The protection of pensions and retirement funds

Tue June 18, 2013

Judith Veira’s supreme command of long-term risk management issues was demonstrated at the Peace Memorial Hall on April 17, 2013, when she delivered the second lecture in the O. C. Forde Memorial Lecture Series on “The Protection of Pensions and Retirement Funds.”

Veira is one of only two local actuaries and she showed a thorough appreciation of the need for greater public financial awareness throughout the course of her speech.{{more}} The ‘tour de force no doubt expanded the scope of her listeners’ knowledge on retirement planning, the operation of public and private social security institutions and on pension reform in the Caribbean.

Veira referred to local and regional financial institutions that have experienced their “fair share of trouble” recently and the financial blow that Caribbean citizens suffered as a result. This bad experience has caused greater financial sensitivity and there is now a general demand for a higher level of accountability and a stricter code of conduct for the fiduciaries of pension plans.

The renowned local actuary stressed the need for early and ongoing retirement planning, and for a disciplined approach to saving to minimise retirement risks. The following retirement risks were identified: longevity risk (the risk that an individual would outlive his or her assets); the risk of insufficient retirement income (from pensions, investments or other sources), which results in an inability to maintain a decent standard of living; inflation risk or the risk that a rising cost of living would reduce the purchasing power of a fixed retirement income when there are no cost of living adjustments; the risk of premature death and leaving behind living dependents, such as a spouse or young children; the risk of becoming disabled without health insurance coverage and receiving inadequate disability benefits; and the risk that the company responsible for pension payments becomes insolvent, or bankrupt, and goes out of business (business risk).

Veira showed that someone who sets aside $1,000 per year in a retirement savings programme, starting at age 30, could accumulate, by the time he or she is 60, a fund that is twice as large as the fund of another 60 year old who started the same savings programme at age 40. She pointed out that personal retirement plans should be adjusted when there are family situation changes which accompany marriage, childbirth or other notable events, and that the plans should also be modified with age. Mrs Veira alluded to the ancient wisdom which says that no one should put “all their eggs in one basket” and mentioned that a good way to achieve asset diversity with a limited budget is by an investment in mutual funds. Banks and insurance companies in this country offer mutual funds advice. Young people were said to be better positioned to take greater investment risks than their elders because of their comparatively long remaining work life, during the course of which they could make up for the adverse consequences of investment mistakes. A more risk-averse, conservative investment strategy geared towards guaranteed retirement income should be adopted as they get older.

The public could invest in cash instruments (such as fixed deposits and personal savings), treasury bills, bonds, annuities, real estate, profitable business ventures (through stocks or shares, such as those recently issued by the Bank of St Vincent and the Grenadines, or in personally owned small businesses), and even in an inheritance (with all its vagaries and uncertainties). Stocks are historically known to outpace inflation over the long term.

Judy Veira explicitly identified three potential sources of  retirement income: the National Insurance Services (NIS), employer pension plans (the civil service pension plan and private sector pension plans) and direct personal savings. She said that (according to a basic “rule of thumb”) workers should aim for lifetime retirement income from these sources, that is at least 75 per cent to 85 per cent of their pre-retirement salary. Veira pointed out though that public servants could currently receive a pension higher than their previous salaries when NIS benefits are combined with the benefits specified in civil service pension legislation. She said that there is no justification for this (especially since civil service plans are non-contributory) and that the government, and by extension current and future generations of Vincentians, should not be forced to bear the high associated costs. Her views were challenged by educator Curtis King and several of his Teachers Union colleagues during the discussion period.

Educator Philbert John posited that the retirement income of public servants only appears to be abnormally high because of their unusually low career earnings and suggested that civil servants make de facto contributions to a pension fund, given their low salaries. He expressed the hope that there would be a corresponding review of parliamentary pensions. Oswald Robinson, the Teachers Union President, suggested that their current retirement package was well deserved and vowed to resist any move to reduce the benefits. Donald Peters, a dock foreman at the SVG Port Authority, contended that while he understands the Union’s position, he thinks that civil servants are relatively well paid and that consideration should be given to the plight of workers like him, who pay taxes to fund tidy civil service retirement benefits, but who will have to “make do” with only a meager NIS pension during what may therefore be not so golden years. Peters then mischievously asked the teachers to consider “giving him a piece” of their pension.

Judy Veira herself had acknowledged earlier that even though public servants have the potential to receive an abnormally high pension, their occupational mobility is constrained by a “golden handcuff,” because there are no vesting rights built into their packages. They have no right at all to a pension unless they have served a full 33.3 years in the public service (with few exceptions). Typically, employees could leave jobs in private sector companies that have pension plans after five or so years and take with them all the accumulated funds (from both employee and employer contributions) in their retirement accounts at the time of their departure. Also, civil service pension plans (unlike the NIS) have no survivor pensions. Note, though, that both civil service plans and the NIS only offer ad hoc inflation adjustments. It was underscored that SVG is the only Windward Island in which there is still any kind of civil service pension plan whatsoever for new employees.

Veira, in her memorable and insightful lecture, said that there is a pension reform movement throughout the Caribbean. She commented on the recent NIS reform measures that were announced by the SVG Prime Minister in his 2013 budget address. The Prime Minister mentioned in the same address, without giving specifics, that a study of the civil service pension provisions was being done. There have been no reforms of local civil service pension plans. The ECCB Commission on Pension and Pension Administration Reform that was chaired by Marius St. Rose of St. Lucia published a report in July 2010 that contains comprehensive recommendations.

Veira revealed that United Nations data show that the life expectancy of Vincentians (which is now 70 for males and 74 for females) is increasing and she mentioned that fertility rates are falling. These two trends may lead to a situation where fewer workers are required to support more retirees in an unpredictable and limited investment environment which currently offers low rates of return. These factors, along with unpredictable costs and increasing financial strain, the actuary said, have resulted in a shift from defined benefit systems (in which contributors are guaranteed a certain amount of retirement income) to defined contributions systems (in which the retirement income that a person would receive could rise or fall depending on the investment success of the pension fund pool). There has also been the privatisation of state-owned social security institutions in countries such as Chile and elsewhere in Latin America (with less than stellar results). There was no suggestion that the state-owned NIS, which operates a defined benefit system, should be privatised or that it should contemplate systemic reforms. NIS benefits could be augmented by private pension plans.

A number of private pension plans already exist and have been created by private sector companies like Coreas Hazells Inc. and the St. Vincent Cooperative Bank Ltd., and by statutory organisations like the CWSA and VINLEC. Private pension plans receive tax concessions once they are registered with the Supervisor of Insurance and approved by the Comptroller of Inland Revenue. They must satisfy the requirements set out in Section 65 of the Income Tax Act and the Insurance Act of 2003 contains a schedule of transactions from which pension plans are prohibited. There are also restrictions on the size of investments in particular asset classes and asset diversification criteria which must be met. There must be an asset spread across classes, industries and regions. Pension funds are expected to adopt a conservative investment policy in order not to compromise their ability to honour their long term commitments.

In addition, the experienced actuary gave a very good overview of the operation of public and private pension plans and encouraged her listeners to become familiar with the NIS Act of 1986, the Teachers Pension Act, the Police Pension Act and the general Pension Act. She said that the operational rules of their private or public pension plans should be available in a condensed format with simple explanations in plain English and benefit illustrations. She further said that plan members should be advised on the advantages and disadvantages of optional benefit payments by competent agents and that the plan’s benefits must be provided to all members on an equitable and non-discriminatory basis. The laws and plan rules are there to provide a good governance framework.

The contributions to private pension programmes are placed in a Trust Fund and must be kept separate from the general assets of the company. The Trust Fund has to be governed by at least three trustees (including an employee representative) who are ultimately responsible for all aspects of pension plan operation (including the investment of its assets). The trustees have a fiduciary responsibility and are expected to act in accordance with the prudent man rule. The prudent man, according to an 1830 Massachusetts court ruling, handles the affairs and assets of other people as if they were his own and with care, skill, dignity, competence and integrity. He does not take undue speculative risks and tries to ensure the safety of capital so that common goals can be achieved.

Companies with pension plans, in addition to the trustees, typically have a pension committee. The trustees need not get involved in the day-to-day business of the plan but are duty bound to establish an efficient and well-staffed administrative apparatus complete with an actuary, who examines the long run financial sustainability of the plan every three or so years and prepares valuation reports, an investment advisor, accountants and attorneys. The investment advisor, the plan administrator, and pension committee members, all have some degree of fiduciary responsibility, but the trustees are assigned the principal fiduciary role. Private pension plans are regulated by the Supervisor of Insurance and the Comptroller of Inland Revenue. These officers are expected to be fair in their decision making and their main concern has to do with a plan’s compliance with the laws and statutes.

The NIS has a National Insurance Board which contains two employee representatives, two employer representatives, two government representatives, two independent financial experts and the Executive Director. Judy Veira encouraged private and public plan participants to directly question trustees and administrators on their performance and to examine audited financial statements (within 6 months of the end of the plan’s financial year) and actuarial valuation reports. Curtis King also chipped in on this point. He expressed the view that employee representatives should not be handpicked by Finance Ministers and complained about the inaccessibility of NIS actuarial valuation reports which have not apparently been laid in Parliament as required. Randolph Clarke, a recent retiree, slammed what he described as poor record keeping by the NIS. He said that there are inadequate mechanisms for NIS contributors to monitor the buildup of their retirement funds and he recommended the introduction of NIS books (which are similar to bank books). Veira had already highlighted the desirability of accurate records and annual benefit statements from pension plans.

The members of the audience were warned against squandering hard earned retirement savings like many people have done in the past. The NIS and private pension plans are generally clients of insurance companies, but listeners were told that they themselves could use, say, a large retirement payout from a private pension plan that was received by them to buy carefully selected annuities (annual income streams) from reputable insurance companies rather than keeping all the cash at hand. There could be a staggered purchase of annuities from different companies for the sake of diversity and examples of annuities that protect insurance clients from the various kinds of risk were provided. It is true that lump sum payments may be preferable in certain exceptional circumstances and there is always a need for a contingency expenses fund to deal with financial shocks. The point was made that high-risk-high-reward payments were not always best. Institutional investors (pension plans) and individual investors should be aware that products like the Deposit Administration Contracts, which were very popular among insurers, such as CLICO, offered high interest rates that were guaranteed for a period of time but, on the flip side, provided unsecure arrangements because pension assets were comingled with the general assets of the insurance company. Always remember that high expected returns come with high risk and be sure to have a basic safety net in place before making risky investments.

The eminent actuary ended by saying that Vincentians should “be informed, and stay informed” on broad financial subjects. She said that the lecture provided an important educational opportunity and that a vigilant and knowledgeable citizen is the best safeguard against pension fund mismanagement and of our national interests. These sentiments were publicly expressed by a number of other forum participants.

contributed by the Financial Alliance