Defusing the pension bomb

ARTICLE: Tick tock tick. That is the sound that the consolidated budget position of any growing expenditure element makes. Circular debt is a well-known fact in the country. Pension is another elephant in the room growing out of control. Ten years ago, the combined pension expenditure of federal (including military) and four provinces was Rs164 billion. Today, it is Rs988 billion. Pension liabilities have grown by 6 times, while the consolidated tax revenues are up by a mere 2.7 times. As percentage of taxes, pension expense grew from 9 percent to 21 percent in the last decade.

The situation becomes scary when any of future liabilities are funded. Future pension liabilities of Punjab were evaluated in 2015 at Rs3.8 trillion while pension expense was Rs104 billion. Today, the expense is at Rs250 billion and unfunded liabilities are estimated at Rs5-6 trillion. Punjab is one fourth of total expense. Using simple arithmetic, unfunded future liabilities of all federal, military and provincial direct employees could be around Rs20-24 trillion. According to Hasaan Khawar, a development specialist, the number is Rs33 trillion to 34 trillion.

Actual number cannot be evaluated without proper actuarial evaluation of all government employees. It is too big to handle. The prime minister has created a Pension Reform Commission. According to Dr Waqar Masood, an effort to fund pensions was initiated in 2001, but lack of will to contribute towards pension fund by military employees killed the plan in its infancy. In 2001, it was a future threat. Today, the storm is hitting. The way pension is growing, in 10-15 years this could be the single biggest expense item (after debt servicing) in the consolidated budget - bigger than defense or development.

The story does not end here. The PSE employees' pension is unfunded too; and it would become liability of the government. Pakistan Railways and Pakistan Post were mentioned by the PM in his interview. Add utility companies (gas and electricity) as well. If these are not funded, eventually electricity bills might have a surcharge to pay for pension of employees. At one point, General Motors' pension liabilities were $5,000 dollar per car the company used to sell. Then the company moved from vested to portable pension.

What can be done today in Pakistan successfully avert the future impact? The music must be faced. But future pension liabilities should be funded. The government cannot back out from its liabilities, as these are contractual obligations. But a cash strapped government cannot run this extravagant pension programme. Right now, the unfunded pension liability can go up to 100 years after retirement. There is no contribution by the employees or the employer (government) and all pensions are inflation linked. This simply cannot continue.

The current model is of unfunded defined benefits where the employee gets the said benefits at and after retirement, and the pension continues till the time any of the pensioner's dependents is alive. This is an age old model. Today, the world has moved towards defined contribution. In this model, every month, both employee and the government contribute towards employee's future pension liabilities. This fund is invested in capital markets and other avenues and is used to pay pension after retirement.

This can happen for the fresh hires. But something must be done for existing employees (future pensioners) and existing pensioners. The government cannot fund this through its tax revenues. Given the number of hirings in the last two regimes, the liabilities growth could be even faster in the next decade or two.

For existing employees, if consent is obtained, they can be moved to defined contribution. For that, government has to set aside a fund and these employees have to contribute equally. But they may demand increase in the salary amount to their contribution to make disposable income unchanged. In essence, the government will have to fund existing employees' portion as well. Then the risk of investment has to be borne by the government, as employee would want the obligated amount the government has promised.

One way to fund for existing employees (with or without contribution) and pensioners is to sell the real estate owned by the government to create a fund for existing employees and pensioners. For future, pension funds need to be created as well. At the entry level, salaries are low and having contribution from the day one would not be that costly. These shall be invested for long term. This will help develop a long-term capital bond market in the country.

Around four decades ago, to solve the pension problem, the government in Chile increased the employees' salary by 18 percent - 10 percent went for pension, 5 percent for health insurance and 3 percent for life insurance. These funds helped develop the pension and insurance markets in the country. The cash generated by these companies was used to buy long-term bonds for infrastructure, and a privatization fund was created to buy government assets and so on and so forth.

Pakistan can develop a similar model. Link this to PM's ambitious programme for housing. For housing to spur, a vibrant mortgage market is a prerequisite. But for banks and non-banking financial institutions to finance housing, one impediment is absence of long-term assets to match the housing liabilities. Housing finance companies can issue long term bonds for financing mortgages. Pension funds can buy these long-term bonds to fund their pension liabilities. A similar structure is suited for infrastructure financing - government needs to have funding for infrastructure in public-private partnership. The real estates to be sold for funding existing unfunded pensions can be built by issuing pension bonds for the future.

It's a difficult task; but not an impossible one. The demographics are in Pakistan's favour. Unlike Japan or western countries where aging populations are creating issues for funding pensions as more people are retired (or retiring). In Pakistan, the younger population cohort is large enough to fund old retirees, provided the pension structure is right and implemented.

Copyright Business Recorder, 2020