Pension benefits

We talked about pensions two years ago.

First, we voiced concern that the NPPF pension scheme was sustainable for only 30 years.

Then, we discussed the merits of a defined-contribution plan over the existing defined-benefit plan.

And then, we expressed alarm that the government was interfering in how our pension scheme was being run.

Let’s keep talking about pensions. There’s good news. And there’s bad news.

The good news is that, despite increased competition in the financial sector, NPPF seems to be performing well. In the last year, the membership base has increased by 5.4%, from 40,222 to 42,393 members. Revenue generated increased by 14.57%. And the total fund grew by 18.6% to Nu 8.97 billion.

The good news is also that NPPF’s pension scheme could soon become available for workers in the orgranized private sector.

The bad news is that our pension scheme is become even more defined by benefits. Retirement pension benefits have now been increased to 40% of final salaries. This is bound to make our pension scheme unsustainable, especially after returns on NPPF’s investments start to inevitably drop due to the growing competition in the financial sector.

The bad news is also that some six serving ministers are already drawing pension benefits.

Our ministers collect pensions because they have retired from the civil service. And because they’ve reached the retirement age. They’re entitled to draw pensions. But, as serving ministers, they still have regular incomes. So the very purpose of pensions – i.e., to provide predictable income when income from formal employment is not longer available – seems to be lost.

In a defined-benefit plan, pension rates are based on the salary of a member with little regard to how much that member has contributed.  Such a scheme naturally encourages members to collect their pensions as soon as they reach retirement age, even if they are still formally employed. That’s why our ministers collect their pensions although they have regular salaries. The system encourages them to do so.

In a defined-contribution plan, pension rates are based on the contributions of individual members. So the more a member contributes, the more that member will collect during retirement. Such a scheme would encourage members to make contributions as long as they have regular jobs, so that they enjoy bigger benefits when they no longer have regular jobs.

NPPF knows that defined-benefit plans are not sustainable. The experience of many countries has already demonstrated that.

So NPPF should migrate to a defined-contribution plan. The transition will be difficult. And it will be painful, especially for members who will retire in the next few years. But it is possible, now. Our pension scheme is still young; contributing members outnumber pensioners by a huge margin; and returns on the pension investments have been good. Plus, our government may be willing to chip in to defray some of the immediate costs associated with migrating to the more sustainable defined-contribution plan.

Major pension change

According to the finance minister’s Pay Revision Notification of 13th February, “The Government has approved a major change in the pension scheme…” The “major change” involves increasing pension benefits to 40% of the final basic salary and raising contributions to 22% of the basic salary (11% each by the member and employer).

Increasing pension benefits will, as I argued in a previous entry, affect the sustainability of our pension scheme. Some of this pressure will no doubt be relieved by raising the contribution levels.

So what overall impact will the government’s decision will have on the pension scheme’s sustainability? We don’t know yet.

What we do know, however, is that the government is dictating how our pension scheme will be run. And that is not good. Careless governments could easily misuse the pension fund to gain political mileage.

True, major reform is needed to make our pension scheme more sustainable and robust. But reform should come from the NPPF; it should not be imposed by the government.

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!