Fund manager shoots down public-sector pension plan

A major pension fund administrator has denounced the recommendations for a defined contribution pension scheme for public-sector workers where the input rate for both employer and employee would be five per cent.

Managing director of Prime Asset Management Limited, Rezworth Burchenson, believes it would be more appropriate to put in place a funded-defined contribution scheme in which the employer contribution was determined by actuarial analysis, to ensure a replacement ratio of 75 per cent after 37.5 years of service.

The replacement ratio is the percentage of working income that an individual needs to maintain the same standard of living in retirement, and is usually between 60 and 90 per cent.

Burchenson was responding to Financial Gleaner queries on a Green Paper on Options for Reform of the Public Sector Pension System, tabled in Parliament last week. It was developed by the Ministry of Finance and the Public Service in collaboration with the World Bank.

"Having read the reports, we disagree with the recommendation of the steering committee in proposing a parametric reform," Burchenson said.

"The biggest challenge with the current system is the unfunded liability and affordability. Every year the cost goes up and is now some 30 per cent of GDP," he said.

"We need this variable to go to zero as quickly as possible, and the best option is the defined contribution plan," Burchenson added.

Simulation exercise

According to the consultative document, after an extensive simulation exercise of various pension system-design options, it was thought that the best option would be one of a parametric form, where the salary used to calculate pension benefits changed from final salary to an average of five years' salary.

In the model, a combined contribution rate of 10 per cent would also be made by both employee and employer.

The model was also chosen based on its fiscal sustainability, affordability and the adequacy of the benefits provided.

Presently, there exist a non-contributory 'pay as you go' system in place for public-sector workers.

This system has become burdensome on the government, contributing to a significant portion of the country's debt, having ballooned to some $22 billion since this year.

So, as part of the country's medium-term economic plan, Jamaica has committed to the International Monetary Fund (IMF), that it would reform its pension arrangement for the public sector.

According to the discussion paper, the three main pension systems are the defined-benefit scheme, defined-contribution scheme, and a notional-defined contribution scheme.

Based on the result of the simulation, the parametric reform type was recommended, as it would best serve the function of ensuring that the system is sustainable and affordable for the Government while also providing adequate benefit.

It will result in a one per cent increase over the four per cent contribution that is currently being made by civil servants towards family benefits, and 1 per cent less than those who are currently contributing 6 per cent towards their pension.

In the recommended model, nurses and teachers who currently make no contribution to the Consolidated Fund, would now also be required to contribute five per cent of their salary, while the 1.6 per cent contributed by the police would be increased to the 5 per cent level.

The Green Paper further states that the model would be more sustainable than the existing system as the implicit pension debt decreases from 57.7 per cent of GDP to 32.3 per cent.

But even this 32.3 per cent is still not sustainable by Burchenson's measure.

"An unfunded liability of 32.3 per cent of GDP is unsustainable over the long term, and bold action would be required to eliminate this burden," he said. "This unfunded liability equates to an increase in Jamaica's debt stock and contributes to the vulnerability in our fiscal resources," he explained.

"Most countries which are reviewing the public-sector pension plans for reform are choosing the route of a funded plan for its many attendant benefits," said the Prime Asset Management managing director.

Under Burchenson's alternative, contributions should be managed by the investment department of the National Insurance Fund or outsourced to investment managers licensed by the Financial Services Commission under strict investment guidelines.

Growing pool

Additional benefit of such a plan, he said, is that payment of contributions will create a growing pool of long-term investable funds, contribute to an increase in the national savings rate and impacting key macroeconomic variables such as balance of payment, inflation and interest rates positively.

But results for the simulation on the funded-defined contribution goes against some of the objectives of the reform.

For example, the Green Paper states that it may be unaffordable for workers due to the high contribution rate.

And while it would be clearly transparent as benefits are directly related to the contributions made, and sustainable in the long run, it would, however, prove very costly and unaffordable for the government in the medium term.

However, Burchenson contends that in the absence of absolute data, stating that it would be more costly meant nothing.

"To state it without giving a number/figure I can't accept; in the absence of actuarial data I have a problem," said Burchenson.

He also said that further analysis is required on the replacement ratio under the defined contribution and the notional-defined contribution schemes.

"We have spoken to a number of trustees, actuaries and investment managers of private-pension plans who have indicated that, in their experience, defined contribution plans are generating adequate replacement ratios for their members," he said.

"We recommend that the team consults with a local consulting actuary towards making a more informed view of the replacement ratio under a defined-contribution scheme," he said.

Results of the simulation for alternative options, such as defined contribution with a 10 per cent contribution for both the employee and employer shows that it will provide higher replacement rates for the new retirees, peaking at over 70 per cent in the short run, but will decline to approximately 50 per cent.

In the case of the notional-defined contribution and defined contribution with a combined contribution rate of 10 per cent, lower replacement rates were projected.

For the defined contribution scheme, the replacement ratio started slightly below 50 per cent and eventually tapered off at 25 per cent, while the notional defined contribution decline from 42 per cent to 17 per cent in the long run.

Among the other recommendations Burchenson made is the discontinuation of the practice of granting early retirement at age 55 without a reduction in annual pension, as well as the practice of granting automatic reinstatement of full pensions after 12.5 years.

The indexation of pensions should also not be automatic but based on the ability of the budget to accommodate such increases.

sabrina.gordon@gleanerjm.com