One of the greatest threats to our way of life is the ability of our elders to take care of themselves, after they stop working. It is a critical concern that I believe we are not having mature conversations about. I want all of you to sit down with your families and discuss what you are doing to maintain your standard of living after the pay cheque stops. If those plans include an NIS pension and you are under age 40; change those calculations because there is a big possibility it is not going to happen.
Retirement systems are intended to handle the key risks confronting people in old age. It is primarily an individual risk but if not managed prudently, it has a debilitating impact on the entire community and by extension the country. Barbados, as we can see, has developed a demographic very similar to that of some major developed countries, with a birth-rate of 1/100 and a retirement rate of 30/100. Consequently, we will have a problem caring for the elderly if pensions are compromised.
Designing a retirement system that can effectively cushion an aging population against these risks requires (1) understanding the source of the risk; (2) determining how to avoid and reduce the risks where possible (with due regard to the costs and benefits of doing so); and (3) designing mechanisms for insuring against these risks. In 2003, the National Insurance authorities recognised the risk to the Fund and the following actions were taken on January 1:
1) A decision was made to increase NIS contribution rates by one per cent of insurable earnings each year for four years shared equally by employees and employers.
2) It was also decided to raise the NIS retirement age for unreduced pension by six months every four years starting in 2006 until age 67 is reached in the year 2018.
3) The introduction of flexible NIS retirement ages so that in due course persons may retire on NIS pension at any age from 60 to 70.
To summarize, contributions to NIS have increased by a point per year over the last four years. The retirement age has also increased by 1.5 working years for each calendar. Retirement age is now 67, but you can work through until 70. The person requesting early retirement must have actually retired from regular employment to qualify. From this year, early retirement will only be allowed from age 64, with the intention of gradually reducing that age until we reach a lower limit of 60. This phased introduction will allow monitoring of the early retirement experience and appropriate management to protect the Fund’s finances. Late retirement up to the limit of age 70 will be allowed immediately.
The introduction of annual increases, known as ‘indexing’, to the NIS insurable earnings’ limit presently at $3,100 per month, will be increased in line with national average wage increases. Pensions and Maternity and Funeral benefits will be increased by a formula which may be summarized as follows: the lesser of the three-year average of wage or price increases subject to actuarial advice on the maximum which may be granted to maintain the target Reserve Ratio of five times through to the year 2030.
Following are two other more technical changes:
4) The rate of accrual of pension entitlement will be two per cent per year of “final insurable earnings” for the first 20 years, thus 40 per cent of “final insurable earnings” will be earned for the first 20 years of contributions. Thereafter, the rate of accrual will be 1.25 per cent per year of “final insurable earnings” with the maximum remaining at 60 per cent. This new basis will be phased in very gradually. Thus, insured persons within ten years of the then NIS standard retirement age will see no change. For those who are between ten and 20 years to retirement age, 50 per cent of pension benefit will be based on the new basis and 50 per cent on the old. Only those with more than 20 years to go to the new NIS retirement age will now earn a pension on the new basis entirely.
5) The definition of final insurable earnings will be amended to the average of the best five years’ insurable earnings instead of the best three as at present.
All of this is fluid as the underpinning directive is to maintain the target Reserve Ratio of 5x. It is also at risk with 50.99 per cent of the National Insurance Fund being held in Government Debentures; some BDS $2.97, which is being reconfigured as part of the administration’s debt restructuring package.
One reason people face old age insecurity is that they are unable to protect themselves and their families against consumption shortfalls in old age. This is sometimes due to personal attributes such as low earnings ability and/or inability to save. Alternatively, it might be due to myopia, such as when people underestimate their likely life expectancy in retirement. Yet another source of insecurity is health or employment shocks – workers may experience unanticipated earnings declines due to disability or job loss due to unemployment.
It is useful to think of two approaches that may be used to handle such risks – risk avoidance and insurance. Focusing first on risk avoidance, workers might curtail their risk of old age poverty by improving their earnings capacity. This enables them and their families to retire later, and to save more on their own, both of which diminish the chance of inadequate consumption in old age. Such an approach encompasses investments in worker education, health, skills training, and perhaps labour market mobility.
Similarly, worker training in financial planning is useful for reducing the probability of suffering retirement consumption shortfalls. This is because better informed decision makers are likely to save more and more effectively, to protect against old age shortfalls. The general goal, of course, is to increase workers’ awareness of the need for retirement saving and enhance their understanding of investment principles. To this end, for example, Uruguay recently launched a public education campaign emphasizing the importance of saving for retirement in connection with its pension privatization reform. Also, employer-based retirement education efforts in the US have been found to result in substantial improvements in workers’ voluntary retirement saving rates.
Having suggested that greater retirement saving would enhance retirement security, the question arises as to what people should invest in. It may be that having a strong stock market is helpful for a powerful and reliable pension system though little is known about whether pension systems are spurred by stock market growth or vice versa. It does appear that stock market growth enhances overall economic development.
This is something we should speak more about as some economists at the UWI have cited. Moving beyond the individual and family form of saving to the workplace, a measure of protection against old age consumption shortfalls can also be achieved by encouraging specific retirement program features in company, occupational or national pension systems. For example, a World Bank 1994 study suggested workers are more likely to contribute to a group pension programme when retirement payouts are linked closely to contributions, as contrasted to a plan where taxes paid are unrelated to benefits paid out.
As a result, defined contribution pension plans are more likely to diminish retirement system evasion than are means tested or redistributive defined benefit alternatives. A related argument is that workers who can take their pension savings with them as they move across the labour market are more likely to amass retirement savings for old age. Hence, rules permitting easier job mobility via pension vesting and portability are likely to attract and retain more workers in an employment-based retirement system.
Tax reform is a step governments can take to help cut old age insecurity due to individual risk. This is because high payroll taxes encourage movement into informal sector work where workers are often excluded from participation in retirement programs. Payroll taxes tend to be quite high in many developing countries, with the result that substantial segments of the population remain outside the public retirement system. Lower payroll taxes may well enhance compliance with the system, generating more retirement income. Also, offering workers tax subsidies to save for retirement, or moving toward a consumption tax rather than an income tax, enhances participation in pension and other deferred saving programs. Hence, tax policy can increase old age consumption by inducing workers to participate in the retirement system and to save more over their work lives.
George Connolly is a Finance and Technology professional.