Widespread protests by retirees across the country over their meager pension benefits and the fact that under the 2022-23 budget bill, one-third of the government’s operational budget is to be spent on addressing pension funds’ deficits indicate that the country’s social security system is not working properly and needs to be revamped.
A government that has no option but to spend 50% of its budget on pension funds should normally be interested in finding a long-term solution to this problem, said veteran economist, Hossein Abdoh-Tabrizi, in an article for the Persian economic daily, Donya-e-Eqtesad. A translation of the text follows:
In addition to poor performance, demographic changes and the rise in life expectancy are other fundamental problems facing pension funds. Over the past few years, the number of jobs created was barely sufficient to provide new investments by new workers in pension funds and resolve the funds’ deficit, at least for a short time.
One way to reform the structure of these funds is for the government to avoid committing itself to providing people with a future pension higher than a certain salary. To do so, insurance funds can be divided into two tiers. This initiative had been envisioned in the Sixth Five-Year Development Plan (2017-22) but was not implemented.
The government and semi-governmental institutions (such as the Social Security Organization) will be responsible to pay pensions up to a certain level of salary.
With the current level of wages, the Social Security Fund can cover salaries up to 100 million rials [about $370] per month. This pension level would be enough to protect people from falling under poverty line.
Second Tier of Social Security Funds
Salaries higher than 100 million rials should be covered by the second tier of funds such as corporate and non-governmental pension funds.
Corporate pension funds are being established by large companies. They avail themselves of the skills and experience of professional directors to run their businesses. These funds are a kind of complement to the Social Security Fund.
Non-governmental pension funds are also established on the stock exchange and they make investments in various fields as per regulations of pension fund transactions like any investment fund. Non-governmental funds, like corporate funds, are among the second tier of pension funds.
Long-term resources of corporate pension funds will greatly enhance the financing capacity of the capital market and the implementation of long-term projects. The capital market will also have investors with long-term perspective besides its usual small investors.
Resources belonging to corporate pension funds should be separated from other resources of the company. In addition to these funds, which are usually formed within the framework of capital market concepts, life insurances must be expanded in line with the second tier of funds. Corporate and non-governmental pension funds have not been formed in the capital market up until now because the Securities and Exchange Organization and the High Council of Securities and Exchange have yet to formulate the required regulations.
The question is why life insurance industry, which does not face such restrictions, has also failed to expand the second tier of social security funds, such that overall mathematical reserves [provision made by an insurer to cover liabilities] of life insurance companies are no more than the value of a single steel or petrochemical factory.
Today, a significant number of companies and individuals have supplemental health insurance; these insurances are kind of second tier healthcare service.
One might ask why in a country where along with the first tier of government health services and semi-governmental insurance companies widely offering supplementary health insurance policies, the supplementary category of pension funds [in the form of life insurance] has not been formed? If we believe that the pension benefits are in line with receiving medical services, why are we failing to form life insurances, which are the second tier of future insurance plans along with government pension funds?
Inflationary Factor
It’s patently clear that the benefits senior citizens receive from pension funds at present are not enough. So, why life insurances have not been able to find a decent place in the Iranian financial market?
The answer to this question goes back to the wrong adoption of life insurance in Iran. Designers of the Iranian version of life insurance have ignored the fact that inflation rate in the country has been in the double-digit territory for more than 40 years, averaging at 23%. As a result, a long-term contract makes no sense because the current value of cash flows about seven years later, with a discount rate of over 20%, will be close to zero.
That explains why, thus far, in Iran, neither the government nor the private sector has been able to sell bonds with maturity periods longer than four or five years. This is one of the reasons why the debt market in Iran does not expand.
Similarly, the mortgage market, i.e., the market for long-term home loans, has not put down roots here. Except for Bank Maskan, the state agent bank of the housing sector, which has been able to provide suitable 12-year loans by receiving cheap credit lines from the Central Bank of Iran, other Iranian banks are not active in this important market and young people, particularly first-time homebuyers, do not know how to buy a home in the absence of the mortgage market.
Under such macroeconomic conditions, if we tell a person, eager to buy insurance policy, to pay premiums over the next 20 years and get a monthly pension from the insurance company, they will not have an accurate estimate of what they will receive.
As a result, long-term life insurance has not been able to encourage people to buy life insurance policies. The life insurance market has remained small; it has not been successful in becoming the tool for providing second tier social security for people.
Remedies
The solution is to design savings insurance for up to five years under which the insurer can choose between renewing their policy and referring to another insurance company depending on the performance of the insurance company.
Such an arrangement can help increase the number of insurance policies, even at constant prices, by 100 times. Undoubtedly, corporate and non-governmental pension funds, as well as life insurance, must be constantly under the supervision of the government to avoid problems similar to those created by non-governmental banks in the past. Such a mechanism concerns the life and death of the public; it affects the future of people. Any problem in this mechanism will put direct pressure on the expenses of the social security system and the country’s budget.
Governmental and semi-governmental pension funds that provide the primary insurance coverage must have a defined benefit (DB) pension plan.
In a DB pension plan, an employer/sponsor promises a specified pension payment, lump-sum or combination thereof on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns.
The insurance policy for the secondary insurance tier, i.e., corporate and non-government pension funds, as well as life insurance, must be designed based on a defined premium and defined contribution. A defined-contribution plan allows employees and employers (if they choose) to contribute and invest in funds over time to save for retirement.
Here, the regulator must continuously monitor the performance of these policies; the government can also prevent any bankruptcy and non-payment of corporate and non-governmental funds by establishing a guarantee fund and receiving a percentage of the amount paid by employees.
Although the regulator must ensure that funds formed with insurance resources are managed efficiently, the directors of corporate and non-governmental funds and life insurances must be cautious when it comes to the management of pension funds, meaning that they must avoid making high-risk investments. In addition, releasing reports regarding the investment performance of these resources is vital.
Imagine how different the performance of Social Security Fund could have been over the past 40 years if it had to reveal the value of its assets every month. There are countries where the value of pension fund assets is being reported on a daily basis. Transparent reporting will improve the performance of governmental and semi-governmental sectors. Therefore, it is necessary to oblige the providers of secondary tier of insurance policies to announce the monthly value of their assets; that would alleviate the concerns of pensioners.
Life insurers must also report on their accounts and reserves at short intervals.
