Reforming the private pension system

(First of two parts)

The Philippine private pension system has serious flaws that need to be fixed. It is not portable, not funded, not adequate, not actuarially fair, not sustainable. As a consequence, it does not ensure the continued well-being or provide a comfortable living for our retirees, especially future retirees coming from the millennial workforce and the next generation.

Based on a 2018 study by the Philippine Institute for Development Studies (PIDS), the Philippines will be an ‘aging population’ by 2032 when 7 percent of its population are 65 years old and older, and will become an ‘aged society’ by 2069 when this goes up to 14 percent. With the increasing life span of people and the waning traditional support for older members of the family, this segment of the society will rely more on pension benefits, and if pension support fails, on the government. The cost of old-age retirement will become a heavy burden to the government and the society.

Compared with other pension systems around the world, the Philippines is ranked 36th, or fourth lowest, out of 39 countries in the 2020 Mercer CFA Institute Global Pension Index (MCIGPI), which scores a country’s pension system based on three indices—sustainability, adequacy and integrity. The index for sustainability measures the capability of the pension system to provide for old-age benefits in the future. The adequacy index measures the system design, benefits, levels of savings, source of financial support and other parameters to determine if the pension system can provide adequate retirement income. The index for integrity, on the other hand, considers factors such as regulations, practicability of implementation, communication, governance and operating costs.

In terms of adequacy, the study of Renato Reside mentioned that our pension assets under management represent a measly 16 percent of gross domestic product (GDP) compared with the average of non-OECD (Organization for Economic Cooperation and Development) countries of 36 percent, and the OECD countries of 124 percent. Said another way, we have only 1.3 pension assets per worker compared with Thailand’s 126 assets per worker and Singapore’s 900,000 assets per worker. The replacement rate, which measures the percentage of preretirement income paid out of the pension plan, ranges only from 3 percent (for a five-year service) to 22 percent (for a 40-year service), a far cry from the commonly accepted replacement rate of 70 percent for retirement income to be considered adequate.

Our current pension system relies mainly on the Social Security System (SSS) for the private workers, and the Government Service Insurance System (GSIS) for workers in the government. Others include the provident-type Pag-Ibig Fund that provides housing loans, and certain senior citizens’ benefits, such as the 20 percent discount on their purchases. Under Republic Act No. 4917, private employers can establish their own retirement plans, with certain tax exemptions, as a supplement to SSS benefits; however, this is not mandatory, hence, are very few.

RA 4917 and RA 7641 have put in place the Philippine private pension system. But because of its faulty structure, the private pension system did not grow or develop to a desired level that adequately meet the needs of old-age retirement. It has serious problems, defects and weaknesses to be fixed. Due to lack of space, I will limit the discussion to four major issues.

First, there is no requirement for prefunding. While the law mandates the payment of retirement income (1/2 month salary for every year of service) upon reaching the age of retirement, it does not require the prefunding of pension obligations. Except for a few big companies with an established employee retirement fund, pensions are on a pay-as you-go or paid out-of-pocket rather than built up over the period of employment, thus, exposing a retiring employee at risk of not being paid in case of bankruptcy, business reverses or illiquidity. Extremely vulnerable are employees of micro, small and medium enterprises comprising about 60 percent of the total workforce and those working in the informal sector who may retire without pension. Many of them are minimum wage earners with no savings for their retirement needs. The gig economy is another sector not covered. Based on a report on Global Gig Economy Index by Payoneer, the Philippines placed sixth in the world as the fastest growing market for the gig industry with a 35 percent growth in freelance earning.

Second, pension cost is borne solely by the last employer rather than shared among all employers from the time an employee enters the workforce until retirement. As a result, there is no accumulation or buildup of investible pension fund. Employers prior to the last employer are freed of the burden of contributing to the pension of his employee. As worded in the law, the pension shall be paid by the employer to an employee upon reaching the age of retirement (60), provided the employee is under his employ for at least five years prior to retirement. This is called the ‘five-year residency rule.’ Millennial and Gen Z workforce—who will likely stay an average of two to three years in a single employer and work with at least 12 employers during their working life—are left unprotected in the current pension system as pension benefits cannot extend to workers that fail to meet the strict requirement of five-year service prior to retirement. Likewise, such residency rule has encouraged the practice of not hiring employees nearing their retirement, and some reported cases of unwarranted dismissal to break the five-year requirement.

Third, there is no portability. Since there is no pension buildup, and the vesting only happens with the last employer, there is no way to make it portable. Portability of pension plans, including pension accruals and the ability to consolidate accumulations of different plans, is considered by the OECD as an important and core feature of a good pension system. An employee’s entitlement to pension should accrue and vest as it enters the workforce, and credited with that accumulated pension income as they move from one employer to another.

Fourth, it is a Defined Benefit (DB) plan rather than a Defined Contribution (DC) plan. The core of pension is the benefit that one receives upon retirement and is heavily influenced by the pension system or the schemes for the plan. The Philippine private pension system is based on a DB plan where workers are given benefits based on a formula linked to an employee’s wages and the years of tenure. On the other hand, in a DC plan, the workers and/or employers contribute to a fund in their individual accounts — administered by them directly or by a qualified fund administrator. Many countries’ private pension systems have shifted from a DB to DC because of the wealth accumulation in the process, while maintaining a DB scheme for their public pension plans.

The second part of this article will discuss recommended reforms for the Philippine private pension system. INQ

To be continued

This article reflects the personal opinion of the author and not the official stand of the Management Association of the Philippines or MAP. The author is chair of the MAP Tax Committee, and founding partner and CEO of Du-Baladad and Associates (BDB Law). Feedback at [email protected] and [email protected].