Akhtar & Hasan (Pvt) Ltd Actuaries Conference on the Voluntary Pension System (VPS) Karachi, 11 Aug 2005 Sponsored by the Securities and Exchange Commission

Akhtar & Hasan (Pvt) LtdActuaries

Conference on the Voluntary Pension Conference on the Voluntary Pension System (VPS)System (VPS)

Karachi, 11 Aug 2005

Sponsored by the Securities and Exchange Commission of Pakistan

VPS in the Context of the Whole Retirement System

AA presentation by Samee-ul-Hasanpresentation by Samee-ul-HasanConsulting Actuary, Akhtar & Hasan (Pvt) LtdConsulting Actuary, Akhtar & Hasan (Pvt) Ltd

Akhtar & Hasan (Pvt) LtdActuaries ContentsContents

A.A. IntroductionIntroductionB.B. Points from Labour Force Survey 2003- 2004Points from Labour Force Survey 2003- 2004C.C. Growth of the informal sectorGrowth of the informal sectorD.D. (EOBI) (EOBI)E.E. Retirement schemes other than EOBIRetirement schemes other than EOBIF. Total number of Provident, Pension, Gratuity F. Total number of Provident, Pension, Gratuity

Funds.Funds.G. Critical current issue for such Funds G. Critical current issue for such Funds H.H. How will VPS fit into the scene?How will VPS fit into the scene?

Akhtar & Hasan (Pvt) LtdActuaries A. IntroductionA. Introduction

The VPS should be warmly welcomed. It will raise the level of The VPS should be warmly welcomed. It will raise the level of pension consciousness, and introduce new players into the pension consciousness, and introduce new players into the market.market.

I congratulate the SECP and CBR on a thorough job, with I congratulate the SECP and CBR on a thorough job, with good co-ordination between themselves.good co-ordination between themselves.

The description of the VPS has been assigned to other The description of the VPS has been assigned to other speakers. The object of this presentation is to place VPS in the speakers. The object of this presentation is to place VPS in the context of the whole retirement benefit system in Pakistan.context of the whole retirement benefit system in Pakistan.


This presentation does not refer to the pension and This presentation does not refer to the pension and “general provident fund” schemes run for Federal “general provident fund” schemes run for Federal and Provincial Government Servants, Railways, and Provincial Government Servants, Railways, Defence personnel and certain other government, Defence personnel and certain other government, autonomous or semi-autonomous bodies. It autonomous or semi-autonomous bodies. It relates primarily to other categories of employed relates primarily to other categories of employed persons, and self-employed persons, in the so-persons, and self-employed persons, in the so-called “formal sector”.called “formal sector”.


B. Points from Labour Force Survey 2003-B. Points from Labour Force Survey 2003-2004, based on 18,912 households2004, based on 18,912 households

Est Population 1 Jan 04: 148.72 millionEst Population 1 Jan 04: 148.72 million

Employed Persons: 41.75 million (34.69 males Employed Persons: 41.75 million (34.69 males + 7.06 females) + 7.06 females)

Un-employed Persons: 3.48 million (2.44 males Un-employed Persons: 3.48 million (2.44 males + 1.04 females) + 1.04 females)

Civilian Labour Force: 45.23 million (37.13 Civilian Labour Force: 45.23 million (37.13 males +8.10 females) males +8.10 females)


Distribution of employed persons aged 10 or more Distribution of employed persons aged 10 or more by monthly income:by monthly income:

Monthly income groupMonthly income group Percentage of all Percentage of all employed persons employed persons aged 10 or moreaged 10 or more

Upto Rs 1,500 pmUpto Rs 1,500 pm 18.1318.13

1,501-2,5001,501-2,500 24.8024.80

2,501-4,0002,501-4,000 27.6427.64

4,001 and above4,001 and above 29.4429.44

Average monthly incomeAverage monthly income Rs 4,088.49Rs 4,088.49


Monthly income groupMonthly income group Percentage of Male Urban Percentage of Male Urban Employed age 10 or moreEmployed age 10 or more

Upto Rs 1,500 pmUpto Rs 1,500 pm 9.719.71

1,501-2,5001,501-2,500 19.1519.15

2,501-4,0002,501-4,000 31.4431.44

4,001 and above4,001 and above 39.7039.70

Average monthly incomeAverage monthly income Rs 5,107.69Rs 5,107.69

Clearly, Clearly, most Pakistanis live from hand to mouthmost Pakistanis live from hand to mouth. Their . Their capacity to save is limited or zerocapacity to save is limited or zero. When they can no longer . When they can no longer work, they depend on their children or family members, or work, they depend on their children or family members, or charity. In many cases, they live in dire poverty.charity. In many cases, they live in dire poverty.


C. Growth of the informal sectorC. Growth of the informal sector The informal sector grew from 65% in 2001-2002 to The informal sector grew from 65% in 2001-2002 to

70% in 2003-2004.70% in 2003-2004.

The reason for this growth in the informal sector is a The reason for this growth in the informal sector is a subject by itself. This is not the place to discuss it. But subject by itself. This is not the place to discuss it. But allow me to quote from the Labour Survey:allow me to quote from the Labour Survey:

““However, the inhibiting influence of However, the inhibiting influence of government’s long held predilection to generate revenue government’s long held predilection to generate revenue by hook or crook cannot be discounted altogether as a by hook or crook cannot be discounted altogether as a reason for the surge in informal activities”reason for the surge in informal activities”


The rest of this presentation relates to the “formal The rest of this presentation relates to the “formal sector”, which covers less than 30% of the work-sector”, which covers less than 30% of the work-force. force.


D. Employees' Old-Age Benefits Institution D. Employees' Old-Age Benefits Institution (EOBI)(EOBI)

Currently EOBI pays old-age, spouses, and invalidity Currently EOBI pays old-age, spouses, and invalidity pensions to 200,000 people. This is a fraction of people pensions to 200,000 people. This is a fraction of people over 60, widowed and invalid persons, who in a civilised over 60, widowed and invalid persons, who in a civilised society should be getting subsistence pensions. society should be getting subsistence pensions.

Only 1.5 million individuals working in 33,000 Only 1.5 million individuals working in 33,000 establishments are currently insured, and stand to get establishments are currently insured, and stand to get pensions eventually. pensions eventually.

EOBI is and will remain the pension scheme with the EOBI is and will remain the pension scheme with the largest coverage.largest coverage.


BUT the great majority of Working Pakistanis remain BUT the great majority of Working Pakistanis remain out in the cold.out in the cold.

The The ONLYONLY way to provide a minimum subsistence way to provide a minimum subsistence income for working Pakistanis is to expand the EOBI income for working Pakistanis is to expand the EOBI scheme, and convert it into a scheme, and convert it into a National Minimum National Minimum Pension SchemePension Scheme. Commissions, Committees and some . Commissions, Committees and some individuals have made do-able recommendations on individuals have made do-able recommendations on EOBI’s phased expansion to cover the entire working EOBI’s phased expansion to cover the entire working population. But there has been population. But there has been zerozero action. The action. The scope of EOBI remains the same as it was in 1976. scope of EOBI remains the same as it was in 1976.


EOBI’s expansion requires EOBI’s expansion requires political willpolitical will, and a , and a real concernreal concern for the average Pakistani. Let us for the average Pakistani. Let us hope this political will and this concern can be hope this political will and this concern can be generated in future.generated in future.


E. Retirement schemes other than EOBI.E. Retirement schemes other than EOBI.

GRATUITY SCHEMESGRATUITY SCHEMES

With very rare exceptions, Pakistani gratuity With very rare exceptions, Pakistani gratuity schemes are Defined Benefit (DB), and the gratuity is schemes are Defined Benefit (DB), and the gratuity is defined in terms of last drawn basic or gross salary.defined in terms of last drawn basic or gross salary.

(a) Statutory Gratuity under the Standing Orders: (a) Statutory Gratuity under the Standing Orders: Every industrial or commercial establishment in Every industrial or commercial establishment in which 20 or more “workmen” are employed must, if which 20 or more “workmen” are employed must, if the “Standing Orders” apply to it, pay a gratuity of the “Standing Orders” apply to it, pay a gratuity of 30 days’ last drawn gross wages for each year served 30 days’ last drawn gross wages for each year served on the cessation of a “workman’s” serviceon the cessation of a “workman’s” service


BUT if there is a Provident Fund to which the BUT if there is a Provident Fund to which the Employer's contributions equal those made by Employer's contributions equal those made by workmen, no gratuity applies to the period for which workmen, no gratuity applies to the period for which the Provident Fund has existed.the Provident Fund has existed.

(b) Non-statutory gratuity schemes: A very large (b) Non-statutory gratuity schemes: A very large number of employers have set up gratuity schemes number of employers have set up gratuity schemes outside the scope of the Standing Orders. These apply outside the scope of the Standing Orders. These apply to employees who are not workmen governed by the to employees who are not workmen governed by the Standing Orders. They may also apply to workmen Standing Orders. They may also apply to workmen who get a Provident Fund, but for whom the Employer who get a Provident Fund, but for whom the Employer has in addition provided a gratuity, either voluntarily has in addition provided a gratuity, either voluntarily or as a result of collective bargaining.or as a result of collective bargaining.


There is no legal requirement to fund a gratuity There is no legal requirement to fund a gratuity scheme. But income tax law encourages funding. scheme. But income tax law encourages funding. Many schemes remain un-funded, backed by Book Many schemes remain un-funded, backed by Book Reserves. But many employers have set up Reserves. But many employers have set up Income Tax approved Gratuity Trust Funds.Income Tax approved Gratuity Trust Funds.


PROVIDENT FUNDSPROVIDENT FUNDS

These are Defined Contribution Schemes, in the form These are Defined Contribution Schemes, in the form of Tax approved Trust Funds. of Tax approved Trust Funds.

The Employee can contribute up to 10% of basic The Employee can contribute up to 10% of basic salary. The law does not require the Employer to salary. The law does not require the Employer to contribute. But under almost all Provident Funds set contribute. But under almost all Provident Funds set up outside Government and the Defence Services, the up outside Government and the Defence Services, the Employer matches Employee contributions. Employer matches Employee contributions.

There are very many Provident Funds, covering a There are very many Provident Funds, covering a large number of employees.large number of employees.


PENSION SCHEMESPENSION SCHEMES

Pension schemes have been set up for decades by Pension schemes have been set up for decades by progressive employers under the Income Tax, 1922, progressive employers under the Income Tax, 1922, and the corresponding provisions of the Income Tax and the corresponding provisions of the Income Tax Ordinance, 1979, and the Income Tax Ordinance, Ordinance, 1979, and the Income Tax Ordinance, 2001. 2001.

There is no statutory requirement to Fund a pension There is no statutory requirement to Fund a pension scheme. But with very rare exceptions, all existing scheme. But with very rare exceptions, all existing Pension Schemes are run as Trust Funds Approved Pension Schemes are run as Trust Funds Approved by the CIT.by the CIT.


F. Total number of Provident, Pension and F. Total number of Provident, Pension and Gratuity Funds, their total size and coverageGratuity Funds, their total size and coverage

This question is of great interest. Unfortunately, This question is of great interest. Unfortunately, the information is buried in the files of the Income the information is buried in the files of the Income Tax Department, the Central Directorate of Tax Department, the Central Directorate of National Savings, Banks, listed companies, mutual National Savings, Banks, listed companies, mutual funds and other organisations. Nobody has funds and other organisations. Nobody has extracted and collated this data. extracted and collated this data.

One can only guess at the total. One can only guess at the total.


The number of Funds is probably well into 4 The number of Funds is probably well into 4 figures. The total number of employees is figures. The total number of employees is probably well into 6 figures, perhaps even into 7 probably well into 6 figures, perhaps even into 7 figures. The total size of these Funds is probably figures. The total size of these Funds is probably well over Rs 100 billion. And the total amount well over Rs 100 billion. And the total amount they have to invest each year, including new they have to invest each year, including new money and maturity of old investments, is money and maturity of old investments, is probably well over Rs 10 billion.probably well over Rs 10 billion.

Also, there are a large number of un-funded Also, there are a large number of un-funded gratuity schemesgratuity schemes


G. Critical current issue for Provident, G. Critical current issue for Provident, Pension and Gratuity FundsPension and Gratuity Funds

The issue at the top of the agenda of all Funds is The issue at the top of the agenda of all Funds is where to invest the money.where to invest the money.

New investment in National Savings Schemes was New investment in National Savings Schemes was stopped on 25 March 2000.stopped on 25 March 2000.

NS Schemes were to be replaced by Pakistan NS Schemes were to be replaced by Pakistan Investment Bonds. But for various reasons, this has Investment Bonds. But for various reasons, this has not worked out, (except for some jumbo funds).not worked out, (except for some jumbo funds).

There are illogicalities and inconsistencies in the There are illogicalities and inconsistencies in the investment regulations of such funds. The regulation investment regulations of such funds. The regulation is split between the SECP and the CBR. is split between the SECP and the CBR.


This is a subject by itself, and there is no time to go This is a subject by itself, and there is no time to go into details today.into details today.

Apart from the regulatory aspect, if Government Apart from the regulatory aspect, if Government securities are excluded, is there enough scope for the securities are excluded, is there enough scope for the existing retirement funds + VPS (plus life insurance existing retirement funds + VPS (plus life insurance organisations, EOBI, NIT and other mutual funds) to organisations, EOBI, NIT and other mutual funds) to invest in shares and the corporate debt market? I invest in shares and the corporate debt market? I personally don't think so. It will be like trying to personally don't think so. It will be like trying to fit a fit a gallon into a pint pot. gallon into a pint pot. As of now, Income Funds have As of now, Income Funds have invested heavily in COT and similar things. Do we invested heavily in COT and similar things. Do we want to base our retirement plans on such want to base our retirement plans on such investments? investments?


H. How will VPS fit into the scene?H. How will VPS fit into the scene?

VPS has not come into a vacuum. There is a substantial VPS has not come into a vacuum. There is a substantial existing retirement system, based on EOBI, Provident existing retirement system, based on EOBI, Provident Funds, Pension Funds, Gratuity Funds and un-funded Funds, Pension Funds, Gratuity Funds and un-funded gratuity schemes.gratuity schemes.

As with any new law, experience may require some As with any new law, experience may require some corrections. corrections.

Only time will tell how VPS will work. Only time will tell how VPS will work.

It is important for it to work to the It is important for it to work to the Golden RuleGolden Rule of of selling: sell only what you yourself would buy if you selling: sell only what you yourself would buy if you were in the same position.were in the same position.


Care should be taken to build up trust in VPS. Care should be taken to build up trust in VPS.

Fiascos like pension mis-selling in the UK should be Fiascos like pension mis-selling in the UK should be avoided.avoided. UK proved that a Voluntary, Personal or UK proved that a Voluntary, Personal or Insured Pension scheme cannot provide a better Insured Pension scheme cannot provide a better through-put to the employee than an Employer's self-through-put to the employee than an Employer's self-administered scheme. A self-administered scheme has administered scheme. A self-administered scheme has no marketing costs. Administration costs are no marketing costs. Administration costs are generally lower, for all but very small employers. generally lower, for all but very small employers. And there is no profit element to be passed on. And there is no profit element to be passed on. Pakistan will not gain if VPS takes the easy way out Pakistan will not gain if VPS takes the easy way out by cannibalising or replacing existing Provident by cannibalising or replacing existing Provident Fund, Pension or Gratuity Schemes.Fund, Pension or Gratuity Schemes.


Life insurers will no doubt keep in mind the Life insurers will no doubt keep in mind the draconian compensation provisions of S.76(4) of draconian compensation provisions of S.76(4) of the Insurance Ordinance, 2000, and SECP the Insurance Ordinance, 2000, and SECP Insurance Rule 31. UK life companies came to Insurance Rule 31. UK life companies came to grief on account of similar provisions, when their grief on account of similar provisions, when their agents persuaded people to switch OUT of their agents persuaded people to switch OUT of their employers’ self-administered schemes and IN to employers’ self-administered schemes and IN to personal pensionspersonal pensions

VPS seems specifically designed for self employed VPS seems specifically designed for self employed persons and persons whose Employers provide no persons and persons whose Employers provide no pension. pension.


Pakistan will gain if the VPS develops this large un-Pakistan will gain if the VPS develops this large un-tapped market. tapped market. This is essentially based on sales to This is essentially based on sales to individuals. individuals.

Sales will be made one by one. The VPS fee Sales will be made one by one. The VPS fee structure may need re-tuning to suit this individual structure may need re-tuning to suit this individual market. Tax relief will be a powerful tool. Even so, market. Tax relief will be a powerful tool. Even so, 3% seems too low to cover sales costs, especially for 3% seems too low to cover sales costs, especially for annual contribution plans. Expenses allocated by annual contribution plans. Expenses allocated by cost could mean higher sales and other charges as % cost could mean higher sales and other charges as % of contributions, offset by lower fees as % of assets. of contributions, offset by lower fees as % of assets.


Points which may need attention now or in Points which may need attention now or in the future:the future:

Compulsory annuitisation at age 75: Compulsory annuitisation at age 75: Improving mortality means well over 50% of Improving mortality means well over 50% of

those who retire at age 60 will survive to age 75.those who retire at age 60 will survive to age 75.

As of now, there is no annuity market in Pakistan As of now, there is no annuity market in Pakistan to speak of. to speak of.

For a life insurer, conventional annuities are a For a life insurer, conventional annuities are a difficult business. Annuity rates which are difficult business. Annuity rates which are actuarially sound for the insurer may be un-actuarially sound for the insurer may be un-attractive for the purchaser. attractive for the purchaser.


In modern life insurance products, like unit-In modern life insurance products, like unit-linked or universal life, life insurers offer no linked or universal life, life insurers offer no guarantees on mortality, investment income guarantees on mortality, investment income rates or expenses. The actual experience is rates or expenses. The actual experience is passed through to policyholders, and the passed through to policyholders, and the insurer is effectively a manager acting on their insurer is effectively a manager acting on their behalf. behalf.

Akhtar & Hasan (Pvt) LtdActuaries o

Flexible annuity products can be designed on similar Flexible annuity products can be designed on similar lines. It remains to be seen whether they will prove lines. It remains to be seen whether they will prove attractive or understandable to a 75 year old person.attractive or understandable to a 75 year old person.

I look forward to Mr Omer Morshed's and Mr Javed I look forward to Mr Omer Morshed's and Mr Javed Ahmed's observations on annuities.Ahmed's observations on annuities.


Investment Management ChargesInvestment Management Charges

It is good that the fee of 1.5% of the average value of net It is good that the fee of 1.5% of the average value of net assets is less than 2% or 3% for mutual funds generally. assets is less than 2% or 3% for mutual funds generally.

Investment management fees as % of MV of assets is Investment management fees as % of MV of assets is market practice. But it creates a conflict of interest market practice. But it creates a conflict of interest between the Fund Manager and participants. The Fund between the Fund Manager and participants. The Fund Manager gains if market prices rise. Participants, as Manager gains if market prices rise. Participants, as buyers, gain if market prices remain low, i.e. a low P/E. buyers, gain if market prices remain low, i.e. a low P/E.


Consideration should be given to a Consideration should be given to a composite fee composite fee for investment management, partly based on the for investment management, partly based on the market value and partly on the income. As market value and partly on the income. As mentioned earlier, realism could mean higher mentioned earlier, realism could mean higher charges as % of contributions, and lower for charges as % of contributions, and lower for investment management. investment management.

The charges and expenses of the Pension Fund The charges and expenses of the Pension Fund Manager, on a compound basis, could amount to a Manager, on a compound basis, could amount to a noticeable % of the Fund over a period of 20 noticeable % of the Fund over a period of 20 years. This aspect may need re-examination.years. This aspect may need re-examination.

Documents

Akhtar & Hasan (Pvt) Ltd Actuaries Conference on the Voluntary Pension System (VPS) Karachi, 11 Aug 2005 Sponsored by the Securities and Exchange Commission