Many years ago in advanced economies, a company might make a promise to pay pensions without setting aside any funds to support this promise. As these arrangements became more formal, government regulations were established to ensure the promised pensions were available and required that companies put aside the necessary funds to ensure that pensions were paid.
Once companies were required to set aside monies to fund their pension promises, it became attractive to invest these funds to earn a higher return that would lower the cost of providing pensions. Without debating the finer points of pension plan law, we can say that pension plans exist to provide post-retirement income to employees. A pension plan is really a number of promises to pay people income after retirement.
In Nigeria, before the Reformed Pension Act of 2004 which gave momentum to contributory pension by both employers and employees cutting across the public and private sectors, the traditional “defined benefit” pension plan is distinct according to a formula specified in the plan documents. This usually takes the form of a percentage of the “best years” of salary. The traditional pension system was only applicable to the public sector. The promise by government to pay pension was a knotty task, leaving pensioners in a state of pity from accrued pensions, in some instances, ranging several years after retirement. That was the norm. However, with the Reformed Pension Act of 2004, employees or retiring employees need not wait endlessly for their pension to be paid, as their contribution is vested in a fund that is managed by professionals (other than government or employers) in the form of investment which yields additional income to the deposits or contributions.
Pension plans are usually considered “patient capital” because of their long time horizon. The types of investments undertaken by a pension fund depend on its objectives and constraints which are provided for in its “investment policy statement”. Legislation demands a “prudent approach” of diversifying risk across a number of securities or asset types. Taking prudence into account, pension funds strive to achieve the highest practical return which lowers the cost of their pension “obligation” considerably. Pension funds can invest in many different types of financial securities and can own assets directly. The type of investments undertaken by a pension fund depends on its investment policy statement. The nature of the investments allowed in the policy statement depends in a large part on the financial situation of the plan. Generally, the better the finances and the younger the plan participants, the more riskier the investments that can be held by the plan.
Being a part of the financial sector of any economy, pension funds must consider the basic economic indices before investing its contributors’ funds into financial securities (including government securities). At any point in time, an actuary can calculate how much money must be set aside to cover the future cost of pensions, given an investment return until eventual retirement; but this could only be successful in a deafening economy in order to achieve the aim and objectives of the pension scheme. Unlike the commercial banks and their mini contemporaries, the Micro Finance Institutions (MFIs) who had developed the normal bumper harvest of declaring huge profits at the expense of the economy, the pension funds may likely be at a better side to consolidate the economy towards growth and buoyancy. As it stands today in Nigeria with interest/lending rate jetting towards a high 23% and government issuing treasury bills/certificates hovering around 8.5%, commercial banks will be seen to be at a profitable stand, yet not financially healthy to meet the growing demand of the economy as borrowers of funds for plausible investment propels are terrified away by super high lending rates and left in an awe to watch such investment ideas wash away.
It is not so long ago that companies would put their pension funds in government bonds or life insurance company annuities. As inflation rises, companies found that rising salaries and low fixed-income returns made their pension plans very expensive. If economic growth explained all of the poverty reduction, then the path to eliminating poverty would. Giving that there exists a Save Withdrawal Rate in the pension fund, available cash with pension funds can be provided to the public at a single digit interest rate (maximum of 9%), while government complement their efforts to compete financially by issuing treasury bills at a minimal rate, as this will be the country’s path to eliminating poverty.
The practice across the globe was that pension funds turned increasingly to investment in equities to obtain a higher return and lower the eventual cost of their pension plans. More so, it would be suggested that pension funds embrace plans to begin to place funds in direct real estate investment, venture capital and mortgages. These measures had shown tremendous results for most advance economies; properly established economic variables like the interest rates and treasury bills rate has awakened growth indices and in turn, drastically reduced the poverty rates. In the Southeast Asia, for instance, poverty incidence declined dramatically and long-term economic growth has been impressive throughout most of the region, despite temporary setbacks like the financial crisis of 1997-98. This has simply been the maximization of the sustainable rate of growth by the government through the empowerment of the financial sector with favourable treasury bills at rates lower than Savings/Deposit rates. Overall, I think this is a much better strategy than one of wealth preservation which the country’s commercial banks had fashioned into with the apex aim of maximising profit from government’s treasury bills over the years.
Salim Salihu Muhammed
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