Guyana's private sector pensions failing to meet stakeholders' expectations
Business Page
Stabroek News
December 3, 2006
This column provides informative commentary on business and financial matters and is written by Patrick van Beek, Managing Proprietor of Caribbean Actuarial & Financial Services.
Introduction
Some two years ago, while I was writing for Stabroek Business I prepared a two- part article comparing the benefits which would be expected from the two most popular types of pension schemes, the defined contribution (DC) and defined benefit scheme (DB) (SN August 6 2004 & July 31 2004). I concluded that on first sight defined benefit schemes appear more attractive to the members, though this depends critically on the members staying in the scheme until retirement and then only if the employer keeps the scheme running until then. One thing I did not touch on then was the applicability to Guyana. This week I will discuss why by and large I believe private sector pension provision is failing to meet stakeholders' expectations in Guyana.
There are three pillars of support for benefits in retirement - the state, the employer and the individual. In Guyana state provision is covered by the National Insurance Scheme. In Guyana, many employers operate a pension scheme (note that in its capacity as an employer the state may offer provision for pensions over and above that provided nationwide). If the first two sources of benefit are insufficient to meet the costs of living then the burden will fall on the individual. If they have not made provision for themselves then they may be forced to rely on family to support them in retirement or spend their remaining days in penury. The main problem that I see is that although much private provision is being made, nobody is really asking the question of whether a sufficient level of benefit is being provided for at a cost acceptable to the parties providing it.
It is this tension between cost and level of benefit that falls at the heart of the debate between DC and DB schemes - on one hand the cost is known to the employer while the benefits are unknown, on the other hand the benefits are known to the employer but the benefits are unknown to the beneficiaries.
The Actuary's Role
As an actuary, I see a number of defined pension schemes in the day to day course of my business. For the most part my work with DB schemes involves the valuation of benefits, that is putting a value in today's terms on the benefits promised by the scheme, determining the contribution rate which is required to be paid to meet the benefits which will accrue going forward and recommending the action to take in respect of any surplus or deficit in the value of the assets compared with the actuarial liabilities.
Somewhat unusually, Guyana also requires an actuary to undertake a valuation for DC schemes. In these types of schemes each member of the scheme has their own pot of money, which can be likened to a bank account. The sponsor pays in regular contributions, which together with the employees' own contributions (if any) are rolled up with interest and other investment returns. The value of a particular member's benefit at retirement is simply the amount of money in the pot at that time. A valuation in this case involves checking that the assets of the scheme are sufficient to meet the aggregate value of all the individual balances in the scheme. It may not be immediately apparent, but unless the returns credited to the members' accounts exactly reflect the returns on the underlying fund the value of the balances do not necessarily tie up with the assets. Indeed due to this very feature I have been involved in recommending rates of interest to credit to members' accounts. Another area in which actuaries are often involved in DC schemes is the projection of balances and hence an estimate of the level of benefits which will be paid in retirement.
Do tax breaks exceed regulatory costs?
Despite the fact that the social security benefits provided by the National Insurance Scheme barely provide for a basic standard of living, with the exception of the tax exempt status of approved schemes there is little policy in place to encourage pension provision by the private sector. These tax breaks can be significant, especially when it is considered that as they currently stand they apply over the lifetime of a member.
Even though the fiscal incentives exist, I am often asked why an employer cannot run a savings scheme rather than a pension scheme. With the coming into force of the Insurance Act 1980 pension schemes faced new requirements for disclosure - in particular for audited accounts and the actuarial valuations which I touched on above. The costs of these investigations are not insignificant causing many to question whether the approved status is actually a liability rather than an asset. There are two potential problems in assessing whether this is indeed the case. First it takes many years for the tax breaks to become financially significant, whereas the costs of an audit are incurred now and each year thereafter. Second, in the case of a DC scheme the tax breaks largely benefit the members of the scheme rather than the employers. Take away the tax benefits and the cost to the employer may not be significant - however the reduction in benefits may well be.
By focusing on the short term costs alone there is thus a danger that companies will close pension schemes and replace them with savings schemes that ultimately provide an insufficient level of benefit. Before any employer goes down this road I would recommend that they quantify the level of tax breaks expected over the life of the scheme and compare this with the regulatory costs.
The DC vs DB debate
Another question I am often asked is whether a scheme can switch from being a DB scheme to a DC scheme. There is a perception that running a DB scheme is more expensive than running a DC scheme, though as I showed (in the absence of regulatory costs), both schemes can provide the same level of benefits for the same contributions provided the experience of both schemes is the same. The real driving force I think is the uncertainty in cost involved with defined benefits - many schemes have moved from surplus to deficit as interest rates fell and the assumptions underlying previous actuarial reports proved overly optimistic.
The problem here is that quite often a DB scheme will be replaced with a poorly designed DC scheme, typically having no thought for the level of benefits the new scheme will provide. It should be borne in mind that if the main reasoning behind closing a DB scheme is that the ongoing contribution rate required exceeds current contributions being paid, in a new DC scheme established with the current contribution rate of the DB being paid in, the ultimate benefits under the DC are almost certain to be lower.
Lack of investments
Underpinning both DC and DB schemes is the fact that many of the underlying investment portfolios are woefully unmatched to the nature and term of the liabilities they are funding. Large holdings of cash and treasury bills mean funds are failing even to keep pace with the cost of living. Little wonder that almost every pre-retirement leaver from a defined contribution scheme in Guyana is happy to walk away from the contributions paid by the employer (which can only be accessed at retirement) in order that they can receive a return of their own contributions today. The lack of long term Government Paper makes it impossible to hedge long term liabilities and thus increases the uncertainty of those trying to run defined benefit schemes.
The restriction on having to hold investments in Guyana cannot help - it is completely perverse that the banking sector is allowed to hold a G$20 billion long position in foreign assets - larger than all pension scheme and insurance company assets combined as reported by the June 2006 Bank of Guyana statistical bulletin - yet both Insurance Companies and Pension Schemes are required to hold upwards of 70% of their assets in Guyana. This provides yet another argument companies are using to justify the move from approved schemes to unregistered arrangements.
Conclusion
Unless action is taken soon by the Government to establish clear policy guidelines I can see private sector pension provision unravelling in years to come. While most employers genuinely want to provide some level of retirement provision for their employees they do not want to do so at a cost that is prohibitive. However, cheaper alternative arrangements which ultimately fail to provide any benefits in retirement do not meet the needs of the beneficiaries and thus fail to meet the purpose they were set up for in the first place.
The pensions industry is caught between a rock and a hard place, and it is time for a major rethink by the state of what role private sector provision is expected to take. The current review of the National Insurance Scheme provides an ideal opportunity to do this in tandem.