By Kenneth A. Donkor-Hyiaman
I recently wrote about what I call the 'Pension Irrelevance Theorem' (PIT) which literally suggests that pension schemes in developing economies are ineffective and for that matter of no need for the low and middle-income work force, who constitute the majority of pension scheme membership. The fact that pensions are mostly annuity payments unlike lump sums to be received commencing upon retirement expands the risk that many low and middle-income people in developing economies would not receive pensions due to low life expectancy, averaging 54.9 in Sub-Saharan Africa whiles compulsory retirement age is about 60 years - I refer to this as the 'Retirement Planning Puzzle'.
The Retirement Planning Puzzle was defined in the previous article as the difficulty in realizing and actualizing pensions. The phenomenon therefore pushes the receipt of pensions further into the uncertain future beyond the reach of the contributor who is likely to demise before pension benefits accrue. Unlike developed economies with high life expectancies making pensions important, low life expectancy in developing economies render a contributor's personal need for pensions unjustified.
In this article, I argue that the primary and most critical lessons have not been learnt from pension reforms in Ghana. This view is arrived at by analyzing the applicability of the 'Pensions Irrelevance Theorem' through a review of the history of the pension industry in Ghana. The New National Pension Act of Ghana, 2008 (ACT 766) requires retrofitting or its effectiveness cannot be traced in the sands of time to come.
Defined Benefit and Defined Contributions Plans: Why it Matters
A fair understanding of pension plans is perfect for understanding the arguments raised in this article. In spite of the varying terms, three basic designs (types) of pension schemes are common globally including defined benefit (DB) plans, defined contribution (DC) plans or both. DC plans by nature specifies contributions as a predetermined fraction of salary without certainty of benefits upon retirement unlike DB plans.
The latter is a promise by a sponsor bearing responsibility to pay a fixed life annuity; sometimes inflation-adjusted and benefits are a function of both years of service and wage history. Whereas member contributions are ring-fenced and individually invested in a DC model, DB enables the pooling and group management of funds. Hence, the investment risk of DC plans is emergent at two levels; investment performance uncertainty and the real value of income streams or lump sum generated at retirement. Therefore, DB plans could offer superior risk-sharing properties that are not captured by DC models.
Pension Reforms in Retrospect [1946 - 2014]
The Pension terrain in Ghana has undergone several developments from pre-independence to post-independence. The first pension program - a non-contributory pension scheme - was introduced by the Government in 1946 to cater for the retirement benefits of workers of the Colonial Administration offices. In 1950 and early 1960s, the CAP 30 Pension Scheme - created by the Pensions Ordinance Number 42 (CAP 30) - and Superannuation Schemes for public servants including certified teachers, university lecturers, and all government workers in the Gold Coast were established.
Given the narrowness of coverage, the vast majority of ordinary Ghanaian workers could not benefit from these schemes. To cover all private and public sector workers who were not covered by the CAP 30 schemes, the Social Security Act (No. 279) was passed in 1965 originally as a Provident Fund to provide lump sum benefits for old age, invalidity and survivor's benefits.
The establishment of the Social Security and National Insurance Trust (SSNIT) in 1972 under the NRCD 127 to administer the National Social Security Scheme replaced the repealed Social Security Act, 1965 (Act 279). After twenty-five years of administration, it was converted to a Social Security Pension Scheme which invested contributions in long maturity low interest rate special government bonds. Coupled with high inflation, lump sum benefits due to retiring beneficiaries were insignificant. To bring some adequacy into workers' pension packages, the Social Security Act, 1991 (PNDC Law 2427) was enacted to transform the 1972 Scheme from Provident Fund to a DB Scheme. This came with a shift from investments in special government bonds to investments in a broad portfolio.
According to the NBD Ghana Limited, ' [t]he transition to a very broad investment portfolio required considerations that satisfied the needs of government on the one hand, the need to satisfy some social needs of the contributors and the need to generate commercial rates of return to balance the lower rates from the other portfolios'. Notwithstanding, the SSNIT schemes were less favourable compared with the CAP 30 pensions, particularly in terms of the lump sum benefit, which resulted in agitations and protests by some public sector workers on the SSNIT Scheme.
The Bediako Commission set up in 2004 led to the enactment of the current National Pension Act, 2004 (Act 766) to introduce a contributory three-tier pension scheme to provide improved retirement benefits for all workers. The ACT requires employers to contribute 13% and workers 5.5% of gross income, making a total contribution of 18.5%. This distribution is presented below:
a. First tier basic national social security scheme (13% out of total contributions); which is managed by the SSNIT is mandatory for all employees in both the private and public sectors. 2.5% out of 13% is a levy for the National Health Insurance scheme;
b. Second tier mandatory occupational (or work-based) 'defined contribution' pension scheme (5% out of total contribution) is 'fully funded' by employees and privately-managed by approved Trustees assisted by Pension Fund Managers and Custodians. It is designed primarily to give contributors lump sum benefits.
c. Third tier voluntary provident fund and personal pension schemes, supported by tax benefit incentives for workers in the informal (blue collar) and formal sectors (white collar).
Lessons Learnt from Pension Reforms [1946 - 2014]
The first obvious lesson is the issue of 'increasing coverage of pension schemes' that replaced old schemes. For instance, prior to the coming into existence of the SSNIT in 1972, which extended its pension scheme to private sector workers, only public sector employees were covered by some form of retirement scheme. This has arisen because of concerns particularly about old age income security for all in Ghana. The second lesson is the issue of 'pension inadequacy', and a clear example was the disparity between pensions of previous CAP 30 members and the SSNIT pension schemes. One of the approaches used to achieve this ideal was to convert provident funds (usually for lump sums benefits) into DB plans as was the case in 1972 with the coming into effect of the Social Security Act, 1991 (PNDC Law 2427).
The two major issues here is the investment problem: the limited availability of investment conduits and mandatory investment of contributions in low-yielding government bonds in the face of high inflation. Thus, creating diversification, risk reduction and return maximization problems for the schemes. The fact that pension contributions constitute a source of cheap funds to governments contributes to the pension inadequacy problem. The third lesson is a corporate governance issue. Prior to the enactment of the National Pension ACT, 2008 (Act 766), the DB nature of pensions in principle gave the 'right to invest pension funds to a sponsor (SSNIT)', who promised some predetermined benefits on a non-negotiable basis. Individual contributors had no business in determining their preferred investments.
Their concerns were to be addressed by a Board, which ideally was believed to have comprised some sophisticated and experienced financial and investment experts. Moral hazards resulting from principal-agent problems largely because of information asymmetry are consistently persistent in all the schemes. To deal with this canker, a more diversified pension portfolio combining DB and DC plans has been introduced by ACT 766. DC plans as described earlier give the right of investment to the contributor; hence, contributors are as of right mandated to choose the pension trustees that manage their second-tier contributions as well as engage in investment asset selection. In effect, there is a sharing between contributors and trustees in the right to invest and the management of the pension scheme.
No Lessons Learnt
Despite these reforms, pensions in Ghana are still inadequate and largely unrealizable - that is the pension reality effect. In my candid opinion, these reforms are good but materially insignificant in maximizing the welfare of contributors, especially when the scheme is compulsory - the counterfactual could have been better. There appears to be a holding back in the choice to make the right decisions about the designs of pension schemes in Ghana; perhaps, deliberately from the government end or designers and managers have either lost touch with the pension reality or are not skilful enough.
The very problem of pension inadequacy which has necessitated these reforms is still persistent and unlikely to be resolved by the new three-tier pension scheme. More seriously, is the existence of the Retirement Planning Puzzle and the Pension Irrelevance Theorem. Pension scheme coverage is increasing but many either do not live to enjoy their pensions or demise very shortly upon reaching retirement age because of low life expectancies and the drastic fall in their standards of living during the retirement period.
What could be wrong with the design of national pension schemes in Ghana? Although the new three-tier scheme blends the benefits and characteristics of DB and DC plans, the concentration of a chunk of contributions (11.5% out of 18.5%) in the first tier DB plan could be the avoidable risk. Traditionally, the first tier is just like the 1972 Social Security Pension Scheme which invested in low risk low-yielding long-term government bonds, which are inevitably susceptible to the depreciation effect of high inflation.
In effect, higher returns on pension investments are compromised for certainty (low risk). It appears to me that the desire to satisfy government needs is to blame; yet, historically funds have been wasted mostly in unproductive and unviable investments. Therefore K.B. Asante 'maintained that SSNIT money was not government money but contributions by workers and would have accrued to workers if the SSNIT law did not exist'. Reports reveal that SSNIT spends about 40% of members' contributions on administrative expenditure. Lately in 2012, the Director-General of SSNIT admitted that some of its investments in some companies had gone bad.
A typical example is the State Transport Corporation (STC) bankruptcy case, making losses in the last five year prior to the reportage. Similarly, the two central car parks constructed by the SSNIT adjoining the Ridge Towers and the Pension House have been deserted by the target clients - workers of the various corporate institutions located around Ridge and Heritage Towers in Accra according to investigations conducted by Economy Times. The car park at Ridge has a parking capacity of 818 cars, but less than 150 cars patronise it daily due to high rates charged by the Trust according to the Economy Times. The very recent distasteful deal is the Fortiz-Merchant bank sale. The SSNIT has demonstrated in no uncertain terms its capability and capacity to manage the public pension fund to maximize profits for its agents in the public interest. It is therefore, a wrong decision to allocate more funds to the SSNIT - it is likely to go waste and pensioners may continue suffering.
Further, pension reforms have barely made it possible for contributors to benefit from their contributions while alive - during their economic and active lives. The only provision is found in section 103 (2) of ACT 766, which allows members to secure a primary mortgage with their accrued second-tier DC benefits; this is however yet to be implemented and of no benefit to members currently. There is doubt about the feasibility of this provision as well because accumulated benefits could be very low due to low contribution rate (5.5% of salary). This is worsened by the fact that a chunk of contributions are invested in DB plans managed by the SSNIT.
The problem is that, this scheme buys deferred annuities for contributors to be received upon retirement. The fact that these annuities are received each successive year expands the risk of members realizing and actualizing their pensions with substantial real value due to high inflation; the very essence of the Pension Irrelevance Theorem (PIT) has barely been noticed by stakeholders. Members therefore live with the hope of longevity less they would not personally have access to their pensions but their survivors. In that case, it could be concluded that pension schemes in Ghana have predominately been for the benefit of survivors in title, not contributors. The lump sum benefits promised by the second-tier DC scheme could partially mitigate the PIT intrinsically.
The extrinsic benefit of the DC scheme is meagre just by the simple reason that the promised lump sums are likely to be small because the contribution rate of 5.5% is insignificant for investment purposes. This is worsened by the fact that each member's contributions in the DC scheme is ring-fenced and invested individually; thus, it lacks the benefit of risk and fund pooling as well as investment diversification. The latter requires substantial funds to achieve; hence, members would inevitably carry substantial specific (diversifiable) risk against Modern Portfolio Theory and investor rationality. This is quite technical and would be discussed in a separate article soon.
Remedy and Conclusion
Pension contributors' best bet in the face of the PIT and moral hazards, is to have more control over the investment of their contributions through the DC scheme. In other word, dealing with the design risk of the new scheme requires that the chunk of contributions should be in the DC scheme for maximum benefits economically. There is a high likelihood that a higher second tier DC contribution rate than the first tier DB could lead to higher accumulation rates and the insufficiency of investible funds problem addressed.
To deal with PIT, two non-mutually exclusive approaches are opened to administrators. First, benefits should largely compromise of a provident fund as argued above and secondly, many ways should be devised for contributors to benefit from their pensions while alive. In effect, risk reduction, diversification and return maximization is more likely for pension contributors in Ghana in this proposed framework.
In conclusion, the Pension Irrelevance Theorem is real and still a problem against the need for pension schemes in Ghana. The life changing root lessons from triggers of pension reforms have not completely been learnt. The knowledge-base informing the design of the new pension scheme is sideline and symptomatic in nature. Unless dealt with through robust pension scheme design, contributors would not benefit maximally, others including pension administrators, trustees, managers and custodians would.
Kenneth A. Donkor-Hyiaman
Managing Partner, MeTis Brokers
University Of Cambridge
United Kingdom
kwakuhyiaman@gmail.com
Source Modern Ghana
No comments:
Post a Comment