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Pension reform: Relatively low hanging fruit.

Byline: Zafar Masud

There was an enlightening seminar organised by SDPI recently on pension reforms. It was not only educating but an eye-opener to an issue which has a multifaceted impact on the performance of the government and its delivery, as it's directly related to the performance and compensation of civil servants. I was invited as one of the panellists due to my active engagement in the past on tapping long-term project finance funding through capital market instruments, and exposure to this concept of being on the board of various public sector entities.

I have always been aware about the seriousness of the issue of growing pension liability for the government and the public sector entities, but it was only during the research on this topic that it dawned upon me how grave the circumstances are. I must, at the outset, thank my colleagues, Sayem Ali and Irteza Qureshi, who had done the research for me on this very critical topic which helped me realise how this existing/emerging fiscal burden could be addressed.

Let's begin with context and the extent of the challenge of the rising pension bill. The federal pension bill has increased to Rs480 billion in 2021, from Rs150 billion in 2011. According to reports from donors, the federal government's unfunded liability currently stands at around Rs3 trillion. Post the 7th National Finance Commission award, provincial governments' pension bills have also increased exponentially to Rs500 billion in 2020, from Rs75 billion in 2011. This is clearly an unsustainable path. Studies suggest that with no changes to the existing pension arrangements, the federal pension bill will rise to an alarming level of Rs750 billion by 2023. Provinces are likely to face similar challenges.

This is a very frightening situation indeed which becomes more complicated due to the presence of fiscal pressures from compromised tax collections, SOE losses, accumulating circular debt, etc. However, the silver-lining is that out of all fiscal challenges of the government, this appears to be an easier one to plug, given that this problem is faced by almost every country, particularly in the developed world where the average life expectancy is much higher.

Before we go any further, I would like to elaborate on fundamental concepts about pension scheme options which will help readers, especially who're not much familiar with this theme. Employee benefits classify post-employment plans into two categories: 1). Defined Contribution (DC), whereby the employer's liability is limited to the amount that it agrees to contribute to the post-retirement fund, consequently, actuarial risk and investment risk falls on the employee. In other words, the risk of investment performance of the fund and resultant pension returns, rests with the employee or its representatives. The return could be better or worse depending on market factors and competence of the fund manager(s); whilst, on the other hand, 2). Defined Benefit (DB), is the scheme where the amount of pension benefit is defined; therefore, all actuarial as well as investment risks are borne by the employer. Irrespective of what the market circumstances are, and if pension liability is funded or not, the employee will get a defined (pre-set) return post retirement; there will be no upside or downside for the employee(s), unlike DC.

Experience from the last 30 years shows significant changes in pension schemes in most developed and emerging markets. As per international best practices, Pakistan Government's DB and unfunded pension arrangements are out of line. Non-contributory, or DB, schemes are reducing: many countries have switched to DC plans due to financial stress. PAYG financing is also reducing: most countries have moved to full or partial funding of future pension liability. The advantage is that the financing burden can be spread across different periods in a more stable and predictable manner. New accounting standards have helped governments better understand the underlying accrued liabilities and the long-term costs of their pension arrangements.

With enhanced life expectancy and widening fiscal deficits in emerging markets, this problem is becoming more glaring. There are successful examples from the countries where the make-up of the society and the community are very similar to ours and they have been able to put a check on mushrooming concerns around this dilemma.

Based on the above, this could be concluded that on fiscal management front, pension reforms are 'low hanging fruit in relative terms' and could be fixed while keeping the below considerations in perspective:

Political will is required to implement pay and pension reforms. Tried and tested solutions could be borrowed from across the globe. All new hiring in the government shall be under the DC system with restructured pay-scales having ranges backed by a pension fund management structure. Other than maximum salary and pension entitlement capping, halt on retrospective increase in future retirees, and (subject to legal provisions) cull the number of pension beneficiaries; extending retirement age or providing less benefits in early retirements are two options which could be implemented in the existing DB plans as a package. There is no argument that pension funds need to be developed in Pakistan, and the pension liability of the government is required to be funded. There has to be a plan which should be managed through a pension fund regime only. The existing DB pension liability shall be funded through a combination of in-kind assets of the government (for example, existing properties/offices given to pension funds and rented back by the Government, lands could be handed to funds for development, etc.) and in-cash, albeit in tranches, as funding in one-go is not possible, as the government is in borrowing mode and that would put unnecessary debt burden on the country. This plan ticks lots of boxes with the biggest box being conversion of dead assets into earning ones. To reiterate, DC pension arrangements are fully funded while returns depend on the pension fund's underlying performance; therefore, it must allow employees to be party to investment decisions of their own funds. This is a way of empowering employees and making them in charge of their own fate about their future decisions.
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Author:Zafar Masud
Publication:The Nation (Karachi, Pakistan)
Date:Jun 12, 2021
Words:1006
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