Crunching the pension numbers

Pakistan’s pension system has been under controversy for over a decade, raising questions about policy decisions regarding funding and structural flaws in pension administration.

The decision in 2009 to include future retirees in the pension increase has compounding effects on the financial burden faced by the government, meaning that the new pension increase will be applied to an expanding group of recipients.

While the scale of the problem is clear, the politicization of pensions, both civilian and military, is a major obstacle to discussing the issue and implementing the necessary reforms.

Currently, pension expenditure has risen to unsustainable levels and takes up a significant portion of government revenue and tax collections. Over the past five years, federal pension expenditure has increased four-fold and is expected to reach a staggering Rs 1.01 trillion by FY25, representing a 26% increase over the previous year. At this pace, annual growth is expected to be 22-25% for the next 35 years.

The current pension scheme promises a set benefit at the time of retirement and does not require any contribution from employees during their working years, so the entire burden of the pension scheme falls on the government.

Given that life expectancy is 67 and the retirement age is 60, the 30-year guaranteed benefit, which is passed on to family members after the pensioner’s death, also creates an additional burden.

Key lessons learned from international experiences offer efficient solutions that can help build reliable pension systems that are financially sustainable and socially equitable. In Sweden, for example, a comprehensive multi-pillar model has been designed that combines public and private contributions to ensure financial security in retirement.

The first pillar is called the Income Pension and operates on a pay-as-you-go (PAYG) basis, with 18.5% of an individual’s earnings contributed to the pension.

Benefits from this pillar are calculated taking into account an individual’s lifetime earnings and a notional account value that adjusts for economic growth to ensure that pensions are appropriate for current economic circumstances.

The second pillar, premium pensions, is a compulsory defined contribution scheme, where 2.5% of an individual’s income is directed into private funds of their choice, allowing for a personalised investment strategy. This pillar gives individuals a say in their investment choices and potentially higher returns based on the performance of their chosen funds.

The third pillar is voluntary private pension savings with tax-favorable incentives, encouraging individuals to make private savings on top of their mandatory pension contributions, thus ensuring greater financial security in retirement.

The Netherlands also boasts a strong multi-pillar pension system designed to guarantee financial security in retirement. The system is underpinned by a universal pay-as-you-go pension system funded by payroll taxes, providing fixed benefits to all residents from the age of 67.

This is complemented by a compulsory occupational pension to which most employees contribute, which operates on a collective defined contribution model, where contributions are pooled together and invested, with benefits then adjusted according to the fund’s performance.

Furthermore, the Dutch system encourages autonomous private pensions by offering tax benefits for personal savings. One of the system’s great strengths is its wide coverage and generous benefits.

Finally, Singapore’s Central Provident Fund (CPF) operates on a compulsory defined contribution system, which consists of three main accounts: an Ordinary Account (OA), used for housing, insurance and investment purposes, a Special Account (SA), primarily dedicated to retirement savings, and a MediSave Account (MA), which is earmarked for medical expenses.

Both employees and employers contribute to these accounts and funds are allocated accordingly. These contributions are invested in various financial instruments and members are free to choose their preferred investment avenues.

The CPF system is acclaimed for increasing people’s savings rates and ensuring provision for housing, healthcare and retirement needs. It emphasises the importance of personal responsibility and financial acumen, enabling people to skillfully manage their personal finances and effectively plan for retirement.

These are some of the various interventions that Pakistan can consider as it looks to overhaul its spiralling pension expenditure. As things stand, the steady increase in pension expenditure is financially unsustainable and takes up a large chunk of the country’s total revenue.

The government should take inspiration from examples from around the world to come up with solutions suited to Pakistan’s problems and seek support from all stakeholders including the government, private sector and civil society.

A phased and graduated approach should be considered to allow for necessary adjustments and to ensure that the rights and expectations of current and future retirees are respected and met.

Proactive and transparent risk management and a well-designed regulatory framework are crucial to the health of any pension system. These elements, coupled with an informed investment strategy that delivers safe and healthy asset growth, can form the foundation of a reformed and resilient pension system in Pakistan.

The author is an analyst at Karandaaz Pakistan.

Disclaimer: The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Geo.tv.