Kenyan retirees doomed to poverty as pensions eat up 25pc of GDP

from The East African

The EastAfrican

Workers who retire in Kenya are condemned to abject poverty because the pensions paid to the majority are woefully inadequate for providing for their declining years.

This is the conclusion of a new study conducted on the government’s behalf by a World Bank team of experts comprised of labour economists, actuarial scientists and social security specialists.

Still in draft form — a confidential copy of which has been obtained by The EastAfrican — it is by far the most comprehensive and scientific assessment of the pensions system in Kenya.

What emerges from the report is a society where the majority are without a secure and reliable source of retirement income, where contributions to pensions are not aligned to old-age income and where pension incomes are not indexed to inflation.

The report says the pensions system in Kenya is more or less dysfunctional since most pensions schemes are unable to guarantee a retiree even one-tenth of the income they earned while they were in employment.

The study is the closest somebody has come to explaining one of the most intriguing phenomena in the labour market in Kenya: why the majority of workers in the country hang on to their jobs even when they are well past retirement age.

Kenya does not have any form of government assistance to the elderly.

Because of the multiplicity of pensions schemes in Kenya, the total number of citizens living on pensions is difficult to compute.

But the research basically relied on secondary material and statistics already in the public domain — a labour force of 15.1 million, 850,000 workers actively contributing to the mandatory National Social Security Fund and 350,000 contributors to occupational pension schemes.

According to the study, the civil service alone has 158,700 pensioners on its roll.

In the year 2005, the National Social Security Fund (NSSF) paid benefits to an estimated 60,000 retirees.

Perhaps the worst affected by the misery of low pension benefits are public service retirees – former civil servants, teachers, employees of the Judicial Service Commission and members of the disciplined forces.

The study found that, when measured as a percentage of average salaries, about 75 per cent of public servant retirees receive a monthly benefit less than 16 per cent of the average pre-retirement salary while about 50 per cent receive a benefit equal to or less than 8 per cent of their average pre-retirement salaries.

Low monthly pension receipts are, however, not the only problem for civil service retirees.

The civil service pension scheme does not provide for portability, the implication being that any civil servant quitting employment early, for instance due to retrenchment, has no chance of continuing with pension contributions.

Perhaps this is what gives civil servants in Kenya the incentive to stay on the job even in cases where some of them have found opportunities elsewhere.

Then there is the fact that there is currently no provision for deferred retirement.

This situation gives the civil servant very strong incentives for working at least until the early retirement age of 50 — because losing their job prior to that age is simply disastrous.

Worse still, because monthly payments are not indexed to the rate of inflation, the purchasing power of monthly benefits for public servants is gradually eroded by incessant price increases even as the retirees grow older and older.

What remains paradoxical, however, is the fact that despite the overwhelming evidence that the civil service pension scheme cannot guarantee old-age retirement, the study, in practically the same breath, finds that the system has put the government in a situation where it is spending far too much of tax revenue on pensions — a clear indication that the current scheme is unsustainable.

The civil service pension scheme is indubitably beginning to prove unaffordable for the government. According to a recent actuarial projection, the cost of unfunded accrued pension liabilities are now equivalent to 25 per cent of GDP — meaning that the liability to pensioners amounted to one quarter of the wealth created in the economy.

Indeed, the projections by the government now are that civil service salaries and remunerations are to rise from 5.2 per cent of fiscal revenues in the year 2004/2005 to 7.8 per cent in the year 2015.

Which is why the government has over the years been groaning about pensions payments, predicting that civil service pension expenditures were likely to crowd out other essential expenditures in the next decade.

Three solutions have been floated as possible remedies for the crisis of low pension benefits for civil servants.

First is the introduction of a completely new pension scheme for civil servants that, while retaining the benefits of the current scheme, will also provide members with the voluntary option of opting out and joining a totally new scheme for civil servants.

Second is a fully – funded pension scheme where both employers and employees contribute and in which benefits are clearly defined.

It is proposed that all new civil servants joining the service after the introduction of the defined benefits scheme be required to join the new contributory scheme.

What is the state of affairs at the NSSF — the mandatory pension scheme that has been operating since 1965?

The verdict of the World Bank report on the NSSF’s ability to provide adequate old-age income is even more damning. “As currently designed and managed, NSSF does not adequately deliver on its core mandate to provide basic social security and welfare support to its members,” it says.

At current calculations, says the report, replacement of pre-retirement income is severely limited because lump sum benefits only amount to two and a half times average wages.

And why does the NSSF give low benefits to retirees? A major part of the problem — according to the report — has to do with the low ceiling on the monthly contributions that workers make to the NSSF.

The required contribution rate is 10 per cent of wages divided equally between employer and employee up to a maximum contribution of Ksh400 ($5.70) per month.

As a matter of fact, this maximum contribution represents only 1.6 per cent of the average formal sector wage earnings.

And since 1999, members have been allocated an administered nominal rate of return of 2.5 per cent on their account accumulations — a rate substantially below the inflation rate.

Currently, the old-age benefit is paid in the form of a lump sum at the age of 55, with a reduced early retirement benefit that can be provided at the age of 50.

The high cost of administering the fund is another factor responsible for the low benefits that NSSF pays.

Low returns on the investment portfolio have led to low returns being apportioned to members’ accounts.

Thus, what the worker gets from the NSSF as retirement income can hardly last him 12 months if he is to maintain his pre-retirement standards of living.

An actuarial valuation of the Fund conducted in the year 2004 found that as at end-June 2003, the value of assets was estimated to be worth 92.6 per cent of members’ accounts — implying that the members were at a relatively disadvantaged position.

However, the report found that this estimate did not give a full picture.

According to a report done by the Kenya National Audit Office, offers received for some properties in the year 2004 were much lower than the cost at which the properties were acquired —indicating a significant depreciation on these properties.

Apparently, the NSSF has not updated the value of the assets placed in real property. Its financial statements reflect the values at the time when the properties were acquired.

Historically, the report adds, NSSF’s investment performance and the amount allocated to individual accounts have lagged behind virtually all market benchmarks including the inflation rate.

According to calculations conducted by the researchers, there have been instances and years when a worker would have made more money if he had invested his pension contributions in a fixed deposit account with a bank than keeping it with the NSSF.

It would appear that the situation has improved in recent months. The report found that the NSSF had outperformed market benchmarks for most assets classes in the year 2004/2005.

For instance, investments in companies listed on the Nairobi Stock Exchange in that year returned 31.4 per cent compared with the 28.4 per cent return on the NSE 20-Share Index.

With regard to fixed-income securities, investment in government T-bills and T-bonds returned 8.8 per cent compared with the average T-bill rate of 8.3 per cent during the year.

Term deposits yielded a 10.9 per cent rate of return compared with the 6.0 per cent that was the average reported deposit rate of the four major banks in Kenya.

The property portfolio is, however, still in a poor state: During the same period, investment in real estate — the largest NSSF asset class — were reported to have yielded a rate of return of only 1 per cent, for which no market benchmark was available.

Neither has the Fund made any major breakthroughs in addressing the problem of high administrative expenses.

According to the report, NSSF’s operational expenses have eroded approximately 4-5 per cent of its assets in recent years. NSSF is also plagued by the problem of incomplete records.

Inaccurate and incomplete information from employers and the limited capacity of the NSSF to identify the corresponding employee for employer remittances have led to the accumulation of a sizeable suspense account of Ksh6.2 billion ($88.5 million).

This is the account to which unidentified contributions are diverted.

Of the total Ksh6.2 billion, Ksh3.6 billion ($51.4 million) is from the biggest 200 employers out of a total of 72,000 employers, some of which are not active.

In the year 2003, the suspense account stood at Ksh8.4 billion ($120 million).

But the current management of NSSF has gradually brought it down, mainly by reconstructing and updating documents.

The Fund has been given a performance target of reducing the suspense account to Ksh1.5 billion ($2.1 million) by July 2008.

How can NSSF’s problems be resolved?

The main suggestion in the report is a higher ceiling on wages subject to mandatory pension contributions.

It is proposed that the contributory ceiling be raised mainly in areas not currently covered by any voluntary retirement scheme, including the informal sector and small firms in the formal sector.

The report admits that one unfortunate impact of such a move will be the crowding out of occupational schemes.

But it still concludes that there is no other way of providing a meaningful retirement benefit to retirees in Kenya.

The only retirees who earn meaningful benefits, according to the study, are members of occupational retirement schemes.

There are 1,352 occupational pension schemes currently operating in Kenya, established by employers either in the form of a defined contribution or defined benefit scheme.

Defined benefit schemes account for 87 per cent of the total schemes. The total assets of occupational schemes stood at Ksh155 billion ($22.1 million) as at June 2005.

Of the total occupational schemes in Kenya, 125 are established by parastatals. The study also touches on the controversial proposal to introduce a non-contributory social pension that provides benefits to all citizens who have attained a specified retirement age.

Countries as diverse as South Africa, Mauritius, Bolivia, Namibia, and New Zealand currently have such schemes.

But the report’s conclusion is that such a scheme is not feasible for Kenya.