The world of pensions, whether state social security or private schemes, is constantly under pressure or in question as to its future sustainability. To put things in context, the seven largest pension funds in the world are those in Japan (US$1.14 trillion), Norway (US$884.031 billion), South Korea (US$429.794 billion), China (US$247.361 billion), Canada (US$228.431 billion), Singapore (US$207.872 billion) and Malaysia (US$184.697 billion or RM684.53 billion).
The gatekeeper of Malaysian pensions is the Employees Provident Fund (EPF), which is one of the most proactive public investment funds (PIFs) in the world that regularly invests in Islamic finance assets, especially sukuk (Islamic bonds), and which provides retirement benefits for members through the management of their savings and a framework for employers “to meet their statutory and moral obligations to their employees”.
The good news is that the standard of pension systems across the world is increasing, but the bad news is that various factors are conspiring to put enormous pressure on governments that continual review and improvement remains vital to ensuring that pensions systems can continue to deliver.
This is according to The 2015 Melbourne Mercer Global Pension Index (MMGPI) Report, which covers some 60 per cent of the world’s population and measures 25 retirement income systems against more than 40 indicators. According to the report, published in 2016, Denmark, The Netherlands and Australia have the best pension schemes in the world that are robust, deliver good benefits, sustainable, and have a high level of integrity with developed regulations.
The report’s author, Dr David Knox, concedes that there is no perfect pension system that can be applied universally, but there are many common features that can be shared for better outcomes.
“Developing and implementing the right reform to improve pension systems and provide financial security in retirement has never been more critical for both individuals and societies. In coming years, age-related spending around the world, driven by increased pension and healthcare costs, will potentially outstrip the costs of the Global Financial Crisis, the most significant financial crisis in 100 years. The MMGPI suggests how governments can provide adequate and sustainable benefits that protect their citizens against longevity risk, the risk of their ageing population outliving their savings, potentially one of the biggest economic and social risks facing many retirees today,” warns Dr Knox.
This uncertainty facing the pension industry is due to a cornucopia of reasons, including ageing populations and higher life expectancy; uncertain global and regional economic conditions, coupled with greater government indebtedness; a record low interest rate environment, especially in the last two decades; volatility in pension portfolio investment asset classes, including the equity markets, hedge funds, real estate prices and even the bond and sukuk market; poor asset allocation strategies; a global shift towards individual provision of social safety nets, in the case of retirement schemes through defined contributions plans as opposed to the traditional defined benefits ones; and the seeming inability and reluctance of politicians and taxpayers to take the issue of public pension shortfalls seriously.
In the United Kingdom, for instance, according to a recent report by the Centre for Policy Studies, the National Insurance Fund, which pays out the state pension, is running out of cash. This means that the government will have to fund any shortages out of general taxation, which in turn could mean higher taxes for the under-45 and a later retirement age. State pensions in the UK are funded through social security contributions, which are deducted from the wages of working people.
In the United States, many state public pension funds are similarly short of cash. According to a study by the Hoover Institution at Stanford University, the estimated public pension black hole in the US totals US$3.4 trillion. Chicago’s public pension scheme alone has an estimated shortfall of up to US$32.5 billion.
To many right-wing politicians in the West, state pensions are anathema. They want the abolition of state pensions and force everybody to take out private pensions for their retirement. They are dead against the state raising taxes to pay for any pension black holes, irrespective of socio-economic background and circumstances.
The centre-left, on the other hand, are strong proponents of the state pension, where workers have contributed towards all their working life and deserve a decent standard of living after retirement. Some of the more radical thinkers want this pension to be inflation-linked and to the full salary of the individual.
Pension used to be simple when you paid money in every month, and you knew how much cash you would receive once you retired. This “defined benefit” model however, today, is the preserve of the very few wealthy ones.
The overwhelming model used worldwide is the “defined contribution” scheme, where you know exactly how much you are paying in, but you are not sure how much you will get out on retirement.
Pension schemes will inevitably face constant restructuring of both contributions and benefits given the ever-changing global economic and market conditions.
For instance, already Australia, Germany, Japan, Singapore and the UK have increased their pension age to offset the increase in life expectancies, albeit these may not be enough to halt the increasing length of retirement.
A unique change in state-run pension funds is unfolding in Malaysia, which could be a game-changer for the world’s one billion plus Muslims. The EPF, this month, took a step nearer to launching the world’s first dedicated syariah-compliant public pension fund, Simpanan Shariah, which will run parallel to its conventional pension fund (Simpanan Konvensional).
Registration for Simpanan Shariah opened on Aug 8. In the first five days, a total of 208,795 EPF members had registered, averaging some 40,000 per day and uptaking RM25.1 billion of the allocated RM100 billion in the process.
EPF chief executive officer Datuk Shahril Ridza Ridzuan is confident that up to two million members would switch from Simpanan Konvensional to Simpanan Shariah when it becomes operational on Jan 1, 2017. Eventually, it expects its Islamic fund to account for a 40 per cent plus uptake by “members regardless of religion, race and nationality”.
The scheme is being introduced following a survey of its members, of whom 71 per cent agreed with the launching of a syariah-compliant retirement offering. Malaysia’s second largest pension scheme, Retirement Fund Incorporated, commonly known as Kumpulan Wang Persaraan (KWAP), is going one step further — it is in the process of converting into a full-fledged Islamic retirement fund.
KWAP manages about RM120 billion in assets, which is set to increase substantially as it takes over the pension payment operations of the Malaysian government, involving some 1.6 million civil servants.
The eventual aim is to transform KWAP into an EPF-type scheme where future civil servants may have to contribute to their own pension scheme.
These are the only state-run Islamic pension schemes in the world, which could be the model for other countries to follow. Imagine the potential if other pension funds in Muslim countries follow suit.
Islamic pension products are not new. If you are an employer in the UK for instance, you are required to automatically enrol your employees in a workplace pension scheme.
Qatari-owned Al Rayan Bank works with Carey Pensions to provide The Islamic Pension Trust to its employees in the UK. So do The National Employment Savers Trust (NEST) and The HSBC Life Amanah Pension Fund.
Of course, there are risks and market challenges involved in Islamic pension funds, as there are in any other Islamic financial products and the whole gamut of conventional products.
But, what could be appealing to non-Muslims as well is the overarching principle of fairness and full disclosure in Islamic pensions, which is in stark contrast to English law, which emphasise freedom of contract and “buyer beware”. Indeed, the syariah governance structure also serves as an extra tier of protection and compliance.
Fee charges of Islamic pension funds, especially in the West, tend to be higher, which could be further increased because of syariah advisory fees.
But, as Malaysia’s EPF and KWAP have shown, these can be mitigated with the right structures and management ethos, to make Islamic pension products just as, if not more price and benefit competitive.
The ball is indeed in the court of EPF and KWAP to export their pension models once they get going.
Mushtak Parker is an independent
London-based economist and writer