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Pension Problems in Youthful Africa

Session 1: November 6, 2019

Melis U. Guven and Anita M. Schwarz

World Bank

Pensions Core Course

As anywhere else, pension schemes come in all shapes

and sizes

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Social Pension PAYG DB FDC FF DB Hybrid DB-DC Point Systems

Most countries in Sub-Saharan Africa have

separate civil service systems

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• 11 countries have an integrated pension system: Cape Verde, Central African Republic, Chad, Ghana, Liberia, Nigeria, Rwanda, Sao Tome e Principe, Seychelles, Sierra Leone, and Zambia.

• 34 countries have a separate pension system for public sector workers.

• In some countries public sector workers are also covered by some type of social pension in addition to their civil service pension: Botswana, Lesotho, Mauritius, Namibia, Seychelles, Swaziland.

On the surface, African pension systems look to be in

good shape

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Africa is a young continent

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Rosy Picture

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❑ Spending levels as a percentage of GDP are

relatively low

❑ Almost all national pension schemes are

running surpluses

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Pension Spending (% GDP)

Civil Service National Sechemes Social Pension

Reality is more complex

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❑ For countries with separate civil servant

schemes or separate schemes for public

enterprise workers

• Demographics of these schemes are far different from

general population

• Not only are these schemes older, but life expectancy

of participants is much longer

System dependency rates are relatively higher for

civil service schemes

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Demographic structure of national and civil service pension schemes in an African country

PSPF

NSSF

Many public employees are expected to retiree

soon to further worsen system dependency rate

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18 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 74

Fre

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Age

Age Distribution of public sector employees in an African Country

❑ Age distribution of existing public employees is skewed

Even private sector systems have longer-run issues

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❑ Systems are immature

➢ Initially systems take in contributions, but pay few

benefits because people reaching retirement do not

have enough contribution years to qualify for a

pension

➢ Maturity will take place when individuals with full

working career of contributions spend their full

retirement period with pensions

❑ Coverage is low

National Pension Schemes are immature

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0%

5%

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Number of Beneficiaries per Contributor

❑ Fewer beneficiaries per contributor

Few of the elderly are receiving pensions

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Total

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And relatively few workers are making contributions

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70%Percentage of working age making contributions

Share of elderly population will double on average

between 2015 and 2050

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Elder share 2015 Elder share 2050

Very high contribution rates

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❑ Desire for actuarial balance has led to higher contribution

rates than desirable given young demography

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5%

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Contribution Rates as % of Wage

National Civil Service

In European countries contribution rates grew as

population aged

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1940 1949 1961 1977 1983 1989 1993 1997 2002 2010 2012

High Income Moderate Spenders

Netherlands

Finland

Norway

Iceland

Ireland

UK

Germany

Austria

Portugal

Sweden

High contribution rates are problematic

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❑ Disadvantages of high contribution rates

➢ Limit growth of formal sector

➢ Discourage labor-intensive growth

➢ Lower global competitiveness

Combination of high contribution rates and youthful

population leads to large surpluses or reserves

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❑ Pension fund becomes the largest financier in the country – politically powerful

❑ Symbiotic relationship with government• Governments use pension fund to advance projects

for which they otherwise do not have financing

• Governments frequently do not pay their required contributions to the pension fund

• Governments of course rely on pension funds to buy their securities

• Government loses ability to enforce governance and accountability

Many earn negative real rates of return on their

investments

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❑ Lack of marketable securities leads to

investments in real estate and non-liquid

investments

❑ Reluctance to invest abroad

❑ Pressure to invest in “socially targeted” projects

Pension funds spend an enormous amount on

administrative costs

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❑ Typical developed country system spends no

more than 1-2% of contribution revenue on

administrative costs or 1% of wage

❑ Recognize that there are far fewer economies

of scale and potentially higher costs

• Could justify administrative costs 3 or 4 times higher

than in developed countries

❑ In reality, range from between 14% of

contribution revenue to as high as 70%

❑ Lack of accountability

Benefits are also more generous than is sustainable

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❑ Hard to resist demands for higher benefits when the pension fund is flush with reserves

❑ Often long duration of benefits due to early retirement➢ People should expect to spend no longer than 15 years in

retirement

➢ Civil servants actually do not want to retire

❑ Higher accrual rates than will be affordable in the long run

❑ Benefits not related to lifetime earnings, but focused on earnings of last few years – incentive to underreport earnings in early years and over-report in last years

Life expectancy at age 60 on basis of national statistics

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Current accrual rates will not be affordable in the

long run

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1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Accrual rates

Wage patterns when only last few years covered

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0%

200%

400%

600%

800%

1000%

1200%

15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

% o

f m

inim

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wage

Age

Other issues with benefits

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❑ Lack of legislated indexation leaves retiree with uncertainty

❑ Often include step accrual rates, with higher benefits given for first 15 years than for subsequent years➢ Or high minimum pensions

❑ Commutations result in low benefits over retirement life

❑ Civil service benefits sometimes based on base salary, rather than salary plus allowances, resulting in very low pensions compared to working age income

❑ Benefits for survivors not always designed to protect surviving family members

❑ Use of gratuities fairly common in addition to pension

Reform challenges for African countries (generic)

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❑ Universal pension schemes• Identifying eligible beneficiaries and removing them upon death

• Maintaining sustainable benefits

❑ Defined contribution schemes• Improving governance

• Increasing investment instruments for funds to invest in

• Enhancing supervisory capacity to ensure that funds are safe

❑ Defined benefit schemes• Maintain contribution rates at levels needed to pay current benefits until there are

investment instruments which can reliably earn positive rates of return

• Keep benefit design simple

• Provide benefits of 1-1.5% of average lifetime salary per year of contribution

• Inflation index benefits after retirement

• Adjust retirement ages targeting life expectancy of 15 years after retirement for covered group

❑ Consider integration of multiple schemes for better labor market mobility

Increasing number of countries are looking at ways

to extend pension coverage to informal sector

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❑ Coverage of contributory pension systems remain limited to

the formal sector

❑ Several high-middle income countries extended coverage

through social pensions but at a high cost

❑ Informal sector is large in Africa

❑ Informal jobs comprise more than 90% of total

employment in some countries

❑ Most countries in Africa are likely to have large informal

sectors for many years to come

Areas that need particular attention (1)

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❑ Important to look at existing financial inclusion landscape

(microfinance sector, mobile money, etc)

❑ Voluntary, DC scheme- individual accounts

❑ Identify main target groups

❑ Household survey data analysis to get an indication of target groups

Additional surveys, focus group analysis

❑ Use technology to reach geographically dispersed informal

sector

❑ Mobile money could be considered

❑ Link long term old age savings with short term products;

flexible product design

❑ Health, microfinance

❑ Short term savings account along with long- term savings for old-age

Areas that need particular attention (2)

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❑ Professional management of savings

❑ Maximize returns

❑ Minimize asset management costs

❑ Regulation

❑ Appropriate administration platform

❑ Link with ID

❑ Budget for start up costs, staffing

❑ Design the pay-out phase from the start

❑ Effective communications strategy and an implementation

plan

❑ Work with existing partners to build trust

❑ Be clear on what benefit is being promised at eligibility age

❑ Important to pilot test various approaches