Voluntary Pension System Its Development, Structure

1
Voluntary Pension System Its Development,
Structure Prospects

• Nasim Beg
• 11th August 2005

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Pensions in Pakistan The Background
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Dependant on the next generation to provide for us

• Like most countries of the world, Pakistan has
  weak provisioning for pensions.
• We primarily depend on the next generation to
  provide for us during our retirement.
• Most governmental jobs are covered by unfunded
  pensions current employees will be paid
  pensions by taxing the next generation.
• Some private sector employees and the organised
  sector labour are covered by funded pensions.
  Funds are primarily invested in government bonds,
  which will be repaid by the next generation.
• A very large section of the population has no
  pension provisioning totally dependant on the
  joint family support system.

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Pensions that existare mostly inadequate

• Most government jobs entitle one to a pension
  linked to ones last drawn salary but the salary
  does not necessarily reflect ones true earnings
  mostly salaries are low and are supplemented by
  benefits, which can include plots of land that
  help make up on the low salary. Thus the pension
  is a fraction of the true wage.
• Private sector pensions are better but applicable
  to a very few.
• Most employers require a minimum years of service
  to get pension rights. Only EOBI allows for
  portability of pension rights.

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Employers worldwide want to get away from defined
benefit plans

• Defined benefit pensions systems require
  employers to ensure availability of funds to meet
  the obligation.
• Many plans set up in Pakistan under a high real
  interest rate environment are now creating an
  additional burden on the employers.
• High market volatility makes the investment of
  pension funds even more burdensome.
• Employers would rather have defined contributions
  and let the employee carry the burden of the
  final benefit.
• In turn, the employee would get portability
  through the defined contributions system.

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Tax Breaks

• Most pension regimes give varying degrees of tax
  breaks.
• Most pension savings and incomes in Pakistan are
  tax free.
• Some long-term savings which can be used towards
  retirement by individuals are entitled to tax
  deferral.
• Some savings towards annuity plans give tax
  rebates.

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Pension Reforms in Pakistan

• Reforms have been considered on several fronts
  funding of government pensions, allowing for
  portability, compulsory provisioning by all
  employers, proper regulatory authority, etc.
• There has been some discussion on a national
  pension scheme but many difficult issues have
  forced the government to initially concentrate on
  the Voluntary Pension System.

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Development of the Voluntary Pension System
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Initiated by the Finance Ministry

• The current Prime Minister (then Finance
  Minister) initiated the process soon after taking
  charge of the Finance Ministry.
• The SECP was given the assignment to develop a
  pension system.
• Several models were studied. The first proposal
  of 2002 recommended a mandatory system. This was
  not accepted by the Finance Ministry.
• The SECP then commenced work on a second
  proposal for a voluntary scheme.

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Evolution of the Voluntary Pension System

• The SECP set up a committee in June 2003
  consisting of persons from Industry, the Ministry
  of Finance and the SECP itself.
• The committee had several meetings and developed
  a broad proposal recommending a voluntary scheme,
  with a tax deferral structure.
• This was presented by the SECP to the then
  Finance Minister.
• Some additional research was conducted, including
  study of models in some emerging economies.
• The final draft was circulated and posted on
  SECPs website and several meetings were held by
  the SECP with representatives of various
  financial institutions and members of the
  actuarial profession.
• The Voluntary Pension System Rules, 2005 were
  finally issued in January 2005.
• The SECP had continuous interaction with the CBR
  throughout.
• The Finance Bill 2005 has introduced several
  changes in the Income-tax law incorporating all
  the necessary features for an EET structure.

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The Structure of the VPS
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Main Features

• A self contributory pensions savings scheme open
  to all adult Pakistanis registered with the tax
  authorities, if not covered by other occupational
  pension schemes. Employers can also contribute.
• Certain limits on the maximum annual
  contributions with some catch-up provisioning for
  persons above 41 years age.
• Contributions to be invested in specially set up
  mutual funds, with flexibility of individualised
  asset allocation through individual accounts.
• Stringent requirements for licensing of pension
  fund managers under SECP regulation. Fee
  structure much lower that normal mutual funds.
• The individual can diversify savings
  (contributions) amongst more than one fund
  manager and can transfer the account to other
  fund managers.
• EET structure, i.e., tax rebated on
  contributions, investment income and gains
  accumulate tax-free, tax is paid at the stage
  pension is drawn.

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The Legal Structure

• VPS Rules set up under the framework of the NBFC
  Rules, which in turn are issued under the
  Companies Ordinance, 1984.
• The VPS Rules allow for asset management
  companies and life insurance companies to be
  licensed by the SECP as Pension Fund Managers.
• Pension Fund itself is authorised by the SECP as
  a unit trust scheme and structured under the
  Trust Act.
• The Income Tax Act provides the tax breaks.

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Structure of the Pension Fund

• Three sub-funds - equity, debt and money-market.
  Additional asset classes later.
• SECP mandated investment policy governing each
  asset class.
• Mandatory for each Fund Manager to offer a
  minimum of four pre-set asset allocation plans.
  Very Conservative plan with maximum 20 equity
  and Aggressive plan with maximum of 80 equity.
  Two additional plans (like life-cycle) may be
  offered by Fund Manager during first 5 years.
• Each sub-fund to announce NAV based prices daily.
• Management fee not to exceed 1.5 p.a. and Front
  Load 3 but no load on transfers.
• Funds will not distribute dividends but are
  totally exempt from tax.

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Investment Limits Restrictions

• Equity Limits 5 per company, 20 per sector.
  1 per green-field, 5 total green-field. None in
  unlisted or PFMs associated companies.
• Debt Limits at least 50 in government
  securities. Other debt range between 5 in any AA
  rated and 2.5 in BBB. Average duration of fund
  within 10 years.
• Money-market Limits GoP securities no limit
  Others upto 20 (Minimum rating A-) Bank
  deposits no limit but 25 per bank. Average
  duration of fund not to exceed one year.

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Participants Rights

• Tax rebate on contributions of upto 20 of income
  or Rs. 500,000 per year.
• Eligible persons investing under VPS
  (Participants) have right to save with one or
  more PFM.
• Right to transfer the account to some other
  manager/s once a year. No restriction if PFM is
  de-authorised.
• Select plan of choice within the offerings of
  each PFM.
• Select retirement age between 60 and 70 years.
• Cash out any time before retirement by paying
  tax.
• Draw 25 of fund at retirement tax-free (grey
  area).
• Opt for an annuity plan or income draw down plan
  at retirement. At age 75 funds left over must be
  invested in annuity plan.
• Receive account statements and financial
  statements.

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Regulation

• SECP to license PFMs and authorise schemes.
• SECP shall measure performance against
  benchmarks. SECP may take corrective action. SECP
  will publish comparative performance each year.
• SECP can order Special audit.
• SECP can carry out inquiry/inspection.
• SECP can de-authorise manager and fund.

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Prospects

• Wonderful opportunity for self-employed to build
  their own pension funds.
• Opportunity for employees not covered by
  occupational pensions to build their portable
  pension funds.
• Opportunity for corporate sector to supplement or
  replace provident funds with matching
  contributions to VPS for their employees.
• Opportunity for NRPs to build pension funds in
  Pakistan.
• Opportunity for individuals to build
  professionally managed portfolios, with optimal
  asset allocation.
• Example of asset allocation benefits Rs. 1,000
  invested each month and increased over time in
  line with salary growth (average 15 p.a.) over
  30 years Equities give Rs. 34 million DSCs Rs.
  24 million. Please note that DSCs no longer
  giving old level of real returns and are now
  taxable.
• Opportunity for corporate sector and local
  governments to benefit from inflows into the
  market.
• Regular inflows will help market stability.
• Over time should overtake investment in NSS and
  replace the traditional retirement savings and
  long-service plans of the corporate sector.

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Thank you

• Questions welcome