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Dr. Ade Ibiwoye
Department of Actuarial Science & Insurance, University of Lagos, Lagos

 In the public sector where Government operated a pay-as-you-go pension system, pension was treated as a subject of last resort after salaries and other compensations have been settled. Retirees were not getting their pension entitlements as and when due. In the private sector many organizations had no pension scheme whatsoever in place and pensioners in such private sector organizations were left entirely to fate. This tends to put a lot of pressure on these private sector employees as many, in their active years, resort to organising a retirement scheme for themselves. It seemed a welcome development, therefore, when Government in 2004 reformed its multifarious pension schemes. However, there appears to be many unresolved issues. The main features of the reform are examined; some critical issues are highlighted including how to ensure sustainability in an era of fast demographic changes; management of contributions and assets and the effect of weak infrastructural support. Remedial actions are suggested.

Keywords: Pension; reform; demographic change; transition problem

All societies, in one way or another, try to meet people’s needs as they age and can no longer provide for themselves (Barr, 2002). Traditionally the aged in Nigeria have often been catered for through the extended family system. But as demographic changes particularly that in which parents and offspring are dispersed in different, sometimes very distant, locations take place this practice has been replaced by Western democracy type of pension provision. But perhaps because it is an adopted concept or because people feel that retirement and the need for pension income is a long time away there is a general tendency to approach pension issues with levity in Nigeria. People also tend to have an optimistic disposition that all will be well or that the future will take care of itself and therefore let matters be. However, this ‘do-nothing’ strategy hardly ever works except to worsen the insecurity situation in old age.  

The levity with which pension matters were treated was evident in many private sector organizations that had no pension scheme whatsoever in place for their employees so that pensioners in such private sector organizations were left entirely to fate in old age. In the public sector where Government operated a pay-as-you-go pension system, pension payments for retirees was erratic and irregular. It probably could not have been otherwise as most developing countries have been observed to spend all their energies in a losing fight against hunger and disease in the face of secularly declining prices for commodities (Fox and Palmer 2000). In Nigeria, in spite of the windfall from oil revenue successive regimes had displayed a lot of difficulty in paying the salaries of current employees let alone pension entitlements. 
There is thus a lot to bother the individual in Nigeria about what in times past was regarded as a blessing: namely exceptional longevity. They include loss of earning power, elusive pension, deteriorating medical condition, and general insecurity to life and property. In an attempt to cater for an uncertain future many resort to “organizing” an individual retirement scheme for themselves, through means that are far from orthodox, like fraud. It would perhaps not be incorrect to say that the fear of insecurity in old age is one of the major causes

of the corruption that pervades both the private and public sector organizations in the country.
It seemed a welcome development therefore, when Government in 2004 radically changed the form of the pension system in Nigeria by bringing the multifarious pension schemes in the country under a uniform regulation. However, there remains many issues that need to be resolved if the new pension system is to meet the objectives outlined in the Pensions Reform Act 2004 (PRA).

This paper examines the main features of the reform; highlights some of the critical issues that can in one way or another impinge on the success of the scheme and suggest remedial actions including how to ensure sustainability in an era of fast demographic changes, the management of contributions and assets and how to mitigate the effect of weak infrastructural support. Because much data have not been generated about the operation of the new scheme the study will essentially be exploratory preparing as it were the groundwork for later research.

Main Features of PRA
The Pension Reform Act (2004) which repealed the Pension Act of 1990 established uniform contributory pension scheme for all employees in public and private sector organizations in Nigeria. The 1990 Act had been the main regulation guiding the operation of pension schemes in Nigeria and in spite of slight amendments in 1999 and 2000 had remained largely unchanged in form and content.

Apart from establishing standard and uniform set of regulations for the administration of retirement benefits, the Pension Reform Act 2004 was also aimed at assisting improvident individuals in ensuring that they make savings to cater for livelihood after retirement. It also aimed to ensure that retirees collect their pension entitlements as and when due.
The 2004 Act prescribes a minimum contribution rate of 7.5% of an employee’s annual salary by the employer and an equal

sum by the employee for all organizations that employee five or more persons except the military where the minimum contribution rates are 12.5% by the employer and 2.5% by the employee.  These contributions are mandatory.
Unlike in the past where there was no regulatory body, the National Pension Commission (PENCOM) was established to regulate the activities of all the operators in the pension sector in the country. This body is saddled with the responsibility of evolving uniform rules and regulations for the industry.

The Act also provides for the establishment of Pension Fund Administration (PFA) who are to manage the retirement savings account on behalf of each employee and for Pension Fund Custodians (PFC) who are to take custody of the funds and invest them as instructed by the PFA. The PFA is to invest and manage the funds and assets in accordance with the provisions of the Act on investment and with the aim of ensuring safety and maintenance of fair returns on the investment.

Key Reform Issues
Globally there has been an improvement in longevity. The implication of this demographic change for employees is that they could still be around for a longer period of time after retirement than anticipated. An immediate corollary is that the period for which they have to be catered for compared to the past is also increased. Unfortunately the economies of developing countries have continued to experience a downward slide. Productivity is low as unemployment rate is high and continue to worsen. Thus dependency ratio, that is, the number of retirees to the number of workers has been on the increase. Some developed economies have been able to manage these demographic changes through parametric reforms in which some factors, like retirement age, accrual rate, maximum number of years of service allowable for pension, and so on are tinkered with and the effect of these changes on the pension system are examined. In developing countries, however, a number of factors like poverty, uncommon inflation,

weak infrastructural facilities and other problems of underdevelopment make the impact of such parametric reforms very negligible. Radical reform seems to be the antidote and that had made the example of Chile which made a radical reform to its pension plan in 1981 a form of benchmark for developing countries. However, studies have shown that the Chilean model suffers from very serious flaws (Erlich, 2002; Modigliani and Muralidhar, 2005; Riesco, 2005). To avoid some of the inefficiencies observed in the Chilean model and move nearer optimality in attaining the objectives of the model adopted in Nigeria we examine below key issues that need to be addressed.

Weak Institutional Support
Given the administrative requirements of managing a pension scheme, record keeping, fund management, report generation and so on there is need for an efficient private sector. Without this, the administrative cost could be excessive and this could negatively affect the returns on investment and subsequently the viability of the pension system.
Pension planning and administration are multi-period and inter-generational functions. Within any one period there is continuous flow of employees in and out of the pension system. Any reform must take cognizance of this flow and the needs of employees at various stages of employment. For young employees just flagging off a career their priority would be growth funds since their retirement is a long time away. This is where a vibrant capital market comes into reckoning. At present, with many companies experiencing underutilization of capacity, there is paucity of quality equities to trade in and when this is coupled with inflation the capital market in Nigeria cannot but operate at less than optimal level. If the capital market is to respond to the surge in funds expected from the savings from the pension scheme there will be need to deepen the market by introducing new instruments such as futures, options, and asset-backed securities.


Banks are also required at the different stages of an employee’s career and no less in retirement. Many of those leaving employment may be relocating and the easiest way to settle their pension entitlements would be through the banks. Thus reliable banks with branches in every part of the country are required. Those retiring also have need for liquidity especially in exercising the phased withdrawal option and this can only be made possible through the inter-bank clearing system. Even after the recent consolidation in the banking sector, however, it is feared that some of the emerging banks comprised strange co-travelers and are unsound. The risk that this presents is that in the event of a bank failing in its functions it can send a panic signal to the entire banking sector.

Another financial sector that is required for running a successful defined contribution pension system is insurance. Unfortunately in Nigeria this sector is still regarded with distrust. Aside the image problem, however, the role the sector has been assigned to play in the new dispensation is a tall order, especially in a developing country environment. The function of estimating a retiree’s expectation of life for those choosing the phased withdrawal method or that of providing level annuities for those settling for a life income poses a serious problem where there is no reliable mortality data.

Investor Characteristics
Although the defined contribution system encourages long-term saving, which enhances economic growth, the sensitivity of the benefits to the rates of interest at retirement and poor hedge against inflation are some of its demerits. An investment attitude that tends to buy and hold stocks instead of actively trading in them suggests that many investors in Nigeria are risk averse. Such investors would generally put their investments where the risk is least. This of course has its price in low returns. In the new scheme although combating the up and down movement of stock prices is the preoccupation of the PFAs the individual

employee cannot afford to be taciturn. The task of knowing which PFA is performing and when to change the fund administrator is not one to approach casually.

Transition Problem
The Act stipulates that the benefit accrued by employees who had been in employment before the new Act and had more than three years to retire would have their benefit converted to a retirement benefit bond redeemable at retirement. This category of employees had based their pension expectation on the benefit schedule of the previous defined benefit scheme which had been very generous; possibly even over-generous (see Villafuerte, 2005). At retirement date the values of these benefits are easily determined by the formula and the regulations that guide the scheme. However, anywhere before this unique date the true value of the pay-as-you-go promises can only be forecasted imperfectly. The redemption bond therefore faces the risk of being conjectured as a mechanism for governments to partially repudiate some of its implicit debt by issuing bonds for an amount less than the expected value of these implicit obligations (Samwick, 2000). The organized labour in Nigeria indeed argued that the reform was targeted at defrauding funds in the existing pension schemes in the private sector to settle pension debts in the public sector (Nwachukwu, 2004). But perhaps the greatest fear is that, shortly, members of the cohorts that were to have part of their pension entitlements from the redemption bond and part from the accumulations under the new arrangements would be retiring. Yet Government has not determined the amount that has accrued to each individual in the old system. While the case of existing pensioners has not been fully sorted out (they are still undergoing rigorous verification exercises), a new class of pensioners with more complex mode of computing their benefits are now being released to the system unprepared for.

Another problem with the bond is that there is no attempt to project how much would be

required to fund the bond except in so far as to earmark an arbitrary 5% of total employees’ wage bill. If the bond is not adequately funded it means that over time, as the number of retirees increase, there may not be enough fund to redeem the bonds and this could mean that the system would be back to the situation from which it sought to flee – that of inadequate funding. Further since both the interest payments and subsequent redemption depend on future taxpayers, the reality is that the pension regime is still such that today’s pensioners are taken care of by tomorrow’s taxpayers; meaning, again, that we are essentially back to a pay-as-you-go scheme (Barr, 2002) with all the ills that plagued the old defined benefit pension system.
The redemption bond option may also lead to other operational problems. For example, government bonds may be in short supply or there could be an absence of secondary markets for government debt and lack of alternative investment opportunities in domestic markets. This may lead to lowering of public confidence and trust in the new system. Majority of the new redemption bonds may also eventually find their way to banks which are primarily not equipped to manage pension funds.
Economic Instability
Financial stability of a pension system is positively correlated to macroeconomic stability. When the economy is unstable there are no adequate investment instruments to protect against financial instability. Pension reserves and real benefit levels whether in the form of annuities or lump sum payments are quickly eroded. Working towards economic stability, therefore, is sine qua non to successful operation of a pension system. It stands to reason that in a defined contribution system where the contribution is a percentage of annual salary, productivity is key to the sustainability of the system. The more that is produced the more that can be saved and the more maturity proceeds at retirement. For pensioners however it goes beyond immediate

production and consumption. As Barr (2002) argued, pension plans are claims on future output, and they are no use to retiree if the country is not producing enough goods and services to meet those claims. What for example is the use of a fat pension cheque to one retiree who requires drugs for his arthritis but is only presented with fake drugs or to another who has to vacate his government quarters in government reservation area (GRA) but cannot afford the rent even in a remote part of the town where he used to live or of yet another who has been placed on a protein diet but can only find cassava products to buy in his neighbourhood? These could lead to psychological and social dis-equilibria.  The role of government in pension reform is therefore multi-dimensional. It must not only stimulate production it must be effective in its regulation.
Payout Options
Another department that requires attention relates to the mode of collection of pension benefits. Section 4 of the Act provides for essentially two methods: programmed withdrawal calculated on the basis of an expected life span and annuity purchased from a life insurance company. What appears to be a third method is a modification of the annuity method. With phased or programmed withdrawal based on expectation of life of 47 years (Library of Congress, 2006) this option faces the same problem as that of a fixed period annuity. This is because no one can accurately forecast the time he would die. Experience has, however, shown that payments would almost always stop before the individual’s death (Daykin, 2004). With this option the old age insecurity burden is not removed as the retiree is now faced with a new risk, the mortality risk, which is the risk that a participant would outlive his accumulated entitlements. 
The annuity option even poses a greater challenge. First because people may not want to purchase a life annuity since it is only payable while the annuitant is alive. For someone who commutes the entire balance in

his retirement savings account into an annuity, no portion of the fund could be passed on to surviving dependants and what is more if he dies shortly after purchasing the annuity a greater proportion of the fund is lost. Therefore, even in developed economies there is the danger of what is referred to as anti-selection whereby only those members of a cohort who think they would live longer than the average lifetime of their peers would purchase an annuity. To hedge this risk, insurance companies base their annuity rates on a mortality data that presumes that those who will buy annuities are those with light mortality (Blake, 2003). This is only half of the problem however. The insurance companies even in developed economies with well run insurance system and well developed annuity markets are not enthusiastic about selling annuities as the market for immediate annuities is uncompetitive and/or poor value for money (Blake, 2003)
Limited Scope of Coverage
The nature of contractual saving arrangements such as obtained in a pension plan is different from other forms of saving plans as the participant has no access to the fund until the end of the contract. It takes a lot of self discipline to operate the usual saving scheme. Thus if the larger members of the society who are outside the scope covered by the new Act are not to constitute a burden to those covered in the scheme when they retire, then they too ought to be encouraged to participate in the scheme. The Pension Reform Act (2004) provides coverage to all employees in well established organizations having five or more employees. It thus excludes the self-employed, who are in the informal sector and who are in majority. Although this category of workers are advised to voluntarily contribute to the scheme, where there is no compulsion to save towards retirement, majority would suffer from a myopic view of their needs in retirement, would not feel obliged to set aside money for old age and the burden of providing for them when they can no longer work will inevitably

bounce back to covered retirees or the younger working generation. Ultimately, the primary objective of the new Act for the covered employees would be defeated except the minority lucky participants choose the un-African path of not being their brother’s keeper.
Asset Management
Even while operating the sundry models that were in existence prior to reforms many countries in Anglophone Africa had been observed to garner large reserves from these schemes (Fox and Palmer, 2000). The major problem, however, was that these reserves tend to be mismanaged. The cases Fox and Palmer (2000) reported like that of Egypt and Zambia where real interest rates trailed bank rates by 8 – 12% or that of Uganda where the real annual rate of return between 1986-1994 was highly negative in the neighbourhood of minus 33% presented no cheering news.
In Nigeria the previous federal civil service pension system generated no accumulation since it was completely unfunded. However, the experience with the partially funded parastatal schemes was not different from that described in Fox and Palmer (2000) and there is nothing to guide an employee who was in such a parastatal scheme about how to manage the new defined contribution pension scheme. However, many of the private sector deposit administration schemes, barring fraudulent practices of the fund manager, were fairly well managed and may provide a few lessons about how to design a management policy for the new system. In these schemes the employer, through the Board of Trustees, had usually selected and monitor the performance of the fund manager. Many of the Trustees used to farm out this role to external pension fund consultants whose core preoccupation is pension management. These consultants evaluate, select and monitor the performance of fund managers.



With the new scheme, however, an employee makes the investment decisions all alone. Since every employee is required to open a retirement savings account with a Pension Fund Administrator of his choice, who manages the account on his behalf, this provision cuts off group intervention and leaves the evaluation and monitoring of the performance of the fund administrator entirely in the hands of the individual member. Aside the fact that most members are not skilled in investment or portfolio management even the skilled participants can hardly afford the time required to do it effectively, on a regular basis. The end result is that the portfolio may witness more periods of lower return than the industry average without the investor being able to sanction the pension fund administrator for underperformance. Although the Act allows the member to change his administrator, it ignores the possibility that the existing PFA, in all likelihood, would not let go easily. Chances are that the PFA would urge the participant to exercise patience arguing that the usual trend in equity market is for alternating periods of low and high returns. Such arguments would be supported with spurious statistics which may end up confusing the investor further. Unfortunately unlike what operated with the more familiar private sector deposit administration schemes where the employer exacts a minimum guarantee as return on investment from the fund manager, there is no such guarantee in the new arrangement.
There is a peculiar marketing challenge for the PFAs in the new dispensation. While in the old private sector deposit administration schemes it suffices for a prospecting fund manager to showcase its track record and convince the Board of Trustees about its competence in managing an organization’s fund, the new PFAs have to market each individual employee. Sometimes their marketing effort could be a total waste particularly if the individual had already picked a PFA and the

Act forbids the splitting of management between PFAs.
Recommendations and Conclusion
Apart from the operators, there are three principal actors who have a role to play in ensuring a successful outcome of the new pension system. The first are the individual employees themselves. A major thrust in ensuring that the benefit a pensioner gets in retirement is close to what it was shortly before retirement is for each individual to ensure better performance of his Retirement Savings Account during his contribution years by continuously monitoring the PFAs and evaluating and re-evaluating their performance. To be effective in this exercise the employees need to avail themselves of basic financial education. Individuals could enroll in personal financial planning programmes and, for instance, learn to take simple steps to change their PFAs before major problems arise.

The second group is the regulator, Pencom. It has to set the appropriate guidelines and sanction erring operators. It must be transparent in its relationship with the operators and where required must be firm. In the case of weak institutional support, there is need for effective regulation of financial markets to protect consumers if public confidence in the new pension system is to be sustained. This is because pensions are complex instruments, perhaps too complex for consumers to effectively protect themselves (Barr,2002). It requires tightly drawn regulatory procedures and a body of people with the capacity and will to enforce those procedures. Highly skilled regulators whose abilities command high price in the private sector are required for such an assignment. In respect of the capital market requirement a standard that is regarded as minimum for pension fund development is one that can boost the market’s liquidity, standardize the trading activities, eliminate the risk of price manipulations on equity markets, standardize the market supervision and eliminate covering

of losses through speculative trades with illiquid bond issues/equities (Slovak Republic, 2003).  In addition to the new capital requirement insurance companies that would be selling annuities must themselves be insured against bankruptcy, otherwise the income of many pensioners would be at risk. The PFAs must be transparent in their dealings with the employees. Details about contributions, pension accumulations, and administrative charges must be disclosed through periodic individual statements. An individual must be able to access his accounts on-line. Pencom must also insist on uniformity in the statement disclosures so that employees can compare the PFAs item for item. Since most of the Pension Fund Custodians are banks the objects of the Nigerian Deposit Insurance Corporation must be redefined to take special care of pension funds, for instance, if a PFC should collapse it should be easy to transfer its assets to another PFC, rather than promising the account owner a fixed amount.

The third and most important actor is the Government. Although the new pension system has been conceived as a private sector driven scheme which will require little government intervention, some of the issues raised in this paper have shown that government cannot wash its hands from the pension scheme. Radical reform of the pension system is not expected to be a fait accompli. Modifications are required from time to time in order to achieve desired results. Many of the issues raised in this study like expanding the scope of coverage, economic stabilization, and managing the transition require government intervention. To encourage wider participation there is need to educate the populace about the advantages of putting “just a little” of their income away purposefully for retirement. This task may not be as difficult as it was first imagined when it is remembered that there is a traditional contribution scheme, ‘esusu’, to which participants often contribute religiously. The modalities used here may be borrowed to encourage informal sector participation. 

For the redemption bonds, a proper actuarial valuation of Government liabilities in respect of active workers who are caught up in the transition should be done. This will help in determining the actual rate of funding that should be embarked upon.

Long-term government commitment is needed in stimulating output and in fashioning stringent regulation required in a multi-regulatory concern like the new pension system. Other areas where government intervention may boost the chance of success of the reform include encouragement of home ownership and establishing effective health care system. Pensioners need to spend less on housing in retirement; retirees who already own houses of their own would bother only about maintenance. Health is another recurrent factor in the life of a pensioner. At least in the first couple of years or so after retirement an arrangement should be made whereby the pensioner can still access the health provider he was using before retirement except he has relocated. From all indications, therefore, even with the new pension system effective government is a very critical success factor.

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