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National insurances under pressure


INTERNATIONAL MONETARY FUND

National insurances under pressure

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POPULATION AGING, SLOW economic growth and high unemployment are weighing on National Insurance Schemes (NIS) in the Caribbean. Recent demographic trends – declining fertility rates and rising life expectancy – have reduced the number of the economically active population and pushed up the share of the elderly.

Long-term projections point to continuing unfavourable demographic trends and large increases in pension spending.

In addition to demographic pressures, the region has been saddled with tepid economic growth, rising unemployment, widening fiscal deficits and elevated public debt levels since the onset of the 2008 global financial crisis.

Against this background, reforms to contain the growth of pension spending should figure prominently in fiscal consolidation strategies over the next several years.

The NIS in the Caribbean are pay-as-you-go (that is, they use employer and employee contributions to pay for retirees’ current benefits) and defined-benefit arrangements. Since their establishment in the 1960s, 1970s and 1980s, contribution incomes have exceeded benefit payments and administrative expenses for most countries and the systems have accumulated a large fund.

The schemes appear relatively sound until about 2017. Thereafter, they are projected to incur substantial deficits and eventually run down their assets, raising the prospects that the government would have to bear a share of the promised pension benefits.

These developments will take place as the authorities aim to scale up infrastructure spending, while at the same time, pursuing debt sustainability.

To avoid crowding out other priority expenditures, the authorities could, in the short term, implement parametric reforms that would help offset the impact of demographic pressures.

Phasing in these reforms now will prevent a significant build-up of pressures and avoid the need for drastic measures in the future.

The actuarial deficits calculated as the Present Discount Values (PDVs) of future benefit expenditure minus income over the period 2016-60 at a discount rate of five per cent, range from 0.7 per cent of GDP in Barbados to 92 per cent of GDP in Jamaica.

Thus, absent reforms, contingent liabilities of several percentage points of GDP could materialise in few countries, putting substantial pressure on public finances.

It is, therefore, imperative that these risks be mitigated by taking timely reform measures.

Raising the retirement age, freezing old-age pension benefits and increasing the contribution rate, taken together, would not be sufficient to effectively contain actuarial deficits for a few countries.

For these countries, we recommend that they also take measures to improve coverage of the scheme, with a view to reducing the old age dependency ratio.

Population aging is putting increasing pressure on public finances in the Caribbean.

Long-term projections point to continuing unfavourable demographic trends. Thus, pension schemes have become unsustainable. In addition, there is a concern that investment of pension funds may lead to high exposures to government securities.

These developments, together with anemic economic growth, rising unemployment, and limited room for macroeconomic policy intervention, suggests that pension reforms are unavoidable.

A range of reform measures, with varying socio-economic impact could be implemented to contain the projected increase in pension spending.

This paper quantifies the impact of three parametric reforms, highlighting their implications for economic growth, intergenerational equity, and fiscal savings.

In addition to containing demographic pressures, raising the retirement age would not only be inter-generationally fair, but could also have a positive effect on economic growth in the long run by increasing participation in the labour force.

At the same time, it will reduce the welfare of older workers and the unemployment of the young. An across-the-board freeze in old-age benefits for two years is shown to improve the financial position of the pension systems but it could somewhat dampen economic growth and, at the margin, could increase old-age poverty.

Finally, a one percentage point increase in the pension contribution rate would bring the contribution rate closer to global averages and improve the sustainability of the pension systems, but it could also discourage labour market participation and aggravate intergenerational imbalances.

For most countries, implementing these three reform measures concurrently would suffice to put the pension scheme on a sustainable path.

For other countries (such as Antigua and Barbuda, Belize, Jamaica, and St Vincent and the Grenadines) these measures would need to be complemented by improvement in the coverage of the pension schemes.

While the appropriate combination of the measures necessary to eliminate the actuarial deficits varies depending on each country’s circumstances, most countries need to undertake these reforms now or risk even higher taxes, lower growth and unsustainable debt dynamics.

Finally, it is imperative that the authorities begin to build national awareness of the fiscal risk associated with the pension schemes and the need for reforms.

At a minimum, the actuarial deficits should be systematically monitored and reported to the public with more frequency and a degree of detail to allow proper evaluation of the fiscal risk.

Taken from a new International Monetary Fund paper titled National Insurance Scheme Reforms in the Caribbean. It was authored by Koffie Nassar, Joel Okwuokei, Mike Li, Timothy Robinson and Saji Thomas.

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