Are Nigerians better off with a pension plan?

Gbemi is 25 years old with an annual gross salary of ₦4,800,000. She and her employer save ₦864,000 every year towards her pension. By the time she retires at 60 if the current trend of inflation (18.6%) continues and her salary doesn’t change, her ₦30.2 million saved will only be worth ₦25 million.
 

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The scenario above has been playing out across the country in multiples. Some Nigerians have even taken to sharing their frustrations online. The truth is, public opinion about pensions hasn't been the best, and people are worried about the value of their pensions dropping. These concerns are valid, given the rising rate of inflation eroding the returns people get on their savings toward retirement.

This declining value in pension assets is not peculiar to Nigeria. Due to inflation, many pension schemes in the UK have been forced to sell off assets, such as equities, to secure their long-term plans and reduce the risk of being unable to pay the retirement income promised to members.

Unfortunately, with such value erosion, some Nigerians are now considering dropping out of the pension scheme altogether. For instance, one tweet solicited the government to cancel pensions, making it voluntary as opposed to the current compulsion. Although the reason behind this advocacy was primarily based on value erosion, the writer raised other issues showing she had little trust in Nigeria’s pension scheme.

Lower returns on pensions might discourage people from buying into the idea of saving for their future. But does this mean there are no ways of convincing workers to stick with a pension plan beyond making it compulsory?

Several studies show pension funds are essential, not just for individuals but for the broader economy. Given the current macroeconomic environment, we need to unpack whether Nigerians are still better off with a pension plan. 

To do this, we will look at the importance of pensions for the ordinary Nigerian, the government and the economy. We will also assess the performance of other factors that should protect pension funds from inflation. Then we will conclude by examining whether this performance and other incentives are sufficient to satisfy workers enough to keep up with their pension plans.
 

Why do pensions matter?

Let’s look at three reasons. Pension plans provide income for ordinary Nigerians when they’ve stopped working. It also helps the government and other employers of labour meet obligations like gratuity promised to people when securing employment. Lastly, pensions are a source of funds that help the growth of a country’s domestic capital market.

The first reason—getting paid without working—is pretty obvious. Pensions are regular payments made to individuals that have retired from working. The official retirement age in Nigeria is 60 years, or after 35 years of public service. But this varies per sector. For instance, Nigerian teachers retire at 65 or after 40 years in service.

So, if you stopped working at 60 years, these payments, usually from an investment fund or account that workers and their employer(s) contributed to when they were in the workforce, will continue to go to the workers till their death or an estimated lifespan. There are different ways retirement benefits are paid in Nigeria. But the point is that pensions help people earn a living after they’ve stopped working.

Pensions are also more economical when considering care for our older population. Nigeria is a young nation with a median age of 18 years. But the country’s elderly population (60+ years) is estimated to increase from 10 million (5% of the population) today to 36 million (9% of the population) by 2050. Without a pension plan, the next best thing is a tax-funded benefit scheme, which would impose a severe burden on Nigeria’s already stretched finances and prevent the retired workers from getting their benefits. This was the norm before 2004, when the government enacted the Pension Reform Act (PRA).

Before 2004, getting your pension was a nightmare in Nigeria. Employers used to have confusing schemes that did not inspire confidence in the employees. In the private sector, some schemes were less than beneficial and often implemented in ways that short-changed workers. Also, the public service operated the Defined Benefit Scheme (DBS), under which retirees were entitled to a life pension based on years of service and hierarchy.

However, economic challenges and fiscal crises caused arrears of pension payments to government retirees to pile up. Pensions were budgeted annually but only paid if there was funding, which was usually the least on the priority list. The reality is that the new contributory pension scheme (CPS) provided a sustainable method for the government to provide income for the elderly.

And the last reason I’ll explain is that pensions provide much-needed patient capital and spur growth in our domestic financial markets. All the money contributed to different pension fund administrators (PFAs) does not just sit in one account. The PFAs invest these funds in several assets such as bonds and equities, serving as cheap capital that helps businesses to grow and the economy thrive.

According to a study on the matter, total pension investments in Nigeria improved the performance of the Nigerian capital market significantly in terms of depth, liquidity (market capitalisation) and value traded. The study showed that a 1% increase in pension funds investments between 2009 and 2016 led to a 3% increase in Nigeria’s total capital market capitalisation in the same period. A more recent study corroborated this finding. However, both research studies noted that other factors such as inflation and exchange rate stability also play a key role in the capital market’s performance, not just pension funds alone.

We’ve seen how pension matters for the government, pensioners and even the economy. But is this enough to drive away the apathy for pensions in Nigeria?

Some unhappy returns

Nigeria’s pension industry regulator or PenCom set a target of providing pension coverage for at least 30% of the workforce by 2024. This means at least 17 million people should be contributors by next year, but pension contributors are still about 10 million. Yet, when we look at the assets under management in the industry, we see a positive growth trajectory. In the last decade, total pension fund assets have multiplied six-fold, from ₦2.3 trillion in 2011 to nearly ₦14 trillion as of March 2022.

But this is thanks to the rapid increase in net asset value (NAV) of total pension contributions recorded in the early to mid-2000s. For instance, NAV grew by an average of 32% between 2008 and 2013. These were healthy growth rates for people to recover returns compared to an average 12% inflation rate during the same period. 

However, growth rates in pension assets have dropped to an average of 16% since 2014, while inflation has averaged 13% in the same period leaving little room to recoup investments.

These slowing investment returns explain why pension contributors might worry about the decline in the worth of their pension balance. As I described earlier, the whole point of a pension is to preserve or grow whatever wealth you save today for the future.

Pension fund administrators (PFAs) try to do this (preserve and grow wealth) by investing in several assets such as equities and bonds that can deliver returns. Essentially, using the investment to fight inflation.

But investment returns are growing too slowly. Pension contributors belong to several schemes that invest their contributions into several funds. The schemes are the Retirement Savings Account (RSA), the Closed Pension Fund, Administrator (CPFA) and the Approved Existing Schemes (AES).

However, we will focus on the performance of RSA funds because it is the largest, comprising over 99% of the total contributors in the industry. As of 31 March 2022, ₦6.2 trillion, representing 64% of the funds' total active assets, was invested in Federal Government securities.

But in the first quarter of this year, interest/coupons received on investments in fixed income securities amounted to ₦228.1 billion. The amount indicated a 5% decrease compared to the sum of ₦239.72billion recorded in Q4’2021. This decrease resulted from poor yields on additional investments/reinvestments in short-tenured fixed income securities during the period.

As we can see from the chart, yields across most naira-denominated fixed income assets have increased over time, indicating a negative bond market performance. Investors have been selling off naira assets due to the uncertainty over the naira being devalued, and the higher interest rate environment in advanced economies.

But even with the latest hikes in interest rates, which should make fixed income assets more attractive, we've argued that this move is not significant enough to boost investor confidence to sufficiently improve the bonds market. Hence, the performance of asset classes such as bonds—which make up the more significant part of pension fund assets—might not recover anytime soon.

On the other hand, returns in the form of dividends from the equity market (domestic and foreign), where about 7% or ₦1.04 trillion of pension fund contributions were invested, quadrupled. RSA active funds received dividends of ₦23 billion in Q1’2022 compared to ₦5.7 billion in Q4’2021, representing a ₦17 billion or four-fold increase.

Essentially, equity investment performed better than fixed income in the first quarter of this year. But, the bulk of investment was in fixed income, which robbed the industry of potential returns. However, this is no fault of Pension Fund Administrators (PFAs). All investments of pension funds by PFAs are made per guidelines and regulations issued by the Commission and guided by the primary objectives of safety and maintenance of fair returns.

You might wonder how PFAs can maintain retirement payments if such performance continues. Frankly, there is little pressure on the PFAs, considering that Nigeria is still a young nation with a median age of 18. So, currently, the pension industry can sustain payments because of net contributions, i.e. the value of current and new contributors outweigh the value paid to retirees.

This means PFAs have money to pay retirees and don’t need to sell off assets, as we saw in the UK at the beginning of this article. According to PenCom’s 2021 annual report, pension contributions are adequate for the industry to record a net inflow, amounting to an average of ₦75 billion monthly. This is almost equal to the total of ₦74.6 billion paid as retirement benefits for the entire Q1’2022.

The monthly contribution figure of ₦75 billion is also expected to rise mainly due to the ongoing efforts to expand pension coverage and implement additional measures to recover outstanding pension contributions and accrued penalty charges from defaulting employers.

However, return on investments and price appreciation of assets such as equities and bonds in the portfolio of each pension fund is still the major source of growth for the industry—it keeps the cycle moving. And there is reason to worry about declining returns in an asset class where over 60% of the industry’s funds are invested.
 

Taking back control

From my observations, it is clear that PenCom (the industry regulator) realises these challenges. Lately, the Commission has taken to announcing more aggressive strategies aimed at driving pension participation.

PenCom is planning for RSA holders to use their pension accounts to access loans or pay for mortgage plans. To be honest, the mortgage industry itself needs an overhaul. Regardless, increased access to finance to fund large ticket purchases (like buying a house) is one proven way to improve the quality of people’s lives and even boost economic growth. Another notable strategy involves providing basic health insurance through pension schemes. This added layer of security (access to healthcare) should boost the benefit of contributing to a pension.

 You see, most human beings tend to be shortsighted, preferring to take decisions that will benefit them today instead of sometime in the future. So, offering health insurance to workers from when they are still working in addition to a pension scheme will ensure workers start to feel the benefits of participating in pensions and improve their perception of it immediately. 

PenCom's health insurance is also strategically targeted at micro pension plans for informal sector workers, who comprise nearly 70% of the country’s workforce. Yet only about 77,000 informal sector workers contribute to the micro pension plan as of March 31, 2022, compared to 9.7 million pension contributors from the formal sector.

However, if these incentives roll out today, they are barely enough to encourage more people to embrace pensions. The direct erosion of people’s wages during double-digit inflation still bites.

Ultimately, the direct solution to the inflation issue will mean better fiscal policies addressing the structural factors that drive high and rising inflation in Nigeria’s economy. This is why it’s not just enough for the government to encourage increased active pension contributions. The way the government uses proceeds from bonds matters too.

Remember, when the government raises bonds to fix infrastructure, the result is usually to drive economic growth and slow down the rise of prices. 

Better roads or working rail lines mean smoother and cheaper transportation which doesn’t add to rising prices (inflation) and wealth erosion. It also means there are opportunities to raise more attractive bonds that improve the value of assets held by pension contributions. It’s a cycle that, if well run, will add to the layer of a protected future for us and the generation to come.