Should Social Security Funds Invest in Government Securities? Derek Osborne CAA Conference, Dec. 2 nd, 2010, Barbados

Should Social Security Funds Invest in Government Securities? Derek Osborne CAA Conference, Dec. 2 nd, 2010, Barbados

Today s Agenda Features of Caribbean social security schemes Social security investments Challenges facing social security funds Investing in government securities To fund or not to fund? 2

Social Security Design Features Defined benefit Partially funded Publicly managed Final average insurable wage Most 3 years, some now 5 years Wage ceiling limits coverage < 1 to > 3 times avg. national wage Contribution rates Most between 8.5% to 11% Jamaica 5%, Guyana 13%, Barbados 20.25%

Social Security Pensions Retirement/Age, Invalidity, Survivors Normal pension age 60 in most Some gradually moving to 65, Barbados to 67 In most, pension not dependent on actual retirement EPA 60 where NPA > 60 Maximum pension 60% of final avg. ins. wage 30% after 10 years Maximum earned after 35 to 40 years Flat pension in T&T Flat + earnings related in JA

Other Benefits Short-term: Sickness, Maternity, Funeral Unemployment in Barbados & Bahamas Employment Injury: Medical care, short-term & disablement pensions Health Bahamas: Chronic disease prescription drugs (elderly, children) Belize: Primary care in several pilot areas Turks & Caicos: Comprehensive Many considering various forms

Barbados NIS Contribution & Exp. Rates 6

Current Financial Position Contributions > Expenditure Most Expenditure > Contributions A few Ratio of Reserves to Annual Expenditure 3 to 23

Barbados NIS, Dec. 2009

Bahamas, Dec. 2009

St. Kitts-Nevis, Dec 2008

St. Vincent, Dec 2009

Trinidad & Tobago, June 2009

Recent Experience Contribution income Investment yields Benefits Significant losses following collapse of CLICO & British American Low inflation

Projected Reserves 14

Challenges Facing Caribbean SSS s Unsustainable at current cont. rates & benefit promises Contribution rate increases needed Benefit reforms needed Higher pension ages Lower benefit replacement rates Progressive pensions or pensions with better links to historical wages Design issues Wage ceiling & pensions not automatically adjusted in most Ceiling levels, coverage gaps Self-employed participation High administrative costs Political interference

Social Security Is Different! System expected to be perpetual Statutory rules not contractual rules Able to raise contribution rates and reduce benefit promise at any time National plan with mandatory coverage Core goals & principles: Pooling, redistribution, solidarity, basic safety net Financial backing of government 16

Social Security Investment Criteria Safety of principal Liquidity Yield Social & economic utility 17

Investment Objectives Diversification Asset classes Issuer Maturities Location Asset-Liability match Term Nature (real vs nominal) 18

Investment Challenges Limited options Fund growing faster than economy Investment skills Political interference Weak boards 19

Public Debt As % of GDP

Types of Government Securities T-bills Bonds Loans Leases/mortgages Other bonds/loans with government guarantee Fixed deposits In government owned banks

Investing in Government Debt Pros Simple Competitive rate Low/moderate risk Offers diversity Varied terms Marketability Societal yield Cons Presumed safety (buyer) Gov t could become largest contributor debtor & tenant Already highly indebted Vulnerable to gov t influence 22

Experience With Government Securities T-bills rolled over & over again Long-term borrowing at short-term rates Restructurings (not risk-free) Antigua-Barbuda, Belize, Dominica, Grenada, Guyana, Jamaica Unpaid interest, principal, loans Using SS funds to finance social welfare & fulfill political motives Pressure to invest where otherwise would not 23

Gov t Debt & Social Security Funding Social security contributors? Workers mainly Tax payers? Workers mainly To extent that SS invested in government debt, system is pay-as-you-go 24

Conclusions Hard to ignore government securities Governments in borrowing mode Large funds in small economies with few opportunities Alternatives do not necessarily provide higher returns But cannot overdo Government debt not a real asset Risk of default and inability to convert to cash when cash needed to pay benefits Must have sound investment governance structure Investment policy Board & committees Skills set 25

Pay-as as-you you-go, full funding, or something in between? 26

Financing Future Pensions Pay-as-you go Contribution rate set each year to collect just enough to meet expenditure Very small reserve Full funding Contribution rate set so that reserves + PV of future contributions equal PV of future benefits Very large reserves assets >= accrued liabilities 27

Risks Facing SS (Pension) Schemes Pay-as-you-go Full Funding Macroeconomic Shocks Demographic Shocks Political Risk Management Risk Investment Risk Annuities Market Risk 28

The Price of Converting To Full Funding Initial unfunded liability must be financed by: Public borrowing Raise funds to finance deficit and pay back over time Taxation Increase taxes so deficit financed from budget surpluses No benefits in transition generation They finance previous generation but get no pension at all! 29

Final Notes Ability of social security funds to fulfill promise does not rests with how promise is financed but instead with: Increasing output (economic growth) Good design Affordable promise Efficient administration Good governance 30

Questions?