MAPping the Future

(1st of 2 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 ‘ageing population’ by 2032 when 7% of its population are 65 years old and older, and will become an ‘aged society’ by 2069 when this goes up to 14%. With the increasing lifespan 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, from the government. The cost of old-age retirement will become a heavy burden to the government and the society.

 

Compared to other pension systems around the world, the Philippines is ranked 36^th, or fourth lowest, out of 39 countries in the 2020 Mercer CFA Institute Global Pension Index (MCIGPI) ranking. MCIGPI scores a country’s pension system based on 3 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 the regulations, practicability of implementation, communication, governance, and operating costs.

 

In terms of Adequacy, the study of Dr. Renato Reside mentioned that our pension assets under management represent a measly 16% of Gross Domestic Product (GDP) compared to the average of non-OECD countries of 36%, and the OECD countries of 124%. Said another way, we have only 1.3 pension assets per worker compared to Thailand’s 126 assets per worker and Singapore’s 900,000 assets per worker. The replacement rate which measures the percentage of pre-retirement income paid out of the pension plan, ranges only from 3% (for a 5-year service) to 22% (for a 40-year service), a far cry from the commonly accepted replacement rate of 70% 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% discount on their purchases.  Under Republic Act (RA) 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 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 pre-funding.  While the law mandates the payment of retirement income (½ month salary for every year of service) upon reaching the age of retirement, it does not require the pre-funding 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 MSMEs comprising about 60% 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 to draw from 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 6th in the world as the fastest growing market for the gig industry with a 35% 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 build-up 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 (age 60), provided the employee is under his employ for at least 5 years prior to retirement. This is called the ‘5-year residency rule’.  The mobility of the millennial and Gen Z workforce with an average of 2-3 years stay in a single employer, and worked 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 5-year service prior to retirement.  Likewise, the ‘5-year residency rule’ has encouraged the practice of not hiring employees nearing their retirement, and some reported cases of unwarranted dismissal to break the 5-year requirement.

 

Third, there is no portability.  Since there is no pension build-up, 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 are credited with that accumulated pension income as they move from one employer to another.

 

Fourth, it is a Defined Benefit plan rather than a Defined Contribution 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 Defined Benefit (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 Defined Contribution (DC) plan, the workers and/or employers contribute to a fund in their individual accounts that is 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 the recommended reforms for the Philippine private pension system.

 

(This article reflects the personal opinion of the author and does not reflect 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 <map.map@map.org.ph> and <dick.du-baladad@bdblaw.com.ph>.