“Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.” – Winston Churchill
In 2005, the Barbados National Insurance Service introduced a Pension Reform program. The baseline for the discussion was to take appropriate action to address a global pattern seen within developed and developing countries where low birth rates on one hand are accompanied by increased longevity on the other, despite high incidents of cardiovascular and other Chronic Non-Communicable Diseases. Left unresolved, there would be many more pensioners than workers to support those pensions.
The formula was simple and consisted of two parts:
(1) Raise the pensionable age by six months every four years from 2006 to 2018.
(2) Introduce flexible retirement options starting from 60 to 70 years.
a. Early retirement carries a reduction factor of six per cent for each year before pension age.
b. Late retirement is increased by 6 per cent per year for each year after pension age.
My argument is that the NIS pension scheme is inequitable and should be reformed even further to offer a mixture of private pension in addition to the existing NIS or government pension.
Here is why I say it is inequitable. A contribution at the top of the scale for a private sector employee is 22.35 per cent of $4,650 which is $1,039.28 per month – 11.5 per cent employee paid and 11.25 per cent employer paid.
This equates to a total of $374,139 over a thirty-year period. 500 contributions – the holy grail for the NIS – would be $519,554.36 and the minimum pensionable number of 150 contributions would be $155,891.25.
The average payback based on a person retiring at age 70 with an aggregated life expectancy of 80 years would be 60 per cent of the total insurable earnings per year by 10 years ($2,790 per month x 12 months = $33,480.00 x 10 years = $334,800.00). If you are lucky, you might live long enough to get a zero per cent return on that investment.
What would the return be if that money were placed with a private life insurance company in a managed pension trust? Certainly, one would expect a minimum of 2.5 per cent on investment per annum over a 30-year period for even half that amount. Notwithstanding sickness benefit, unemployment benefit and maternity leave, I would bet, giving my basketball nemesis a 10-point start, that the bulk of the NIS funds are in the pension portfolio.
The recent action by the Government to unilaterally cease all debt repayment and then trigger a hostage negotiation for a restructured debt package has brought some weaknesses glaringly into the open. There are not many options for investment in Barbados. This was the cry of the CLICO management when they invested in distressed business operations and idle plantations across the island. We need to correct this urgently by innovating and liberalizing our capital markets.
In the financial services area we have the potential to further deepen the integration of regional capital markets, and we must start seeing the Caribbean as it really is: 26 countries, 43.8 million customers in a USD $305 billion GDP market. That will further lower the cost of capital for industry. There is an opportunity to expand, innovate and improve the efficiency of our pan-Caribbean payment and clearing and settlement systems. We must facilitate the development of a deeper and more liquid market for investment, venture and development capital.
The time has come to implement measures on the markets in Financial Instruments Directive to take a major step forward in developing cross border competition between stock exchanges and investment banks in securities dealing. Local stock exchanges must be fused with regional partners and have access to global exchanges that investors can have access to all markets and spread their risk accordingly.
I hope in the longer term we can make progress to facilitate fund pooling and possibly fund mergers if we can overcome some of the tax obstacles. That will help extract further scale of economies for operators.
I suggest a hybrid pension insurance plan that will take some of the risk from the NIS, provide new opportunities for regional insurance companies and offer consumers more options on the direct management, visibility and risk/reward ratio of their pensions.
This Integrated System of Retirement and Pensions (ISRP) would be made up of a basic publicly managed pension system, which is what currently exists and a mandatory mixed contributory system. I move that we abolish Non-Contributory Pension and label it correctly as elderly welfare as it provides a non-earning related benefit, which is a monthly flat amount of approximately 33 per cent of average wages, that can be claimed by any national or resident who reaches the pensionable age. We fund this separately and manage it differently from contributory pensions.
The mandatory mixed contributory system comprises two alternatives: a new Pay-As- You-Go (PAYG) government-run scheme, and a privately managed fully funded scheme based on defined contribution individual accounts. The public scheme is managed by the NIS and the private scheme by private pension fund managing companies.
Participation in the system is mandatory for both employees and self-employed. When they enter the labour force, they are automatically enrolled in the public system. Additionally, citizens must choose between the publicly managed PAYG system and the private system for their earnings-related pension.
Employees and self-employed could also contribute into voluntary complementary pension plans. Under the contributory mixed pension system, workers cannot participate in both the new PAYG government-run system and the private system simultaneously. Members choosing the PAYG system can switch to the funded system at any time. However, those who chose the private scheme cannot switch to the PAYG system. The default option is to be placed in the private scheme.
Both employees and employers contribute to the ISRP. Employees who chose to enroll in the funded system pay a minimum contribution of seven per cent of their monthly gross salary, (original employee contribution imposed by law was 11 per cent), of which 4.5 per cent goes into their individual account, 1.250 per cent to the insurance company and 1.250 per cent to the private insurance to cover the administrator’s commission. The remaining four per cent goes to Sickness, Maternity and Unemployment. The employer contribution is 16 per cent of the employee’s monthly gross salary. It finances entirely the cost of the new PAYG government-run system (11 per cent), the remaining five per cent goes to Sickness, Maternity and Unemployment.
Employees and employers enrolled in the private system can also make additional contributions to the individual accounts. Self-employed workers contribute both the employee and employer contributions totalling 27 per cent according to the $4,650 fixed income reference scale determined by the NIS. The employee element is paid to the system chosen by the self-employed person.
Individual accounts in the funded system are managed by private pension fund managing companies. These companies are strictly regulated by the Financial Services Commission (FSC) Pension Fund Management Department. Asset Managers are to be created solely for investing employee contributions and for administering payments to retirees. Each approved Insurance Asset Manager administers one fund, which is a defined contribution fund, and the assets that are accumulated in individual accounts are the exclusive property of each respective fund. The insurance firm must keep the pension fund’s assets separate from their own assets.
Private Fund Managers should be bound to a minimum guarantee rate of return. They should be allowed to invest in a variety of financial instruments, such as Government bonds, mutual funds, corporate stocks, and derivatives. However, investment is subject to quantitative limits per instrument, per issuer and per risk rating levels. There are also investment limits on type of assets. They cannot invest on equities issued by other pensions managed under the same program by similar investment fund management companies.
Spreading the risk
Assets in which Pension Managers may invest must have a minimum risk qualification issued by the Central Bank or authorized rating agencies. Additionally, each Pension Manager must hold liquid reserves of an agreed percentage of the pension fund balance and must not, in any case, be less than ten per cent of the total value of the fund.
Minimum rate of return regulation
In order to ensure an appropriate combination of high yield and low risk in their investments, all pensions are required to guarantee a minimum return equivalent to the average for the industry minus three per cent or two hundred basis points, whichever is smaller. Symmetrically, if returns of any fund exceed the industry average plus three per cent or two hundred basis points, the share value has to be reduced to this maximum level, and the excess is credited to a special account that serves as a profit reserve under the ISRP Private Fund.
When, in any given 12-month period, a fund’s return is below the minimum guaranteed, the ISRP must compensate the affiliates, transferring assets from the profit reserve and, if necessary, from an investment reserve. If both reserves are exhausted and compensation is still due, the ISRP must pay the difference, take over the administration of the fund and withdraw the license of the Fund Manager.
The ISRP management makes a daily valuation of all instruments, according to their economic or market value. However, certain public bonds which are kept until maturity in the portfolios in order to reduce the volatility of the fund are subject to a different valuation. For calculating the daily price of these bonds, the ISRP takes into consideration that debt instruments and floating rate notes are valued daily according to their market value at the relevant markets. For securities issued in foreign currency, the relevant rate in order to estimate the present value of the future flows is the free risk rate at the authorized market. For securities issued in domestic currency, the relevant rate will be the domestic rate of return at the time of carrying out the calculation.
It is time to bring a new disruptive action to the pension market where pension holders take greater control of their NIS/Private pension contributions. They should also be able to use it as a security instrument and pass the net present value on to their beneficiaries. The risk should be spread giving opportunity to private fund management speculation and investment in and from foreign markets. Citizens need to understand, manage and value their pension investment ‘portfolios’ and in the process save the Government from itself.
George Connolly is CEO of Business Technology Solutions Firm and a former candidate of the Democratic Labour Party.