Defining pensions

Yesterday, the finance minister confirmed what we already knew – that the NPPF pension scheme is sustainable only for about 30 years. What does it mean? It means the pension scheme will not be able to pay benefits to all its pensioners in about 30 years. It means that by 2040, give or take a few years, total benefits payable to pensioners are projected to exceed total contributions of the members plus any income from its investments.

Why? There are a number of reasons. But, the main one is that our (and our employer’s) pension contributions are not “saved” for us. They do not stay in our individual account, to be invested to secure our future benefits.

Today’s contributions pay today’s pension benefits of today’s retirees. When we retire, younger ones should do the same for us … but, that’s where the problem is.

Today, the bulk of pension scheme members are young (almost 70% are below 35 years in age; more than 50% are between the age of 26 and 35). Our pension scheme currently has about 38,000 members, of who only about 1700 are the beneficiaries (1200 pensioners plus 500 surviving family beneficiaries). Many members and few beneficiaries: our pension scheme will appear to grow.

But, this is not likely to continue, because we do not expect the eligible employees (of the civil service, public corporations and armed forces) to grow in numbers. By the time this young group retires, pensioners will outnumber members by a big margin. Few members and many beneficiaries: our pension scheme will collapse.

The problem, however, is not that most of the pension scheme’s members are young. The real problem is that the way the pension benefits are defined is not sustainable. What we have is a defined-benefit plan that determines pension rates according to a formula, which is based on the salaries of its members. So, all things considered, benefits have not much to do with actual contributions, especially if the final salary is used.

What we should consider is a defined-contribution plan that will determine pension rates based on the actual contributions of individual members. And if higher pension levels are desired, members or their employers would make bigger contributions. A fully defined-contribution plan should be sustainable, simply because pensioners will get only what they and their employers set aside for retirement.

The good news is that we aren’t the only one with this problem. Many countries and companies have made exactly the same mistakes, and are now reforming. We can learn from their mistakes and successes.

The NPPF have been doing a lot of good work, especially after the Pay Commission was established. And the government’s decision to base pensions on 40% of the final salary will, no doubt, make them even more nervous. I hope the government will reconsider its decision. And I hope that the government will support the major reforms that will be needed to make our pension scheme sustainable.

And what should we do? Inform ourselves. For now, it’s important that all of us understand how our pension scheme works and what options we have. I’m learning. And, believe me, there’s a lot to learn. Wikipedia has a quick explanation on various pension plans and some international comparisons. And the NPPF website has information on our pension plan.

Postponing a problem won’t make it go away. It will only get bigger and uglier.

Pension is for our peace of mind. It gives us that precious sense of security. More security means greater happiness for us, our families and our communities. That’s got to be good for GNH. Let’s practice what we preach!

 

Facebook Comments:

Comments

  1. The Pay As You Go(PAYGO) you’re refering to does have a lot of problem. Germany and France follows this system and i hear my friends complain a lot about it mainly due to high demographic pressure. Right now, every working person in Germany supports at least one retiree (which is expected to grow in future).
    I really don’t want our Pension system to collapse. I hope our government and NPPF comes with good solution. As long as its about solving the problem, i am in.

  2. Who would want pension system to collapse? For that matter anything to collapse unless someone is on some evil mission … haha

  3. Anonymous says:

    First of all I want to make it clear that I have nothing personal against the management and staff of NPPF. My view is that we need a professional management to run NPPF.The biggest problem is that the right people are never placed in the right job. Pension fund is all to do with finance and investment and should not be totally dependent on Pension deposits of the younger generation. After all it for the future financial security of the people. Everyone has to retire one day and for most of the people, pension is the only source of income. Investments for the fund should be looked into. The question I ask is what is the rate of return for the funds with pension? Is the management equipped with professional manpower to study investment oppurtunities outside of Bhutan? Has NPPF hired professional help form outside to prepare a report on fund management? Is real estate building the right thing to do? What is the rate of return on real estate investment? Is the 30 yrs sustainability calculated based on real estate price of today? (NPPF is one of the biggest realestate owners in the Country and the office is overshadowed by the engineering cell over financial analyst)These are few of the questions I ask. Please comment and correct me if I am wrong.

  4. Anonymous says:

    Why dont we ask DHI to take over the pension fund also..ha ha.. That will make them wake up and perform. For all you know DHI might get NPPF the right management team.

  5. Bhutanese Blogger says:

    Paying today’s retirees from today’s contribution isn’t a desirable situation. Even though adjustments will have to made for the shortcomings of the past, this cannot go on for long. It will assume proportions like the Ponzi scheme run by Madoff in the US, and take everybody with it.

    NPPF must now look to professionally manage our pensions. Seek to match pension payments with returns from the funds. Diversify from real estate into more assets like foreign equities and bonds. Develop investment research and analytical skills, and risk management capabilities within the organisation.

  6. Sonam Yeshey says:

    I think we would also explore new retirement products in the near future to provide a fair retirement income, if current scheme is not sustainable. We will review all possible assumptions to make it long-term sustainable.

    NPPF would consider various options.

    Sonam Yeshey
    NPPF

  7. I thank you, Sonam Yeshey, for the information, and I respect your integrity in posting comments under your real name.

    I suggest we all heed OL’s advice, and INFORM OURSELVES first. Pension is a serious business for its members as well as those who are tasked to manage it, and calls for an well-informed and constructive dialogue.

    To add to our information, managing investments that demand long-term security of their returns is one of the most challenging undertakings in finance anywhere in the world — especially in Bhutan where such investment opportunities are rare.

    And, remember, diversifying into foreign assets in countries other than India introduces foreign exchange risks of unknown magnitude. If it were my money, I would invest overseas if and only if I can match the foreign assets with my liabilities (pension benefits) in the currency of denomination dollar for dollar, euro for euro, etc. For NPPF liabilities, this is obviously not an option.

    Easier said than done, everyone!

  8. Anonymous says:

    The comments posted for need of professional mangement has to be seriously considered. Everyone is aware that certian risk is involved in investments outside the country but the question is has anything been done to dertermine the study the impact of investment outside Bhutan? Every Finance person understands the currency denomination liability but there is something called the risk management which can determine the investment oppourtunities and risks involved. Is everyone aware that NPPF did loose a lot of money in investments in America a few years back? The problem is not about investments outside because of our currency denomination liability, it is about getting professionals to manage the funds. I agree with Zekom it is easier said than done but what can be done if there is no start to it.

  9. Hey hey, be careful anonymous2:50pm.

    The so-called foreign exchange risk isn’t a “risk” at all.
    It’s what real finance experts call “uncertainty.”
    I call it “gambling”!

    Risk is something one can manage, because one knows the probability of it happening.
    Uncertainty cannot be managed, because one doesn’t even know how likely it can happen.

    In the finance jargon, foreign exchange rates take a random walk.
    In our lingo, you take a bet.

    The only way you can manage the foreign exchange risk is by not taking that risk, i.e., match the currency on both sides of your balance sheet, or not making the investment at all if you don’t have any liabilities denominated in foreign exchange.

    All in the spirit of keeping ourselves informed…

  10. bhutanese blogger says:

    For the sake of informing ourselves.. I take the discussion a little bit further..

    Uncertainty and risk are not two different things and are almost synonymous. Risk by definition has to be uncertain. If an outcome of an event, say your investment, is certain, there is no risk at all. But when it is uncertain and you have the possibility of losing your investment, you have risk.

    All kinds of risks encompass uncertainty. Take market risk – you don’t know how it will behave, it is uncertain and takes a random walk. Otherwise anybody could predict the market and become rich. What about financial risk of your customer? Again there is uncertainty that they may not pay and you lose money. This is true for credit risk, country risk, political risk and all sorts of other risks.

    Foreign exchange risk is also no different. It is a risk because it is uncertain (in terms of movement of exchange rates) and you have a possibility of loss.

    There are financial instruments which are used to manage foreign exchange risks. These instruments aim to hedge potential losses that a company can incur through foreign exchange.

  11. Anonymous says:

    Its heartening to see that we have woken up to the pension catch-22 situation. Sustainability of the pension fund forty years down the line is questionable. But look at what is happenening now? The Fund has obviously left out our poor and needy.

    Can we not start something called the Universal Non-Contributory Pension Scheme. This is based on the principle of Solidarity-‘we look after each other’s backs’.

    The government would bring all bonafide citizens, regardless of whether they paid to a formal pay-as-you-go scheme or not, above a certain age into a minimum monthly pension. This would immensely benefit the poor and the rural needy. For instance, the monthly pension of Nu 500/- to a urban and rural pensioner will have differences.

    Google it. Advanced countries like NewZealand and underdeveloped countries in the African Continent alike have used this system to distribute national wealth and address many social issues like social welfare, bridging the haves and have-nots gap and transfering the traditional Pay-as-you-go pension scheme to a three tired scheme.

Trackbacks

  1. […] we discussed the merits of a defined-contribution plan over the existing defined-benefit […]

Leave a Reply