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Pension Reform in Jamaica

Pension Section News – Number 64 | May 2007

Pension Reform in Jamaica

By Megan Irvine and Cathy Lyn, FIA, FSA

Introduction

The government and private sector of Jamaica have been working hard to enable people who have worked a full career to receive pensions that can at least provide for minimum living requirements in their golden years. This is a worldwide problem and while each country presents unique issues, the sharing of knowledge and strategies may be of general benefit to practitioners in pension systems and consequently the population covered by these systems.

Jamaica has a total population of 2.7 million people. Retirement with an immediate pension can be as early as age 50 years and as late as age 70 years. The average age at death for persons receiving a pension from a pension plan is in the late seventies to early eighties; so retirees need an income for many years after ceasing employment.

The “social security system” is weak but occupational pension funds (private sector) with retirement savings now worth about US$1.5 billion have been established since the 1940s covering about 70,000 private sector workers out of a total workforce of 1 million. A further 130,000 to 180,000 working persons are covered under unfunded government programs for the public sector.

As elsewhere, the population of senior citizens (aged 60 and over) is increasing both in absolute number and as a percentage of the total population and is the fastest growing age group of the population. It is therefore critical to implement long-term measures that allow larger numbers of senior citizens to be financially self-sufficient.

In addition to the benefits to the retirees, more savings could strengthen the economy as these funds provide financing for profitable long-term ventures.

The Present Retirement System

In 1966 The National Insurance Scheme (NIS) was introduced to provide basic pension benefits to a wide cross-section of Jamaicans and their dependents. In spite of these broad-based provisions in the NIS Act (1965), only approximately a third of older persons 60 years and above meet the qualifying criteria and are in receipt of NIS pensions, the majority of whom are women.

Approved Superannuation Funds and Approved Retirement Schemes (for individuals) set up in British-style trusts benefit from preferred tax treatment. Until 2005 the legislative framework governing these funds were provisions in the Income Tax Act primarily dealing with the conditions necessary to qualify for tax exemption on contributions and investment income.

In the private sector there are currently about 800 employer sponsored pension funds covering about 80,000 persons. Within this group there are about 8,000 persons receiving pensions today. However, a high proportion (more than 50 percent) of pensioners still receive pensions that are below the minimum wage of the country (less than US$2,500 per annum).

Small pensions in Jamaica are usually the result of:

  • Insufficient savings caused by:
  • Low wages and/or
  • Pensionable earnings that are a fraction of taxable earnings
  • Sporadic or limited participation in pension plans
  • Access to cash refunds of “own contribution” (tax free) when changing jobs thereby losing any accrued benefit for that period of service. The refund is typically used for consumption rather than investment.
  • Falling interest rate environment (which is significant factor since the majority of pension plans are of the defined contribution type)
  • High Inflation Rates

Virtually all plans only guarantee a fixed pension payable for life and do not grant automatic post retirement pension increases. So pensioners can only rely on discretionary ad hoc increases.

In summary, working Jamaicans are unlikely to accumulate enough money to provide an adequate pension at retirement and current pensioners are likely to face increasing difficulties meeting their financial needs as inflation erodes the purchasing power of their pensions.

The New Legislation

The pension reform process in Jamaica has evolved over the past two decades. It accelerated and became a priority after a meltdown of the financial sector in the nineties. This crisis caused the government a huge increase in debt financing to support the sector and led them to institute extensive financial reforms.

In 1999 a foundation document pronounced reform for the Jamaican Pensions system. The objectives included:

  1. Ensuring proper arrangements for employees to enable them to receive adequate pension at retirement
  2. Reducing dependency of the aged on the state and families
  3. Heightening social awareness about the need to prepare for retirement
  4. Increasing access to pension arrangements with tax incentives to facilitate self-employed persons and persons in non-pensionable employment to meet this need.
  5. Providing for effective governance and supervision of pension arrangement so as to ensure accountability, solvency of funds, and the protection of the plan participants' interests.
  6. Introducing minimum benefit standards e.g. vesting and portability
  7. Ensuring Transparency
  8. Transforming some existing pension arrangements for public sector workers from the partially and non-funded Pay-As-You-Go (PAYG) schemes to fully funded contributory schemes, thereby creating investment opportunities and possible improved benefits to retirees from the sector and their beneficiaries.

The pension reform process is being conducted in stages. The first stage was completed recently by issuing the Pensions (Superannuation Funds and Retirement Scheme) Act 2004 effective 1 March 2005 along with new Regulations, which were passed in 2006. The first stage of the new legislation dealt primarily with:

  • Minimum operating standards for Plans with a focus on investments and the trust deed and rules (constitutive documents) of the Plan.
  • Registration and Approval of Superannuation Funds and Retirement Schemes, Trustees and Responsible Officers
  • Licensing of Administrators and Investment Managers
  • Amendments to and Winding-up of Approved Superannuation Funds and Retirement Schemes

This achieves formal supervision addressing matters of governance, operational standardization, transparency, penalties for non-compliance and a mechanism to handle complaints from members.

Will the Legislation Meet the Objectives?

Will this refurbished system ensure employees receive adequate pensions at retirement?

The new legislation introduced a registration process for plans, trustees, investment managers, administrators, and their professional advisors with accompanying registration fees. It contains provisions as to how all these parties should function and tries to replicate the contents of the constitutive documents. It is trying to put “proper arrangements in place” by setting a standard of governance and requiring a substantial amount of detail to be submitted to the regulator.

The cost of submitting and reviewing all this information in a central place is high. The impact of the cost is likely to have a negative impact on benefits paid from these funds (current industry estimate is a reduction of 15 percent over time). This aggravates rather than improves the situation.

Mandatory locking in of members’ retirement savings until retirement has been so controversial that this was delayed. This provision was intended to force members to keep their retirement savings intact until they were allowed to start their pension.

The implementation of the locking in, when it occurs, will only apply to future contributions. However, once implemented the impact on benefits is expected to be positive over the long term provided the benefits are not eroded by inflation.

Will the dependency of the aged on the state and families be reduced?

This will depend on whether the cost of regulation and its impact on pension fund management can be contained and the “buy in” of employees saving for retirement (especially against a background of high inflation and limited or no access to cost of living adjustments).

Has social awareness of the need to prepare for retirement been heightened?

Pension reform has been given a lot of publicity by the government and private sector. Also, there is mandatory communication with participants on a regular basis. However given that only about 25 percent of the working population has access to pension arrangements there is a continuing disconnect. Growth of social awareness is likely to take some time but should improve as access improves and if participants see that savings are not depleted by expenses and inflation.

Will access to self employed persons and persons in non-pensionable posts be improved?

The first stage omitted the area of greatest need in the Jamaican retirement system. A decision was made to delay introducing the regulations for Approved Retirement Schemes or personal pension plans until the next stage of legislation. The benefit of allowing the self-employed and persons in non-pensionable employment to make realistic savings earlier far outweighs the benefit to the public of legislating for occupation funds.

Will the new legislation provide for effective governance and supervision of pension arrangement so as to ensure accountability, solvency of funds, and the protection of the plan participants' interests?

Success hinges on a well-crafted Trust Deed and Rules otherwise referred to as the constitutive document and a regulator that enforces the provisions of the trust and the recommendations in the actuarial valuation report.

Newly introduced mechanisms include:

  • Mandatory professional indemnity coverage for each of the Investment Manager and Administrator (about US$76,000 coverage minimum) and fidelity guarantee insurances for each Investment Manager (about US$152,000 coverage minimum)
  • Detailed prescribed reporting for each of the Administrator, Investment Manager and Trustees (reporting timelines range from 60 to 120 days)
  • Detailed report of the Plan’s operation (annual report) within 9 months of the Plan’s year end
  • Changes to the Plan’s Trustees, Administrator, Investment Manager or professional advisors where made should be reported within 14 days.

Resources and expertise are scarce in a small developing country like Jamaica. The regulator is not immune to this scarcity and will face difficulty in efficiently analyzing the detailed reports demanded. This challenge will be exacerbated (at least in the near term) by the fact that the reports are not submitted electronically.

At the same time Trustees and participants may be lulled into a false sense of security having accepted the assurance that the regulator is keeping tabs on the health of each plan.

The outcome is that governance standards have been strengthened but the supervision end may not be sufficient to enforce them.

Will transparency be ensured?

Members have the right to information about the operation of the plan (inclusive of annual report to be produced annually) and their level of participation in the decision making process has been increased:

  • Nomination of a minimum number of Trustees,
  • Approval for all amendments to the constitutive documents except those made for compliance purposes,
  • Minimum standards for member communication material (what they should receive and the minimum information to be included)
  • Severe penalties for breaches of the 2004 Pensions Act and regulations (fines and/or imprisonment)
  • A complaints mechanism so participants can go to the regulator (FSC) as a last resort to resolve their problems.

The introduction of transparency is expected to have positive impact. The main challenge will be the participants’ ability to digest and use the information.

Have minimum benefit standards been introduced?

This introduction of minimum benefit standards will be a part of the next stage of legislation and will include vesting, locking in and portability.

When introduced, social awareness will be a key component to translating the objective into a benefit to working Jamaicans. Access to more pension arrangements for working Jamaicans is likely to drive the social awareness so the benefit of the minimum standards is likely to take a few years to emerge.

Will public sector arrangements be able to make the transition from pay as you go or partial funding to full funding?

So far all pension reform has mainly dealt with pension plans set up in the private sector. There are some indications that the public sector has been attempting to move in this direction. Nonetheless public sector issues remain outstanding (at least in the public domain).

Will the Retirement System be Strengthened?

Employers, administrators, investment managers and trustees will be under more scrutiny from the regulator and the participants. This is expected to raise the confidence levels of existing pension savers.

The expenses of operating these plans are a challenge. Following the introduction of the new legislation, employers and trustees are in the process of winding up at least 100 plans, mostly small or dominated by low income workers. The main reason is the increased cost introduced by the new regulations. However, pension reform is weeding out the weak plans and the costs of compliance are giving employers incentive to consolidate pension arrangements for their employees.

There will be a future shift towards Approved Retirement Schemes (ARS) or personal pension plans as employees of small businesses, self-employed persons and persons in non-pensionable posts gain access. This is expected to expand the base of pension savers overall.

Unfortunately, growth is likely to be slow due overall lack of education in the population (generally and particularly in respect of retirement issues). This, coupled with a general distrust of institutions social awareness may be slow to changes. Substantial funds will be required for education.

In the meanwhile, the government is committed to at least biannual reviews of the legislation (once completed) to fix what does not work and fine tune where needed. This is significant as it provides the government and pension industry with a mechanism to respond to unintended negative provisions in the legislation.

 


 

Megan Irvine is assistant vice president of Pension Services at Life of Jamaica Limited. She can be reached at mirvine@life-of-ja.com. Cathy Lyn is with Duggan Consulting Limited. She can be reached at clyn@sympatico.ca. Both are based in Kingston, Jamaica.