World Bank ASEM Trust Fund
Project (TF052298)
Contract No. 7138110
Final Report
Submitted by The Services Group (TSG)
August 31, 2006
(Revised March
2007)
EXECUTIVE SUMMARY
The Government of the
Philippines faces an important fiscal, demographic, and political window of
opportunity to improve the structure and governance of its
pension system so that the system is more adequate, affordable, sustainable,
and robust. This report is intended to assist such reforms.
The Philippine pension
system consists of several components: The Social Security System (SSS) and the
Government Services Insurance System (GSIS) provide pensions and related
programs to private- and public-sector workers, respectively. (Some
civil-service workers have schemes separate from GSIS, such as the Armed Forces
of the Philippines Retirement and Separation Benefits System, AFP-RSBS, for the
military.) Additionally, private and public workers contribute to the Home
Development Mutual Fund (HDMF, also known as Pag-IBIG). Private firms,
commercial banks, insurance companies, and Pre-Need companies also provide
various pension-related programs. This set of institutions is successful in
many respects in providing pensions to the population. Nonetheless, the system
suffers from a number of weaknesses:
Investment decision-making is not
sufficiently robust or protected from political processes.
Pension assets are insufficiently
diversified and not well matched to risk/return needs.
Supervision, regulation, and auditing
are fragmented and in some instances inadequate.
The mandatory system provides
replacement rates that are too high given policy objectives, threatening fiscal
sustainability and necessitating onerous payroll tax rates.
Benefit formulas are not harmonized and
equitable across ages and participant categories.
The defined-contribution, fully-funded
element of the pension system is quite small.
Taxation is not harmonized or
consistent.
Administration in some respects
needs improvement.
The system provides limited
coverage – not sufficiently reaching poor elderly.
The following
key recommendations are made by the report:
The governance
institutions of SSS, GSIS, Pag-IBIG, and AFP-RSBS should be strengthened:
•
Members of SSS Social Security
Commission, GSIS Board of Trustees, and other boards should have clear legal “fiduciary”
responsibility to make decisions solely in the interest of members, and
should be chosen through a selection process that ensures professionalism and
protects from political interference.
•
A
professional Investment Board should be formed for each institution, to
take specific investment decisions, under the broad investment strategy to be
set by the governing board. Investment Boards similarly should have fiduciary
responsibility and professional, depoliticized selection processes.
•
Strict rules should apply to governing
and investment board members regarding conflict-of-interest, financial
disclosure, accountability, and transparency.
Investment processes should be
further strengthened:
•
Institutions should adopt explicit investment
policies that set objectives regarding returns, risk management, types of
assets, etc., in order to guide specific investment decisions.
•
Institutions
should solicit outside professional investment advice.
•
Independent asset managers and custodians should be used.
•
Investment restrictions should
eliminate minimum limits, reconsider maximum limits, and prohibit
inappropriate investments. Principles of overall risk management should guide
rule making.
Investment portfolios should be better
diversified and shifted out of inappropriate assets:
•
Some
investments should be made internationally to diversify beyond the
relatively small Philippine capital market.
•
Domestically,
equity investments should be shifted toward pooled instruments such as
an allocation matching representation in the Philippine Stock Exchange index,
thereby reducing influence on specific share prices and avoiding the need to
place members on corporate boards of directors.
•
SSS,
GSIS, Pag-IBIG, and AFP-RSBS should divest entirely of loans to members.
Any new loan programs should be run by unrelated institutions without
cross-subsidization. Pension institutions only should invest in such
instruments through market-priced, arms-length transactions, for instance by
buying freely traded mortgage-backed securities.
•
A limit on investment in government
bonds or loans should be set at no more than 30%. Institutions only should
invest in tradable securities, not in government loans. Practices should change
to permit trading of government securities between tax-exempt and
non-tax-exempt entities.
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.
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.
Replacement rates should
be reduced gradually to 40-50% for SSS, GSIS and AFP-RSBS. This should
apply to younger workers and new entrants, not to current retirees or older
workers close to retirement. A uniform ceiling on wages should apply across all
programs. Benefit formulas should be revised to provide more consistent
rates of return for varying categories of members.
The contribution rate to SSS
should not be raised any further. The contribution rate to GSIS gradually
should be reduced somewhat, to the extent permitted within the constraint of
maintaining financial sustainability.
The role of Pag-IBIG should be
re-defined and gradually expanded, to provide a fully-funded
defined-contribution pension. Initially, the cap on wages subject to
contributions should be increased to the same level as SSS. Investment
decisionmaking capacity would need to be improved, and Pag-IBIG should divest
of member loans.
Taxation should
be rationalized and harmonized, following an “Exempt-Exempt-Tax” model,
treating similar instruments similarly, with a cap to prevent excessive tax
avoidance by the affluent.
The Government should consider the
merits of a universal or needs-based pension, paid from general state
revenues, to complement existing pension programs, in order to expand coverage
and reduce elderly poverty. An eligibility age of 70 or even higher should be
considered. Poverty data needs to be improved to facilitate analysis of this
issue.
The benefit formulas of military
pensions need to be gradually reduced and harmonized with those of GSIS and
SSS, affecting younger participants but not the current elderly. Investment
processes need to be improved. Increased contributions to a reformed Pag-IBIG
might be a good means for providing a larger share of military pensions rather
than creating a new specialized fund for the military.
PERA legislation
needs to be improved including ensuring sufficient caps on tax exemptions.
Pre-Need supervision and regulation need to be strengthened and made consistent
with regulation of similar pension instruments.
Pension reform needs to fit into a
context of overall financial sector development. Only with greater
financial sector development in parallel will the pension system itself be able
to develop and gain access to increasing numbers of suitable investment
opportunities.
An Action Plan is needed to move
pension reform forward. Reforms requiring changes in legislation could be
developed in draft form between now and Spring 2007 elections, to be considered
by the post-election Congress. Reforms just requiring executive decision could
be implemented sooner. Some reforms requiring greatly increased capacity would
require more time; those just requiring policy decisions could be implemented
sooner.
Part One gives
summary recommendations, and Part Two presents supporting analyses.
Chapter 1 of Part Two describes the programs of each pension and related
institution and gives an overview of recent reform efforts. Chapter 2
reviews governance structures and investment decision-making processes. Chapter
3 examines the appropriateness of investments. Chapter 4 considers
how to strengthen supervision and external auditing of pension institutions. Chapter
5 evaluates financial sustainability, projecting when SSS and GSIS
expenditures will begin to exceed revenues and when reserves will be exhausted.
Chapter 6 addresses inconsistencies and inequities in benefit formulas
and replacement rates. Chapter 7 considers administration of programs. Chapter
8 deals with taxation issues. Chapter 9 analyzes demography, poverty
among elderly relative to other age groups, and the extent of coverage of
current pension programs. Chapter 10 considers options for increasing
coverage through either a universal or needs-tested pension program funded from
general revenues, not linked to previous contributions. Chapter 11 examines
military pensions. Chapter 12 discusses issues related to Pre-Need,
PERA, and other programs. Chapter 13 presents an Action Plan for
reforms. Annex 1 identifies legislative and regulatory gaps.
Annex 2 gives the presentations from an August 2006 seminar on
pension reform. Annex 3 presents organizational charts of key pension
institutions.
SUMMARY
RECOMMENDATIONS
I.
INTRODUCTION
1.
The Government of the Philippines is
considering how to improve the structure and governance of its
pension system so that the system is more adequate, affordable,
sustainable, and robust. This report is intended to assist
that effort. The report is prepared for the Department of Finance and the World
Bank. It is funded by the World Bank ASEM Trust Fund (TF052298), Contract No.
7138110.1
2.
Part One of this report presents summary
recommendations for improving the structure and governance of the pension system.
Part Two of the report contains supporting analyses on which the
recommendations are based.
II.
BRIEF OVERVIEW OF THE PENSION SYSTEM
3. The mandatory pension
system of the Philippines is comprised of several institutions. Private-sector
firms are required to contribute to the Social Security System (SSS), which
provides a pension at retirement and other insurance services. Similarly, most
civil-service workers contribute to the Government Services Insurance System
(GSIS). SSS and GSIS offer defined-benefit, partially-funded pensions.2
Some civil -service workers (military, police, judges and local-government)
contribute to their own schemes instead of GSIS. In particular, the armed
forces contribute to the Armed Forces of the Philippines Retirement and
Separation Benefits System (AFP-RSBS). AFP-RSBS is a defined-benefit, unfunded
scheme, with an investment fund not directly related to contributions that is
managed separately. Additionally, SSS, GSIS, and AFP-RSBS members also
contribute to the Home Development Mutual Fund (HDMF, also known as Pag-IBIG).
In addition to subsidized housing loans, Pag-IBIG provides a lump sum benefit
after twenty years of affiliation, in a manner similar to a
defined-contribution, fully-funded pension.
4. Contribution rates for SSS and GSIS members
are shown in TABLE I.1.
TABLE I.1:
Payroll Tax Rates
|
Private sector
firms
|
|
Government
entities
|
|
|
(SSS members)
|
|
(GSIS members)
|
|
|
Employer
|
Employee
|
Total
|
Employer
|
Employee
|
Total
|
Social
insurance contribution
|
7.07
|
3.33
|
10.4
|
12.0
|
9.0
|
21.0
|
Retirement pay
|
2.5
|
|
2.5
|
2.5
|
|
2.5
|
Employee
compensation
|
1.0
|
|
1.0
|
1.0
|
|
1.0
|
Pag-IBIG
|
2.0
|
2.0
|
4.0
|
2.0
|
2.0
|
4.0
|
Total
|
11.57
|
5.33
|
16.9
|
17.5
|
11.5
|
28.5
|
5.
A number of other institutions also play
a role in pensions. Some private firms make contributions to pension schemes in
addition to the SSS. Commercial banks, insurance companies, and Pre-Need
companies manage employer-sponsored schemes and also can offer schemes directly
to individual participants. Some employers manage their schemes themselves.
6.
The pension system of the Philippines is
successful in that it provides pensions to millions of elderly; it collects and
invests contributions from millions of workers; it is financially sustainable
in the short run; it achieves a policy objective in some cases of distributing
resources to lower-income workers; and it has built a number of relatively
efficient, complex administrative structures.
7.
Nonetheless, the pension system of the
Philippines has a number of weaknesses, some of which are as follows:
Governance
weaknesses
• The
processes for making investment decisions do not fully follow international
best practices for serving the interests of participants in public pension
funds.
• Investments
of pension assets are not sufficiently diversified and in some cases are not
made in the most appropriate instruments given the needs of participants for
balancing return expectations and risk management.
• Supervision,
regulation, and auditing of pension programs are fragmented across many
institutions, and in some instances are inadequate.
Structural
weaknesses
• For
many participants, the mandatory pension system aims at replacement rates that
are too high, given the pension system’s key objectives, such as ameliorating
old-age poverty, and constraints, such as the need to ensure long-term fiscal
sustainability.
• Payroll
tax rates (including pension contribution rates) are often higher than
desirable levels.
•
SSS,
GSIS, and the AFP-RSBS systems are not sustainable in the long term.
• Benefit
formulas across institutions and for various types of participants are not
harmonized across sectors and are not equitable. Participants of varying ages,
lengths of service and income levels do not receive similar internal rates of
return on contributions. The present system interferes with portability and
therefore with labor mobility and efficient allocation of labor. Equity issues
relate to both old-age and to survivor programs.
• The
defined-contribution, fully-funded element of the pension system is quite
small. World trends have been away from unfunded (or partially funded) defined
benefit components, toward larger defined-contribution, fully-funded programs.
•
Administration
of pension programs in some respects can be improved.
• AFP-RSBS,
Pre-Need, and certain other programs have weaknesses specific to them, which
need to be addressed.
• The
mandatory pension system provides very limited coverage—that is, it only
reaches a small share of the elderly population, and in particular does not
adequately reach the poorest of the elderly.
8.
This
report makes recommendations to remedy each of these weaknesses.
III.
GOVERNANCE ISSUES
Governance
Institutions
9.
The Social Security Commission that
governs SSS, the Board of Trustees that governs GSIS, and similar institutions
for the other institutions do not have a sufficient legal and regulatory
foundation to protect them from political interference and to otherwise ensure
they take decisions solely for the benefit of members.
10.
Recommendation: Measures
should be put into law, regulation, and practice to strengthen these
governance institutions. Standards and codes of conduct should be specified for
governing members. They should be given a legal “fiduciary” responsibility to
make decisions solely for the benefit of members, with sanctions including
criminal penalties and possibility of removal for violating their
responsibilities. Conflict-of-interest and financial disclosure requirements
should be enacted. The selection and appointment process should be made as
depoliticized as possible.
Investment
Processes
11. Guiding principles for organizing the investment
processes of a public pension fund are as follows:
• Investment
decisionmakers should be professional and protected from political pressure. A
professional Investment Board should make specific investment decisions, not a
political Governing Board, and not staff. (That is, while Governing Board
members might be chosen for political reasons, such as representing employers
or employees, Investment Board members should be chosen based on their
qualifications and financial-market expertise. Such an Investment Board likely
is more protected from political pressures than are Governing Board members or
an institution’s staff.) A Governing Board can set broad strategy and
parameters.
• Formal
structures and processes should protect from mismanagement, corruption and
fraud. They should ensure accountability and transparency, and provide
performance incentives.
•
A
nominating and selection process should ensure Investment Board
professionalism.
•
External audits are important for
ensuring transparency and accountability, and for checking that rules and
procedures are properly followed.
12.
The investment decisionmaking processes
within SSS and GSIS only partially follow these guidelines. While the level of
professionalism of investment processes has increased markedly within both
institutions in recent years, investment decisions still are made largely by
internal staff and individuals appointed by the institutions themselves, in an ad
hoc manner. While these individuals might be quite competent, they are not
as protected from political pressures as a carefully constituted Investment
Board would be.
13.
Recommendation:
SSS, GSIS, Pag-IBIG, and AFP-RSBS should create professional Investment
Boards, to assume responsibility for making investment decisions. Investment
Boards would focus specifically on deciding in what to invest and divest and
would work subject to broad policy guidelines set by the Governing Board, which
would have broader governance responsibilities. A best approach would be for
the Investment Board to be vested with decisionmaking authority, but
alternatively it could act in an advisory role, with decisionmaking authority
maintained by professionals within each institution, supervised by Governing
Boards. The roles of the SSS Social Security Commission and the GSIS Board of
Trustees would be narrowed, to setting broad investment policy but not to making
any specific investment decisions.
14.
Recommendation: A
nominating process should be established whereby prominent individuals
in academia, the financial sector and the government nominate skilled
professionals to a short-list, from which a Selection Committee proposes
appointments to Investment Boards. Regulations should define the rights,
responsibilities, and anti-conflict-of-interest rules for Boards. Processes
should yield decisions based on merit and protected from political influence.
15.
The investment procedures within SSS,
GSIS, Pag-IBIG and other institutions follow a rather loose set of policies and
appear somewhat ad hoc. . Formal investment review and approval systems
appear to have not been institutionalized. The institutions do not articulate
specific investment objectives with regard to return and risk, and do not hold
regular reviews of investment policy.
16.
Recommendation: SSS,
GSIS, Pag-IBIG and other institutions should adopt and clearly articulate
explicit investment policies. Specific investment objectives should be clearly
delineated, and a regular review of investment policy should be instituted.
17.
Recommendation: Investment
decisionmaking processes should be clearly specified in written manuals.
The investment procedures should include 1) a risk management process to
monitor and measure the risk of investments and their contribution to the
overall risk profile; 2) procedures for selecting asset managers and monitoring
their performance against appropriate benchmarks; and 3) a process to review
the appropriateness of investments in terms of the investment policy on a
regular basis and to identify action to be taken when investments do not comply
with the policy. The investment policy should include an integrated approach
linking long-term liabilities with asset duration and liquidity.
18.
Rules regarding in what instruments
pension institutions can and cannot invest are set in legislation and charters.
The 1997 SSS Act sets broad guidelines for the SSS, defining a list of
permissible asset classes with limits on allowable investment, and the 1997
GSIS Act plays a
similar role for the
GSIS. While it is appropriate to set such restrictions in legislation and
charters, in some cases the specific limitations are not appropriate. As a general
rule, it is necessary to set maximums for investment, but not minimums. The
overly specific investment limitations defined in the 1997 SSS Act are
unnecessarily restrictive and leave little room for the pursuit of other
investment objectives, such as diversification. Moreover, both charters permit
investment in too many inappropriate vehicles. (Investment portfolios are
discussed more in depth immediately following this sub-section.)
19.
Recommendation: Investment
restrictions set in legislation and charters should be changed. Minimums
generally should not be specified, and in some cases more maximums should be
specified and inappropriate investments should be prohibited entirely.
Restrictions should allow for greater flexibility and diversification in asset
allocation, while directing against inappropriate assets.
20.
Investment
practices often are not consistent with best international practice.
21.
Recommendation: Investment
practices should be improved. Specifically, investment decisions should
be made taken into consideration criteria reflecting risk assessments of the
total portfolio; matching the timing of liabilities and assets; and valuation
of assets that use mark-to-market approaches.
Investment
Portfolios
22. Pension asset
portfolios should meet the following criteria:
•
Appropriate
returns and risks
•
Liquidity
•
Diversification
•
Assets
purchased at market values and “marked-to-market”
•
Transparency
• No
lending or investments to related parties
•
No
politically directed investments
23. The investment
portfolios of SSS, GSIS, Pag-IBIG and AFP-RSBS only partially meet these
criteria. Diversification of portfolios is a significant issue for each
institution. A basic problem is the diversification of investments within the
relatively few opportunities offered by the local financial markets. As noted
in TABLE
I.2, pension-related institutions already play a substantial role in the
Philippines’ capital markets, with a capacity to move market prices. Part of
the problem is that the pension institutions tend to hold and manage stocks in
individual companies, so even if their share in the overall stock market is not
so great, they are able to move market prices for specific companies. Greater
diversification domestically and investing through pooled instruments would
reduce the impact of investment by these institutions on price movements.
TABLE I.2:
Assets as a Percentage of GDP
SSS
|
GSIS
|
Pag-IBIG
|
AFP-RSBS
|
Pre-Need
|
Insurance
|
Total
|
3.7
|
6.3
|
3.3
|
0.2
|
2.9
|
4.5
|
20.9
|
24. Recommendation: Pension institutions
should reduce their concentrated influence on equity share prices and corporate
governance in enterprises in which they invest. Pension
institutions should
contract to multiple private fund managers to manage diversified portfolios of
equity investments according to clear guidelines, or otherwise invest in
indexes and pooled instruments. Related to this, pension institutions should
delegate voting rights and become less involved in active management of firms.
25.
Other rules on where pension
institutions can and cannot invest also reduce the suitability of pension
investments. Institutions are likely invested too heavily in government securities
of various types, particularly in securities that are not tradable. This
problem is partially related to differential tax treatment between public and
private institutions. At present, only public institutions (mainly the pension
institutions) can trade certain government securities that are exempt from
taxation, while other government securities are traded by the private sector.
26.
Recommendation:
Limits should be set on the extent to which pension institutions can invest
in government bonds or loans, at 30% of the total portfolio (including bonds
and loans to the government). Investments in government loans and non-tradable
securities should be phased out entirely, eventually only permitting
investments in tradable securities. Means will have to be developed to allow
trading of government securities among public and private institutions,
preserving tax exempt status for public institutions but not private
institutions. Together with this measure, the Government has to commit to
undertaking continuous financial sector reform to increase the availability of
eligible private domestic financial instruments.
27.
As pension assets grow, there is a limit
to the extent of diversification that can be achieved from investments within
the Philippines. The size of the Philippine capital market obviously is quite
small compared to the size of world capital markets.
28.
Recommendation:
SSS, GSIS, Pag-IBIG and AFP-RSBS should gradually diversify their investments
by increasing their investments abroad with the assistance of leading world
financial institutions chosen through open, competitive tenders. Assets abroad
generally could be invested in mutual funds and other pooled equity and debt
instruments.
29.
Salary, housing and multi-purpose loans
offered by SSS, GSIS, and Pag-IBIG violate a number of principles of sound
pension investment, including: diversification, market rates, liquidity,
lending to related parties, and avoiding politically directed investments.
30.
Recommendation:
Pension institutions should divest of salary, housing, and multi-purpose loans.
If socially desirable, new institutions should be created to offer salary and
housing loans, with any transparent government subsidies that may be
appropriate. Pension institutions may continue to invest in such lending
institutions through arms-length market investments, such as mortgage-backed
bonds and others.
31.
SSS and GSIS offer a number of programs
in addition to pensions, including insurance. At least to some degree, the
funds of the pension programs are not segregated from the funds of other
programs. Pre-Need programs also appear to have only partially segregated
pension assets from assets of other programs, including the education programs
which have recently experienced severe financial problems. This increases the
risk for pension assets. Furthermore, these other programs, while providing
some social benefit, do so at a cost – namely, crowding out private-sector
provision of such programs.
32.
Recommendation:
At a minimum, SSS, GSIS, and other institutions should improve the extent
to which they segregate pension assets from assets of other programs, both
institutionally and legally. This should involve segregated accounts and legal
protections to maintain firewalls
between types of
assets, to ensure that one program type is not tapped to fill a liability in
another. Furthermore, it is preferable that institutions divest themselves of a
number of such programs, including insurance, and delegate such functions to
the private sector. Careful analysis if administrative costs should ensure that
pension programs are not cross-subsidizing the administrative costs of more
resource-intensive programs.
Regulation,
Supervision and Auditing
33.
Supervision and regulation of pensions
are fragmented. The Financial Institutions Division of the Department of
Finance Corporate Affairs Group supervises SSS, GSIS, AFP-RSBS, and Pag-IBIG.
The Tax Administration registers the employer-sponsored schemes. The Central Bank
supervises trust accounts at commercial banks. The Insurance Commission
supervises insurance companies. And the Securities and Exchange Commission
supervises plans of Pre-Need companies. These institutions are audited only on
an ad hoc basis, and audits are not publicly available. Only the State
Commission on Audit has jurisdiction over auditing these institutions.
34.
Recommendation:
An expanded, strengthened Insurance and Pensions Commission should supervise
all pensions institutions, including SSS, GSIS, Pag-IBIG, AFP-RSBS and private
schemes. The capacity of such a Commission would need to be greatly enhanced,
which would necessitate increased resources, exemption from civil-service
salary limits and substantial training. Supervision should follow the
principles of risk-based supervision. Significant amounts of training would be
needed to facilitate undertaking these new responsibilities.
35.
Recommendation:
Law and regulation should require that SSS, GSIS, Pag-IBIG and AFP-RSBS undergo
annual audits by private audit firms experienced with auditing the assets,
liabilities and procedures of pension institutions.
IV. STRUCTURAL ISSUES
System Parameters: Replacement Rates,
Contribution Rates, Long-term Financial Balance and Harmonization of Benefit
Formulas
36.
Key parameters of the pension system
determine: the size of benefits paid by the system; the burden of the system on
workers and firms that comes from contribution obligations; the long-term
financial sustainability of the system; and the system’s equity – how various
population groups in the system are treated relative to each other. The
replacement rate (the ratio of a worker’s pension to previous salary), which is
a function of the benefit formula and economic conditions, determines the level
of pensions paid. The contribution rate and ceilings on wages determine the
burden on firms and workers. Replacement rates and contribution rates, coupled
with economic conditions, determine financial sustainability. And the details
of the benefit formula determine how various groups within the population are
treated relative to each other.
37.
Mandatory
pension plans should aim for replacement rates in the range of 40-50% of an
average
full-career worker’s lifetime average salary (adjusted for wage growth.)3 SSS, GSIS,
3 This target of
40-50% is not a magic number but a broad guideline based on several factors. A
government’s main policy objectives in mandating a pension system are to keep
the elderly out of poverty and to ensure at least an adequate pension for
participating workers, keeping in mind that individuals can and should seek
additional forms of saving and inter-generational support. Since the elderly
usually fall into lower tax brackets and no longer need to
and AFP-RSBS provide
much higher replacement rates (using “base salary”) than this target level.4
While SSS has a ceiling on wages for which contributions are made and pensions
paid, GSIS has no ceiling, meaning that generous pensions can be paid even to very
high income workers. AFP-RSBS offers even more generous replacement rates (and
early retirement ages) to members than SSS and GSIS. Given the lack of
long-term financial balance in the system, as well as some negative
redistributional aspects (whereby the poorer are cross-subsidizing the richer),
the replacement rates in the Philippines’s pension system are too high.
38.
Recommendation:
Replacement rates should be reduced gradually to 40-50% for SSS, GSIS
and AFP-RSBS. This should apply to younger workers and new entrants, not to
current retirees or older workers close to retirement. A uniform ceiling on
wages should apply across all programs.
39.
The contribution rate to SSS, 10.4% of
wages (7.07% from employers, 3.33% from employees following the January 1, 2007
increase in contribution rate from 9.4%), is somewhat high given what
private-sector firms are likely willing to bear and given several other payroll
tax deductions. The contribution rate to GSIS, 21% (9% from employees, 12% from
employers) is much higher – a fact that is significant in light of the high
arrears of the Government to GSIS.
40.
Recommendation:
The contribution rate to SSS should not be raised any further. The contribution
rate to GSIS should be gradually somewhat reduced, to the extent permitted
within the constraint of maintaining financial sustainability.
41.
SSS and GSIS predict long-term financial
imbalance. SSS is expected to experience a negative cash flow (i.e.,
expenditures exceeding revenues) in 2019, and to be unable to meet its
obligations after having exhausted its reserve by 2027. GSIS is in slightly
better condition but is also expected to experience a negative cash flow in
2049, and to be unable to meet its obligations by 2060.5
42.
Recommendation:
Long-term financial sustainability needs to be re-established in both SSS and
GSIS. This should be done through gradually changing benefit formulas to reduce
replacement rates, and by reducing opportunities for receiving pensions that
are not commensurate with contributions. For instance, benefit formulas should
be based on lifetime contributions, not just final career years, and minimum
pensions should not be so easily granted without sufficient contribution
history. Contribution rates should not be raised.
43.
Benefit formulas are inequitable in that
they offer varying internal rates of return on contributions to members of
varying ages, lengths of service, and wage-growth and participation patterns.
Rules also do not always encourage long contribution periods, instead granting
pensions after only a few years of service, or heavily weighting final years of
service in the benefit formula.
44.
Recommendation:
Benefit formulas should be revised to provide more consistent internal rates
of return for various categories of members. Benefit levels should be based on
lifetime contributions, not just final years, and should reward longer periods
of contribution. A ceiling should be placed on wages subject to contributions,
and also on the base wage used to calculate pension level, so the system is
well targeted toward lower- and middle-income workers. Benefit formulas should
be harmonized between SSS and GSIS to permit full portability between the
public and private sectors. Survivor benefits should be rationalized, providing
lifetime benefits at a reasonable rate with reasonable eligibility. With a good
survivor program, life insurance and funeral benefits could be eliminated.
45.
Recommendation:
Taxation of pensions needs to be rationalized and harmonized so individuals
and institutions are subjected to the same taxation regardless of what type of
pension program they participate in and in what sector they work. The standard
should be E-E-T: Contributions should be tax exempt; income on investments
should be exempt; but pension income should be taxed just like any other income
type. Caps on tax exemptions should facilitate policy goals without permitting
excessive tax avoidance by the affluent. Tax issues should not impede financial
market functioning. Specifically, new mechanisms are needed to allow tax-exempt
and non-tax-exempt institutions to trade in government securities.
Coverage
46.
The pension system reaches less than a
third of the Philippines’ elderly. Those not covered by the system tend to be
poorer than those who are covered. Recent world experience suggests that
coverage can only be expanded to substantial shares of the population in
developing countries through some kind of universal or needs-based pension –
that is, through a pension that is funded from general revenues and not linked
to previous contributions, so that people who either work in the informal
sector or who do not work at all can still qualify.
47.
Recommendation:
The Philippines should consider the merits of a universal or needs-based pension,
paid from general state revenues, to complement existing pension programs.
Several options are possible. A universal pension could be granted to all
citizens over a specific age, or a needs-based pension could be granted, only
to the poorest. “Need” could be broadly defined, considering all types of
income, or narrowly defined, only considering other pension income. A
needs-tested pension has the advantage of being less expensive than a universal
pension and better targeted at the poor, but is administratively very hard to
implement—verifying need is much harder than simply verifying age. A
needs-tested pension also can create incentives to not work or to not
contribute to other components of the pension system. Varying eligibility ages
could be considered. Analysis suggests that prevalence of poverty among the
aged does not increase substantially until age 70 or even 75. We therefore
would recommend an age of eligibility for such a pension of not lower than 70.
Several options for benefit level also could be considered, ranging from a
level as high at the official poverty level, to some estimate of the amount
needed to close the gap between poor income’s and the poverty level. Analysis
suggests that many reasonable options would be fiscally affordable.
48.
Another issue to consider is the extent
to which scarce resources should be spent on alleviating old-age poverty
relative to other social needs, for instance child poverty. The data on child
vs. old-age poverty in the Philippines is flawed in some important respects so
must be carefully considered to analyze this question. Poverty data does not
take into consideration
44.
Recommendation:
Benefit formulas should be revised to provide more consistent internal rates
of return for various categories of members. Benefit levels should be based on
lifetime contributions, not just final years, and should reward longer periods
of contribution. A ceiling should be placed on wages subject to contributions,
and also on the base wage used to calculate pension level, so the system is
well targeted toward lower- and middle-income workers. Benefit formulas should
be harmonized between SSS and GSIS to permit full portability between the
public and private sectors. Survivor benefits should be rationalized, providing
lifetime benefits at a reasonable rate with reasonable eligibility. With a good
survivor program, life insurance and funeral benefits could be eliminated.
45.
Recommendation:
Taxation of pensions needs to be rationalized and harmonized so individuals
and institutions are subjected to the same taxation regardless of what type of
pension program they participate in and in what sector they work. The standard
should be E-E-T: Contributions should be tax exempt; income on investments
should be exempt; but pension income should be taxed just like any other income
type. Caps on tax exemptions should facilitate policy goals without permitting
excessive tax avoidance by the affluent. Tax issues should not impede financial
market functioning. Specifically, new mechanisms are needed to allow tax-exempt
and non-tax-exempt institutions to trade in government securities.
Coverage
46.
The pension system reaches less than a
third of the Philippines’ elderly. Those not covered by the system tend to be
poorer than those who are covered. Recent world experience suggests that
coverage can only be expanded to substantial shares of the population in
developing countries through some kind of universal or needs-based pension –
that is, through a pension that is funded from general revenues and not linked
to previous contributions, so that people who either work in the informal
sector or who do not work at all can still qualify.
47.
Recommendation:
The Philippines should consider the merits of a universal or needs-based pension,
paid from general state revenues, to complement existing pension programs.
Several options are possible. A universal pension could be granted to all
citizens over a specific age, or a needs-based pension could be granted, only
to the poorest. “Need” could be broadly defined, considering all types of
income, or narrowly defined, only considering other pension income. A
needs-tested pension has the advantage of being less expensive than a universal
pension and better targeted at the poor, but is administratively very hard to
implement—verifying need is much harder than simply verifying age. A
needs-tested pension also can create incentives to not work or to not
contribute to other components of the pension system. Varying eligibility ages
could be considered. Analysis suggests that prevalence of poverty among the
aged does not increase substantially until age 70 or even 75. We therefore
would recommend an age of eligibility for such a pension of not lower than 70.
Several options for benefit level also could be considered, ranging from a
level as high at the official poverty level, to some estimate of the amount
needed to close the gap between poor income’s and the poverty level. Analysis
suggests that many reasonable options would be fiscally affordable.
48.
Another issue to consider is the extent
to which scarce resources should be spent on alleviating old-age poverty
relative to other social needs, for instance child poverty. The data on child
vs. old-age poverty in the Philippines is flawed in some important respects so
must be carefully considered to analyze this question. Poverty data does not
take into consideration
44.
Recommendation:
Benefit formulas should be revised to provide more consistent internal rates
of return for various categories of members. Benefit levels should be based on
lifetime contributions, not just final years, and should reward longer periods
of contribution. A ceiling should be placed on wages subject to contributions,
and also on the base wage used to calculate pension level, so the system is
well targeted toward lower- and middle-income workers. Benefit formulas should
be harmonized between SSS and GSIS to permit full portability between the
public and private sectors. Survivor benefits should be rationalized, providing
lifetime benefits at a reasonable rate with reasonable eligibility. With a good
survivor program, life insurance and funeral benefits could be eliminated.
45.
Recommendation:
Taxation of pensions needs to be rationalized and harmonized so individuals
and institutions are subjected to the same taxation regardless of what type of
pension program they participate in and in what sector they work. The standard
should be E-E-T: Contributions should be tax exempt; income on investments
should be exempt; but pension income should be taxed just like any other income
type. Caps on tax exemptions should facilitate policy goals without permitting
excessive tax avoidance by the affluent. Tax issues should not impede financial
market functioning. Specifically, new mechanisms are needed to allow tax-exempt
and non-tax-exempt institutions to trade in government securities.
Coverage
46.
The pension system reaches less than a
third of the Philippines’ elderly. Those not covered by the system tend to be
poorer than those who are covered. Recent world experience suggests that
coverage can only be expanded to substantial shares of the population in
developing countries through some kind of universal or needs-based pension –
that is, through a pension that is funded from general revenues and not linked
to previous contributions, so that people who either work in the informal
sector or who do not work at all can still qualify.
47.
Recommendation:
The Philippines should consider the merits of a universal or needs-based pension,
paid from general state revenues, to complement existing pension programs.
Several options are possible. A universal pension could be granted to all
citizens over a specific age, or a needs-based pension could be granted, only
to the poorest. “Need” could be broadly defined, considering all types of
income, or narrowly defined, only considering other pension income. A
needs-tested pension has the advantage of being less expensive than a universal
pension and better targeted at the poor, but is administratively very hard to
implement—verifying need is much harder than simply verifying age. A
needs-tested pension also can create incentives to not work or to not
contribute to other components of the pension system. Varying eligibility ages
could be considered. Analysis suggests that prevalence of poverty among the
aged does not increase substantially until age 70 or even 75. We therefore
would recommend an age of eligibility for such a pension of not lower than 70.
Several options for benefit level also could be considered, ranging from a
level as high at the official poverty level, to some estimate of the amount
needed to close the gap between poor income’s and the poverty level. Analysis
suggests that many reasonable options would be fiscally affordable.
48.
Another issue to consider is the extent
to which scarce resources should be spent on alleviating old-age poverty
relative to other social needs, for instance child poverty. The data on child
vs. old-age poverty in the Philippines is flawed in some important respects so
must be carefully considered to analyze this question. Poverty data does not
take into consideration
family economies of
scale—adding one more person to a large family does not require the same level
of incremental income as one person living alone needs to achieve the same
living standard. As a result, data in the Philippines exaggerates the extent of
child poverty. (Even correcting for this issue, child poverty will remain a
serious social issue.)
49. Recommendation:
Poverty data needs to be improved in order to better prioritize social programs
for the elderly (such as a universal or needs-based pension) vis-à- vis
programs for children and other social groups. Specifically, it is necessary to
incorporate understanding of economies of scale and age equivalence in poverty
analyses in order to accurately measure and compare poverty across families
with varying numbers of individuals and varying ages.
The
Defined-Contribution, Fully-Funded Element
50.
SSS and GSIS are defined-benefit,
partially-funded programs. World trends over the last two decades have been
away from such schemes, toward defined-contribution, fully funded programs. In
the Philippines, only Pag-IBIG comes close to this type of program. Pag-IBIG is
a defined-contribution program, offering a lumpsum benefit after twenty years
of affiliation. It invests mostly in housing loans that benefit a small share
of members rather than investing solely on behalf of all participants.
51.
Recommendation:
The Government should aim to gradually increase the share of contributions
that go to the defined-contribution, fully-funded element (Pag-IBIG).
Initially, the ceiling on wages from which contributions must be paid should be
raised to the same level as the ceiling for SSS. The contribution rate to
Pag-IBIG should not be raised at present. In parallel, the operations of
Pag-IBIG need to be improved. Pag-IBIG should divest itself of housing and
multi-purpose loans, and build capacity for other types of investment within
the Philippines and worldwide. The program should evolve into a standard
defined-contribution pension scheme, with annuities offered at retirement age,
rather than a lumpsum paid after 20 years of membership regardless of age. This
would require a fundamental re-definition of Pag-IBIG’s mission, a re-direction
of investment policies, and greatly enhanced capacity for investment
decisionmaking.
Administration
52.
Administrative costs need to be
transparent so that members know what they are. This is part of accountability
to members. Administrative costs also should be rationally funded, without
hidden means by which low-cost programs cross-subsidize high-cost programs.
53.
Recommendation:
Administrative efficiency needs to be analyzed on a per-program basis to assess
whether costs for any specific programs are too high. Cross-subsidization of
administrative costs across programs should be avoided. An assessment is needed
to determine if current administrative costs are high by international
standards, compared to other similar and relevant systems.
AFP-RSBS
54. AFP-RSBS offers very high benefit formulas even
compared to SSS and GSIS, and only related to final salaries. Related programs
for provident fund and retirement benefit are not
rationalized with the
pension, and in certain cases investments have been not suitable for a pension
fund profile. AFP-RSBS now has been declared bankrupt, but presumably the
program will continue to operate in some capacity and so still merits evaluation
and reform recommendations.
55. Recommendation:
These benefit formulas need to be reduced, at least for younger workers, based
on average long-term history (not “rank next higher”), indexed to prices not
wages. The target replacement wage should include and not supplement the
provident fund and retirement benefit. The provident fund should pay interest
rates actually accrued, rather than those that are administratively mandated.
Future development of the system should focus on provident fund and Pag-IBIG contributions.
That is, for the military going forward, a greater share of pension could come
from increased contributions to Pag-IBIG rather than continued contributions to
the current or some new specialized military pension fund. (This only would
make sense if Pag-IBIG is transformed into a modern defined-contribution
pension fund, following international best practices in pension investments, as
discussed above.) Investment processes need to be modernized, divesting of
member loans and real estate.
PERA, Pre-Need,
and Other Programs
56.
The PERA bill seeks to rationalize rules
and supervision for private-sector supplemental pensions. Gaps still exist in
issues related to taxation and ensuring prudent investment. Other related
investment instruments, such as Pre-Need programs, are either inadequately
regulated or subject to regulation that differs to other institutions offering
similar products.
57.
Recommendation: PERA
needs to be improved to set appropriate limits and conditions for when
tax privileges are granted. Investment guidelines need to be tightened.
Pre-Need and other programs related to pensions need to be improved so that the
same tax and regulatory rules apply to all institutions and products.
Regulation and supervision over these various institutions also needs to be
harmonized. The recently established financial markets inter-agency commission
would be a good forum for facilitating standardization of such rules.
Financial Sector
Strengthening
58.
A pension system that seeks to improve
its investments needs a more developed financial sector. This includes: better
and consolidated overall regulation and supervision of pensions, insurance,
securities, etc.; new products such as asset-backed securities; improved
transparency and accountability; and increased capacity in private financial
institutions and in supervisory authorities.
59.
Recommendation:
Pension reform needs to fit into a context of overall financial sector development.
Only with greater financial sector development in parallel will the pension
system itself be able to develop and gain access to increasing numbers of
suitable investment opportunities.
V.
CONCLUSION
60. The Philippines faces a historic window of
opportunity to implement fundamental pension reforms over the next two years.
The leadership in each of the pension institutions, relevant
supervision agencies,
and Department of Finance are thinking about pension reforms at the moment and
are positively inclined to make significant steps. The May 2007 Parliamentary
elections suggest a calendar for legislative reforms in which legislation could
be drafted between now and those elections, for consideration in the early
post-election environment. The financial situation is such that significant
problems are looming on the horizon, but are sufficiently far off that there is
still a fiscal window of opportunity to undertake difficult reforms. All these
factors create an auspicious climate to launch reform efforts now.
