Pension without pain

Last week I wrote about huge unfunded pension liabilities of the government, posing a serious fiscal challenge. But that does not mean that the government should stop paying pensions to its employees. On the contrary, the government pensions should be made more secure and fiscally sustainable. How can the government continue to pay pension without pain?

Pension is pegged with the base salary, without any employee contributions and after retirement, payouts are made from the budget. No one knows the amount of the government’s already accrued pension liabilities, owed to existing employees and pensioners through these pay-as-you-go pension schemes.

Many countries meticulously estimate their unfunded pension liabilities and some even account for them in their debt-to-GDP ratio. While it is difficult to calculate Pakistan’s total pension liabilities, without a detailed actuarial study across the federal and provincial governments, a guesstimate can be made. Punjab last had an actuarial valuation done in 2015, putting its unfunded accrued pension liability at Rs3.8 trillion — 34 times the province’s Rs112 billion pension expenditure. If that is taken as a benchmark, our overall pension liability can touch Rs33-34 trillion. This is as high as the total central government debt of Rs34 trillion.

There is a need to immediately cap these massive unfunded pension labilities at their present level, by terminating this scheme for any future government employees. From here on, the government should follow different models for existing employees and pensioners versus the future employees.

For new employees, the government should introduce a fully funded contributory scheme. Every month, the employees and the government should both make contributions, which should then be invested through a well-structured pension fund. The post-retirement payouts have to move away from defined benefit and should instead be linked with the contributions made.

India has successfully implemented such a model. Civil servants contribute 10% of their salary, which is matched by the central government. The proceeds of the fund are invested. When civil servants reach 60 years of age, 40% or more of the account balance is used to purchase an annuity policy, while the remainder is withdrawn as a lumpsum amount or as phased withdrawals till the age of 70, at which point the pensioners exit from the system. The pension fund is managed by the National Pension System Trust for the central government, but 26 state governments have also joined hands.

For existing employees and pensioners, any unilateral change in the pension structure would be politically very difficult. Therefore, the government should start from revising the elaborate three-generational eligibility structure, encourage a culture of contributions by starting with mandatory but modest deductions for the pension fund, offer incentives to employees to voluntarily opt for the new contributory pension scheme and start making budgetary allocations for future pension payments.

The government may consider additional measures to take the pension liabilities off budget. For instance, the government can earmark unproductive assets for sale or lease, transfer them to the pension fund, and match their duration with the pension liabilities. A similar model was tried by the French Pensions Reserve Fund, which received a significant portion of its seed equity from the privatisation of government assets. Other innovative measures could include buyout programmes, offering options to existing employees to accept immediate partial payments in lieu of full future benefits. This model was tried in Illinois, United States, where payments typically amounted to 60-70% of the market value of employee pension.

The pension liabilities are ballooning at a rapid pace, squeezing the development space fast. The long-overdue pension reforms are no more an option but a fiscal necessity and the sooner the government realises this, the better.

Published in The Express Tribune, July 7^th, 2020.

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