The viability of a private sector pension scheme

Dinesh Weerakkody

Traditionally we have been used to a culture where children and families as such have taken the burden of the aged and caring for them.

Many are of the opinion that like in the West the situation is changing fast in Sri Lanka as well and concern for the aged is losing its place as an accepted norm.

We are also confronted with the aging population issue and although we could address part of the problem by extending the age of retirement, we are likely to have a large segment of our population as retirees.

Therefore, a pension fund is a laudable objective, but in a culture where employees still like the feel of their money in their hands when they retire, to one where they would understand the benefits of a regular pension payment requires selling the idea through proper education as well as seeing how it benefits public sector employees.

The State needs to address issues which exist in the State run scheme for public servants as a first step so that this example could be the cornerstone of a marketing exercise for the private sector pension scheme.

Many of the younger workers would like the idea of a pension scheme if it is explained to them and certain problems in relation to sectors such as apparel which attract young females, need to be examined and dealt with effectively.

The overall objective of a scheme should be to secure to an average worker a payment, which at least guarantees his or her financial independence at the time of retirement.

End Game

However, the main issue for them is how the scheme is funded - what commitments are expected from them? What could they expect in terms of sufficiency of the monthly payments? Would it have an adverse impact on their existing benefits? What special benefits does the scheme offer in real terms to an employee who works loyally for 25-35 years for one company? Globally, schemes tied to final salary are on the decline.

Most are now closed to new employees joining and some are closing to employees already in the scheme, with a buy out.

One or more Banks in Sri Lanka which had pension funds have either moved away from them or closed the schemes to new entrants. These existing schemes will continue their progression from a core employee benefit to a complex and risky financial liability.

Managing these liabilities creates little upside opportunity for companies but instead poses significant financial risks and ties up precious management time.

This has led to an End Game in many pension schemes: the beginning of the approach whereby a company and its trustees start to consider the final settlement of pension scheme liabilities at some point in the future.

For some, the End Game could be many years from now, requiring a carefully managed programme to control risk until that point is achieved.

For others, the End Game may be in the near future. The dramatic growth in the number of insurers seeking to acquire these liabilities from organizations is driving a growing market in accelerated settlements.

The Boards of many companies no longer consider their company final salary pension scheme as a key part of their HR strategy.

Their sentiment is often that final salary pensions ceased being a core employee benefit long ago; particularly for new and younger employees, and that the pension scheme is a risky and uncertain millstone around the company’s neck. Most final salary schemes are closed to new entrants, with many now closing to existing employee members.

As the working life of these pension schemes draws to a close, they become only a liability to the company consisting of promises to pay pensions to ex-employees.

Put simply, the pension scheme has now become a financial liability to be managed, controlled and ultimately eliminated in due time.

Challenges

In any pension scheme, the return on investment, inflation and mortality are the top three risks faced by any pension scheme. Therefore, one needs to take a closer look at some of the issues behind these risks and how they might affect a pension plan: A) Investment risk can be largely controlled but often is not.

The assets of a pension scheme may not perform in line with the expected assumptions and may also not match changes in the size of the liabilities over time as interest rates at different durations change.

This creates a risk that in the future the investments either outperform or underperform relative to the liabilities and assumptions.

In a typical pension scheme assets are not closely matched to liabilities. B) Inflation can pose a significant risk to pension schemes.

For most pension schemes, a large proportion of pension benefits are linked to the inflation rate if future inflation is higher than anticipated, then the cost of providing benefits will also be higher.

However, the overall impact on the schemes’ finances will depend to a large extent on the inflation matching provided by the scheme assets.

In circumstances of very high inflation with assets providing real returns, pension schemes’ finances could be significantly improved C) The longevity risk is the number one risk for any pension scheme and also the most difficult risk to control.

Therefore longevity risk must be uppermost in the minds of the promoters as a problem area for any proposed scheme.

During the past century, longevity has been improving steadily thanks to medical advances and improvements in the standard of living.

Way Forward

Therefore, it may be prudent for the government to study its current and long-term funding options and the risks associated with managing pension scheme in consultation with the private sector because any scheme that is launched must not fundamentally alter the rights of workers over their current short-term benefits (Gratuity, ETF) and especially the planning based on receiving a lump sum at 55 (EPF), such as giving financial support to children and fulfilling other domestic obligations.

However, for a start the private sector could benefit a lot through a form of an unemployment benefit scheme, which the current system ETF or EPF can fund.

That would help companies to restructure and become competitive and for the economy to maintain its desired growth through productive employment.

Therefore, in the final analysis, the government should be lauded for attempting to secure the retirement future of underprivileged workers who do not have the privilege of hefty bonuses and long-term share options. What they need to do is work out a scheme that is viable and does not fundamentally alter the current retirement rights of the average worker.

(The writer is a former Chairman and CEO of the ETF)