Swelling public pensions adding a peril to Pakistan’s finances

One of the more positive postwar global trends has been the fact that on average people are living longer. Pakistan is no different, where average life expectancy has increased from 45 years in 1960 to 67 years presently, and it continues to improve. While this is undeniably good news, it has also contributed to the exponential growth of public sector pension expenses. 

The consolidated federal and provincial governments’ pension bills have grown over sixfold, from Rs164 billion in FY2011 to almost Rs1 trillion in FY2021, even before accounting for state-owned enterprises’ (SOEs) retirement liabilities. In the same period, consolidated revenues have increased less than three times. Consequently, retirement payments as a percentage of the consolidated revenues have grown from 7 percent in FY2011 to around 17 percent presently.

The pension system is designed as a defined benefit scheme, where payout is not directly linked to the contributions or taxes paid by individual beneficiaries as would be the case in a pay-as-you-go plan. At the same time there is virtually no provision by the state toward contributing into a pool of funds in order to finance future pension payments, and the unfunded liability is paid from annual budgetary allocations. 

An actuarial evaluation by the Punjab government in FY2015 estimated that the present value of liabilities (i.e. current value of a future sum stream of payments) was over 30 times the annual pension expenditure by the provincial government. While it is important to caution that the projections are highly sensitive to actuarial assumptions, if a similar multiple is applied today to estimate the present value of consolidated provincial and federal liabilities, it would range between Rs30 trillion and Rs35 trillion. While an actuarial study needs to be undertaken to get an accurate appraisal, it is safe to assume that the future liabilities are many multiples of the annual budgetary resources currently available, and growing at a faster pace than tax revenues. 

Generous increments awarded to government employees between FY2010 and FY2019 almost doubled individual pension payments for those retiring recently. Effectively some retirees receive more as monthly pension payments than their last basic salary, thereby incentivizing early retirements. 

 Javed Hassan

As well as increased life expectancy, various other government policy measures have contributed to the growth of the pension time bomb. Generous increments awarded to government employees between FY2010 and FY2019 almost doubled individual pension payments for those retiring recently. Effectively some retirees receive more as monthly pension payments than their last basic salary, thereby incentivizing early retirements. 

Consequently, the number of retirees as a percentage of government employees in Punjab has increased from 32.5 percent in 2010 to 48.3 percent in 2019. In 1980 they were less than 4 percent. To varying degrees the same behavior is observed among other provincial and federal government employees. Early retirements not only accelerate the growth in the overall number of pensioners, but their replacement on the payroll effectively continues to grow the pension pool. 

Adding to the ballooning liability is the fact that the pension schemes allow children and grandchildren to draw 75 percent of the entitlement after the demise of the pensioner and his spouse. The multigenerational nature of the scheme implies that annuities can continue over several decades.  

A scheme that was designed for life expectancies that were on average lower than the retirement age and assumed that few would retire early is now not only unviable, but also crowding out fiscal space. After accounting for public servant salaries, debt servicing and pension payments, less than 45 percent of the consolidated federal and provincial budget is available for national security, provision of basic services, and investment in human development.  

Reform is therefore required to move pension schemes toward a self-sustaining model that should look into instituting more fundamental changes than simply financial structuring of products such as pension funds and bonds. It will have to address the employee-retiree ratio by considering proposals that raise the retirement age in line with global trends, initially to, say, 65 years and then gradually to 67, as well as amend employment rules to preclude early retirement.

The state must also look to reduce its obligations by shifting from defined benefit to defined contribution pension plans, especially for new entrants. Non-monetary emoluments should be monetized such that they can be accounted for in the overall retirement package. The strategy should consider rationalizing existing pension benefits, for example, limiting beneficiary entitlement to the spouse and dependent children only. Finally, the state must generate additional resources for making investments for future pension payments. 

The changes are likely to face resistance from entrenched interests, and require political will and deftness to gain acceptance from a diverse set of stakeholders. In order to withstand judicial scrutiny, the implementation process will have to be supported by regulatory and legislative amendments, and will have to be equitably applied across the public sector. The challenges are significant, but the risks posed to national finances by the pension pile up in absence of reform are acute, and therefore cannot be deferred any further.

*Javed Hassan has worked in senior executive positions both in the profit and non-profit sector in Pakistan and internationally. He’s an investment banker by training.

Twitter: @javedhassan