It must be very difficult being Portia Simpson-Miller. As the current minister with responsibility for social security, she is the person who has to deal with one of the biggest crises facing the country today - pensions, or rather, the lack thereof.

For example, look at the following problems:
About 70,000 working-age people make some sort of contribution to a company or individual pension plan. But, about 1,000,000 do not !

Today's 40-year-olds are as likely to live beyond the age of 70 as are their parents likely to live beyond the age of 65. One in four women aged 40 is expected to live beyond the age of 95!

It is clear that the government has potentially got a lot of longer-living, non-saving people on their hands, and that something has to be done. Add to that the fact that working people are being encouraged to retire earlier than previously, and you see that the problem is exacerbated.

But what is this entity we call a pension? A pension is nothing more than a regular stream of income paid to a retired person. The pension may be paid once per month, once every three months, or even once per year. This is all well and good, but as with everything in life, there is a cost attached. Funds have to be on hand when persons retire, from which to make these income payments. Pension provision can involve a significant cost to whoever is going to provide the pension. So, who provides the pension? How is this achieved? Contributions, which include deductions from employees' salaries, as well as contributions from a sponsoring employer, are invested with an investment manager, and these funds build up over time, eventually providing the capital to pay the pensions at employees' retirement. In Jamaica, contributions up to 10 per cent of employees' salaries can be deducted before any tax is paid.

Pensions can be provided by:

. The Government
. Employers or groups of employers
. Individuals or groups of individuals

Employer-sponsored pension schemes and individual personal provision are generally designed to complement Government provision, or more particularly, to compensate for deficiencies in it. Personal provision only occurs where the individual chooses to save for certain benefits or take out insurance against certain risks. This may boost provision by the Government and/or an employer. Alternatively, it may provide benefits currently unavailable from these providers, or for those who are not eligible for the benefits.

The Role of The Government

The Government has a major role in the provision of pensions. This may be through direct provision, through encouragement of provision, or through the regulation of provision from other providers. With life expectancy in the modern world extending way beyond working age, retirement pension benefits become financially very significant! Sadly, they are often not recognised as such by the potential recipients. Here the Government should have its greatest role in order to try and ensure the population receives or has the opportunity to receive some form of income after retirement.

The Government may not be able to pass the responsibility for the provision of retirement benefits completely to individuals. After all, many people will simply not earn enough money in their working lifetime to accumulate the capital required to provide an adequate level of income in retirement. Passing the responsibility onto employers may assist low-paid employees, but it will not alleviate the problems for the self-employed or the un-employed.

The political, economic and fiscal viewpoints of the Government will determine the precise roles that it will play. However, the roles are likely to fall within the following categories:

. Provide pensions to some or all of the population. This is currently being done, but, for many, not at a level that can maintain a decent standard of living;

. Educate or require education about the importance of providing for the future;

. Regulate to encourage or compel pension provision by or on behalf of some of the population;

. Regulate bodies providing benefits, and those bodies with custody of funds, in an attempt to ensure security for promises made or expectations created. This latter role has been realised with the responsibility for the regulation of pension schemes being passed to the Financial Services Commission.

The Role of The Employer

Like the Government, employers can play a role in educating and either encouraging or compelling their employees to plan pension provision. However, perhaps the most significant role that can be played by employers is the financing of benefits for their employees.

Such financing may result from:-

. Compulsion or encouragement from the Government

. A paternalistic desire to look after employees and their dependents financially beyond the level provided by the Government, or

. A desire to attract and retain the services of good quality employees.

Employers have commercial objectives as well as benevolent intentions. These usually stem from a desire to maximise profits, by developing the business and attracting and retaining the right staff. These commercial objectives include:

. Providing benefits that employees perceive to be attractive;

. Providing benefits that are at least in line with those offered by competing employers;

. Take advantage of the tax incentives offered by the Government;

. Rewarding loyal and long-serving members of staff;

. Controlling costs.

In providing the facility for the provision of pensions, ie a scheme, the employer has greater control over the level of benefits being provided and the costs involved in that provision. Establishing a scheme can help to ensure a consistent approach to pension provision between employees. At one extreme, the employer may agree to meet the full cost of all benefits. At the other extreme, the employer may simply contribute the minimum required under the law.

The Role of The Individual

Like employers, the main role that individuals can play in the provision of pensions is in the financing of the pensions. This may result from compulsion or encouragement from either the Government or an employer or a personal desire for larger pensions for themselves or their dependants than are provided by either the Government or an employer. The financing may be through a formal pension scheme operated by the employer, an insurer or other financial organisation. Alternatively, it may be by way of non-specific individual savings.

In an environment without compulsion or encouragement, individuals will have to find a balance between need and affordability. The appropriate balance will depend on each individual's relative utility of money spent on pensions and money spent on other goods and services. One would think that the balance may be tilted by the existence of financial incentives, e.g beneficial tax treatment, as exists now, but the figures above indicate otherwise!!

An individual can provide through one or more of the following:

. Employer schemes;
. Personal schemes;
. General savings.

Types of Retirement Benefit Schemes
There are three main types of retirement benefit scheme (Pension scheme):

. Defined benefit;
. Defined contribution;
. A hybrid of the two.

Defined Benefit Schemes
A defined benefit scheme is one in which the benefits are defined in advance. The benefit may be fixed, related to the period of employment, related to some form of inflation, or related to the individual's own salary at or near retirement (final salary). For example a scheme may provide a lump sum of $100,000 or a fixed pension of $10,000 per annum for each year of service. The retirement benefit may reflect both an employee's final salary and service with an employer.
This type of scheme is known as a final salary scheme. e,g a scheme may provide a retirement pension equal to 2% of salary close to retirement for each year of service.

There are also schemes that base the benefit on an individual's career earnings rather than final earnings.
However, to be meaningful, the career earnings would have to be revalued in line with some form of inflation index, to reduce the eroding effect of inflation. There can be different periods of averaging, e.g. last five years or last three years. The longer the averaging period used, the greater the need for revaluation.

The cost of providing the benefits is not known precisely until all the benefits cease to be paid. Estimates can be made in advance on the basis of assumptions about future investment returns, employment patterns and inflation, to determine regular contributions for funding purposes. However, the ultimate cost of the scheme will depend on the actual experience of these factors. Members may be required to contribute towards the cost of their defined benefit provision, although this will be at a fixed level. The employer will then meet the balance of the cost. The total contribution rate, from employer and employee, usually varies according to how the funds held compare with the estimated cost of the benefits. If the scheme experience is better than expected then, at times, the employer may be required to make only a token contribution.

Defined Contribution Schemes (Or Money Purchase Schemes)

A defined contribution scheme is one that provides benefits on a money purchase basis. The member's benefits are determined by reference to contributions paid into the scheme in respect of that member, usually increased by the investment return on those contributions. The amount that the employee and employer contribute to the scheme is defined and accumulates in a specific account for each member. The benefit that will be provided to the member is not defined in advance, but will depend on:

. How much has been paid in;

. The investment return on the funds during the period up to retirement, and

. The cost of buying a pension at the time it is required.
Under this type of scheme, the cost to the employer and employees is known, but the level of benefit is not known in advance. However, defined contribution schemes can provide more flexibility in benefit delivery than can defined benefit schemes. The employee can often choose how to use the account for the purposes of providing an individual pension, pension benefits for dependants or a cash sum.
They offer good flexibility and adaptability to an individual's personal choices and needs. However, employees need to receive sufficient information and understanding ot make an informed choice regarding the flexibility in benefits.

Investment Risk

One of the key differences between defined benefit schemes and defined contribution schemes is the issue of who bears the investment risk.

In a defined benefit scheme, the sponsor carries the investment risk. The cost to the sponsor of providing the benefits will be higher than expected if investment returns are unfavourable, and lower than expected if returns are favourable. The members' benefits will be unchanged.

In a defined contribution scheme, the members carry the investment risk. The members' benefits will be lower than expected if investment returns are unfavourable, and greater than expected if investment returns are favourable. The sponsor's cost will be unchanged.

There are many other risks associated with pension schemes, but these will be looked at in future articles.

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