Reforming social security

As it turns out reforming social security is a well studied topic. A Google search reveals studies and articles by PIDS, the government economic think tank. There is also a ten year old study by the World Bank.

Interestingly, the lack of action on recommendations makes these documents seem current. The SSS management, particularly its Board, should have made stronger moves to get Malacañang and Congress on board the reform train.

The impression that one gets on reading these studies is the not too surprising reality that we do not always get good people to run the pension funds. Appointments to the boards and perhaps the staff as well, are politically determined and that imperils the funds.

Politicians, particularly Presidents, are easily tempted to use the pension funds for purposes other than their principal reasons for being that is to provide worker pensions and other benefits.

The main conclusion one gets after reading the studies is that we can certainly do a whole lot better managing those funds. But the attitude of the folks responsible for them is business as usual, meaning looking after their own benefits rather than the members.

It is no wonder that the World Bank study done in 2006 made a strong pitch for much improved governance and minimizing political interference. Management performance at the main pension funds, SSS and GSIS, had been spotty but not as bad as in the pension fund for the armed forces and the national police.

The World Bank wants members of SSS Social Security Commission, GSIS Board of Trustees, and other boards to have clear legal “fiduciary” responsibility to make decisions solely in the interest of members.

The World Bank also recommends that these officials should be chosen through a selection process that ensures professionalism and provides protection from political interference. It is particularly important to have a professional and depoliticized Investment Board for each of the pension funds.

The experience with having a politician on top of GSIS in the past administration supports this World Bank observation. How Erap used the pension funds to support cronies, as cited in his plunder conviction, is another sad experience.

Now that there is renewed public interest in how the pension funds invest, they have to be more transparent. They must make an effort to share their investment policies that set objectives regarding returns, risk management, types of assets, etc., in guiding their specific investment decisions.

Furthermore, the World Bank urged our pension funds to solicit outside professional investment advice. “Independent asset managers and custodians should be used… and prohibit inappropriate investments. Principles of overall risk management should guide rule making.”

The World Bank also recommended that domestic equity investments should be shifted toward pooled instruments such as an allocation matching representation in the Philippine Stock Exchange index. This, the World Bank said, reduces the influence on specific share prices and avoiding the need to place members on corporate boards of directors.

“Pension institutions only should invest in such instruments through market-priced, arms-length transactions… Institutions only should invest in tradable securities, not in government loans.”

The World Bank also recommended that “supervision should be unified and strengthened. A new Insurance and Pensions Commission, built on the foundation of the current Insurance Commission, should supervise SSS, GSIS, Pag-IBIG, AFP-RSBS, all private pension schemes, and any similar instruments.”

Additionally, “SSS, GSIS, Pag-IBIG, and AFP-RSBS should be required to be audited annually by a private international audit firm experienced with auditing assets, liabilities and procedures of partially funded defined-benefit pension funds.”

A PIDS paper, on the other hand, called for “improving the financial viability of and corporate governance in both the GSIS and the SSS.” It also emphasized the need for strengthening “the link between contributions and benefits.”

 Specific recommendations include: (a) the removal of the minimum pension guarantee; (b) further increases in the contribution rate; (c) additional increases in the maximum salary credit; (d) review the use of the final salary as basis of pension benefit; and (e) an increase in the vesting period.

The PIDS paper called for improvement in the protection provided to pensioners. “At present, pensions are adjusted in an ad hoc manner over time. The value of pensions may be better protected from erosion due to inflation if pensions are adjusted in a systematic manner through inflation indexation.”

PIDS also doubts the wisdom of the practice of allowing pensioners to get their benefits as a lump sum at the time of retirement. “The withdrawal of benefits in such a chunky manner rather than in the form of annuities tends to reduce the welfare of beneficiaries as they run the risk of outliving their retirement savings.” This observation makes sense.

The PIDS study by Rosario Manasan cited the need for reforms aimed at broadening coverage and promote compliance. “Poor compliance will persist if the incentives for evasion are engendered by the very design of pension benefits and contribution.”

For instance, it was pointed out that “the minimum pension provision and the provision that pensions are computed on the basis of salaries in the last five years of service tend to result in the evasion of the payment of appropriate premiums.

“In short, these two provisions create incentives for workers and employers to collude by either (a) under-reporting earnings until the last five years of their working lives and/or (b) artificially boosting pay that is reported to the pension system in the last five years of their working lives.

“On the other hand, the lack of sanctions on employers who either under-report or who do not remit the contributions they withhold from their employees obviously reduces the amount of contributions to the system. It also adversely affects the credibility of the system and discourages other workers from participating in the system.”

They also pointed out that the fiduciary role of pension funds must be paramount. There had been many instances when “the funds were used in pursuit of other domestic policy goals (e.g., financing of infrastructure investment, foreign exchange management, even outright political intervention) as these pension funds manage their investment portfolios.”

Examples were cited of the politicization of the SSS and GSIS in the past.

“Given the large pool of funds, it is often tempting for government bodies to direct the investment of a portion of these assets to specific domestic political purposes such as low-income housing, financing startup businesses, and development of the capital market, among others. While well intended, these economically targeted investments normally result in returns that are below market rates and thus deviate from the fiduciary principles.”

 The study cited that for instance, “at the behest of the Marcos government, the GSIS funded the construction of numerous hotels, which later on became nonperforming loans in the mid-1980s. At about the same time, it also took over the ownership of the Philippine Airlines. More recently, both the GSIS and SSS acquired substantial shares in a commercial bank at the behest of former President Joseph Estrada in support of a crony’s take-over of the said bank.”

Like the World Bank, the PIDS study noted “a need to strengthen the governance structure of SSS, particularly in terms of the selection of members of the Social Security Commission… the broad selection criteria used for selecting the members of the Commission in the past had resulted in its limited technical capacity to understand complex technical issues and take appropriate policy decisions.

 “In contrast, this problem has been mitigated in the GSIS by the requirement in its charter that four out of the eight members of the GSIS Board come from the banking, finance, investment, or insurance sectors and that one be a recognized member of the legal profession.”

PIDS also sought a reduction in administrative cost. It cited another study that “found that the administrative cost of running the SSS and GSIS is high relative to that of social security systems in other countries. For instance, the operating expense of the pension fund in Malaysia is two percent of total contributions while that of the pension fund in Singapore is 0.5 percent of total contributions.

“In contrast, the operating expense of the SSS stood at 11 percent of contributions in 2007, marginally higher than the corresponding ratio (10.7%) in 1995. On the other hand, the operating expense of the GSIS was equal to 15 percent in 2007, even higher than the corresponding ratio in 1996 (10.8%).”

Like the World Bank, the PIDS study urged setting up a noncontributory social pension for aged poor. PIDS observed, “the low coverage rate of the social security system underscores the importance of social safety nets not just for the aged but also for the informal sector.”

There is a lot of real work to do to reform our social security systems. But politicians look at short term payback which do not address problems but endanger what we already have.

Boo Chanco’s e-mail address is [email protected]. Follow him on Twitter @boochanco