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 Ghana can use the many lessons from the past if they are well identified and understand. However, the primary and most critical lessons in my opinion 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
incentivesfor 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
kwakuhyiaman@gmail.com
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