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PENSION FUNDS


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INTRODUCTION

Pension system provides an income support to those individuals who

endure a loss in earnings capability because of old age or incident of

disability or death of wage earner in the family.

There are state benefit schemes offering limited financial support for yourold age, and a number of other private schemes enabling you to build a

larger fund for the future. To avoid a paltry income in retirement it is in

everybodysbest interest to save more for it.


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FORMS OF PENSION SYSTEM


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CONTRIBUTORY

PENSION

SYSTEMS

Contributory pension systems are the most important forms for

providing income support to elderly. Contributory pension

systems are distinguished either by the financing mechanism

or by benefit structure.

Financing methods are in general of two types.

1. Pay-As-You-Go mechanism

2. Fully-funded mechanism


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Pay-As-You-Go Mechanism

In pay-as-you-go pension system current workers make

contribution based on their current earnings.

The contributions collected through this system are instantly

used to pay pensions to current retirees.

The government only makes a promise to current workers

who make contribution that it will pay benefits related to these

contributions when the workers become eligible for pension.


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Fully-Funded Mechanism

In the fully-funded pension system workers make contribution

to their own accounts.

In this system workers contributions are invested rather than

paying pension to current retirees.

The investment earnings are essential part of benefits finally

paid to workers.

These investments can be administered by monopolistic public

agency or competitively with the involvement of private

sector.


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TYPES OF BENEFIT METHOD


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Defined Benefit Mechanism

Pension received under the defined benefit system is usually a

function of income, articulated as a fraction of income per year

of contribution.

Either the government in a public plan or the employer in an

employer-based plan is responsible to give the pensions.


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Defined Contribution Mechanism

Under this mechanism, the contribution is defined as a

percentage of wages, and rates are also defined for employees,

employers, and for the government.

The final pension is determined by the amount that the

individuals have in his pension accounts at the time of

retirement.

The pension that an individual receive at the time of retirement

depends on both the contributions and the investment earnings

on these contributions.


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NONCONTRIBUTORY PENSION SYSTEMS

The purpose of noncontributory pension is poverty reduction

among the elderly.

Even in the presence of contributory system, there will always

be some people who do not participate regularly to qualify for

pension benefits or whose lifetime incomes depart them with

less pension benefits.

All these types of people are at risk of poverty in old age.


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VOLUNTARY PENSION SYSTEM

The Voluntary Pension System provides a comprehensive

framework for the employed and self-employed individuals to

contribute into the Pension Funds launched under this system,

during their working life to provide regular income after

retirement.

This way, an effort is made to enable the participants maintain

a reasonable standard of living at retirement.

Therefore, inevitably makes the Pension Funds a savings-cum-

investment Vehicle.


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PROBLEMS IN PAY-AS-YOU-GO PENSIONSYSTEM


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International Demographic Trends

The age structure of the population around the world is changing with

increasing life expectancy and declining birth rates.

Such demographic change will result in larger proportion of older people.

The OECD countries at present have the oldest populations as on average the

ratios of people between the ages of 20 and 59 to individuals above the age of

60 is lowest.

Demographic projection shows that the current pay-as-you-go pension

system will become financially unsustainable in the near future.


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Budgetary Conditions of Public Pension Schemes

The most important problem that sets in motion the process of pension

reform is the fear that financial equilibrium of public pensions will be in severe

threat.

The most apparent danger comes from the changes in age structure of

population and subsequent ageing process, with its overwhelming effect on

pension budgets.


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Labor Market Distortions

One setback of pay-as-you-go defined benefit systems is that the

high payroll tax will possibly direct to labor market inefficiencies

resulting from:

distorted decision about labor force participation,

age of reti rement

hour s worked

choice of job and location

degree of effort


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Growing Informal Sector

High and rising payroll taxes results in evasion and escape to

the informal sector, where efficiency is lower.

In developing countries the distortionary labor market effects

of pay as you go pension system may be larger because flight

to the informal sector is easier there.

Productivity in the informal sector may be lower because of

less access to product and credit markets.


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Reduction in Supply of Experienced Labor:

Due to the absence of penalties on early retirement encourages mostworkers to stop working and take early retirement before they reach age 60.Early retirement reduces the supply of experienced labor, thereby placingthe economy at a position below its potential.

Misallocation of Public Resources:Pay-as-you-go public pension system results in misallocation of public

resources as scarce tax revenues are used for pensions rather than forhealth, education, or infrastructure.

Low Coverage:The most serious trouble with the current pension system is that it fails toget in touch with the vast majority of population and no safety net isavailable for those who are not covered under the system. The coverage is

further shrinking due to the stronger growth of informal sector.


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ALTERNATIVE APPROACHES TO

MANAGING THE TRANSITION


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PARAMETRIC REFORMS

Pension systems rely on three parameters including contribution rate, the

benefit structure and eligibility criteria for receiving pensions. Parametric

reforms, particularly in defined-benefit pay-as-you-go pension system will

reduce the level of pension benefits and thus possibly pull more elderly

persons under poverty line or necessitate larger contribution from workers,

consequently putting people at risk of poverty.

Although parametric reforms provide solution to some of the fiscal burden

but such problems still reappear in the long run.


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SYSTEMATIC REFORMS

To avoid problems of pay-as-you-go pension system, the World Bank has

been recommending multi-pillar pension system. Many countries have been

moving toward this system in which individuals pensions are supported by

privately managed pre-retirement savings. The new system contains three

pillars:

A mandatory, publi cly managed, tax-f inanced pil lar for redistr ibution

A mandatory, pr ivately managed, ful ly-funded pil lar f or savings

And a voluntary pil lar for people who want more protection in their old

age.


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Pension structure in India

In India, pension fund managers will manage three separate schemes, each

investing in a different asset class. The three asset classes are equity, government

securities and credit risk-bearing fixed income instruments. The subscriber will

have the option to actively decide as to how the NPS pension wealth is to be

invested in three asset classes:

E Class: I nvestment would primari ly be in Equi ty market instruments. I t wouldinvest in I ndex funds that repli cate the portf olio of either BSE Sensitive index or

NSE Nif ty 50 index.

G Class: I nvestment would be in Government secur ities like GOI bonds and State

Govt. bonds

C Class: I nvestment would be in f ixed income secur ities other than Government

Securities


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PENSIONSTRUCTURE IN PAKISTAN


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Pension System In Pakistan

The present pension system in Pakistan was introduced in 1954 in the form

of pension-cum-gratuity scheme, 1954 and has since been adjusted from

time to time. Its main features are as follow:

Retirement age is 60 years.

Voluntary retirement is possible on completion of 25 years of service.

No pension shall be given to a government servant who resigned from

government job before completion of 25 year service; however gratuity

may be payable.

Pension rate is 70 percent of the last drawn salary on completion of 30

years service.

If service is less than 30 years, proportionate reduction in pension is made.

Commutation is restricted to 35 percent of gross pension whereas the

remaining is paid in the form of net pension.


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Pension System In Pakistan

As pay-as-you-go pension system.

The pension contributions of active workers are used to finance the pension

benefits of current retirees

A specified pension on retirement is provided to workers who contribute

for a certain period of time, equal to a certain fraction of their salary. In Pakistan Pension is determined as a percentage of final salary and length

of service. There are no contributions to the scheme and the system is

maintained on an unfunded basis, that is, presently there is no pension fund.


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EOBI

It is a corporate body that provides national pensions to employees

(laborers) of private sector industries/commercial establishments

employing 10 or more persons (excluding managerial and professional

staff).

It manages its administrative affairs but takes policy guidance from the

federal ministry.

EOB investment (rules) 1979 allow investment in diversified assets such as

government guaranteed securities, interest-bearing deposits in guaranteed

banks, securities and preference securities in Pakistan along with real estate

either freehold or leasehold.

The EOBI had Started to increase its domestic equity investment in

FY2004.


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Government Servants Pensions

Pension system for government servants in Pakistan was introduced in

1954

Comprising A pension-cum-gratuity-cum-general provident fund (GPF).

It includes db pensions and gratuities, which are usually financed through

taxes. No contributions are made by employees, and thus it is maintained on an

unfunded basis.


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GPF

All government servants who have completed two years of continuous

service are bound to join the GPF as compulsory subscribers.

the government fixes the amount of subscription toward the GPF in the

form of interest.

The interest is credited to the subscribers account note. If a subscriber is not interested in the interest rate, it is not transferred to his

or her account, and s/he is allowed the facility of interest-free house

building/conveyance.


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VPS

This is a voluntary self-contributory pension scheme forsalaried and self-

employed individuals with a valid national tax number(NTN).

Employers can also contribute to the pension accounts of theiremployees

Pension account holders have individual pension accounts and have the

option of holding more than one account. Account holders have the option of withdrawing 25% of the balance

amount atretirement age .

The SECP has already given licenses to four asset managementcompanies

under VPSs.

These asset management companies offer three types of accounts, i.e.,equity fund, debt fund, and money market fund to accountholders.


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Additional Benefits To Civil Service Retirees

Government of Pakistan exclusively finances the expenditure by obtaining

a provision in the yearly budget for this purpose; civil service retirees in

Pakistan also receive several additional benefits including the following:

Gratui ties to Short-service Employees

Famil y (Survivor) Pensions

Mandatory Savings Accumulated in General Provident Fund

Survivor Benefi ts Provided by the Benevolent F und

L ife Insurance Provided by the Group I nsurance Fund

Access to Health Facil i ties


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KEY ISSUES FOR REFORM

There is a need to control rising trend in the expenditure pattern of the

defined-benefit, pay-as-you-go, public pension program.

Reforms in investment policies

Policies pertaining to withdrawal of accumulated balances need to be

reviewed. Limited withdrawal services coupled with some form of compulsory

annuitisation is essential for adequate provision in old age.

Issue of extension of coverage to control poverty among the aged

population needs to be considered.

It is not feasible to move towards a universal, publicly managed socialsecurity system covering every citizen attaining old age.

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