By ROSEMARY ONUOHA & RITA OBODOECHINA

Until 2004, Nigeria had operated particularly in the public sector, a Defined Benefit (DB) pension scheme, which was largely unfunded and non-contributory. The system was also referred to as a Pay-As-You-Go (PAYG) scheme since retirees were to be supported not by their previous contributions but by annual budgetary provisions.

Because it was largely unfunded, the DB system led to massive accumulation of pension debt, estimated at over one trillion naira. In response to the telling effects of this system on the lives of our senior citizens and their families, the Government of President Olusegun Obasanjo took measures aimed at reversing the situation by developing a sustainable system with the capacity to achieve the ultimate goal of providing a stable, predictable and adequate source of retirement income for each participant.

With the coming into force in July 2004 of the Pension Reform Act 2004, a new pension scheme was established to replace the previous DB scheme. The new scheme, known as the Contributory Pension Scheme (CPS) which, as the name suggests is contributory in nature, is mandatory for every employee in the Federal Public Service (including employees of the Federal Capital Territory) and employees in all Private Sector organisations.

Employers are expected to deduct 7.5% of the employee’s total emolument and also provide a counterpart funding of 7.5% to be remitted into a Retirement Savings Account (RSA) which the employee is expected to open with any Pension Fund Administrator (PFA) of his choice.

This makes up a minimum of 15% to be paid into the employee’s RSA. However both the employer and the employee may opt to fund the RSA above the mandatory minimum of 15%. Employers may also opt to bear more than half of the mandatory minimum of 15%.

Private Sector organisations with less than 5 employees are however not mandated to adopt the scheme but may elect to do so. This system has a number of features which has made it an increasingly vital component of the pension systems of many countries not only in the Organisation of Economic Corporation and Development (OECD) countries but also amongst the developing countries particularly in Asia and Latin America.

Old Scheme Vs New Scheme

Under the old scheme no contributions were made, and projections were required to be made of the pension entitlements of each employee by the employer, with such projections being determined by the employee’s years of service and earnings.

Thus, the pension obligations were effectively the debt obligation of the employer, which assumes the risk of insufficient funds to satisfy the contractual obligations to retired employees. In contrast, under the CPS, the employer is responsible only for making specific contributions on behalf of employees.

However, the employer does not guarantee any certain amount upon retirement as he is no longer indebted to the employee. Payments to employees upon retirement will depend on age, gender, RSA value and final salary.

The new scheme allows for the maintenance of a RSA by each employee, which gives the workers responsibility over their retirement savings. Pensioners are no longer at the mercy of employer, and are assured of regular payment of retirement benefits.

It is also argued that personal accounts would provide all workers a higher rate of return than can be paid under the DB plan. The new scheme also affords employees an opportunity to pass wealth to survivors in the event of death. In addition, RSAs maintained by millions of workers generate a huge pool of long-term funds, which are available for investment.

Owing to economies of scale, the cost of investing such funds tends to be relatively lower than if an individual employee were to undertake the investment on his or her own account. Finally, having a pension scheme that pays out benefits in the form of a life annuity/programmed withdrawal affords workers protection against longevity risk, by pooling mortality risk across others.

For both the employer and the employee, the new scheme encourages labour market flexibility. The worker is free to move with his account as he/she moves to another place of employment and/or residence. To the extent that the CPS aids mobility of labour, it is an important tool enabling employees and employers to adapt to changing circumstances, especially in a global environment where change is a constant aspect of social and economic life.

Government & the new scheme

As a major stakeholder, the government is expected to benefit in a number of ways from the new CPS. The Scheme has stemmed further growth of pension obligations and provided a platform for addressing the existing liability.

It has also imposed fiscal discipline in the budgetary process because pension obligations are more accurately determined. Apart from the new scheme’s potential to promote national savings and by implication, economic growth, funded pension schemes have the capacity to promote capital market development as well as general economic reforms. A key area in which the government would benefit from the CPS is through the scheme’s ability to support the overall macroeconomic policies of reform.

The last two decades have witnessed a growing support for the idea that enterprises are better run by private individuals and the role of government should be limited to providing a conducive regulatory and institutional framework that would enable the private sector to thrive.

Many countries around the world have adopted privatization as an avenue for reform and have often employed a CPS to support the process. A CPS tends to facilitate such reforms better than a DB scheme. Contributory Pension Schemes have the potential to generate positive economic externalities, including the promotion of deeper, more competitive, and more liquid financial markets.

Challenges

Pension contribution evasion poses a major challenge to the success of the CPS since it influences the adequacy of benefit payments to participants. There are a number of ways in which employers may evade contributions: they might fail to register themselves and some or all of their employees; they might portray their workers as contractors, family members or belonging to other categories that could be considered as non-workers; they might fail to contribute, or decide to embark on late remittance of contribution.