions from both employees and the government will fund this scheme. Contributions will be invested in low-risk, fixed-income instruments (annuity) to ensure the security of pension funds. Tier 1 funds are to be managed by the state with such incentives as tax exemptions.
Tier 2 - Voluntary Pension Fund - The second tier will comprise a voluntary pension fund, allowing employees from the public and informal sectors to contribute additional funds towards their retirement savings. This tier will offer flexibility and opportunities for higher returns through diversified investment options, including equities, bonds, and other asset classes. Employees will be free to choose their level of contributions and investment strategies based on their risk tolerance and financial goals. Tier 2 will be supplementary funds managed by AML 2-level funds management companies.
Investment Board - An independent investment board may be established to manage the assets of the voluntary pension fund. The board will consist of financial experts and professionals with asset management and investment analysis expertise. Its responsibilities will include asset allocation, portfolio diversification, and selection of investment managers to maximise returns while mitigating risks.
Conclusion
Pakistan's public sector pension system is on the verge of collapse. To avoid such a catastrophic outcome, we need to take a multidimensional approach and implement measures to control the growth of our pension expenditure over the next 10-15 years. In parallel, we must implement an effective contributory-funded pension system that aligns with contemporary best practices for new entrants and current employees with more than ten years of remaining service. We must also establish an effective oversight and investment framework that yields higher profits so that pension funds are partially operational within 10-12 years and take the pension expenditure off budget in 25-30 years. The objectives must be long-term sustainability, creating a solid pivot for economic growth while providing adequate benefits for the community of retirees.
The views expressed in this Insight are of the author(s) alone and do not necessarily reflect the policy of NDU.