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Femi Aborisade
Labour Consultant and Attorney-At-Law
Dept of Business Administration and Management Studies
The Polytechnic,

Ibadan, Oyo Nigeria
aborisadefemi@gmail.com

 

 

 


SAFETY NET AND VALUE ADDITION FOR PENSION CONTRIBUTORS UNDER THE NIGERIAN PENSION SYSTEM: A CRITICAL APPRAISAL

by Femi Aborisade
 
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INTRODUCTION

This paper analyses the Pension Reform Act with a view to identifying safety net provisions in the Act, if any, and the adequacy or otherwise of such provisions.

 

The paper first attempts to conceptually explain “safety net” by relying on the existing literature on the subject matter. Next, safety net provisions in the Pension laws of three industrial countries, namely, the US, the UK and Germany are examined. With the benefit of the insight offered in those three industrial countries, the Nigerian Pension Reform Act is analysed with a view to understanding its safety net provisions. Lastly, suggestions are made for improving the Pension law based on the lessons learned from the experiences of the three industrial countries and the reality of the Nigerian employment market.

SAFTY NET DEFINED

The classical definition of the term, “safety net” is that it is "the traditional instrument of almost all organized communities for dealing with destitution."[1] In other words, it refers to series of public assistance programs designed to prevent or relieve insecurity and poverty. Safety nets are usually targeted at the transient and chronically poor and those vulnerable to poverty such as the unemployed, the aged, children, the sick and people with special needs, including the physically challenged. The idea is to ensure that there is a minimum level of living standard beyond which no one should be allowed to fall at any point in time in the life cycle.

However, within the context of pension plans, “safety net” is not specifically or directly defined in the literature. But its usage suggests that it refers to protective measures or provisions in the law to safeguard the interests of pension plan sponsors, the employers, participating public or private agencies/institutions and pension contributors, in the event of imminent or actual difficulties that challenge the sustainability of pension schemes.

Imminent or actual difficulties to pension plans could arise for several reasons, depending on the type of pension system, Defined Benefits (DB) or the Defined Contribution (DC) system. For example, in a defined benefit pension plan, where the investment returns are lower than expected, assets in the plan may not be sufficient to pay retirees their benefits. Such a plan is considered underfunded, and the employer-sponsor would be expected to make up for the difference. Similarly, in a defined contribution plan, where employees make contributions to savings and retirement accounts, which are invested by Pension Fund Administrators, collapse in share values, company insolvency/bankruptcy, winding up, corruption and frauds, and so on, would mean that the pensioner’s savings for the future could simply be wiped out or go down the drain. The concern of “safety-net” is how to protect the interests of stakeholders in difficult situations.

However, the two points of view of looking at safety net would be considered in this paper.

Below, the safety net provisions in pension systems in the following three industrial countries[2], the US, UK and Germany are examined.

SAFETY NET IN THE US PENSION SYSTEM

Sprayregen, and Mazza[3] explain that the combined provisions of Chapter 11 of the United States Bankruptcy Code and Employee Retirement Income Security Act of 1974 (ERISA), as well as ERISA 4042 show that the US legal framework on insolvency and pension provide for both:

  • Voluntary termination, and
  • involuntary termination of pension plans.

VOLUNTARY OR SPONSOR-INITIATED TERMINATION OF PENSION PLAN

Under the Employee Retirement Income Security Act of 1974 (ERISA), a pension plan sponsor may be allowed to terminate its defined benefit pension plan if a bankruptcy court finds that termination of the plan is necessary for the sponsor to operate outside of bankruptcy, provided the criteria for termination are met. One of the criteria is that the terms and conditions of an existing collective agreement with the trade union would not thereby be violated. Once the criteria for termination are satisfied, the Pension Benefit Guaranty Corporation (PBGC), a quasi-governmental agency that insures and oversees the defined benefit pension system, may process a sponsor-initiated “distress termination”.

INVOLUNTARY TERMINATION

However, under ERISA §4042, the PBGC has been vested with the right to seek an “involuntary” termination of a pension plan in spite of any alleged limitations in the collective agreement with the unions, if:

·         the PBGC determines that, among other things, the plan has not been properly funded, or

·         the PBGC’s possible long-run loss with respect to the plan may be expected to increase unreasonably if the plan is not terminated.

PBGC’S ROLE POST TERMINATION

After the termination of an employer’s defined benefit pension plan, the PBGC takes over the administration of the plan by paying pension benefits. But such benefits are limited to a guaranteed maximum of about USD 47 000 per year, depending on certain factors such as a retiree’s age. However, the statutorily guaranteed benefits of certain categories of workers remain unaffected in the context of bankruptcy-induced termination because the PBGC is required to satisfy them. This has meant that the PBGC has a deficit, which is estimated to be about USD 108 billion on account of envisaged future pension plan terminations. However, such estimates are really just guesses, which depend on a number of assumptions.

From the foregoing, the pension system in the US protects employers through the right to terminate pension plans. It also affords contributors to recover to a limited extent while the benefits of some contributors remain protected by the PBGC absorbing and redeeming them. However, it has also been pointed out that for the large majority of employees, there is limited protection in the event of bankruptcy-induced termination. As Sprayregen, and Mazza point out:

 

…other employee losses (such as wage or job loss) suffered by employees in US bankruptcy cases are provided fewer protections. For example, the US Bankruptcy Code only allows workers unsecured, priority claims against their employer of up to USD 10 000 for unpaid wages earned up to 180 days prior to the company’s bankruptcy filing. 11 USC. §507(a)(4). If the employer ultimately fails to emerge from bankruptcy, then the employee may not be paid for lost wages because his or her claim will only be paid after claims of higher priority (e.g. secured or other priority creditors)[4].

SAFETY NET UNDER THE DEFINED CONTRIBUTORY PENSION SYSTEM

Sprayregen and Mazza[5] stress that the trend in the US today is a move to the defined contribution pension plan as opposed to the defined benefit system. Under this system, employees pension funds are not affected by bankruptcies but they are also not protected at all, as they enjoy or suffer, depending on the ups and downs of the economy. In the words of Sprayregen and Mazza:

 

It should also be noted that the trend in the US (and other countries) is now toward employer offerings of defined contribution plans in lieu of defined benefit plans. Thus employees will bear the market risk of a diminution in pension assets in the future. As a general matter, worker interests in defined contribution plans are not affected by corporate reorganisations or bankruptcy. This does not mean, however, that defined contribution plans are fully protected, because the funds in an employee’s defined contribution account ebb and flow with the vicissitudes of the market, thereby leaving workers exposed to potential pension benefit loss.

 

The Enron bankruptcy case in the United States highlighted this stark reality. In that case, employees’ defined contribution plans were heavily invested in Enron’s stock, which was rendered worthless as a result of the company’s bankruptcy filing. In addition, under US pension law, Enron’s rapid stock decline prevented employees from unloading the Enron stock in their defined contribution accounts. Thus, with Enron employees chained to a rapidly declining stock, their defined contribution plans suffered significant diminutions in value[6] (emphasis supplied)

SAFETY NET UNDER THE DEFINED CONTRIBUTION PENSION SYSTEM IN THE UNITED KINGDOM

The problem of pension plan termination is also a feature of pension crisis in the UK. According to Sprayregen and Mazza (2006)[7], approximately 60,000 people have lost part or all of their pension benefits in the United Kingdom as a result of recent pension terminations. In addition, as in the US, there has been a major change from defined benefits to defined contribution pension schemes, with huge savings. Moreover, changes to public sector pension schemes will result in public sector workers paying higher contributions, retiring later and receiving smaller pensions.

In order to address some of the problems afflicting the pension system, the British government enacted the Pensions Act[8] 2004. The Act introduced the Pension Protection Fund (PPF), which is similar to that of the United States’ PBGC.

The PPF is empowered to pay benefits[9] to retirees in the defined benefits plan, in the following circumstances[10]:

  • when an employer becomes insolvent, or
  • when there are insufficient assets to cover guaranteed levels of PPF pension compensation.

The source of compensation paid to contributors in the above circumstances is not the government. The PPF, like the PBGC, is not supported by the government. Rather, the PPF is funded by compulsory premiums charged to employers with pension plans covered by the PPF’s programme. Employers are required to pay a risk-based premium.[11]

Pension Regulator

The Act also provides for the Pension Regulator (TPR). The pension Regulator is empowered to secure extra financial contribution from a company by issuing a financial support direction (FSD)[12] or Contribution Notice (CN)[13] in the following situations:

  • the pension scheme is underfunded, and
  • the principal employer of the scheme is subject to an event - for example a takeover, sale of assets, or payment of dividend.

SAFETY NET UNDER THE THREE-TIER PENSION SYSTEM IN GERMANY

Germany operates a three-tier pension system rather than heavily relying on funded pension plans, as follows:

  • The first tier: the state-run mandatory pension system[14], which covers all employees.
  • The second tier: company-sponsored occupational pension schemes.[15]
  • The third tier: private pension planning.

The company-sponsored pension plans (the second-tier) are backed up by the general assets of the company and so do not need being “funded” by specific assets set aside for that purpose. To this extent, the problem of “underfunding” does not generally arise. For as long as the company is solvent, the pension obligation is deemed protected. However, the pension liabilities are treated as general unsecured liabilities of a company. In other words, other secured liabilities take priority over pension liabilities in the event of formal insolvency proceedings and the need to prioritize creditors’ claims. It should be noted however that this form of protection is no protection because, under general corporate insolvency law, where the assets of the insolvent company are insufficient to meet its liabilities, general creditors are greatly at risk because they do not enjoy priority.

In Germany, it is not legally obligatory for companies to offer pensions. But where a company offers pension plans, it is obligatory to abide by the law (Gesetz zur Verbesserung der Betrieblichen Altersversorgung), which stipulates how pension liabilities are to be administered in the event of restructuring or formal insolvency proceedings.

Sprayregen and Mazza (2006) explain that, according to the governing law, where a company commences a formal insolvency proceeding, a collective insurance scheme (the Pensionsicherungsverein, or PSV) assumes the pension liabilities and is subrogated (as a general unsecured creditor) to the claims of the beneficiaries.

The PSV is funded through contributions by companies operating the “non-funded pension plans” models.

A company may however opt out of the PSV or significantly lower its contributions to the PSV by[16]:

  • converting to “funded” models, or
  • transferring pension liabilities to a third party such as a pension insurance fund or life insurance company, or
  • setting aside specific assets to back pension obligations, through external investments.

Sprayregen and Mazza (2006) observe that there is an increasing trend by distressed investors in Germany to strategically use insolvency proceedings to shed pension liabilities and that the PSV has begun to raise concerns regarding its financial health. The authors presume that there may be a trend in Germany to move towards “funded” pension plans.

The comparative analysis of safety nets in the pension systems in the US, UK and Germany discussed above captures the concerns of certain categories of scholars and public agencies/ officials such as Sprayregen and Mazza (2006) - that the defined contribution system does not appear to be a definitive and effective solution to the problems of defined benefit system, particularly in the light of the Enron experience. Although from the point of view of the company, a move to a defined contribution scheme may significantly reduce the company’s costs. But from the workers’ standpoint, this also significantly reduces their benefits.

SAFETY NET UNDER THE NIGERIAN PENSION SYSTEM

The Nigerian pension system is an amalgam of both the Defined Benefit Pension Scheme and the Contribution Pension Scheme. The Pension Reform Act 2004 (as amended) is applicable to all employees in the Public Service of the Federation, Federal Capital Territory and the Private Sector[17], subject to Section 8(1) of the Act, which exempts two main categories of employees from the scheme, viz:

(i)                 employees who have 3 or less number of years to retire and who at the commencement of the new Act are entitled to existing scheme and

(ii)               judicial officers, particularly the chief Justice of the Supreme Court and all Justices of the Supreme Court and the Court of Appeal as provided under S. 291 of the Federal Republic of Nigeria, 1999.

It should however be noted that the Pension Reform (Amendment) Act, 2011 has also exempted members of the armed forces of the Federation and members of the Intelligence and Secret Services from the application of the Act.

Many of the States of the Federation still operate the partially funded Defined Benefit Pay As You Go (PAYG-DB) system as opposed to the mandatory Fully-Funded-Defined Contribution (FF-DC) system, which is prescribed under the pension Reform Act 2004. The States are being induced by the Pension Commission to fully implement the FF-DC system through all sorts of administrative rules and guidelines which provide that: 

The Commission’s Regulation on the Investment of Pension Fund Assets allows only States that have fully implemented the Contributory Pension Scheme (CPS) to access pension funds for the purpose of infrastructural development[18]

The central protection of pension funds under the Act is to be found under S. 52 (1)(d), which provides as follows:

(d) custodian company shall issue a guarantee to the full sum and value of pension funds and assets held by it or to be held by it; however, where the applicant custodian company is a subsidiary of a qualified parent company such guarantee shall be issued by that parent body.

Similarly, S. 98 protects pension funds kept with the PFC from being used to satisfy PFC’s creditors in the process of any liquidation proceedings. The section provides unequivocally as follows:

98.-( 1) Notwithstanding the provisions of any other enactment or law, no pension funds or assets kept with a custodian under this Act shall be used to meet the claims of any of the custodian's creditors in the event of liquidation of the custodian.

 

(2) In the case of winding up, liquidation or otherwise cessation of business of the custodian or any or all of its shareholders, the pension funds or assets in the custody of the custodian shall not be seized or be subject of execution of a judgment debt or stopped from transfer to another custodian.[19]

However, a key function of the PFA is to ensure that investments are made in pension funds, on behalf of the contributors, in accordance with the provisions of the Pension Reform Act.[20] The critical concern is: what happens in the event of stock market decline or bankruptcy/insolvency, winding up proceedings, virtual failure of companies in which pension funds have been invested, as in the case of Enron earlier referred to? It is doubtful if the protective measures in sections 52 (1)(d) and 98 of the Act are adequate to protect the interests of pensioners contributors who have sacrificed to make savings over their entire working lives. In the specific case of Nigeria, the simplest way to administer pension funds is to invest in oil reserves. Future oil price rises will almost certainly ensure that this is a more reliable investment than investing in private sector companies.

There are other general provisions that may be construed as being protective of pension funds. The critical question is that they appear weak and incapable of providing effective prevention of adverse developments or effective protection in the event of an occurrence of adverse developments. Such provisions include: 

·         S. 9(3), which provides that employers shall maintain life insurance policy in favour of the employee for a minimum of three times the annual total emolument of the employee.

·         S. 49, which provides for application by any person proposing to be a Pension Fund Administrator (PFA) or Pension Fund Custodian (PFC);

·         S. 50, which sets out the conditions to be met by applicants for the role of PFA or PFC;

·          S. 52, which itemizes qualification of a company to be licensed as a Pension Fund Custodian

·         S. 53, which provides for refusal of a license if the stipulated criteria are not met by an applicant for Pension Fund Custodian;

·          S. 54, which sets out the conditions for revocation of license, which conditions include being subject to insolvency proceedings and likelihood of being wound up;

·         S. 56, which makes provisions for keeping of proper books of account by the PFA and PFC;

·         S. 57, which requires annual reports by the PFA and PFC;

·         S. 58, which provides for reporting obligations of the external auditor, including exposing the likelihood of fraud, drawing attention to any evidence of any event which has led or is likely to lead to  material diminishing of the net assets of the pension fund administrator or custodian;

·         S. 69, which makes it mandatory for every PFA to maintain a statutory reserve fund which shall be credited annually with 12.5% of the net profit after tax or such other percentage of the net profit as the Commission may from time to time stipulate as contingency fund to meet claims for which it may be liable as determined by the Commission;

·         S. 70, which provides that all income earned from investment of pension funds shall be placed to the credit of individual retirement saving account holder save for clearly defined and reasonable fees, charges, costs and expenses of transactions made by the pension fund administrator;

·         S. 71(1), which makes provisions for (unspecified/defined) guaranteed minimum pension, as may be specified from time to time by the Commission;

·         S. 71(2), which provides that the Nigeria Social Insurance Trust Fund (NSITF) shall provide every contributing citizen Social Security Insurance Services other than pension in accordance with the NSITF Act 1993[21];

·         Ss. 72 and 73 on how pension funds are to be invested to ensure fair returns;

·         S. 74, which provides for the consent of the President before pension fund assets may be invested outside Nigeria.

·         Ss. 75 and 76, which provide against the PFA investing pension funds in shares and securities issued by itself or selling pension fund assets to itself, its shareholders, directors, their spouses, or its PFC.

·         Ss. 79 to 84, which set out provisions on investigation of the activities, books and accounts of PFAs, PFCs or Pension Department with a view to enforcing the Pension Act and ensuring that at any point in time, they have assets to cover their liabilities, etc.

THE DIRECTION THE PENSION SYSTEM SHOULD MOVE

It is pertinent to rethink the pension policy framework in Nigeria based on the inadequacies of safety nets in existing pension systems of DB and DC as practiced.

Indeed, as Idigbe[22] has pointed out, currently, there is no general and proper framework for the intermediated holding system (wherein securities or investments are indirectly held by account holders through intermediaries such as the PFAs), which addresses specific legal issues pertaining to:

a)                  certainty of the rights of the investor in the securities,

b)                  sufficient protection of investor from the claims of an insolvent intermediary’s general creditors,

c)                  ability of investor to recover all of its intermediated securities in the event of loss of securities in circumstances where the intermediary is unable to disclaim responsibility for the loss,

d)                 ability of investor to recover all of its intermediated securities in the event of shortfall in the pool of securities available to account holders, or

e)                  restricting ability of intermediary to set-off its obligations owed to the issuer against the securities of investors in the event of the issuer’s insolvency, etc..

On the basis of the foregoing analysis, shortcomings, concerns and lessons from the three industrial countries discussed in this paper, I advocate a pension system that combines features of the two existing main systems, the DB and DC plans. The high income earners, chief executives in big private sector establishments, whose level of income is high enough, could be made to operate under the DC system. The DB system should be established to cover the poor in both private and public sectors. The Pay-As-You-Go (PAYG) Defined Benefits scheme makes a lot more sense for governments/public sector. It eliminates extensive and expensive administrative structures such as the PFAs and PFCs in the Defined Contribution scheme introduced in the Pension Reform Act. The PAYG system is what the central government in Britain operates. Funded schemes (separate from the company, as provided in the Act) may be needed in the private sector to protect the workers in case of bankruptcy.

The government has a responsibility, not only to those it employs in the public sector, but also to the entire citizenry, including the unemployed, the self-employed and those employed in the private sector, at their old age, when they are weak to work or when there is no work. Apart from pension schemes maintained by private employers therefore, there is a need for a state-run mandatory pension system that covers all. In Britain, according to information obtained from a British friend, the state pension scheme covers effectively everyone and gives all elderly people at least equivalent of about N100,000 a month. Although this is hardly enough to live on in Britain. But the company or public sector pension schemes are in addition to the pension received from the mandatory small state scheme.

Pension benefits that are constitutionally extended to the President, Governors, top judicial officers should be guaranteed and extended to other citizens, particularly the poor classes that are vulnerable to shocks and changes in the economy. What is good for Mr. President is also good for ordinary persons. For example, the following provisions of the Constitution should be extended to vulnerable classes of Nigerians:

Any person who has held office as President or Vice-President shall be entitled to pension for life at a rate equivalent to the annual salary of the incumbent President or Vice-President.[23]

Any pension granted by virtue of subsection (5) of this section shall be a charge upon the Consolidated Revenue Fund of the Federation.[24]

A law should be made by House of Assembly to grant pension or gratuity

“to or in respect of a person who had held office as Governor or Deputy Governor and was not removed from office as a result of impeachment; and any pension granted by virtue of any provisions made in pursuance of this subsection shall be a charge upon the Consolidated Revenue Fund of the State”.[25]

Pensions shall be reviewed every five years or together with any Federal civil service salary reviews, whichever is earlier.[26]

Pensions in respect of service in the public service of the Federation shall not be taxed.[27]

Pensions shall be reviewed every five years or together with any state civil service salary reviews, whichever is earlier.[28]

Pensions in respect of service in the service of a State shall not be taxed[29]

The right to pension for life at a rate equivalent to the last salary and allowances of the person, subject to periodic reviews as provided for judicial officers in section 291(3), as follows:

(3) Any person who has held office as a judicial officer -

(a) for a period of not less than fifteen years shall, if he retires at or after the age of sixty-five years in the case of the Chief Justice of Nigeria, a Justice of the Supreme Court, the President of the court of Appeal or a Justice of the Court of Appeal or at or after the age of sixty years in any other case, be entitled to pension for life at a rate equivalent to his last annual salary and all his allowances in addition to any other retirement benefits to which he may be entitled.[30]

A person who has held office as Chairman or member of the Code of Conduct Tribunal for a period of not less than ten years shall, if he retires at the age of seventy years, be entitled to pension for life at a rate equivalent to his last annual salary in addition to other retirement benefits to which he may be entitled.[31]

Finally, the following provision relating to pension should be implemented for the deprived classes, without exception:

that suitable and adequate shelter, suitable and adequate food, reasonable national minimum living wage, old age care and pensions, and unemployment, sick benefits and welfare of the disabled are provided for all citizens.[32]

CONCLUSION

Without doubt, the Pension Reform Act, 2004 contains some limited protective provisions, to safeguard pension funds, as against PFAs and PFCs – provided the Act is enforced and observed. However, pension funds are still subject to the risks of market failures, which may involve companies’ securities in which the funds are invested. It does not appear that the existing legal framework has adequately addressed the likelihood of such phenomena. For the public sector, such risks can be avoided by operating the Pay As You Go scheme, which is based on budgetary allocation by government. Unfortunately, this is being replaced by the Defined Contribution system, which will increase the risks and uncertainties of public sector workers to survive financially after they retire.

The above concern suggests that the Pension Reform Act ought to be amended such that there is a responsibility for the State/government to operate a mandatory pension system that covers all citizens. This is particularly important in the context of a trend in which opportunities for guaranteed employment (for a long time until retirement) appear to be fast disappearing. What appears more certain today is a life dominated by unemployment, short term employment, casual and contract employments. The Nigerian pension system should be located within the context of S. 16(2)(d), which guarantees pension at a time when the individual is too weak to work, or becomes disabled for whatever reason or cannot find job even when he is willing and able to work at old age. Therein lies an enduring solution to revamping the economy, encouraging production of goods and services, enhancing purchasing power, creating jobs, tackling corruption, curbing the unprecedented rate of criminality, and so on. 

Thank you for your attention. 

Femi Aborisade


Constitution of the Federal Republic of Nigeria, CFRN, S. 210(3)
Constitution of the Federal Republic of Nigeria, CFRN, S. 210(4)
Constitution of the Federal Republic of Nigeria, CFRN, S. 291(3).
Constitution of the Federal Republic of Nigeria, CFRN, S.17(2).
Constitution of the Federal Republic of Nigeria, CFRN, S. 16(2)(d).

 

 




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