PUBLIC EXPENDITURE REVIEW: GOVERNMENT PENSION OBLIGATIONS AND CONTINGENT LIABILITIES. Policy Note

Transcription

1 PUBLIC EXPENDITURE REVIEW: GOVERNMENT PENSION OBLIGATIONS AND CONTINGENT LIABILITIES Policy Note November 2014 This note is a technical document of the World Bank produced as part of the PER and does not represent an official position of the World Bank or of its Executive Board.

2 Government pension obligations and contingent liabilities under base case, parametric reform and merger scenarios (Net Present Value as % of 2013 GDP)* All funds NSSF PPF PSPF** LAPF GEPF Base case (no reform) 48.5% 5.7% 0.0% 41.8% 1.0% 0.0% Harmonization rules 25.1% 0.6% 7.5% 17.1% 0.0% 0.0% Harmonization rules-partial 19.7% 0.6% 7.5% 11.6% 0.0% 0.0% Harmonization rules-all 18.6% 0.6% 7.5% 10.5% 0.0% 0.0% Merger 15.9% 5.2% 10.7% Merger + cost saving 12.4% 2.6% 9.8% * Assuming interest rate equal to inflation and using 5% real discount rate. ** Assuming PSPF does not finance pre99 pensions. Harmonization Rules Harmonization Rules partial Harmonization Rules all = parameters apply to all members NSS/ PPF/ GEPF but only to new members of PSPF/ LAPF = new reference salary applied to all members of PSPF/ LAPF = all new parameters applied to all members of PSPF/ LAPF Financial position of pension funds under base-case and reform scenarios NSSF PSPF excluding pre99 including pre99 PPF LAPF GEPF Pensions at retirement, full/reduced* Base case (no reform) 47%/40% 75%/37% 75%/37% 42%/31% (DB) 66%/33% 67%/50% Harmonization rules 44%/33% 75%/37% 75%/37% 47%/35% (DB) 66%/33% 67%/50% Harmonization rules-partial 62%/31% 62%/31% 55%/28% Harmonization rules-all 58%/43% 58%/43% 52%/39% Break-even point** Base case (no reform) after Harmonization rules Harmonization rules-partial Harmonization rules-all Assets depletion point*** Base case (no reform) after after 2080 Harmonization rules after 2080 after 2080 Harmonization rules-partial after 2080 Harmonization rules-all after 2080 * Percentage of individual's last wage for an average male retiree in respective fund: retiring at average retirement age with average years of contributions, retiring in around 2035 ** Year when the annual current balance turns negative assuming interest rate equal to inflation *** Year when own assets are depleted and government needs to step in to cover deficits, assuming interest rate equal to inflation 2

3 I. Current status 1. This report examines the current and future pension liabilities of the Government of Tanzania. The report considers both the direct pension obligations which lie with the government and the contingent liabilities for the pension system as a whole which the government holds through its obligation to ensure pension benefits are paid, even if the pension funds themselves do not have the resources to do so. Long term financial projections were produced using the Pension Reform Options Simulation Toolkit (PROST) for five mainland pension funds: NSSF, PSPF, PPF, LAPF and GEPF, based on data provided by each funds. 1 Details of the model can be found in Annex 3 and The study compares the financial sustainability of the pension funds and future government obligations to finance the pension system using the parameters outlined in the Harmonization Rules which were passed in July The modelling in this report contains different scenarios demonstrating how the impact of the reforms on the contingent liabilities of the government changes according to how the new parameters are applied. Membership Table 1. Base Year (FY2013) data on Pension System Members All funds NSSF PSPF PPF-DB** PPF-DAS** LAPF GEPF Contributors Number*, thous. persons Average age Average annual wage, thous. TSH 7,096 6,427 7,047 11,097 9,330 6,006 4,336 Old age pensioners with regular pensions Number*, thous. persons Average age Average annual pension, thous. TSH 1,970 1,929 2,343 1,593-1,401 - Average annual pension, % of average wage in respective fund 28% 30% 33% 14% - 23% - System dependency rate (number of beneficiaries devided by number of contribotors) 8.1% 1.9% 13.2% 23.3% n/a 5.6% n/a *Average number during the year **Number of active contributors for PPF was derived from data on contributions due in 2013, compliance rate and wages of contributors contributors as % of working age population Source: Data provided by respective pension funds 3. Table 1 outlines the current membership profile of the different pension funds. As of 2013, there were approximately 1 million active members contributing to five mainland funds, of which about 75% are covered by the two biggest funds NSSF and PSPF. This accounts for only about 4.5 of the labour force or 2% of the population as a whole, meaning that the system is fragmented and coverage rate is very low. 1 Despite some issues (which will be discussed directly with the funds), sufficient data was obtained to conduct the modelling. Further improvements in the funds management information (MIS) systems to improve data quality are recommended. 3

4 4. The number of pensioners is relatively low, mainly because most of the funds were set up fairly recently (all funds, except PPF were converted to PAYG DB between 1999 and 2013). 2 As a result, the system dependency ratios (the number of pensioners divided by the number of contributors) are low about 7% on average, though this does vary significantly from as little as 1% in NSSF to over 22% in PPF depending on the degree of scheme maturity. This means currently the financial burden on each contributor is low. However, as the system matures, this ratio will grow fast. 5. It is interesting to note how the introduction of competition for new members has affected the funds in the last few years. Since the PROST modelling was last conducted in 2010 (using 2008 data), 3 overall membership of the funds has increased by 25%. However, the LAPF has increased its membership by over 50% during this period. The average age of membership has also changed across the funds declining by around a year on average, but by more than 5 years in the case of the LAPF and actually rising by 5 years at the PSPF. The biggest impact is therefore on the LAPF where the financial position of the fund has been transformed by acquiring a larger base of younger members (previous modelling showed the fund running into financial difficulty around 2020s with the new membership base now keeping the fund in balance for several more decades). 6. The current modelling reflects faster increase in membership over the short-term for the funds which are currently growing most, and then assumes that the membership across all funds remains stable as a percentage of the labour force over the long-term. This conservative assumption is used as achieving an extension of pension coverage is not easy, though coverage will likely rise to some extent as GDP per capita levels increase. Benefits and Financing Table 2. Base Year (Y2013) data on Pension System Finances, millions TSH All funds NSSF PSPF PPF LAPF* GEPF Contributions 1,347, , , , ,143 37,300 Benefit payments, total 957, , , ,971 44,751 9,162 - pension benefits** 943, , , ,094 43,447 9,162 - non-pension benefits 14,143 7, ,877 1,303 non-pension benefits as % of total benefits 1.5% 3.3% 0.1% 3.7% 2.9% 0.0% Administrative expenses 180,897 86,253 26,097 39,994 21,687 6,866 Administrative expenses as % contributions 13% 18% 6% 15% 19% 18% Assets, beginning of the year 4,709,170 1,970, ,021 1,091, , ,411 *LAPF 2013 estimated by WB team as 2012/2013 annual report was not available **GEPF excluding voluntary benefits Source: Data provided by respective pension funds 7. The level of the current benefits varies, from moderate levels at the NSSF and PPF, 4 to relatively generous parameters for the PSPF and LAPF. However, commutation 5 in all funds and 2 This means that these are partially funded schemes. 3 See World Bank Policy Note, Options for the Reform of the Tanzania Pension System, December This is partially due to the high levels of withdrawals in the funds, which leads to shorter periods of contributions. 4

5 lack of indexation in some of them result in relatively low regular post-retirement pensions (about 40% of final salary on average). 8. Mainly due to low system dependency rates, the contribution rate (20% in all funds, including now GEPF) is currently sufficient to cover benefit payments, so all systems are partially funded and presently run surpluses. PSPF is a special issue because of pre-1999 pension rights. 5 Commutation in the pension context occurs where a retiree surrenders part of his or her rights to receive a pension in the form of a future income stream in exchange for receiving an immediate lump sum payment. 5

6 Table 3. Main parameters of the current pension system in Tanzania Provision NSSF PSPF PPF LAPF GEPF (2013 Act) Type of scheme Membership Contributions (employee/employer) Types of benefits Retirement age PAYG DB; converted from a provident fund in Private sector (formal and selfemployed) - Government employees and other not covered by any pension fund PAYG DB; converted from a non-contributory DB scheme in 1999 Central government (pensionable positions) PAYG DB (PPS) and funded DC (DAS) - Parastatals - Companies with Government s shares - Private sector (formal and selfemployed) 10%/10% 5%/15% - 5%/15% (parastatals) - 10%/10% (private sector) - Old age (retirement) - Invalidity - Survivorship - Medical (insurance) - Funeral grant - Maternity - Withdrawal 60; min 55 (0.5p.p. repl. rate reduction per year prior to age 60) - Old age (retirement) - Invalidity - Survivorship - Withdrawal 60; min 55 ( with no reduction) Traditional Pension Scheme (PPS): - Old age (retirement) - Invalidity - Survivorship - Withdrawal Deposit Administration Scheme (DAS): - Defined contribution scheme (lump sum) 60; min 55 ( with no reduction) PAYG DB; converted from a provident fund in Local government - Open to others - 5%/15% (local government) - 10%/10% (private sector) - Old age (retirement) - Invalidity - Survivorship - Funeral grant - Maternity, marriage, other unemployment - Withdrawal 60; min 55 ( with no reduction) PAYG DB (converted from a funded DC starting from July 2014) - Government employees - Open to others Harmonization Rules 2014 Applies to DB funds Will apply to: - New members of all funds - Existing members of NSSF, PPF, GEPF (not LAPF, PSPF) 10%/10% Not set in regulation - Old age (retirement) - Invalidity - Survivorship - Old age - Others according to their own enabling legislation 60 60; min 55 (with 0.3% reduction) 6

7 Provision NSSF PSPF PPF LAPF GEPF (2013 Act) Harmonization Rules 2014 Vesting period Annual accrual rate 2% for first 15 years plus 1.5% for each year above % 2.0% 2.22% 2.07% 2.07% Maximum 67.5% No maximum 66.7% No maximum No maximum No maximum replacement rate Minimum pension 6 80,000 TSH 21,000 TSH 50,000 TSH No minimum No minimum 40% of sector minimum wage Income measure Best 5 year average of last 10 years (not valorized) Final salary Best 5 year average (not valorized) Final salary Last 3 year average (not valorized) Best 3 year average of last 10 years (not valorized) Commutation/ Initial lump sum Indexation 24 x Monthly income measure Follow recommendations from actuarial evaluation reports 50% of regular pension; at 1: 15.5 Ad hoc indexation financed by government 25% of regular pension; at 1: % of regular pension; at 1: %; at 1: % of annual full amount of pension; at 1: 12.5 No indexation No indexation Assumed prices Ad hoc 6 The current minimum pension paid by the NSSF constitutes approximately 15% of the average wage of members of the fund. For the PSPF the minimum pension is less than 4% of the average wage,and less around 5% for PPF. 7

8 II. Impact of Reform on Benefits 9. The reform scenarios for the pension funds are based on the new benefit formula outlined in the Harmonization Rules which apply to all the existing social security funds from 1 st July The main parameters include: Annual accrual rate=2.07% (1/580 monthly) this is the percentage of each year s salary an individual earns as a pension; Income measure= last 3 year average wage, not valorized this is salary which the pension is based upon; Commutation: maximum commuted portion =25%, commutation factor= this is the amount of pension which can be taken as a lump sum. 10. As can be seen in Table 3, the impact of the new parameters is different across the funds: the new accrual rate is higher than the existing at the PPF, lower than the PSFP and LAPF rate, and works out around the same for the NSSF (GEPF is already in line with the Harmonization Rules); the reference salary is higher for the PPF and NSSF and lower for the PSPF and LAPF; the commutation rules are stricter for the PSPF and LAPF (PPF and GEPF are already in line whereas in the current NSSF there is no commutation). 11. Given the impact of the new parameters, the Harmonization Rules state that they should be applied to the different funds in the following ways: GEFP/ PPF/ NSSF: parameters apply to all members of the funds; PSPF/ LAPF: parameters apply only to new members of the funds. 12. The World Bank team understand that the application of these and other parameters outlined in the Harmonization Rules is still under discussion. In addition, the Rules, as currently stated, can be interpreted as applying at least some of the parametric changes to all members of all funds. The World Bank pension team therefore modelled the following scenarios to show the impact of applying the parameters in different ways. 13. Table 4 shows the impact of the reforms under the following different scenarios. There are of course other possible applications of the Harmonization Rules (e.g. apply to certain members over a certain age etc.). The scenarios chosen are presented by way of extremes. 7 Commutation rate (factor) defines the relationship between the lump sum payment received and the future income stream foregone. A rate of 10:1 means that a person commuting would receive $10 now for every $1 of future annual income foregone. An actuary normally calculates the commutation rate using life expectancy tables to reflect the life expectancy of the person wishing to commute. The rate of 12.5 applied in the Harmonization Rules is broadly actuarially fair though this could change in future if longevity increases significantly. 8

9 Harmonization Rules = parameters apply to all members NSSF/ PPF/ GEPF but only to new members of PSPF/ LAPF Harmonization Rules partial = new reference salary applied to all members of PSPF/ LAPF Harmonization Rules all = all new parameters applied to all members of PSPF/ LAPF 14. The table shows the level of benefits which would be received from the different funds, measured as a percentage of final salary for an average male member of each fund. The first figure is the replacement rate a member would receive if the full benefit is taken as a pension. The second figure is the amount of pension income which would be received if the individual opts to take a much as possible as a lump. Table 4. Summary indicators under base case and reform scenarios NSSF PSPF excluding pre99 including pre99 PPF LAPF GEPF Pensions at retirement, full/reduced* Base case (no reform) 47%/40% 75%/37% 75%/37% 42%/31% (DB) 66%/33% 67%/50% Harmonization rules 44%/33% 75%/37% 75%/37% 47%/35% (DB) 66%/33% 67%/50% Harmonization rules-partial 62%/31% 62%/31% 55%/28% Harmonization rules-all 58%/43% 58%/43% 52%/39% Break-even point** Base case (no reform) after Harmonization rules Harmonization rules-partial Harmonization rules-all Assets depletion point*** Base case (no reform) after after 2080 Harmonization rules after 2080 after 2080 Harmonization rules-partial after 2080 Harmonization rules-all after 2080 * Percentage of individual's last wage for an average male retiree in respective fund: retiring at average retirement age with average years of contributions, retiring in around 2035 ** Year when the annual current balance turns negative assuming interest rate equal to inflation *** Year when own assets are depleted and government needs to step in to cover deficits, assuming interest rate equal to inflation 15. As noted above, the Harmonization Rules impact the funds in different ways. However, it should be noted that even after the reforms the replacement rates (at least on a pre-lump sum basis) which the funds can be expected to deliver are still reasonably high. This is even more the case if the replacement rate is measured against the average wage of members of the fund (PSPF and GEPF then delivering close to a 100% replacement rate, the PPF and LAPF around 70% and the NSSF about 50%- as shown in Table 4a). Table 4a. Pensions at retirement as percentage of average wage of contributors in respective fund NSSF PSPF PPF LAPF GEPF excluding pre99 including pre99 Pensions at retirement, full/reduced Base case (no reform) 52%/45% 108%/54% 108%/54% 65%/49% (DB) 86%/43% 95%/72% Harmonization rules 48%/36% 108%/54% 108%/54% 73%/55% (DB) 86%/43% 95%/72% Harmonization rules-partial 92%/46% 92%/46% 71%/35% Harmonization rules-all 85%/64% 85%/64% 68%/51% 9

10 PSPF 16. The table above shows the impact of reforms on existing members of the fund. If the Harmonization Rules are strictly applied, existing members of the fund will have no reduction in benefits are they are grandfathered and the old rules will continue to apply. New members, by contrast, will receive over 20% less benefit under the new rules. This is on a pre-commutation basis the pension received after commutation actually rises as the lump allowed is significantly smaller. However, if, for example, at least the revised reference salary were applied to all members of the fund (which the Harmonized Rules could be interpreted to allow), existing members would see a 17% decline in benefit levels. LAPF 17. The impact of reform on benefits at retirement is very similar to PSPF. 20% lower benefits at retirement before lump sum apply to new member (higher pension benefits because of smaller lump sum portion), with existing members grandfathered. However, differently from PSPF where post-retirement pensions are already indexed, LAPF pensioners will benefit from the reform as indexation of their pensions will be introduced. GEPF 18. The GEPF was previously a provident fund (paying only lump sum and not pensions), and more of a savings account than a retirement vehicle (with membership limited to only a few years on average, before individuals changed from their temporary employment contract and transferred into one of the other social security funds).the GEPF Act was already altered in 2013 and largely reflects the parameters in the Harmonization Rules and therefore the impact of reform is limited. PPF 19. The Harmonization Rules are more generous than the existing parameters of the PPF. Therefore, benefits of new pensioners after taking the lump sum will increase by 12% to around 47% of average wage after the reform. The replacement rates of existing pensioners will also grow higher assuming 100% inflation indexation of pensions in payment. The removal of the maximum replacement rate will also raise the pension for around 5% of members (only this number serve for a long enough period to see their replacement rate go beyond the current ceiling). NSSF 20. The impact of the new parameters is on balance neutral to the NSSF. Given the average service period of 22 years, the previous average accrual rate for pension benefits was around 1.8%. However, members also received a lump sum pay-out (separate from any commutation of benefits) of 2 years of service. This made the effective accrual rate around 2.12%, slightly above the 2.07% in the Harmonization Guidelines. The reforms will therefore serve to reduce the effective accrual rate, which improves the financial balance of the fund. However, this improvement will be offset by an increase in the salary base (best 3 as opposed to best 5 years) meaning that the pre commutation benefits in the reform scenario are little changed. Unlike the 10

11 other funds, regular pensions (after lump sum) will be lower compared to the base case scenario as new retirees will get more at retirement as a lump sum but less as regular post-retirement income. In addition, post-retirement pensions will be affected by less generous indexation if this is changed from wages to inflation (as assumed in the modelling). III. Government Liabilities 21. The government s actual pension payments, made out of the general budget, are limited to PSPF and LAPF pensioners who retired before these pension funds were established and some military pensioners. Total payments amount to TZS 213 billion in 2013/2014, consisting of pension payments of TZS 74 billion made to around 59,000 civilian and military pensioners, plus TZS 139 billion lump sum payments made to retiring military personnel. In addition the government currently finances the indexation of all PSPF pensions. This amounted to TZS 21.7 billion in The government s liabilities with respect to NSSF, PPF, LAPF and GEPF are limited to deficit financing once funds own assets have been depleted. In other words, once the funds have a negative cash flow (having to pay out more in benefits than they receive in contributions) and have sold all their assets to cover the gap, the government would have to step in and pay promised pension benefits to retiring members of the fund. As shown in Table 6, these funds are largely financially sound over the few decades but would require some government support in the longer run. 23. The Harmonization Rules have a potential for a positive effect on the finances of all funds (even when only applied to new members of the PSPF and LAPF), except PPF where the new benefit formula will be more expensive. Overall the reforms reduce government direct obligations and contingent liabilities from TZS 23.5 trillion (present value of government obligations from ) to TZS 12.3 trillion, or from 48% to between 25% of 2013 GDP. Around 11% of these savings come from parametric changes imposed by the Harmonization Rules (even if only applied to new members of the PSPF and LAPF). The rest comes from the change in funding of indexation of PSPF pensions (which is assumed to move from the government to the fund once the new Rules are applied). 24. By way of illustration, if the Harmonization Rules were also applied to existing members of the PSPF and LAPF, the contingent liability would reduce to less than 20% of GDP. 8 Members of the PSPF receive two pension payments the standard pension which covers nominal pension benefits and an additional pension which covers indexation. The indexed, additional pension is paid by the government from the Consolidated Account. The PSPF acts as the payment agent for the government. Unlike the pre-1999 liabilities, the government has been paying the PSPF for making these transfers on its behalf under an agreement signed in 2006, and the fund does not suffer any arrears relating to these payments. Since the Harmonization Rules have been applied, the PSPF will now take on the payment on of these additional, indexed pensions themselves. 11

12 Table 5. Government obligations and contingent liabilities under base case and reform scenario (net present value as % of 2013 GDP)* All funds NSSF PPF PSPF** LAPF GEPF Base case (no reform) 48.5% 5.7% 0.0% 41.8% 1.0% 0.0% Harmonization rules 25.1% 0.6% 7.5% 17.1% 0.0% 0.0% Harmonization rules-partial 19.7% 0.6% 7.5% 11.6% 0.0% 0.0% Harmonization rules-all 18.6% 0.6% 7.5% 10.5% 0.0% 0.0% * Assuming interest rate equal to inflation and using 5% real discount rate. ** Assuming PSPF does not finance pre99 pensions. ***Pre-99 pensions and indexation Figure 1+2. Annual Government Obligations, % of GDP Base case Harmonization Rules 1.0% 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% PSPFtotal NSSF LAPF PPF GEPF PSPF NSSF LAPF PPF GEPF PPF: the change to the Harmonization Rules has the biggest effect on the PPF. The impact of the higher benefits on the system finances will be negative, shifting the break-even point, when benefits are larger than contributions, from the end of the projection period to 2036, and the asset depletion point (by when all assets will have been sold to cover the cash flow gap) forward to In addition to benefits being 12% more generous, the PPF is assumed to move to full price indexing, which has a major impact on the financing of the fund. A combination of further parametric change and / or a merger between funds will be necessary to ensure the financial position of the fund over the long-run. The deterioration in the fund financial position means that the PPF goes from not representing any contingent liability to the government, to being around one-third of the total contingent liabilities under the new Harmonization Rules. NSSF: in the short term expenditures increase because of larger lump sum payments at retirement, in the longer run this effect is outweighed by lower post-retirement benefits. Overall, financial position of NSSF improves with the break-even point and the depletion point moving back by about 16 years, keeping the fund financially sustainable over the longer term. The NSSF moves in the opposite direction to the PPF, going from representing 5.7% contingent liability to the government to effectively zero. 12

13 LAFP: the impact of the Harmonization Rules is to improve the financial position of the fund over the long-run as benefits are reduced. However, much of this reduction will be offset by the introduction of indexation. Given the fund is in a healthy financial position to start with (due to the improved demographics), applying the rules to new or existing members has limited impact. The LAPF barely registers as a contingent liability for the government over the projection period. GEPF: the combination of growing dependency ratio and decreasing benefits of existing pensioners will result in a small deficit of current balance in the long run. The deficit will not deplete fund s assets until after 2070, so there will effectively be no government obligations for the whole duration of simulation period. PSPF 25. The biggest impact on government liabilities remains the PSPF. Whilst the government s liabilities to the other funds is limited to deficit financing once their own assets have been depleted, with respect to PSPF the government s liability covers the following: 1) Pre99 portion of pensions of government employees retired after July 2004 (arrears and future payments); 2) Indexation of the pre and post99 portion of pensions of government employees retired in/after July 2004 (assumed price indexation); 3) Financing PSPF deficits (assuming PSPF finances only post-1999 portion of pensions received by government employees retired after July 2004). Table 6. Government obligations to PSPF and contingent liabilities under base case and reform scenario (net present value as % of 2013 GDP)* Base case (no reform) Harmonization rules Harmonization rulespartial 26. Similar to LAPF, the overall long term impact of reform on PSPF finances is positive, though in the short run it will be negative if the new parameters are only applied to new members This is due to the shift of pension indexation financing from the government to PSPF itself. In terms of indexation, in the current system PSPF is the only pension fund where indexation of post-retirement pensions is financed from the state budget. In all other funds indexation policy and its financing is the responsibility of the respective fund. In the reform scenario it is assumed that indexation policy is harmonized as well and all funds, including PSPF, are responsible for financing their own indexation. 27. An improvement in the fund s position in the short-run can only occur if at least some of the new parameters are applied to all members, especially if that includes the new commutation rules which mean the fund would have to pay out smaller amounts in the short-term, when they are facing financial difficulties. 13 Harmonization rulesall Pre99 pensions, excluding indexation 9.9% 9.9% 8.9% 7.5% Indexation of pre- and post-99 pensions 15.1% 1.9% 1.7% 2.0% PSPF deficits 16.8% 5.3% 1.1% 1.0% Total 41.8% 17.1% 11.6% 10.5%

14 28. In addition to reducing benefits, the stabilization of the PSPF has to come from the government increasing its recompense to the fund for payments made on its behalf for liabilities accrued by members before 1999 when the fund was established. 29. In terms of the pre-1999 liabilities, the base case estimates the net present value of the liabilities from 2013 to 2080 to be TZS 4.8 trillion. This includes TZS1.5 trillion of pre-1999 liabilities already paid on behalf of the government by the PSPF between , (the net amount of these arrears standing at TZS 1.4 trillion as the government has paid TZS 160 billion to the fund). 9 The PV of the future pre-1999 liabilities coming due is estimated at TZS 3.3 trillion. Annual payments of pre-1999 deficits currently amount to TZS 300 billion, and are rising as more members with these benefits retire. The peak will come in 2027 and the last cohorts with pre99 pension rights are projected to retire by around the end of 2030s. As older cohorts of pensioners are replaced with pensioners retiring with fewer and fewer pre-1999 years, pre-1999 pension payments decrease and will essentially phase out by around Figure 3. PSPF: projected pre-1999 liabilities (TZS million) 600,000 Annual payments of pre-99 pensions by PSPF on behalf of Government, TZS mln (nominal values) 500, , , , ,000 0 Base, Harmonization Harmonization-partial Harmonization-all 9 The MOF wrote to the PSPF in March 2013 committing to cover the TSZ billion arrears (as estimated by the independent actuarial review commissioned by the BOT in 2010) in installments of TZS 71.6 billion over 10 years starting from FY2012. To date only TSZ 160 billion out of the promised TZS 395 scheduled payments between FY11-FY15 has been received by the PSPF, making net arrears of TZS 1.4 trillion. 14

15 Table 7. PSPF: projected annual payments of pre99 pensions in , mln TZS Base case (no reform) Harmonization rules Harmonization rules-partial Harmonization rules-all The reforms only reduce the pre1999 liabilities if at least some new parameters are applied to all members of the fund. If all new parameters were applied to existing members of the fund (scenario 3 Harmonization all), the pre1999 liabilities could be reduced by TZS 1.2 billion, or 25%. If only the new reference salary were applied to existing members (scenario 2 Harmonization partial) the reduction is TZS 500 million or 10%. In the case of applying all new rules only to new members, the pre-1999 obligations remain the same. Table 8. PSPF: projected pre99 pensions in , net present value 31. Whatever scenario is applied, the PSPF remains the issue for the government well into the future (the contingent liabilities for the other funds only kick in from 2060 onwards). Some combination of increased government cash injections and parametric reform will be needed to stabilize the PSPF. If this does not happen the fund will shortly be unable to pay promised benefits. The fund has been paying out more in benefits than it receives in contributions since 2013, with investment income no longer able to cover the gap from this FY2015. Unless the government is to step in with further payments, the PSPF will have to conduct a fire sale of its assets, and /or risks only being able to pay reduced benefits. Similar situations in other countries have led to public protests, which can undermine confidence in the pension system as a whole, and potentially have an impact on overall savings rates. Other Issues Discount Factor 32. As with any present value modelling, the results in this analysis are highly sensitive to the discount factor used. The rate of 5% real is in line with other assumptions and modelling used by World Bank economists. However, if the discount factor were reduced by 1% to 4% the overall government liabilities would be over 40% higher. Such sensitivity needs to be taken into account when interpreting the findings from this report. Indexation % of 2013 GDP TSH bln Base case (no reform) 9.9% 4,773 Harmonization rules 9.9% 4,773 Harmonization rules-partial 8.9% 4,283 Harmonization rules-all 7.5% 3, The Harmonization Rules state that indexation of benefits should be done on an ad hoc basis following an actuarial valuation. As it is not possible to estimate what this will mean in practice, for simplicity the scenarios assume this will be close to price indexation, which is 15

16 therefore applied to all funds. Price indexation is the minimum recommended by the World Bank as in the long-run it maintains the real value of pensions, whilst at the same containing costs. Compared to the base case, where current practice regarding indexation is applied, indexation of benefits at the NSSF will be slightly less generous (moving from wage to price indexation), LAPF and PPF benefits are more generous (as no or very minimum indexation is currently applied to benefits) and PSPF and GEPF remain the same. The breakeven scenarios of the funds are of course sensitive to the indexation assumption. Minimum Pension 34. The Harmonization Rules apply a minimum pension to all funds, based on 40% of the minimum sector wage. As the Rules have only been in place since the 1 st July this year, the funds are as yet uncertain as to how this will impact their benefit levels and financial position. For example, the NSSF believes that the 40% minimum sector wage could in some case actually be below the TZS 80,000 a month they currently guarantee, though they do not envisage reducing their minimum pension level. On the other hand, the 40% minimum sector wage could actually be higher than the TZS 21,000 applied at the PSPF. The funds therefore intend to continue with their current minimum pension policy for the time being until further guidance is provided. The reform scenarios modelled assume no change in minimum pension. It is recognized that, if changed, this could mean an increase in benefits in future, and therefore a deterioration of some of the funds financial position. Withdrawals 35. Early withdraws are legally only allowed to be taken from the funds after 6 months of unemployment. In 2012, the SSRA attempted to enforce this legislation. However, following a strong negative reaction from members of the funds, this rule has not been applied in practice, with members effectively withdrawing their balance when they change employment. This remains a major problem for the PPF and the NSSF (covering more mobile, private sector workers), where withdrawals constitute around 75% of benefit payments. The reform scenarios modelled assume that current withdrawals patterns continue. However, it is acknowledged that SSRA are currently examining the issue again and a stricter policy is likely to be applied in future. Previous World Bank analysis showed, this would improve the financial position of the funds in the shorter-term. For example, the NSSF, which could see its breakeven point improve by around 5 years. Segregation of schemes 36. In addition to stating that the new benefit parameters apply only to new members of the PSPF and LAPF, the Harmonization Rules also require that separate accounts are established for new members joining the LAPF and PSPF. This would effectively mean that these funds would run two different schemes, and closed DB fund for existing members based on the old parameters, and an open scheme for new members based on the parameters outlined in the Harmonization Rules. The contributions paid by new members would be directed to the new fund (which would build up a surplus as benefit payments would not commence for 30 years or so), and would not be used to cover the benefit payment of existing members. 16

17 37. The closed funds particularly the PSPF which would be responsible for paying the pre liabilities on behalf of the government - would therefore run into financial difficulties sooner than the integrated fund, as the table below shows. The PSPF and LAFP confirm that they are currently still running their scheme on an integrated basis, and are awaiting further guidance from the SSRA. The reform scenarios modelled assume that the PSPF and LAPF continue to operate on an integrated basis. It is acknowledged that if the segregation is applied the PSPF will need larger cash injections from the government in order to pay benefits in the current and coming years. Though this is a useful exercise to illustrate the financial position of the funds, it is recommended that they continue to operate on an integrated basis. Figures 4+5. PSPF and LAPF: Existing member scheme on open and closed basis PSPF LAPF (500) (1,000) (1,500) (2,000) (2,500) (3,000) Operating deficit/surplus if the fund remains open Operating deficit/surplus in the closed fund (100) (200) Operating deficit/surplus if the fund remains open Operating deficit/surplus in the closed fund (3,500) (300) (4,000) (400) 38. The PPF currently consists of two funds, a DB scheme and the Deposit Administration Scheme (DAS) which is a DC fund (members are generally those who join the PPF after age 45 and therefore would not be able to build a sufficient number of years of contribution history to qualify for a DB benefit). These schemes are current managed in an integrated fashion and there is no segregation of assets between the two (the DAS members being allocated the investment return on assets after the DB benefits have been paid). Due to the young demographics and surplus of the fund, this has not been a problem to date. However, it is not good practice to manage these different types of fund on an integrated basis. This issue should be addressed as a different type of membership from the informal sector is recruited to the join the DAS scheme. If the DB and DAS were to operate on a separated basis, the financing of the DB scheme would be worse. The breakeven point under the new Harmonization Rules of the separated DB fund would be closer to 2030 than the estimated 2036 for the combined DB and DC fund. 17

18 Figure 6. PPF DB + DC schemes 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% -0.1% -0.2% -0.3% DB and DC integrated DB and DC segregated Asset values 39. The financial viability of the funds, depletion schedules, and estimates of government liabilities do depend on investment income. However, as these are these are only partial funded, effective PAYG schemes, the modelling results are not very sensitive to asset valuations and returns. 10 That said, these are important considerations for the short-term cash flows, and longterm investment decisions have an important impact on the economy as a whole. 40. This modelling exercise uses a conservative asset return assumption, based on zero real return. The exercise also uses current valuations of the fund assets, as stated in the latest annual reports. All assets are assumed to be liquid and sellable at marked values. In practice, some assets will be worth more than their book value, whilst others would not be fully liquid. A full asset liability management (ALM) study of the portfolios would be required to derive a more accurate picture. 41. The Social Security Schemes Investment Guidelines issued by the BOT in 2012 under the SSRA Act No are a welcome development given the lack of diversification of the funds portfolios. Almost half of the portfolios on average are in government bonds and bank deposits. Ensuring that the portfolios of the funds meet the spirit as well as the letter of these guidelines will be the next challenge. 42. The most urgent is to ensure that the high level of direct government loans in the funds portfolios (currently 24% on average) are reduced in line with the 10% maximum prescribed in the investment guidelines. This has further increased the government s exposure to the funds - particularly to PSPF, where almost half of their portfolio consists of these loans, and NSSF, with 10 For example a 1% increase in returns improves the breakeven position of the funds in the long-run by around 2 years. 18

19 over one-third of their assets in these instruments, and the exposure highly concentrated in the UDOM loan. The government also needs to address the non-performance of a number of these loans (estimated as of 2013 at TZS 400 billion of total TZS 1.8 billion outstanding, or around 10% of the funds combined assets). 11 The BOT has instructed the funds not to undertake any new loans until the 10% limit in the investment guideline has been achieved. 43. To allow further diversification of the portfolios, investment across the East Africa Community is under consideration, which would bring the Tanzanian funds in line with the other social security funds in the region, and the EAC investment guidelines which are being drafted. Table 9. Portfolio Allocation of Social Security Funds Pension Fund Allocations (% portfolio) Investment Guidelines Funds' Average NSSF PSPF PPF LAPF GEPF Government Securities Fixed Deposits Loans + other special 20 (10 gov/ 10 corp) Corporate bonds Equity (+collective investments) 45 (15 listed/ 30 collective inv) Real estate Infrastructure 25 Source: pension fund annual reports Figure 7. Comparison Pension Funds Portfolios Tanzania Pension Funds CPPIB Canada GEPF SA Source: Pension Funds Annual Reports 11 The topic is covered in more detail in the full Contingent Liabilities Study. 19

20 IV. Impact of Merger 44. The Harmonization Rules serve to improve the financial position of the funds. However, contingent liabilities to the government still remain over the long-term. Merging some of the funds (and thereby combining funds which have surpluses and deficits at different times), would serve to reduce the contingent liabilities further from 25% to 16% of GDP. Table 10. Government contingent liabilities under base case and reform scenarios (net present value as % of 2013 GDP)* All funds NSSF PPF PSPF** LAPF GEPF Base case (no reform) 48.5% 5.7% 0.0% 41.8% 1.0% 0.0% Harmonization rules 25.1% 0.6% 7.5% 17.1% 0.0% 0.0% Merger 15.9% 5.2% 10.7% Merger+cost saving 12.4% 2.6% 9.8% * Assuming interest rate equal to inflation and using 5% real discount rate. ** Assuming PSPF does not finance pre99 pensions. 45. Merging also has the advantage of addressing some of the structural inefficiencies which arise from the having a large number of small funds. Harmonization alone, without merging funds, does not solve issues related to fragmentation, especially the issue of high administrative costs which, taking the basic measure of administration costs as percentage of contributions, range from 6% at the PSPF to almost 18-19% at LAPF, NSSF and GEPF. 46. Administrative costs in the Tanzanian funds are high by international standards, possible due to the relative high numbers of staff employed vs. the size of the funds and the due to the small level of assets under management at each. 12 This is clearly a snap shot in time and costs may improve for small funds such as the GEPF as they grow. However, the planned expansion into the informal sector could actually raise costs in the short-term.. Table 11: Operating costs of public pension funds as share of gross income, mid- to late 2000s Country grouping Operating cost as share of gross income Selected countries in category Most efficient public pension programs Intermediate efficiency public pension programs Most inefficient public pension programs Less than 1% Denmark, Ecuador, Singapore, Korea, Finland, Sri Lanka, Malaysia 1% to 3.3% New Zealand, Ghana, Egypt, France, USA, Japan, Ireland 5% to 24% Tanzania, Philippines, Fiji, South Africa, Costa Rica Source: Sluchynskyy, The ILO is currently conducting a review for the SSRA of the cost structure of the pension funds. Further details and recommendations should be available in this forthcoming report. 13 See Sluchynsky, O., (2014), Defining, Measuring and Benchmarking Administrative Expenditures of Public Pension Programs. The numbers for the Tanzania funds quoted in the report are based on 2007 data. 20

21 Table 12: Administration costs and indicators for public pension funds in selected African and Asian countries Country/Fund Malaysia Provident Fund Philippines Social Security Singapore Central Provident Fund Thailand Social Security Thailand Government Pension Fund Insured beneficiaries per staff USD Admin expenses/contribution revenue % Admin expenses / AUM % 1, , , , , NSSF Uganda 2, NSSF Kenya RSSB Rwanda Source: Sluchynskyy, PSPF 1, NSSF LAPF PPF GEPF Merging funds would allow for economies of scale, which can be significant for pension funds. For example Sluchynsky (2014) estimates that plans with 100,000 pay a premium of 50% in terms of costs due to their size vs. the same plan with 500,000 beneficiaries, and that larger plan sizes can be 25% less expensive per beneficiary to manage. At almost 1 million members, merging all social security funds in Tanzania into one National Fund would easily achieve these beneficial economies of scale sizes, whilst even two separate funds for the private sector (which would have over 500,000 members) and public sector (at almost 500,000) would also be beneficial. 14 See Sluchynsky, O., (2014), Defining, Measuring and Benchmarking Administrative Expenditures of Public Pension Programs. The numbers for the Tanzania funds quoted in the report are based on 2007 data. 21

22 Figure 8. Economies of scale in administrative expenditures (per beneficiary costs relative to per beneficiary costs of plan with 500,000 beneficiaries) Source: (Sluchynsky 2014) Figure 9. Costs of Managing Pension Assets Source: (Sluchynsky 2014) 48. Merging funds will reduce government liabilities even if administrative costs remain at their current level. Contingent liabilities would be reduced from 25% to around 16% were two funds one for the public and one for the private sector established. If administration costs at the more inefficient funds could be reduced to the industry average, contingent liabilities reduce further to around 12% of GDP. However, such reductions may be difficult to achieve in practice (particularly if staff cuts are involved). It should also be noted that costs at most funds are 22

23 South Africa Mauritania Zimbabwe Liberia Rwanda Congo, Dem. Rep. Cameroon Central African Republic Gabon Cote d'ivoire Chad Mauritius Mali Kenya Sao Tome and Principe Swaziland Zambia Burundi Benin Cape Verde Madagascar Niger Burkina Faso Eritrea Togo Congo, Rep. Guinea Senegal Nigeria Sierra Leone Uganda Gambia, The Ethiopia Ghana Tanzania Seychelles Sudan Equatorial Guinea Contribution Rate (% of Covered Wage) currently increasing as the funds expand their coverage to informal sector workers. Though a worthy aim over the long-run, this trend needs to be watched. V. Experience of Other Countries 49. How does the reform of the social security funds compare with reforms conducted in other countries in the region and elsewhere? Level of Parametric Reform 50. The Harmonization Rules do not increase the contribution rate of the social security funds, which is practical given these are already high compared with funds in the region and given levels of economic development in the country. Figure 11. Social Security Fund Contribution Rates Selected Sub-Saharan African Countries Additional Contribution Rate for Non-Old Age Social Security Employee Old Age/Disability/Survivorship Employer Old Age/Disability/Survivorship Source: World Bank pension database 51. In terms of reforms to benefit parameters, many countries have had to adjust their annual accrual rates on pension downwards in recent decades to make their systems sustainable. Table 13 shows the regional average annual accrual rates in DB pension systems by region and in selected African countries. 23

24 Table 13: Average Accrual Rate by Region Civil Service Scheme National Scheme Asia 1.8 LAC 2.3 CEE 0.9 MENA 2.4 OECD 1.5 Africa 2.05 Benin 2 2 Burkina Faso 2 2 Burundi Central African Republic 2.7 DRC 2 Congo 1.7 Cote d Ivoire Ethiopia 3 Gabon Ghana 2.5 Guinea 2 Liberia 1 Madagascar 2 1 Mali Mauritania 1.5 Namibia 1.5 Niger 1.3 Nigeria Rwanda 2 Senegal 2 1 Sierra Leone 2 Togo Uganda 2.4 Zimbabwe 1.3 Source: World Bank pension database 52. The Harmonization accrual rate of 2.07% brings Tanzanian social security funds in line with their regional peers. Though now less generous than the average fund in Latin America or the MENA region, the Tanzania reforms lag behind those in Asia, Central and Eastern Europe and the OECD countries (with the more pressing demographic challenges potentially being behind the impetus for greater parametric reforms). The replacement rates (pre commutation) remain generous (particularly in relation to the average wage of fund members), and the funds will require further reform in future as their membership ages 53. No change in the retirement age under the Harmonization Rules means that the members of the Tanzanian funds will on average spend over 17 years in retirement, which is at the longer 24