The Voluntary Pension System What is the Future? Pakistan Society of Actuaries Seminar on Private Sector Retirement Schemes 14 th May 2013 Presentation by Nasim Beg

VPS – Key Features Designed to manage individualised pension savings during accumulation as well as the consumption stage Low fee structures and distribution commissions Structured as a unit trust with three sub-funds representing equity, debt and the money-market asset classes. Commodity asset class announced by SECP last week. Thus, asset allocation can be managed and optimised for each each individual (unlike other retirement fund structures) 2

VPS – Key Features Continued Open to all Pakistani individuals, employed, unemployed, self-employed etc., irrespective of their being beneficiaries of any other retirement schemes. Investment can be built up in small amounts of savings from time to time (as and when the saver has the ability to invest) Employers can contribute as well but cannot tie employee to any vesting period. Tax incentive at three levels – rebate relating to amounts invested in the scheme and tax free accumulation of investments in the scheme. Tax exemption on drawings during retirement provided certain conditions are met. 3

VPS – Key Features Continued VPS plans offered by several Pension Fund Managers licensed by the SECP Plans offered under conventional as well as Shariah compliant schemes Plans include life-cycle asset allocation structures at accumulation stage; and Orderly, inflation-risk-managed drawdown plans during retirement Savers have choice of changing Fund Managers and Plans 4

Hindsight – Some design defects The sub funds should have been structured as index funds. Expecting the Fund Management Company of today to retain alpha creating ability over a 60- year period is a bit optimistic Current system requires Fund Managers to be assessed against the average performance of peer group. This can lead to excessive risk taking and unnecessary churning 5

How VPS has done thus far Total funds under management Rs 4 billion, (VPS started in June 2007). This compares with Rs316 billion AUM of Mutual Funds. The biggest challenge is our extremely low propensity to save, as indicated on next slide : 6

Gross National Savings (as % GDP)2011 Afghanistan28.7 Bangladesh29.1 China51.3 Hong Kong28.1 India31.6 Malaysia34.6 Pakistan13.2 Philippines24.9 Singapore44.4 South Korea31.8 Sri Lanka20.3 Thailand30.1 (Source: World Economic Outlook - IMF) 7

Challenges Employees by far and large are used to the idea of employers’ promises of pension and have not as yet realised that the DB system is on the way out DC transfers the burden of taking the right investment decisions to the saver (with little or no financial literacy) Self employed do not normally save and invest specifically with the objective of providing for retirement Preference to invest in National Savings Schemes and real estate (No KYC or AML Regulations and weak tax reporting) 8

Challenges Lack of understanding of the need to match the quantum of savings with the objective for which one is saving. Lets look it it very simplistically – a few assumptions: that most people are at best able to achieve investment returns equal to inflation over the long term. an inflation free economy and a person working 40 years at a fixed wage of Rs.10,000 per month that this person saves 10% of the wage towards retirement that this person will consume the accumulated savings over a period of 20 years once retired. the amount available to this person will be Rs. 2,000 per month during the 20 years, i.e., an income replacement ratio of 20% where the person does not advance from entry level position If we assume a growth in wage of 5% per annum attributable to advancement in the organisation, the income replacement ratio works out to 9% of the last drawn wage. 9

Challenges Expecting that less than the required amount of savings will somehow meet the ultimate objective through clever investing. Life-cycle asset allocation can help but it cannot produce magical results Stories of market manipulation and lack of understanding the risk associated with each asset class keeps the average saver away from having an equity allocation Low availability/under-developed market for investible securities In most developed economies, an average family could buy a home on mortgage and had the option of selling it to supplement retirement income but this is not likely to continue and will certainly not happen in Pakistan – as DB structures die out and life insurance remains stagnant; this will also become an issue in the developed economies as appetite for long-term bonds (from DB funds) diminishes 10

Conclusion Given our low propensity to save, not much of a future for voluntary savings; we need to introduce mandatory savings VPS can be one of the vehicles for investing mandatory saving. However, if we move to index fund structures, we will only need an administrator and can do away with Fund Managers EOBI is a mandatory structure (though not universal) but grossly under funded. The employer contributes 5% and the employee 1% of the minimum wage. The pay out usually ranges around 25% but is 45% of minimum wage. EOBI will need to be bailed out at this rate. Political will is needed to introduce mandatory savings, which are meaningful and extremely well regulated 11

Thank you for your attention 12