administrators (PFAs), have so far produced negative real returns for pension savers. Third, the appropriateness of the institutional design of the reformed pension system is highly questionable. Among countries with funded pension systems, Nigeria has by far the lowest GDP per capita in the world. In addition, high degrees of financial instability and lack of appropriate investment outlets for pension savings cast doubt on the basic utility of the system. Fourth, in terms of the actual management of the current system the Nigerian Pension Commission (PenCom) as the regulator has been weak in enforcing regulatory compliance. For example, PenCom failed to enforce regulations stating that PFAs must report in a timely manner about the value of their Retirement Savings Accounts (RSAs). As a result, the regime of 'competition' between PFAs is meaningless as pension savers are unable to evaluate the pros and cons of investing with different PFAs. In conclusion, it is suggested that shortcomings of the current system are unlikely to be addressed by reform within the existing paradigm and that alternative policies, such as non-contributory universal social pensions, should be considered to expand basic social security in the Nigerian context.
Introduction: Funded Pensions in the Nigerian Political Economy
Shortcomings of the pre-2004 Nigerian pension systems, such as the existence of large-scale unfunded entitlements under the defined-benefit pension scheme for civil servants, matched by large-scale arrears of pension payments in all sectors of the system, were one reason the Nigerian reform was undertaken. However, the more prominent line of reasoning was that pension reform should allow Nigeria to use pension savings to provide long-term capital in order to develop financial markets and improve economic growth.
In the Nigerian case, analysis of how compulsory individual funded pensions might affect national savings levels and economic growth must be read against conventional wisdom. This is necessary in at least two respects. First, increased savings rates might not be desirable in a country characterized by large-scale poverty. Given the lack of basic social security in the present, forced saving for the future might not be rational or desirable either for individuals or for society at large. Using funded pensions to develop the Nigerian financial market to provide long-term funding for productive investment and higher growth in the future is an experiment rather than a precondition for development in the present.
Second, even if increased national savings and more developed capital markets were desirable in Nigeria, the existing scholarship on funded pensions points toward various barriers to achieving these objectives in low-income countries. Thus, it must be stressed that the academic literature does not offer support for funded pensions in the context of developing countries with a GDP as low as Nigeria's (Barr and Diamond 2008, 94-110, 159-73). The literature suggests a very close link between GDP per capita and the development of financial markets. It is held to be impossible to skip stages in the build-up of regulatory capabilities, and financial market development must be advanced enough to allow for funded pensions to contribute to the system.
In the Nigerian context, one can expect a mismatch between the accumulation of pension savings and the failure to find appropriate investment outlets that would produce real returns to pension savers. Some of the relevant problems with the funded pension system in the Nigerian context are outlined below.
The First Six Years of Nigerian Pension Reform
This section explores Nigeria's six years of practical reform experience since the passing of the federal Pension Reform Act in 2004 as follows: (1) a review of the debate on the outcome of pension reform within Nigeria; (2) a review of the role of PFAs; and (3) a survey of some features of the banking system and of some macroeconomic issues that might influence the funded pension system.
The outcome of pension reform within Nigeria raises the issue of how the assembled pension savings might be used for productive investment. For example, a Nigerian working group on finance recently expressed 'concerns about (lack of) sufficient depth in the capital market to effectively absorb the available and expected pension funds without causing a glut and overvaluation of existing capital market securities' (Nigerian National Planning Commission 2009, 43-44). However, deliberation has so far failed to produce new insights to enable future action and the problem of lack of suitable investment outlets remains the crucial policy-making dilemma (Stewart and Yermo 2009, 25).
In this context, analysis must now turn to the role of the pension fund administrators (PFAs) at the core of the funded pension system. Their ability to manage contributions over time in a manner that produces real returns to savers after inflation and deduction of management fees determines future pensioners' economic prospects. In the Nigerian regulatory system, PenCom issues guidelines on the maximum share of investment that PFAs are allowed to take out in different asset classes - government bonds, money market instruments issued by domestic banks, and selected domestic equities - and the pension fund custodian (PFC) holds savings on trust to separate asset holdings from the PFA's investment function. For their services, PenCom and the PFC each receive a share of the management fee, which used to amount overall to 3 percent and was cut to 2.25 percent in the second quarter of 2009. Currently, 1.6 percent goes to the PFA, 0.4 percent to the PFC, and 0.25 percent to PenCom.
Judging from the proliferation of PFAs since the start of the reform, management of Nigerian pension investments appears to be a good business proposition - at least as far as the PFAs themselves are concerned. Since an earlier survey on October 23, 2007 (Casey and Dostal 2008, 254), the number of PFAs has proliferated from 13 to 26, and the number of PFCs has increased from four to five (data from PenCom Web site, June 15, 2010). It is likely that the number of competing PFAs in the small Nigerian market (with around four million subscribers) is, in relative terms, the highest in the world.
In spite of the proliferation of PFAs, their competence must be questioned: they appear to fail to provide their customers with clear information about their investment strategy. A survey of PFA Web sites conducted in September 2009 showed that many had not been updated for at least two years. Moreover, virtually all companies were in breach of PenCom guidelines to publish the rate of return of their Retirement Savings Account (RSA) funds at the end of each financial year and to make the unit prices of their RSA funds readily accessible online (Pension Commission n.d.). In fact, only 14 PFAs (out of 26) provided any information about the value of their respective RSA units on their Web sites (see table 2). Of these, seven offered out-of-date or undated unit prices that lacked informational value. Of the seven that provided more recent data, only three provided sufficient data to calculate approximate rates of return, and only a single PFA provided full coverage of the value of the company's RSA unit since its inception, which allowed calculating the actual rate of return.
Table 2. Information Provided Online by 26 Licensed Nigerian Pension Fund Administrators
Information was compiled during a survey of PFA Web sites on September 10 - 11, 2009.
* Of the 26 licensed PFAs, 25 had a website. Four of those websites were no longer functioning.
The silence on rates of return appears to be no coincidence; once inflation and management charges are factored in, it appears to conceal negative returns. For the single case in which a PFA provided sufficient information (the PFA run by IBTC, a South African Bank), the real rate of return after inflation and charges between May 2, 2006, and September 2, 2009 can be calculated as negative (see box below and Dostal 2010, 29). This is significant, since the PFA in question is run by a bank that has been an acknowledged industry leader.
According to plausible assumptions, one must conclude in the case of all six remaining PFAs with recent RSA unit figures that their returns have been negative and in at least two cases highly negative. Since seven other PFAs provided only out-of-date or undated figures (all pointing toward negative returns), and 12 provided no data at all, one needs to suppose that the only successful participants in the system of funded accounts are the PFA companies themselves. These estimates by this author would need to be verified by making all the necessary data available for all 26 licensed PFAs. However, PenCom has not acted to enforce its own regulations and, given its own lack of compliance with regular reporting of activities, might not be in a position to complain.
The issue of how PFAs perform leads directly to the larger question of how the banking system, stock market, and macroeconomic performance of the Nigerian economy might interact with the funded pension system. Defenders of the current system would argue that it is too early to make any claims about the failure of funded pensions to have a positive impact on the economy. They would point to the global economic crisis and the 2008 crash of the Nigerian stock market as unexpected events that explain negative returns of PFAs but do not call into question the system's fundamental viability.
However, the lack of regulatory control of the financial markets might hurt the interests of savers in a number of ways and leaves Nigerian federal government bonds as the only 'safe' investment class for pension savings. If government bonds produce returns that are higher than the rate of inflation and management fees combined, the interests of savers might be protected. If not, they are eroded by the shortfall. The outcome ultimately depends on the type of macroeconomic management adopted; the expansionary monetary policies in Nigeria cast doubt on the viability of this strategy. In fact, it is still the state's public debt policy that determines returns of the 'private' pension system.
Last but not least, the 2004 reform has failed to allow for coverage of workers outside of the formal sector of employment. As it now stands, the funded pension system is isolated from larger social security concerns. It only caters to the needs of workers in the formal employment sector, and it does even that poorly. How PenCom is going to address these managerial and structural issues is everybody's guess.
Barr, N., and P. Diamond. 2008. Reforming pensions: Principles and policy choices. New York: Oxford University Press.
Casey, B., and J. M. Dostal. 2008. Pension reform in Nigeria: How not to 'learn from others.' Global Social Policy 8(2): 238-66.
Dostal, J. M. 2010. Nigerian Pension Reform 2004-2010: Great Leap or Inappropriate Policy Design? Korean Journal of Policy Studies 25(2): 13-37.
Nigerian National Planning Commission. 2009. Report of the Vision 2020 National Technical Working Group on Financial Sector. July. Abuja: Nigerian National Planning Commission. http://www.npc.gov.ng/downloads/Finance%20NTWG%20Report.pdf.
Pension Commission. n.d. Guidelines For The Publication Of Rates Of Return On RSA Funds By Pension Fund Administrators. [Published approximately late 2006.]
Stewart, F., and J. Yermo. 2009. Pensions in Africa. OECD Working Papers on Insurance and Private Pensions 30. Paris: Organisation for Economic Co-operation and Development.
About the author:
Jorg Michael Dostal (D.Phil, Oxon) is an Assistant Professor in the Graduate School of Public Administration, Seoul National University, Korea.
This executive summary is the brief version of an academic paper that was published in the most recent edition of the Korean Journal of Policy Studies (see bibliography above). The open access paper with full referencing is available here: http://gspa.snu.ac.kr/kjps/index.jsp
Article appears in the October 2010 edition of Financial Nigeria - a monthly development & finance journal. To subscribe to it, please complete the form here