Asia's wall of money | The Pera imperitive
THE PRESIDENT AND CEO of the Social Security System, Corazon De La Paz, coaxes into life the reluctant air-conditioning system in her half-lit office in downtown Manila. “We have to turn off the air conditioning to save costs,” she says apologetically. “It’s part of the government’s drive against energy price rises.”
De La Paz knows a thing or two about saving money. Since her appointment to the SSS, the Philippines’ mandatory pension scheme for some 26 million private sector workers, she has had to eke out savings wherever she can find them just to keep the fund alive.
“When we joined in 2001, the fund was okay until 2015 and we were very worried,” she says. “But after our reforms and the economic improvement, we were pleasantly surprised. The fund will take us to 2029 without benefit increases.”
Perhaps, but the SSS is hardly keeping up with paying benefits in real terms and, with inflation in the Philippines at around 7%, the scheme is clearly already failing its members. “If we had to pay [benefits] based on the inflation rate, the fund would only last until 2017,” says Eriberto Valencia, a consultant to SSS.
Across town at the more imposing offices of the Government Service Insurance System (GSIS), the mandatory scheme for public sector workers, things are little better. The escalators have been stopped, the same half-lit gloom pervades the vast corridors and on the wall a handwritten table shows calculations of savings from the energy campaign down to the last peso.
Enriqueta Disuanco, executive vice-president, operations sector at GSIS, has reason to be a little more upbeat than her SSS counterparts, but not much more. “Our computations suggest that GSIS is funded until 2032,” she says, “but we’re conducting a new evaluation and we hope that’ll be better because of the reforms we’ve implemented.”
Like SSS, however, GSIS is not paying its members inflation-linked benefits and both systems are in need of drastic reform, as Romeo Bernardo, managing director of Lazaro Bernardo Tiu & Associates, a financial consultancy, explains. “The basic problem is a mismatch between the present value of contributions and the present value of benefits,” he says. “The structure is flawed: every additional member increases the problem. It’s a fiscal time bomb.”
When the bomb detonates, it will not be the government that foots the bill. It simply does not have the money to do so. “The government will simply default if it can’t pay,” says Bernardo.
Benefits witheld
The government is already defaulting on payments to GSIS, according to Disuanco. “Due to the unfavourable fiscal position, there are outstanding government payments due,” she says. “So there might be benefits withheld.”
According to Disuanco, GSIS is still waiting for premium payments for government agencies’ contributions before 1997, a bill that has already grown to P22 billion ($400 million).
“The benefits of government employees are guaranteed by the Republic of the Philippines,” says Disuanco, “so if GSIS goes down, our liabilities become government liabilities.”
The only reason that neither SSS nor GSIS has fallen over so far is because the contributions made by members against future liabilities are being plundered to meet current benefits payments. It is like a sink being drained too quickly simply because the taps are not turned on full. Eventually, the funds pool will simply dry up, leaving future beneficiaries severely out of pocket. Both systems employ defined benefit schemes that seek payments from employers and employees at varying rates. Getting either side to pay can be a considerable challenge. According to the SSS 2004 annual report, benefit payments have exceeded contribution collections for the past six years.
Both pension systems are clearly in desperate need of fundamental reform, but the government is in a fiscal straitjacket because of its budget deficit and large external borrowings – and the administration of President Gloria Macapagal Arroyo is hamstrung by a political crisis. So there is little chance of meaningful steps being taken by the government.
Muddling through
In the meantime, GSIS and SSS continue to muddle through, cutting costs as best they can and trying to improve collections.
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“There are those that say the government should pay the gap,” says De La Paz, “but they can’t afford to, so we’ve had a very serious campaign to improve compliance and for people to pay what’s due. We’ve gone from building to building, office to office, everywhere. Those that haven’t paid, we’ve filed suit.”
A nation of more than 7,000 islands creates logistical issues for collection and SSS has relied on banks and other agents to collect payments on behalf of it.
“We have to harness the banking system,” says De La Paz, “and use any means we can to collect. People are scattered across the archipelago, so we’ve used just about anyone we can to collect.”
That raises the issue of fraud, especially in a country well known for its systemic corruption.
“There are things falling between the cracks,” admits De La Paz. “We’ve identified many cases of beneficiaries who are receiving money without entitlement or people who have received their money and are still claiming.”
Nazario Cabuquit, special assistant to De La Paz, says: “There are many pensioners whose accounts are just accumulating. So we’re paying them when they’re already dead.”
Despite the big challenges facing SSS, De La Paz and her team have had some success. Collections have already improved under her tenure from annual increases of between 3% and 4% to 8% increases.
GSIS has similar problems, including the lack of premium collection. “In the past, we believed that the government would always meet its obligations,” says Disuanco. “So we didn’t see the need to push premium payments. So when someone retired, even if the agency or the employee was delinquent, benefits were available.”
GSIS staff realized the implications for the scheme after an actuarial study. “Because of malpractice between 1997 and 2002,” says Disuanco, “we lost five actuarial years every year. That reduced our fund’s life from 60 years to 35 years.”
The GSIS acted quickly. “We had to implement drastic reforms,” says Disuanco. “We adopted a premiums-based policy. What you pay is what you get. It’s almost a defined contribution system.”
Defining contribution
According to Romeo Bernardo, a defined contribution system is the way forward for the Philippines. That and a drastic reduction in the state-funded element of the pensions system. In fact, the less reliance placed on government the better, he says. “Culturally, we’re not savers, that’s why a defined contribution system is good: it will encourage us to save. Unlike Singapore, there’s not a lot of faith in government. The only way it’ll work is if you say, ‘this is your money, you choose where it goes’ and of course, it gets regulated well.”
A major part of Bernardo’s pensions reforms proposals is the Pera (Personal Equity Retirement Account) initiative, the aim of which is to steer savers towards providing for their own retirement by introducing a tax-exempt savings scheme [see story, The Pera imperative, this issue]. It sounds like a good idea and it is. The problem is that the government is reluctant to grant tax exemption to savings when it is in such a financially tight spot. Granting tax exemption to Pera savings, say the critics, would merely divert existing savings away from taxed accounts, with little or no additional savings attracted. Bernardo admits that this might be the immediate short-term effect, but that the longer-term benefits outweigh any short-term tax sacrifice.
“The government might not be able to afford to do it now,” says Bernardo, “but it can’t afford not to do it in the long term. You have to make it part of total pension reform, otherwise you just divert savings away from taxed investments to non-taxed investments.”
Those reforms, according to Bernardo, entail a four-pillared pensions system: a modest social assistance programme to assist the aged poor at minimum subsistence level; a mandatory adjusted defined-benefit programme for public and private workers under a merged SSS/GSIS to provide basic pension benefits; a mandatory defined-contribution scheme to account for the replacement ratio; and a voluntary scheme to provide supplementary retirement income. It is under this last voluntary pillar that the Pera scheme would fall.
Another key benefit to the proposed pension reforms, as with many countries in Asia, is the significant effect that additional capital will have on the Philippines’ domestic capital markets. Promoting private pensions schemes at the expense of a smaller state pensions system will encourage savings in the country, which has the lowest savings ratio of major Asian economies (see table) and channel significant sums into the capital markets, encouraging banks and investment institutions to generate more investment products.
Moving markets
Amando Tetangco, the governor of Bangko Sentral Ng Pilipinas, the central bank, believes that the government must take a longer-term view of the pension issue. “Most likely there’ll be a short-term cost,” he says, “but if you have more savings in the economy, the cost of money will trend down, investment will trend up, consumption will increase and the tax base will likely grow.”
Tetangco also believes the Pera plans will benefit the capital markets directly. “We need to improve the demand side,” he says “and Pera will help. The additional contributions from employees against tax incentives will be invested in the securities markets, both government and private sector. We have the smallest capital market relative to GDP in the region: 99.4% of the market is government securities.”
Despite their parlous financial position, both SSS and GSIS are already sizeable institutions, with a combined asset base of more than $10 billion. Putting more of that money into the local and international capital markets would have a profoundly beneficial effect on both the domestic capital markets and on SSS/GSIS returns. Before that can happen, however, the schemes need to reform. Assets are still managed internally within the schemes and much of the investing is still policy-driven, with SSS used by the government to fund cheap housing projects, and GSIS mandated to loan huge sums to its own scheme members, many of whom prove to be ill-disciplined borrowers.
Planning appointments
Despite the obvious drawbacks, there are no plans yet to award fund management contracts externally, although both schemes would like to.
“We have fund advisers,” says De La Paz of the SSS, “but it’s not the same thing [as contracting fund managers]. We were planning to appoint fund managers for cash earned from the sale of our stake in Equitable PCI Bank, but that hasn’t proceeded.”
Disuanco of GSIS is keen to invest overseas and to appoint external fund managers and not just to boost returns. “We want to access international opportunities,” she says. “We don’t have the expertise to do that so hiring a foreign fund manager will be in the fund’s best interests. Plus a foreign fund manager will protect the fund from political influence. In the past, the government has dipped its fingers into the pension funds, especially for housing. SSS’s [housing] portfolio is in a dismal state.”
Disuanco says that GSIS is drafting a request for proposal for appointing external fund managers, with $200 million a likely sum for an external award.
Appointing external fund managers will bring an additional benefit to the state pension schemes, as Bernardo points out. “You’re the biggest player in the market,” he says of the two schemes, “and you do your own investing? It doesn’t take much imagination to see how some clever people in the past could abuse that privilege.”
Time value
The Pera bills that form a key platform of the pension reform proposals are before congress, as they have been for some time, but Bernardo is confident that they will get passed within two years. Fortunately for the Philippines, time is one asset that still has some value in the country. Unlike many countries in Asia, the Philippines does not suffer from the same demographic issues, with a young population and a burgeoning workforce. It is a much-needed window of opportunity for the government to embrace significant reforms, because time will not remain on its side for ever.
“There’s an increase in the life span,” says Nazario Cabaquit of SSS, “and the fertility rate is declining, but not as fast as in other countries.”
With a pressing need for reforms and workable solutions, all that is holding up reform, as with many issues in the Philippines, is the inevitable politicking. “Something like this requires sustained attention,” says Bernardo. “I must have made presentations on this to four finance ministers already.”
Despite the political challenges, Bernardo remains optimistic that the reforms will proceed, especially if the government can mend its finances through other sources such as the planned expansion of value-added tax.
“Hopefully the government will have the e-VAT soon,” he says. “That’ll be 80 billion pesos they didn’t have before so they’ll have the ability to remove taxes from things that shouldn’t be taxed, like savings. So we’ll see.”
If he is right and the pensions reforms proceed, the country’s domestic capital markets could quickly enjoy a substantial inflow of funds from a growing and increasingly sophisticated investor base. They might even prove to be the solution to the government’s own financial difficulties. That would be a welcome fillip to a country that has already slipped too far behind its neighbours.
