Abstract
Tehmina Khan, a 35-year-old, married mother of two, had been working as an assistant professor at a private sector university, University of Management and Information (UMI), School of Business. For the last few years, she had been saving for her retirement via a provident fund (PF) with her employer. The fund had been posting generous returns for years up until July 2018, when it posted earnings well below the inflation rate for the same period. Tehmina wanted to be financially self-sufficient in her post-retirement years and sought no financial dependence on her posterity for that matter. The meagre returns heightened her concerns about the future eventualities, so she had to decide if she should switch to another retirement plan. She needed to explore alternative retirement plans and identify how she could participate in a voluntary pension system (VPS) outside her employer’s PF. Also, if she decided to go ahead with VPS, she had to decide which asset management company(s) and portfolio manager(s) to allocate her savings to.
The case comprehensively discusses the details about different retirement benefits and mechanisms and distinguishes aspects of private and public sector retirement plans in Pakistan. Most importantly, the case includes data on the performance of seventeen out of a total of nineteen pension plans operating in Pakistan. It also includes data on asset allocations of pension funds; overall macroeconomic, historical and stock market performances; and yield curve for the last 10 years.
Discussion Questions
Explain the dynamics of retirement system(s) in Pakistan, especially for private-sector employees.
List some factors which Tehmina might consider important in deciding her investment.
Which metric of evaluation should Tehmina use in deciding her investment? Which benchmark should she choose for the purpose? How should she pick a fund?
Which pension fund(s) should she invest in, and why?
Tehmina Khan, a 35-year-old, married and mother of two, had been working as an assistant professor at a private university, that is, University of Management and Information (UMI), since 2010. For the last few years, her only retirement savings plan provided by UMI—a provident fund (PF)—posted generous returns of about 8–9 per cent annually. However, in July 2018, the fund posted only a meagre 2.3 per cent return, well below the average inflation rate of 5 per cent 1 for the same period. These return statistics came in as an upsetting surprise, for they meant a substantial decline in her real savings for the year—a deficit of almost 2.7 per cent or simply a shortfall of more than 100 per cent below the required rate of return to keep up with the inflation. Furthermore, upon enquiring from the university’s finance department, she learnt that her out-of-pocket contributions lacked capital protection, and there existed scanty regulations to govern private employer’s PFs. Besides this PF, being a private-sector employee, she did not have any other significant government-backed retirement scheme. All these bona fide concerns deluded her into thinking about more severe eventualities like negative returns in the forthcoming years and further clouded her retirement goals with scepticism and ambiguity.
It was October of 2018, Tehmina was sure that she needed to explore alternative retirement plans, but what were the alternatives?
Background
Tehmina was a highly educated individual and manifestly recognized the changing dynamics of sociocultural family settings in Pakistan. She wanted to be financially self-sufficient in her post-retirement years and sought no financial dependence on her posterity for that matter. Her husband, Tabraiz Khan, was also an accomplished person, and at the age of 40, he was working as a professor at another respected university. They had two sons, Ali, who was12 years old, and Kamil, who was 6. The children were studying in an elite school and were in Grade 6 and Grade 1, respectively, with the tuition fee of PKR 30,000 per month per child. Tehmina was earning PKR 3,000,000 as her annual salary. Her husband also earned PKR 4,000,000 per year, and he was satisfied with his employer’s PF scheme, which had been posting a 10–12 per cent return every year for the last 8 years. All of their other major financial obligations, such as college savings for their children and healthcare, were already adequately planned through other investments (primarily, real estates). It was Tehmina who thought that her retirement was not adequately covered.
Recently, Tehmina had opted out of her insurance plans (health and life) with a life insurance company after paying premiums of PKR 125,000 annually for 8 long years. The life insurance company was a government-owned company that had been providing life, health, education and pension plans to individuals and groups since 1972. Lately, one of her close acquaintances had to go through a rough, troubling experience of withdrawing benefits at maturity of educations plans with the same organization. The process of withdrawal was marked by a never-ending list of frivolous complications, including redundant documentation, unmerited objections and unwarranted bureaucratic hurdles. A simple right of an insurance buyer to withdraw benefits at maturity seemed like an ordeal, and this prompted Tehmina to rethink her own choices about the insurance plans. Her experience was not different from that of her acquaintance, but she was relieved when it was all done in a couple of months.
Tehmina’s goal of saving for retirement was to ensure that she would individually have enough to live on after she retired at the age of 65. UMI’s PF was a defined contribution involuntary retirement plan—a PF. Each month every employee, like Tehmina, involuntarily contributed 10 per cent of their basic salary to the fund that was equally matched in amount by the employer. This equal contribution provision gave PF an appealing enchantment, for a mere 10 per cent saving each month translated into a cumulative 20 per cent savings (or simply a 100% additional monthly saving free of cost). Tehmina also found it to be a beneficial opportunity and, over the years, had accumulated a total balance of PKR 3 million in her PF account.
Interestingly, UMI had prescribed the employee participation in PF on an involuntary basis; hence, opting out of the fund was not an option. An employee, however, had the right to take a loan against all of his/her accumulated balance in the PF and invest it in some limited schemes such as equity, mutual funds, pension funds, real estate, and house construction. This was where Tehmina had an attractive opportunity. Although she was not happy with the returns posted by UMI’s PF, she had the option to take a loan against her accumulated balance. She said to herself that she should avail this opportunity, especially after the meagrely posted PF returns. She was cognizant that she would be losing the returns on the borrowed fund but she was willing to forgo returns of the provident fund in her endeavour to earn an appropriate expected return. Yet, she was not so sure of her alternatives.
Retirement Plans in Pakistan
The retirement saving schemes and benefit structures varied broadly across the public and private sectors of Pakistan. Public sector (government) employees enjoyed a spectrum of diverse benefits including pension, gratuity and PFs on a pay-as-you-go (PAYG) defined benefit basis that the Government of Pakistan exclusively financed by obtaining provisions in its yearly budget. However, unlike a fully funded pension system where the contributions were accumulated in individual accounts and invested in private financial assets to finance future retirement benefits liability, governments still mostly relied on their taxation powers for the purpose. Over the years, this had translated into bloated tax bills to provide for inflation-adjusted pensions to a growing number of retirees who were now living longer. The current public-sector employees largely recognized these taxes as an unasked-for appropriation from their salaries instead of savings for themselves. Albeit, a general sense of financial security prevailed higher among public-sector employees, for they knew that future working generations would finance their pension benefits as they were doing for their elder generation(s).
Nevertheless, these government retirement schemes predominantly focused only on the public-sector employees that were mere 10per cent of the entire labour force (Kanwer & Shoaib, 2006). The government-backed old-age benefits and social security scheme only existed very scantily in the form of Employees’ Old-Age Benefits Institution (EOBI) contributions for private-sector employees. It meant that rest of the 90 per cent labour force was left at the discretion of their employers, or perhaps nothing at all. Most private-sector employers like UMI only offered defined contribution retirement schemes in the form of PFs where each employee involuntary contributed a fixed percentage of their basic salary to the fund that was equally matched in amount by the employer. The employer then invested the collective amount on its predefined criteria, and the returns were compounded into each employee’s account. These PFs were also inadequately regulated in protecting the savings of employees. Until recently, the only regulation in place was The Employees Provident Fund Rules 1996, 2 which focused mostly on the reporting mechanisms of the funds. But in April 2018, the Securities and Exchange Commission of Pakistan (SECP) decided to regulate the unregulated employee’s PFs via Employees Contributory Funds (Investment in Listed Securities) Regulations, 2018, which placed certain limits and conditions for investment in listed securities. However, the regulations were new, and enforcement was yet to be witnessed, which meant that employees were at the behest of their employers who solely managed their entire hard-earned savings. In addition to regulatory issues, there existed no law obligating the private-sector employers to at least have a retirement savings plan in place. Employers could always choose to have none. It was for all these reasons that high uncertainty and dissatisfaction prevailed among most private-sector employees. Those who could understand the dynamics of retirement planning and afford to make (additional) out-of-pocket payments could enrol in a more autonomous and portable voluntary retirement scheme on a defined contribution basis.
Tehmina could relate to everything. Her employer’s PF worked in a similar arrangement. She had no say in asset allocation or investment management at all. She was completely at the behest of UMI’s decision-making for her retirement savings, and all that she could do was sit back and wait for UMI to post fund returns year after year. In August 2018, she wrote to the trustees of her PF enquiring about the fund’s asset allocation, risk profile and investment rules. To her disappointment, she never heard back from them, which prompted her to think about taking the loan against the PF and investing in some retirement scheme. Voluntary pension funds emerged as the natural choice.
Voluntary Pension Industry
A ‘Voluntary Pension System’ (VPS) was a personalized, fully funded defined contribution voluntary retirement savings framework in which the pool of investor-owned investments was managed by a licensed pension fund manager(s). Any salaried or self-employed individual, and even employers on behalf of their employees, could opt for this pension scheme. No restrictions applied to its participation except for certain legal bounds like age, national tax number, etc. A private-sector employee, for example, already covered by a defined contribution or PF saving scheme with an employer, could also separately invest in VPS. The modalities of VPS allowed for flexible retirement age, contributions, asset allocation choices and, above all, portability. Portability meant that investors were allowed to keep their savings and continue funding/investing in case they changed their job(s). VPS also gave a choice to change fund manager(s), in case of dissatisfaction with the performance of existing ones.
The market for VPS essentially emerged as an offshoot of mutual funds 3 (MFs) in 2005. The first conventional and shariah VPS in Pakistan was established in June 2007—almost 2 years after the adoption of VPS regulation 4 by SECP in 2005 and about 45 years after the launch of the first mutual fund in 1962. Until the establishment of VPS, mutual funds were the only available option for private-sector salaried and self-employed investors to save (including for old age). A brief overview of the growth of asset management companies (AMCs) and the growth of pension funds is given in Figure 1.
In 2007, a total of nine different life insurance firms and AMCs—legally sanctioned under VPS regulation—came through to fill the market gap and introduced voluntary pension funds. 5 These new funds sought to leverage onto their decades-worth of MF experience and expertise for the benefit of retirement saving investors. Merely within a decade, these VPS funds in particular and AMCs, in general, experienced remarkable growth. The number of voluntary pension plans grew to nineteen by 2017 from only seven in 2008, while the total number of AMCs (all bank-based) offering these nineteen plans grew to ten by 2017. The fund managers, depending on the asset class, charged the pension funds fees ranging from 0.5 per cent to 1.5 per cent per annum.
Further, the fund managers charged sales load up to 3 per cent of the contribution. A comprehensive list of VPS funds, their respective sub-funds and management fee are presented in Table 1. The total net assets of VPS (shariah and conventional combined) had similarly grown thirty-three-fold from PKR 771M in 2008 to PKR 25,257M by 2017. 6 As far as the investment demographics were concerned, conventional VPS had been dominated by people in the age bracket of 51–60+ years in terms of amount invested and by 30–50 years in terms of the number of investors. Shariah-compliant VPS also demonstrated a similar trend in both categories (refer to Figure 2). The most dominant player in the VPS market was ‘Al-Meezan Investment Management Limited’, with a market share of 36.09 per cent of the industry’s total assets under its management. 7 Interestingly, these VPS, like most global pension funds, invested their sums on patterns very similar to those of mutual funds (refer to Figure 3).
List of Pension Funds (and their sub-funds) as of 31 December 2017
The recent steep growth of this industry and gracious tax benefits implied a good bargain. Contributions made in VPS during a tax year were entitled to a tax credit under Section 63 of the Income Tax Ordinance, 2001. This effectively meant that a participant was allowed a tax credit equal to the effective tax on their actual contribution in the fund or 20 per cent of their taxable income for the year (whichever was lower) before the age of 41. An additional tax credit of 2 per cent per annum was allowed for participants at the age of 41 years or above, during the first 10 years, under a condition that the total contribution will not exceed 30 per cent of the total taxable income of the preceding year. The calculation of maximum tax credit allowed through investment in the pension fund is given in given in Table 2.
Tax Credit Through Pension Fund with Respect to Taxable Income
Participants also had the flexibility to choose retirement age anywhere between 60 and 70 years. Upon retirement, they could also withdraw up to 50 per cent of the accumulated balance lump sum and the rest in instalments as a pension. 8
Unlike the scantily regulated employees’ PFs, VPS was regulated by SECP under the Voluntary Pension System Rules, 2005. These rules were further enhanced in 2017 and an updated version of Voluntary Pension System Rules, 2005— incorporating all notifications and amendments till April 2017—was issued by SECP on 28 April 2017. 9 These regulations obliged pension fund managers to manage the funds’ assets in the best interest of the investors, in good faith and to the best of their abilities, without scoring any undue advantage(s) for themselves. SECP also required pension fund managers to maintain proper accounts and records to enable a complete and accurate view to be formed of the pension fund, to prepare and transmit the annual report together with the auditor’s report of the pension fund within 4 months of the closing of the accounting period to the commission and the participants. The books and accounts shall comply with requirements as set out.
To sum up, a comprehensive regulatory framework was in place for VPS, and the pension fund managers had over 40 years of experience and the legacy of the mutual fund industry. This was a relief for Tehmina. However, the enhanced autonomy in VPS and the presence of regulations still felt like a scourge in disguise to her. The full risk of investing her life savings in this modus operandi lay on her shoulders. One casual choice could pivot the odds against her. She doubted if the voluntary schemes were pushing her obliquely into accepting the same risks, or perhaps more, that she wanted to shun in the first place. She asked herself if it was any different from her employer’s retirement scheme. The only exciting perk of pension schemes was the tax credit worth her contributions to the fund or 20 per cent of her taxable income for the year (whichever was lower). But she had to measure if that additional benefit was commendable enough for her to accept the full risk.
Data Screening
After a meticulous deliberation, Tehmina decided to supplement her lookout for pension funds with data analysis. A bird’s-eye view of the industry alone did not serve the entire purpose. She, therefore, sat down with a paper and pen to scribble touchstones of her evaluation strategy. Although mutual funds and VPS worked parallel to each other—Mutual Fund Association of Pakistan (MuFAP) also categorized them alike—with no major differences at the operational level, Tehmina wanted to adhere to her objective of investing in a pension (equivalent) scheme that could provide her with a stream of monthly income when she would retire. VPS unequivocally resounded as a ‘natural alternative’ to her. She needed to gather the financial data of all nineteen functioning pension funds in Pakistan from a reliable database. However, she thought about evaluating her personal risk profile before moving to the data collection step in the process. She promptly pulled out a risk profiling form that she had received from one of the salespersons of a leading AMC. She began putting in her details to cumulate her risk score tally in a precisely quantitative manner (refer to Figure 4). She also collected some macroeconomic data like expected GDP, interest rate and the yield curve, and the equity market outlook (refer to Figure 5). These factors truly played a crucial role in looking at the bigger picture and making decisions when a lifetime of hard-earned money was at stake, perhaps more crucially when one was the principal breadwinner of the family. She was fortunately not, but she dwelled into many distracting thoughts like what if she was. Could she still take the risk. With all these thoughts, she began collecting as much historical data as she could for each of the nineteen pension funds. Unfortunately, some of the funds did not have accessible return data, so that she could collect only 96 months of consistent historical data across seventeen available funds. There was no return data available for two pension funds of Habib Bank Limited (HBL). The return data she collected was net of all fees (refer to Table S1). Tehmina then learnt from the State Bank of Pakistan (SBP) portal that the current 1-month Treasury bill rate was 5.996 per cent on an annualized basis.
Year-on-year CPI and discount rates in Pakistan since 2010
Way Forward
In general, Tehmina felt that saving for retirement was a low priority for her right now—retirement seemed far enough down the road that she could worry about it later. She found the UMI’s PF matching her payments a lucrative option, but she was not sure if she should solely rely on it after a low return in July 2018. She was not even sure if she should worry about saving for retirement at all at the moment. And if she did, she was not sure how to pick a fund. Albeit only a limited number of pension funds were available, what about those outside her guided barometer. All the data and information which she collected was interesting and statistics insightful; yet, they did not give her the absolute clarity that she had hoped for. She was still overwhelmed by the whole prospect of it all. Should she just go ahead with a VPS? Also, if she decided to go ahead with VPS, which AMCs, and portfolio manager(s) to allocate her savings to.
Supplemental Material
Supplemental material for this article is available online.
Footnotes
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.
Funding
The authors received no financial support for the research, authorship and/or publication of this article.
Notes
References
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