SOCIAL SECURITY SCHEME SYSTEM

There have been series of concerns about the pension scheme in Ghana. Retirees and dependents alike complain about the poor and inadequate retirement benefits accruing to contributors after many years of service. You might have heard that some of the pensioners’ allowance cannot carter for even medical bills. Why is the national pension scheme not providing the minimum social protection for pensioners? Is the trust not managing the assets properly? What is the way forward?

Social Security is a way of obliging everyone to undertake at least some savings for old age or retirement during their time of being part of the workforce of the country. Without a pension scheme, we will see some of the aged in our society struggle to cater for their basic needs or literally ‘go hungry’.

It is very beneficial for most people in the developed countries where social welfare benefits are very active and managed properly coupled with the State having social contract to provide the minimum standards of living to its citizens. The State then levies a compulsory tax on the working class, which in turn provides income for them after retirement. Without the policy, and with the public being aware that government is obliged to assign to these citizens the social security programs in the times when they are retired, old and destitute, the citizens may have an incentive not to save for the retirement bearing in mind the government’s support to them to at least maintain a minimal standard of living at old age and after retirement. Given this situation, it is preferable for the government to establish a mandated universal social security program, thus forcing an optimal level of savings for retirement. The standard framework differentiates four resources of economic security (pillars of retirement) during old age. This is made up of basic pension income maintenance programs, industry or company based occupational pension scheme (part of labor condition of service and jointly organized by both employer and employee), private personal pension saving schemes and the working partial after retirement age (Singapore as an example).?

Generally, there are two types of social security programs: Pay-As-You-Go and Fully funded Social Security. We would look at these two types of social security programs in detail.

Pay-As-You-Go Social Security

Before the passing of the National Pensions Act 2008 (Act 766), Ghana’s Social Security scheme was the Pay-As-You-Go Social Security scheme. This seeks to transfer resources from the young to the old. This means that the working-class’ contributions are used to fund for the retirement benefits of the old and retired as their pensions are paid out from contributions.

There is a cross-sectional income redistribution from workers to pensioners based on an implicit social contract. By this, we mean that each generation finances the pension income of the previous generation with the understanding that its own pension income will be financed by the next generation. Pay-As-You-Go is normally implemented through the State or a State trust i.e. SSNIT as an example. The Pay-As-You-Go scheme is as a result termed an intergenerational transfer or public pension. This provides a minimum pension close to minimum wage. Under this policy where resources are transferred from the young to the old, it would be preferred because of the population growth rate and real income growth rate. These are explained below.

·????????Population Growth Rate

A growing population has a higher ratio of young to old than stable population growth, that is each succeeding generation is larger than the one before it. Since the contributions of the young or working class are used to fund the benefits of the old, a higher population growth rate will mean an increase in benefit of retirees. However, where there is a decline in the population growth rate, the only option available to increase the benefits of pensioners is to increase the contributions of the young or otherwise cut the benefits of each retirees. To cite an example, the industrialized countries are paying higher pension contributions because they face a zero or close to zero population growth rate.

Consequently, a PAY-As-You-Go Social Security scheme makes everyone better off if the population growth rate is greater than the real interest rate. Otherwise, retirees in the initial period are made better off at the expense of the current young and future generation. Social security could potentially improve welfare because there is no complete market information, that is a weakness for a private fund manager. The government will use tax policy to provide intergenerational transfer that may yield a pareto improvement, where all consumers’ welfare increases for both the present and future.

For Pay-As-You-Go social security to improve welfare for the consumers currently alive and those in future generations, it requires that the “rate of return” of the social security scheme to be sufficiently high. This rate of return increases with the population growth rate, as the population growth rate determines how large a tax burden there would be for the young generation in paying social security benefits to the old and vice versa.

Therefore, Pay-As-You-Go scheme is beneficial if the population growth rate exceeds the real interest rate. The interpretation is that population growth rate is the implied rate of return for an individual from the social security scheme. As such, social security scheme is only worthwhile if the return exceeds what could be obtained in private credit markets.

·????????Income Growth Rate

It is believed that younger generation have higher standards of living than old generations due to economic growth. Consequently, contributions are set at a certain percentage of income rather than a fixed cedi amount. If productivity grows at a reasonable level, retired workers receive benefits higher than their own contribution. This is because as economic growth will lead to higher employment of workers resulting higher contribution/benefit ratio. On the other hand, if the level of economic growth is faltered, the social security system will encounter challenges. This explains why developed countries relatively higher pension benefits they have than in developing countries.

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??Fully Funded Social Security/Private Pension

This is a social security program where the government invests the proceeds from social security contributions in the private credit market, with social security benefit determined by the earnings government receives from the credit market. Alternatively, pension contributors could be allowed to choose which assets to invest their social security contributions. The retirement pensions are then paid out of income originating from the investment revenue. The private pension program offers economic benefits based on future national product (which would affect investment returns) whereas the public pension program offers economic benefits based on a moral claim.

The fully funded social security scheme is mechanism for solving and controlling the intergenerational problem in respect of pensions for the old in aging society. The scheme is preferable to Pay-As-You-Go because it can have positive impact on future productive capacity of pension savings.

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Which Pension Scheme is the Best?

The choice of the pension scheme depends on the viewpoint of the individual. Both policies have merits as well as setbacks.

With Pay-As-You-Go, contributors’ savings are not invested to be able to get a return close to the private credit market. Contributors are guaranteed a minimum return. Also, there is minimal risk with Pay-As-You-Go since pension assets are not invested in risky assets. The public pension scheme will be preferable if there is large economic uncertainty or change.

The Pay-As-You-Go scheme has its own associated problems: it is usually subject to mismanagement since it is under the control of politicians, lobbyist and interest groups, who could lobby for their interest rather the general interest of the scheme. The program is also subject to sustainability challenges in a society with large an aging population. Consequently, countries with higher aging population have advocated for transition from Pay-As-You-Go scheme into fully funded scheme.

Contrastingly, the fully funded scheme enhances retirees’ welfare as the returns of their contribution is higher than under the Pay-As-You-Go scheme.

Unlike the Pay-As-You-Go scheme, the fully funded pension scheme is less likely to face political interference since contributions are invested and managed in a private credit market. This scheme provides productive use of assets since pension savings are used to provide credit facility in private credit market.

The fully funded scheme has some disadvantages. Fully funded pension scheme is associated with moral hazard. Moral hazard in this context would be situations where contributors can choose which pension funds to invest. They may opt for risky assets with the thought that in an unlikely event of collapse of the risky fund, government would bail them out.

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Policy Response

It is undoubtedly factual that both schemes have advantages and setbacks. As a result, countries have come out with reforms on the pension schemes. Most countries are moving into the fully funded pension scheme while others use a mix of Pay-As-You-Go and the fully funded pension scheme. Canada, to cite an example uses the mixed pension scheme while Chile operates a fully funded pension scheme.

Transforming Pay-As-You-Go to fully funded pension scheme has it associated problems. The last generation of workers in such a case would pay double: contributing for the present retirees and then a contribution for their own fully funded scheme.

There have been recommendations for countries to adopt a multi-tier system. Ghana’s Pensions Act, 2008 (Act 766) is one such pensions law, which provides for mixture of publicly and privately managed funds. Contributions to finance first tier are managed under the public pension scheme while making it mandatory for the second tier to be managed through a fully funded private pension fund. The third tier is a voluntary contribution and lastly, a fourth tier, which are involves contributions of individuals who continue working after retirement. Singapore is one country that encourages workers to still be in active service after the mandatory retirement age of 67 years.

Do you think the new pension system in Ghana will provide a decent income for pensioners? What other means are you adopting towards your retirement?

Share your thought.