How to Modernize Pension Systems in Emerging Markets
Across emerging markets, social protection schemes are underfunded and cover only a small percentage of the population. This is especially true of African states, where mismanaged public funds, the prevalence of informal employment, and shrinking family sizes have meant that pensioners are left with few retirement options.
We have been examining some of the problems with pensions in emerging markets, and are excited to announce a simple and effective proposal to help alleviate the problem. We’re also releasing an interactive pensions calculator that showcases our proposal in action — you can explore the calculator here!
The calculator shows the cost of providing a pension for individuals in select African countries. There is quite a lot going on behind the scenes, which we’d like to explain in this blog.
A key point to understand is that we’re approaching this as a business, which means we’ve included upfront and ongoing costs to better reflect the reality of how much such an undertaking would cost. There will be costs like staff salary, rent, marketing, research, compliance, etc., and we have included these to get a more realistic overview of pricing. As you’ll see, even accounting for these costs, the amounts needed to guarantee a pension are very small — in some cases, under $1,000.
The calculator determines how much it would cost, today, to provide a guaranteed income for a pensioner for life. An important consideration in our model is that we’re looking to begin this pension before a person retires. This is because the earlier a person invests, the more time there is for their money to accumulate interest, meaning the up-front investment is smaller.
A crucial component of every model that deals with retirement income is the longevity table — data on how long a person is expected to live. We used dynamic World Health Organization data, meaning that a person who’s buying the pension at the age of 30 will have a different life expectancy age than someone who’s buying it at the age of 60. This is because life expectancy increases as people age.
Our model also accounts for reserve capital. This provides a cushion in case an individual lives longer than expected. It’s necessary if the pension is provided by a for-profit company or an NGO; if the scheme is run by a government agency, then there is less of a need for reserve capital, as the government would (in theory) be able to cover any shortfall.
Finally, the annual payouts are adjustable in order to be able to cover a number of scenarios. The default payout is 20% of per capita GDP in a country. This is based on average payouts across countries we examined, and provides enough money to cover the essentials. For those who are living in urban areas, simply increase the default payout in the assumptions panel. It also depends on whether a retiree owns his or her place of residence or needs to pay rent, whether he or she has an additional income, etc. Our calculator allows one to choose the annual payouts as percentage of GDP per capita, or to simply input a value (in USD) that they would like to receive.
Let’s run through an example. Imagine a 35 year old Malian who’s planning to retire at the age of 65. He is expected to live until the age of 71, so he needs to cover 7 years (65 to 71, inclusive) of retirement. Given the low per capita GDP in the country ($829 annually), $930 today would grow to $1,162 over the course of his life, and would provide him with enough income to collect $166 annually (that’s 20% of per capita GDP in the country). All admin costs associated with setting up and running the business are included in this total. The pension initial liability and annual payouts for this scenario are illustrated below:
If a 55 year old Malian wanted to guarantee his income from the age of 65, the amount needed to fund his pension would rise to $1,724. That’s because that person would have less time to compound interest, and a longer time period to cover — a 55 year old is expected to live until 75 instead of 71. The amount paid annually remains $166, as 20% of GDP per capita. The pension initial liability and annual payouts for this scenario are illustrated below:
The values will differ by country, sex, age of retirement, etc., and most of these can be manipulated in the Assumptions section of the calculator.
The opportunity to fund a person’s pension for as little as $1,000 is exciting — and can pave the way for more stable, prosperous societies. As we covered in the past, there are numerous benefits to providing a stable income for the elderly. A few of them include better mental health, less of a need for large families, investing instead of hoarding cash, and more. Thanks to mobile money that allows people to receive payments even in the most remote areas of a country, this is a solution that will disproportionately help the poor.
Billions of dollars are poured into aid budgets on an annual basis, and in many cases there are few tangible outcomes. This proposal, on the other hand, is cost effective and can change millions of lives directly and indirectly. We have put together a more detailed document here for those interested in learning more about the idea and how to best move forward.
Feel free to test out various inputs to see how much a basic retirement package would cost, and let us know what you think!