The Suitability of Multi-Fund Structure as Investment Strategy for Contributory Pension Scheme with an Underpin (Guaranteed Minimum Pension) under the PRA 2014 – From Actuarial Perspective
Presented by Dr Pius Apere (PhD/FCII)
(Actuarial Scientist and Chartered Insurer)
The traditional thinking has been that members in defined contribution (DC) schemes bear all the investment risks and rewards and receive benefits (based on whatever contributions and investment returns are produced at retirement), which are adjusted automatically, as asset values move up or down, therefore limiting the need to immunize asset/liability movements. It is normally assumed that such schemes have limited or no actuarial involvement.
On the other hand, a DC scheme such as the Contributory Pension Scheme (CPS) operating in Nigeria that forces compulsory contribution rates (section 4(1) of PRA 2014) and entails significant tax concessions (section 10 of PRA 2014) should not, under reasonable circumstances, be left to require members to bear all risks over many decades of membership. Thus, the introduction of guaranteed minimum pension (GMP) as an underpin (section 84(1) of PRA 2014) is quite appropriate with the aim to reduce the risk of volatility of standard of living in retirement facing the pensioners. Conceptually, the determination of the GMP and the appropriate investment strategies requires an actuarial methodology. In view of the above, PENCOM should also be aware that offering even a minimal defined benefit (DB) underpin can result in the CPS needing to meet DC regulation as well as DC regulation.
Prior to the introduction of Multi-Fund Structure in July 2018, the Pension Fund Administrators (PFAs) operated low risk investment strategies, without taking into account the scheme members’ duration (age) / risk profiles and their freedom of choice of investment funds. Furthermore, there had been an over concentration of pension funds invested in debt instruments (e.g. Government bonds) with limited growth potential for the retirement funds. The Contributory Pension Scheme also had only two investment Funds to invest in, namely RSA Active Fund and RSA Retiree Fund where all active contributors’ and “retirees’ funds were being invested in respectively. Over the long term, these low strategies are likely to result in lower emerging pensions than might have been expected of life-style investment strategies for investment portfolios with different risk profiles.
The foregoing narratives are the over-arching considerations for the introduction of the Multi-Fund Structure.
Life-style Investment Strategy for Defined Contribution Scheme
A typical lifestyle investment strategy is generally carried out by the fund administrators to a defined contribution scheme at an individual member level. Each member’s assets under management (AUM) are being invested initially in risky assets, such as equities, (during the saving phase) and then reducing the allocation to risky assets in an individual’s portfolio (move assets into cash and bonds) as scheme members approach retirement age (i.e. during the retirement income phase starting from 5 – 10 years before retirement). The objective is to give the assets a chance to grow but have a chance to recover from any fall in asset values in the early years and avoid the impact of such a fall just prior to retirement.
However, a group approach is gaining more popularity which retains some pooling and risk sharing for employees within the group. The saving phase is expected to adopt a diversified multi-asset fund approach whereby the asset switches are triggered as age limits are hit rather than particular investment returns achieved. The Multi-Fund Structure methodology as described below is a reflection of the group approach.
Multi-Fund Structure for Contributory Pension Scheme in PRA 2014
Section 85 (1) of PRA 2014 states that Pension Fund Administrators shall invest pension fund assets with the objectives of ensuring safety and maintenance of fair returns on amount invested. In other words, Contributory Pension Scheme members’ are expected to receive pension benefits as at when due and also have sustainable standard of living in retirement.
PENCOM’s regulation (on investment of pension fund assets) in February 2019 specified six investment Fund Types under the Multi-Fund Structure with a given overall maximum percentage exposure to variable income instruments for each Fund Type. The Pension Fund Administrators (PFAs) shall allocate contributors to various Fund Types according to the following criteria:
• Membership of Fund I (75% of Portfolio Value) shall strictly be by formal request by a Contributor.
• Active Contributors who are 49 years and below as at their last birthdays shall be assigned to Fund II (55% of Portfolio Value). An active Contributor in Fund II who wishes to be assigned to Fund I shall make a formal request to the PFA.
• Active Contributors who are 50 years and above as at their last birthdays shall be assigned to Fund III (20% of Portfolio Value). An active Contributor in Fund III who wishes to be assigned to Fund II shall make a formal request to the Pension Fund Administrator (PFA) but not allowed to choose Fund I.
• Fund IV (10% of Portfolio Value) shall strictly be for Retirement Savings Account (RSA) retirees only and they shall not be allowed to choose Fund I.
• Fund V (5% of Portfolio Value) shall strictly be for contributors under the Micro-pension Scheme.
• Fund VI (55% of Portfolio Value) shall be for those that choose to have their contributions invested in Non-interest Money and Capital Market Products.
• An active contributor in Fund I, II or III who wishes to move to Fund VI shall make a formal request to the Pension Fund Administrator.
• An active Contributor may switch from one Fund Type to another Fund Type within a given Pension Fund Administrator, once in 12 months without paying any fees but any additional requests for switches among Funds within a Pension Fund Administrator by the active Contributor shall attract a fee.
The concept and implementation of the Multi-Fund Structure are well conceived, highly commendable and suitable for the members of Contributory Pension Scheme with different risks profiles. However, the Multi-Fund Structure has its own challenges and/or complexities, particularly when the appropriate investment strategies to meet the guaranteed minimum pension under PRA 2014 are to be considered.
Challenges of Multi-Fund Structure for Contributory Pension Scheme
The Multi-Fund structure which offers members with investment choices/options is likely to create the following challenges for the Pension Fund Administrators (PFAs):
• Members may make inappropriate investment decisions due to lack of knowledge to make a choice. This risk can be reduced by providing access to education, advice and/or communication to ensure the members understand what is being offered and the potential consequences of the choices that they make but this is at a cost to Pension Fund Administrators.
• The projections of the future pension benefits will be more complex because of many overlaps between some Fund Types. Thus, the range of investment options (Fund Types) provided will impact on cost of administration of Pension Fund Administrators.
• For a defined contribution scheme that offers an underpin (a guaranteed minimum pension), there is a risk that members will choose a more risky investment strategy than they otherwise might have, since they know they have a minimum benefit promise or members will choose a very safe investment strategy with relatively low expected returns. Both of these approaches increase the likelihood of the underpin biting.
• A pragmatic approach for allocation of investment returns within a given Fund Type amongst contributors may be adopted to take into account of each individual contributor’s asset under management (AUM) and/or duration profile (in years) within the Fund Type.
The assessment of cost of guaranteed minimum pension as an underpin (using stochastic modelling techniques) and the appropriate investment strategy (i.e. a “matched” investment position which would involve holding a portfolio that will behave in the same manner as the guaranteed minimum pension liabilities) may become a great challenge for the Contributory Pension Scheme with Multi-Fund Structure without an actuarial involvement.
The implementation of the Multi-Fund Structure for Contributory Pension Scheme under PRA 2014 is expected to maximize the investment returns for Retirement Savings Account (RSA) holders prior to retirement and this will in turn likely to increase their pension benefits at retirement.