Adding pillars to the World Bank pension model
Since government's second discussion paper on social security and retirement fund reform there has been a great deal of debate about what form South Africa's new pension system will take. Four months have passed since the document's release and the only thing we know for certain is that there is still plenty of discussion to come.
The World Bank's "Three Pillar" model is used as the basis for pension fund systems in more than 80 countries around the world. The same system guided the initial formulation of a South African solution. With this in mind, the Financial Planning Institute of Southern Africa (FPI) invited independent consultant Rob Rusconi to describe the World Bank model and some of the thought processes that have influenced the redesign of the local pension fund system.
Two key factors to consider when implementing reforms
Rusconi began his presentation by looking at two key factors which dominate every pension fund system. The first is the element of redistribution. "You will have some redistributive philosophy in your approach," said Rusconi. Regardless of a country's economic strength there will always be a requirement to provide income for the poor. Rusconi emphasised that a redistributive approach was inevitable in a democracy where government required votes to stay in power. Redistribution in some form exists in every government and every country in the world and the concept is central to almost every system of taxation.
The second major factor which has to be present is saving. Rusconi pointed out that "many countries take the view that saving for retirement needs to be compulsory if it is to take place at all." Although occupational pension schemes create a small pool of compulsory savings in South Africa, the overall savings record is dismal.
Rusconi believes that financial planners play a crucial role in stressing the micro-economic benefits of saving. Through retirement saving, the individual gains "benefits well beyond the money that they have available in retirement."
Cracking the World Bank "Three Pillars" pension provision model
As easy as one two three! says Rusconi. The first pillar is the social security or social assistance program. In South Africa this is known as the Social Old Age Grant (SOAG). This pillar disproportionately benefits the poor and serves as the redistributive element mentioned earlier. Research supports the notion that a cash grant system remains one of the most effective techniques for alleviating poverty.
The second pillar is the mandatory occupational fund or individual account system which is the key to social security funds around the world. Rusconi said that "in many countries it is mandatory for all working citizens to save into an individual account held in their name." And the third pillar is that of additional provision.
The second and third pillars often attract tax support in the form of tax incentives. "Every country has an interest in the savings of the citizens, and the government puts its hand in its own pocket to support it," said Rusconi. Criticisms of the three pillar system include that it is inflexible and designed with wealthy countries in mind. To make the model more useable, two additional pillars were added.
Since redistributive contributions can be contributory or non-contributory a new pillar was added to represent non-contributory redistribution. This pillar is known as pillar zero. The World Bank then identified a fourth pillar, namely community. The community pillar is not well defined in documentation. "The problem with pillar four is that it is very difficult to measure; but very easy to break," said Rusconi.
An easy-to-use 3D pension fund model
Rusconi demonstrated an interesting technique to model a country's pension fund environment. The model offers a three dimensional graphical reference to place various segments of the retirement industry. This is achieved by plotting each segment of the industry on three axes to illustrate its distinct features.
On the vertical axis, Rusconi answers the defined contribution versus defined benefit debate. This question defines who bears the risk in the pension fund system. In a defined benefit system the employer bears the risk South Africa's SOAG falls on the defined benefit side of this axis, with government funding the risk to the tune of R20 billion a year.
Rusconi uses the horizontal plane to plot the answers to two more questions. Is the fund Pay-as-you-go or funded? Most occupational systems are funded while the majority of national systems are not funded. The SOAG system is not funded in any way and "there are no assets backing the promise, implied or explicit..." The final axis is used to plot how the fund is managed. Is the fund administered by the public sector or the private sector? Most occupational fund systems are privately managed, while social security systems are more often publicly managed.
Given this information it is no wonder that Rusconi believes we will not see a final pension fund solution in South Africa by 2010. Rusconi believes the speed of implementation of a new system should be secondary to getting the solution 100% right.
Editor's thoughts:
The fourth pillar of the World Bank's pension fund system is community. The principle is that the community (often immediate family) have a responsibility to provide for the aged. Does South Africa enjoy a strong sense of community? Send your comments to [email protected]
