KP’s Pension Reforms, transition to Defined Contribution scheme

Peshawar    –     The aging population, coupled with changing demographics and economic conditions, has put significant strain on pension systems around the world.

According to Bloomberg and G-30, “The US, China and other leading economies confront a massive funding gap of $15.8 trillion in 2050 to ensure lifetime financial support for their aging populations.” Despite having fully funded or contributory-based pension systems in place, these countries are still confronted with an impending crisis that demands immediate attention and proactive measures to address the situation.

In Pakistan neither the pension is contributory nor funded, it’s totally paid from main stream revenue and behaving like elephant in the room. This issue is also prevalent in Khyber Pakhtunkhwa, where a 2020 actuarial valuation conducted by the finance department revealed alarming figures. The current accrued liability up to June 2020 for active employees and pensioners was estimated at Rs 2.9 trillion, with projected pension expenditures reaching Rs 2.05 trillion by 2050. The present value of this amount is approximately Rs 462 billion, which accounts for around 33percent of the current 2023-24 budget. This raises serious concerns about the sustainability of the pension system in the future. Recognizing the gravity of the situation, the government of Khyber Pakhtunkhwa (GoKP) initiated pension reforms in 2015. Several parametric reforms, such as rules revision and the implementation of an age bar on early retirement, have been introduced. However, the ultimate objective of the pension reform process is to achieve a policy change by transitioning from a Defined Benefits (DB) scheme to a Defined Contribution (DC) scheme. This shift aims to address the challenges posed by the current pension system and promote a more sustainable approach for the future.

Since its implementation on June 7th, 2022, the DC scheme has been successfully adopted provincewide, with over 30,000 employees enrolling in the programme so far. Noteworthy features of the scheme include a 10percent deduction from employees’ current basic pay and a 12percent matching grant provided by the government of KP. To ensure efficient management and compliance, the scheme is regulated by the Securities and Exchange Commission of Pakistan (SECP) in accordance with the Voluntary Pension Rules (VPS) of 2005. Portfolio managers/ Asset Management Companies registered with SECP under the VPS framework are responsible for managing the scheme effectively. The employees will open separate accounts with asset management companies (AMCs). On a monthly basis, the KP government will transfer the overall contribution to these accounts , which will then be invested by portfolio managers based on a policy allocation selected by the employees or the default policy.

To facilitate informed decision- making, employees have the option to choose their preferred AMC by accessing various comparisons available on the finance DCMS.FINANCE.GKP portal.

This portal provides a comprehensive overview of different AMCs, enabling employees to make an informed selection based on their preferences and needs. In the event that an employee chooses an AMC but later determines that it is not performing well in comparison to others, they have the flexibility to change their AMC without incurring any additional costs or charges.

This allows employees to make adjustments to their investment strategy and align it with their desired financial goals. By offering employees the freedom to select and switch AMCs as necessary, the KP government aims to empower them with greater control over their investment decisions, ensuring their financial interests are well-served.

When evaluating pension schemes globally, three key parameters are often considered: sustainability, consistency, and adequacy. A scheme that performs well in all three aspects is deemed highly effective. Therefore, it is important to assess whether the new pension scheme implemented by the KP government will meet these criteria. In terms of sustainability and consistency, the actuarial projections for the scheme indicate positive results. The projected financial burden on the government until 2050 is estimated to be Rs 205 billion, with a present value of Rs 9 billion, which is less than 1percent of the current 2023-24 budget.

This suggests that the scheme is sustainable and its impact on the government’s finances is manageable over the long term. Regarding adequacy, an actuarial valuation conducted for Khyber Pakhtunkhwa reveals promising results. If an employee contributes 25percent of their basic pay over a 35-year service period, assuming a real rate of return of 4percent, the replacement rate at the time of retirement is projected to be 74percent. This replacemeant rate is comparable to the current DB pension scheme, ensuring that the new scheme provides adequate financial support to retirees.

Considering these factors, it appears that the new pension scheme implemented by the KP government has the potential to be sustainable, consistent, and adequate, meeting the essential requirements for a successful pension system.