Report No. 29588-MU Report No. 29588-MU Mauritius Modernizing an Advanced Pension System Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

June 30, 2004

Poverty Reduction and Economic Management I Southern Africa Africa Region

artu Modernizing an Mauritius Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

Advanced Pension System Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

Document of the World Bank Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

GLOSSARY

Actuarial fairness: a method of setting insurance premium according to the true risks involved.

Benefit rate: the ratio of the average pension to the average economy-wide wage or covered wage.

Defined benefit: a guarantee by the insurer or pension agency that a benefit based on a prescribe formula will be paid.

Defined contribution: a pension plan in which the periodic contribution is prescribed and the benefit depends on the contribution plus the investment return.

Demographic transition: the historical process of changing demographic structure that takes place as fertility and mortality rates decline, resulting in an increasing ratio of older to younger persons.

Full funding: the accumulation of pension reserves that total 100 percent of the present value of all pension liabilities owed to current members.

Implicit pension debt (net): the value of outstanding pension claims on the public sector minus accumulated pension reserves.

Means-tested benefit: a benefit that is paid only if the recipient’s income falls below a certain level.

Minimum pension guarantee: a guarantee provided by the government to bring pensions to some minimum level, possibly by “topping up” the capital accumulation needed to fund the pensions.

Old age dependency ratio: the ratio of older persons to working age individuals. The old age dependency ratio used in the text refers to the number of persons over 60 divided by the number of persons aged 15 to 59.

Pay-as-you-go: in its strictest sense, a method of financing whereby current outlays on pension benefits are paid out of current revenues from an earmarked tax, often a payroll tax.

Pension coverage rate: in this paper, the number of workers actively contributing to a publicly mandated contributory or retirement scheme, divided by the estimated labor force.

Pension spending: in the paper, pension spending is defined as old age retirement, survivors’, death, and invalidity-disability payments based on past contribution records plus noncontributory, flat universal, or means-tested programs specifically targeting the old.

~ort~~i~i~:the ability to transfer accrued pension rights between plans.

~ro~i~ent~~~~a fully hded, defined contribution scheme in which hdsare managed by the public sector.

~ep~~~eme~trate: the value of a pension as a proportion of a worker’s wage during base period, such as the last year or two before retirement or the entire lifetime average wage. It also denotes the average pension of a group ofpensioners as a proportion of the average wage ofthe group.

System ~e~en~e~~yratio: the ratio of persons receiving pensions fiom a certain. pension scheme divided by the number of workers contributing to the same scheme in the same period.

~ni~ers~~~a~~e~e~t:refers to pensions paid solely on the basis of age and citizenship, without regard to work or contribution records,

Vesting period: the minimum amount of time required to qualify for full ownership of pension benefits. TABLE OF CONTENTS

SUMMARY ...... i INTRODUCTION AND BACKGROUND...... 1 1. WHY MODERNIZE THE PENSION SYSTEM? ...... 1 2 . WHO ARE TODAY’S ELDERLY?...... 2 3 . A SYNOPSIS OF THE 3-TIERED PENSION SYSTEM ...... 3 4 . THE WORLD BANKAPPROACH TO PENSIONS...... 7 CONCLUSION ...... 7 CHAPTER 1. TIER ONE - THE REDISTRIBUTIVE SCHEME ...... 8 1. THE EXISTING SYSTEM ...... 8 2. ARE THE BASIC PENSION’S POLICY OBJECTIVES STILL RELEVANT TODAY? ...... 9 3 . BEFOREDECIDING, SOME FUNDAMENTALS MUST BE IN PLACE ...... 10 4 . THE OPTIONS FOR MODERNIZATION...... 11 SUMMARY ...... 15 CHAPTER 2 . TIER TWO - MANDATORY INCOME MAINTENANCE SCHEMES ...... 17 1. THE NAT10NAL PENSION SCHEME ...... 17 2 . PUBLIC PENSION SCHEMES ...... 29 SUMMARY ...... 31 CHAPTER 3. TIER THREE - VOLUNTARY INDIVIDUAL AND OCCUPATIONAL SCHEMES...... 33 1. VOLUNTARY SCHEMES IN MAURITIUS...... 33 2 . DESIRABLEFEATURES OF REGULATION AND SUPERVISION ...... 34 SUMMARY ...... 35 CHAPTER 4 . A STRATEGIC DECISION ...... 36 1. WHAT MODERNIZATION MEANS FOR THE INDIVIDUAL...... 36 2 . THE CHALLENGE OF BUILDINGNEW INSTITUTIONS ...... 38 3 . A PROPOSAL FOR NEXT STEPS: SEQUENCING, TO-DO LIST, AND POLITICAL PROCESS ...... 39 APPENDICES ...... -43 APPENDIX I: SELECTED POVERTYMEASURES ...... 45 APPENDIX11: A PROFILE OF THE ELDERLY...... 46 APPENDIX 111: SYNOPSIS OF THE MAURITIANPENS10N SYSTEM ...... 53 APPENDIXIV: THE NATIONALPENSION SYSTEM ...... 54 APPENDIXv: ANOTHEROPTION TO CONVERT TO A DEFINEDCONTRIBUTION SCHEME ...... 59 APPENDIX VI: DEVELOPMENTSIN ASSET MANAGEMENT ...... 64 APPENDIXVII: PUBLIC SECTOR SCHEMES AROUND THE WORLD ...... 67 APPENDIX VIII: TAXATION OF PENSIONS ...... 69 APPENDIXE: FINANCIAL PROJECTION METHODOLOGY,ASSUMPTIONS AND DATASOURCES .. 73 APPENDIXX: PENSION CONSULTATIONS...... 85 TABLES

Table 1 Demographic Statistics 2 Table 2 Household Poverty and Pension Access (1996/97 Household Survey) 3 Table 3 Structure ofMauritius’ Pension System 4 Table 4 Total Pension Payouts: First and Second Tier 5 Table 1.1 Pension Expenditures as Percent of GDP 11 Table 1.2 Sample Schedule for Flexible Pensionable Age 12 Table 1.3 Simulations of Savings in Total Payouts and Poverty Impact from Limiting 13 Eligibility in the Basic Retirement Pension Table 2.1 Projections of the Finances of the NPF - Introducing Wage Indexation of 19 Parameters Henceforth Table 2.2 Recognition ofNPF Participation 21 Table 2.3 A Two-Stage Approach for the Second Tier 22 Table 2.4 Projections of the Finances of the National Pension Fund-Conversion to a MDC 28 Table 2.5 Replacement Rates for a New Entrant on 2005 for a Mauritian Defined 28 Contribution Table Al.l Relative Poverty Line Set at 50 Percent of Median Income and Expenditure 45 Table A2.1 Household Characteristics 46 Table A2.2 Household Income 47 Table A2.3 Household Poverty 49 Table A2.4 Alternative Equivalence Scale Parameterisations 52 Table A4.1 Projections of Finances of the National Pension Fund - Continuation of Current 57 Policies (1998/99 prices) Table A5.1 Illustrative Compensation for Accrued National Pension Fund Rights by Way of 62 Preserved Defined Benefit Right Table A5.2 Illustrative Compensation for Accrued National Pension Fund Rights by Way of 63 Lump-Sum Transfer to Defined Contribution Accounts Table AS. 1 Personal Income Tax: Number of Taxpayers, Total Income, Taxable Income, 69 Tax Paid, and Effective Average Tax Rate by Statutory Rate of Personal Income Tax Table A8.2 Some Alternative Tax Regimes for Pension Saving 70 Table A8.3 Some Illustrative Calculations for Mauritius 71 Table A9.1 Projection of Life Expectancy Changes (Average Remaining Years of Life 76 Expected at Specific Ages) Table A9.2 Population and Old Age Dependency Rate (1998 - 2050) 77 Table A9.3 Evolution of Beneficiaries 81 Table A9.4 Contributory System Demographics and Dependency Rates (1 998-2050) 81 Table A9.5 Key Macroeconomic Assumptions 82

BOXES

Box 2.1 Capital Market Development and Building Equity for the Pension System: What 24 Comes First?

CHARTS

Chart 2.1 Pension Expenditure for the Civil Service Employees, 2000-2050 30 Chart 4.1 Indicative System Performance Beneficiary Replacement Rates 37 Chart A4.1 Ceiling in Real Terms 56. Chart A4.2 Point Cost 56 Chart A4.3 Point Value 56 FIGURES

Figure 1.1 Value of Basic Pension for under 75s 8 Figure A2.1 Percentage of Over-Sixties Income from Different Sources 48 Figure A4.1 Cohort retiring in 1998/99: NPF Pension Replacement Rate relative to Own 55 Earnings Figure A4.2 Cohort retiring in 1998/99 faring relative to those still employed: Value ofNPF 55 Pension relative to Economy-Wide Average Earnings Figure A4.3 Portfolio of the NPF (February 2000) 57 Figure A5.1 Projected Pensions under a Defined Benefit and a Defined Contribution NPF by 61 Age at the Time of Transition Figure A5.2 Valuing Accrued Pension Rights in the Transition to a Defined Contribution 61 System Figure A9.1 Projections Methodology 74 Figure A9.2 Mauritius’ Aging Population 78 Figure A9.3 Labor Force Participation Rates By Age in 1998 79 Figure A9.4 Distribution of Contributors in 1998 80 Figure A9.5 Age-Earnings Profile of Contributors 80 Figure A9.6 Calculation of Revenues 82 Figure A9.7 Calculation of Expenditures 83

DIAGRAM

Diagram A4.1 The NPS Today 56

PREFACE

This report was prepared at the request of the Government of Mauritius as part of its consultation process which aims to modernize the country’s pension system. It is a synthesis report, based on background work prepared by international experts over the period 2000-2001, which was reviewed at the Bank and discussed with Government in 2001-2002. The report contributes to the ongoing public dialogue that Mauritius has undertaken, which seeks to assess the effectiveness of the country’s pension system with a view to ensuring sustainability and equity in light of the forthcoming demographic transition and the fiscal challenges the country is facing. The report forms one part ofthe analysis available to the Government and the public on pension modernization. In the process of consultation, Mauritius has been successful in motivating discussion in the press, in radio, and in television to inform the public about pension issues and modernization options. Background analytical work supporting this report was presented at the Open Conference on Pension Modernization held in March 2001 in Mauritius. The Conference provided a comprehensive review of pensions in Mauritius to policy-makers and the general public for the first time; it addressed the forthcoming demographic transition in the country, the effectiveness of Mauritius’ multiple pension schemes, and the public management of the Mauritius’ contributory pension funds.

To date, the Government is studying options to modernize the various aspects of the pension system, and has taken several actions to address concerns raised in this report and in other forums. In Mauritius pension modernization is an ongoing recess, based on analysis and consensus building.

ACKNOWLEDGEMENTS

The World Bank wishes to thank the Government of Mauritius, in particular the Ministry of Finance and Economic Development (formerly Ministry of Finance and Ministry of Economic Development, Financial Services and Corporate Affairs); the Ministry of Social Security, National Solidarity & Senior Citizen Welfare and Reform Institutions; and the Central Statistical Office, for its fruitful partnership in managing this work. In particular, the Bank wishes to thank the Hon. Paul BQenger, Prime Minister of Mauritius; the Hon. Sushi1 Khuhiram, Minister of Industry, Financial Services and Corporate Affairs; the Hon. Samioullah Lauthan, Minister of Social Security, National Solidarity and Senior Citizen Welfare and Reform Institutions; Mr. Krishnanand Guptar, Financial Secretary; Mr. Philippe Ong Seng, previously Financial Secretary; and Mrs. Asha Burrenchobay, previously Assistant Permanent Secretary for Pensions, Ministry for Social Security, National Solidarity, and Senior Citizen’s Welfare. The pension dialogue in Mauritius and the coordination efforts for the preparation of this report were led by Christos Kostopoulos. The report relies heavily on the following original backround papers: Pensions in Paradise: Modernizing the Mauritius Retirement Income Schemes (Edward Whitehouse and John Piggott), Modeling the Mauritius Pension System (Yvonne Sin), The Relative Poverty of the Elderly in Mauritius (Alan Duncan and Paola Valenti), Mauritius: Informal Pension Arrangements (Jean Claude Lau Thi Keng), Private Superannuation Plans in Mauritius (Rafael Rofman), Private Pensions Regulation and Supervision in Mauritius (Gustavo Demarco), and Policy Issues for the Equity Market in Mauritius (Ajay Shah). The report has benefited from valuable guidance from Robert Holzmann, Sector Director for Social Protection at the World Bank, who reviewed the report and served as a lead adviser in key aspects of the discussions with the Government. Robert Palacios served as peer reviewer and generously contributed his time to discussing strategic issues in design of the study and assembling the team. Extensive comments and support were received from Willem Van Eeghen, Jesko Hentschel, Luis Alvaro Sanchez, and Yvonne Sin who also worked extensively on all technical aspects of the report. Editorial assistance was provided by Vinita Ranade and Brigitte Aflalo. Cdcile Wodon provided expert assistance in processing the document. The report was prepared under the following management team: Jesko Hentschel was Cluster Leader for the Poverty Reduction and Economic Management (PREM) team based in Madagascar. Philippe Le Houerou was Sector Manager through the Green Cover stage, and provided valuable guidance on all aspects of the report; Emmanuel Akpa is Sector Manager at the Grey Cover stage; Hafez Ghanem is Country Director for Mauritius, and has provided valuable comments on substantive issues covered in the report; and Alan Gelb is Chief Economist of the Africa Region.

1. This report takes a close look at the pension system in Mauritius. Over the past two decades the country has made enormous progress in economic development and poverty reduction, propelling its per capita income from about US$1,200 in 1980 to US$3,750 in 2000. As has generally been observed with economic development, there has been both an increase in life expectancy, from 67 years to 75 years, as well as a sharp decline in the population growth rate, from 1.8 to 1.0 percent per annum, over the same time frame. Today, Mauritius is facing a demographic transition much sooner in its development cycle than other upper income and high income countries have experienced. The share of its over-60 population is expected to more than triple in the next 50 years. Such major changes in the population structure require a thorough look at retirement arrangements, as many industrialized countries have done over the last decade. The questions which now need to be urgently addressed are whether the current pensions arrangements will be financially sustainable, given the projected ageing of the population, and whether they will be equitable and efficient at a time when the system will be relied on by a growing number ofpeople. .. 11. Mauritius today has a three-tiered pension system that helps the poor and provides moderate (although declining, in the case of the private sector) replacement income for working Mauritians, and no regulatory protection for voiuntary retirement schemes. The unfunded nature of the universal scheme, together with the income maintenance scheme of the civil service, are endangering the country’s economic stability. At the same time, declining benefits to working Mauritians from the contributory scheme are jeopardizing living standards at retirement, while the lack of a regulatory environment for private savings discourages maintaining private savings through the formal financial system. Concurrently, public sector management of the private contributory schemes deprives contributors ofmaximum returns and concentrates risk only on the local economy, enhances government consumption, and deprives the domestic private sector of financing sources. The poor performance of the contributory tiers exercises upward pressure on the unfunded tier, increasing the fiscal risk of the system. iii. Mauritius’ three-tiered pension system is structured as follows. The first tier consists of a universal non-contributory Basic Retirement Pension which has come to be regarded as an ‘entitlement’ by most Mauritians and has a strong poverty reduction effect. It was introduced to provide a minimum income guarantee for the elderly when most of the Mauritian population was poor. The tax-based financing was to introduce a strong redistributive effect. The second tier, for the private sector, is made up of two mandatory income-related pension schemes (National Pension Fund and National Savings Fund) administered by the public sector. The NPF requires a nine percent contribution (thirteen and a half percent for the sugar sector) and is partially funded, while the NSF requires 2.5 percent and is fully funded. The public sector employees

1 (civil servants and parastatal employees) are members of separate schemes. However, despite differing compensation policies of the private and public sector, the public sector schemes are overly generous. The NPF scheme is contributory and aims at a 33.3 percent replacement of average lifetime earnings for 40 years of employment, while the public sector schemes are non-contributory and do grant a pension of66.7 percent offinal salary for 33.3 years of employment. Lastly, a number ofvoluntary schemes make up the third tier, which is geared to supplementing the pension income.

iv. The report adopts the prism of accumulated World Bank experience in assisting many countries with pension modernization. The approach seeks to diversify the economic and political risk inherent in pension systems. Economic risk can come from fiscal concerns, particularly of unfunded schemes, and from constraints to economic growth stemming from taxation, labor market and investment implications of unfunded and contributory schemes. Economic risk also comes from redistributive concerns, should the elderly and poor have insufficient income during their old age. Political risk comes from politically motivated decisions that are made outside the country’s financing capacity. The approach suggests maintaining a small and efficient unfunded redistributive component (first pillar) to meet the needs ofthe poor, and a dual, funded, and privately managed, component for income maintenance and life-time consumption smoothing. The dual character of the funded component aims to assure moderate replacement income via a mandatory privately managed scheme (second pillar), and to provide opportunities for private provision to meet individual preferences or labor market response for supplementary pensions (third pillar).

Findings

v. Financing of an unchanged pension system entails significant risks. Today, public sector outlays for pensions (the Basic Retirement Pension and the civil servants scheme) are about 4.2 percent of GDP, absorbing about a quarter of recurrent expenditures and a fifth ofrecurrent revenues. In an unchanged system, the demographic transition will be very costly. Expenditures for the basic pension alone are expected to be close to 5.9 percent of GDP by 2020. Civil service pension outlays have already increased by 50 percent in real terms in the past six years alone; the civil service pension bill, as a share ofthe wage bill, can be expected to increase from the current 20 percent to 30 percent over a period of 15 years. The projected high fiscal outlays entail significant risks. They could (i)compromise the fiscal position and economic stability ofthe country if financed through a budget deficit; (ii)crowd out much needed investments in social and productive infrastructure if expenditure envelopes remain unchanged; or (iii) jeopardize competitiveness of the economy through a strong increase in taxes, All such risks need to be avoided.

vi. The effectiveness of the pension system in meeting policy objectives: strong for the first tier and moderate to weak for the second and third tier. The first tier basic pension scheme is overall successful in reducing poverty among the elderly, although it does leave a small share of elderly unprotected. The pensionable age is sixty, although many Mauritians are working beyond their 60th year; they are also living longer than at

.. 11 the time the scheme was introduced. The second tier schemes, however, do not fulfill their promise (National Pension Fund and National Savings Fund), or are inequitable (public sector pension schemes). The current promise of the NPF to deliver a 33.3 percent replacement rate on average lifetime earnings has already begun to fall short of expectations. The scheme is poised to deliver a 15 percent replacement rate. The National Savings Fund is a newer, defined contribution scheme and delivers a lump sum at retirement, and as ofnow, plays no significant role in financing retirement income. Asset management for the NPF and NSF, discussed previously (para. ii),is managed by the public sector and according to research, is unlikely to yield the most optimal return, Finally, the third tier pension schemes are not efficient enough to attract private savings for retirement. The funds are practically unregulated and unsupervised. The poor institutional environment also minimizes opportunities for development of the domestic financial market. vii. The second tier has made some gains however, despite the surrounding controversy. Both the NPF and the NSF have been successful in instituting a culture of contributory retirement savings in Mauritius. They have also accumulated about 19 percent ofGDP in assets (about 17 percent for the NPF and 2 percent for the NSF). viii. Policy objectives have not been met because the parameters of the system have not been regularly adjusted, the management of the system is inefficient, and crucial regulation is lacking. Mauritians were extremely diligent in designing the original parameters of their pension system, but these parameters have not been adjusted. When the basic pension system was designed, the retirement age was very close to the average life expectancy. Its universality protected many from poverty as average incomes were very low, Today, however, with longer life expectancy and much higher average incomes, the situation is very different. Neither of these two parameters has been adjusted, however. Similarly, contribution rates for the National Pension Fund - although explicitly planned for - were insufficiently adjusted to guarantee that the system would deliver the promised replacement rates. Management of the assets of the NPF and the NSF is inefficient and comes at a high opportunity cost for beneficiaries. Investment guidelines are oriented towards supporting public sector activities rather than maximizing risk adjusted returns to contributors. Lastly, the policy objectives were not achieved because the fundamental regulation and supervision ofvoluntary schemes is missing.

Recommendations and Next Steps ix. The report argues for a modernization of the pension system in Mauritius. It proposes options that would make the pension system fiscally sound, more equitable, and better suited to meet current and future needs of the society. Most of the proposed modernization efforts aim to have a minimal impact on current retirees or those close to retirement. They do aim to set the framework for a flexible system for those who retire in the future, based largely on individual contributions, and on the compounding of internationally competitive returns. It is important to begin public discussion of options early on in the process before critical decisions are made. The recommendations of the report would:

... 111 (i) reduce fiscal risk by modernizing the Basic Retirement Pension, (ii) render the system more equitable (through continued, and possibly higher transfers to the poor, maximize retums for contributors), (iii) render the system more efficient (by diversifying risk and enabling resource allocation), (iv) improve transparency in management through introduction of regulation and a supervisory agency for pensions, (v) introduce flexibility in the system, especially regarding the retirement age.

x. First tier: reduce pension expenditure, possibly by targeting and introducing flexibility in the retirement age. Mauritius has several options to modernize the basic pension scheme. The report discusses three categories of options: raising pensionable age, introducing means testing, and reducing the benefit level. The first responds to higher life expectancy and seems to be compatible with evolving employment patterns. The second is controversial: convert the current universal scheme into a targeted scheme for the poor while at the same time possibly undertake a one-time upwards adjustment in the pension. This would (i)reduce the fiscal risk stemming from universality of the scheme and (ii)provide more effective protection from poverty to those in need. The third option is the least efficient, but serves to reduce expenditures while respecting possible constraints.

xi. Second tier: more efficient and equitable design of the mandatory income maintenance schemes. Mauritius would be best served by capitalizing on the assets accumulated by the NPF and NSF and initially maintaining the integrity ofthe asset fund, which has social significance. However, Mauritius should eliminate the complex point system. The report advocates a two stage approach: First stage, replace the points system with a system of individual accounts for contributors, crediting to the accounts the equivalent of individuals’ past contributions, adjusted for inflation. This system of individual accounts is referred to as Mauritian Defined Contribution (MDC) scheme in the report. Regarding asset management in the first stage, the report advocates maintaining public management of NPF assets under more modern asset management practices. Second stage, once the regulatory infrastructure is developed, move to a defined contribution system with commercially based asset management. The proposed arrangement would be more transparent and yield equal or better replacement rates than a henceforth indexed points system, as long as asset management were improved. It would also reduce the contingent liability of the state. Annuities could continue to be handled under the NPF during the first stage. The NSF can be subsumed under the modernized mandatory income replacement scheme (MDC) for the private sector, from which lump sums could be obtainable, as preferences dictated during the annuitization process.

xii. Prior to any modernization attempt, Mauritius needs to undertake a mark-to- market analysis of NPF and NSF assets. Mauritius could use the opportunity to sequester and fully fund as large a share of liabilities to contributors as possible under the aforementioned proposal; preliminary indication suggests that should past contributions be recognized (with inflation adjustment) then fund assets suffice to meet those liabilities and obligations to current beneficiaries. Should additional funding needs arise during the

iv transition period (such as early retirement of sugar sector workers, short fall resulting from mark to market analysis, or other needs arising during the transition), Mauritius would be well advised to issue recognition bonds to contributors or use other financing outside the NPF. It would be critical not to dilute the NPF assets at this stage. Details on the financing arrangement have to be further explored once a modernization strategy has been adopted. xiii. Mauritius needs to urgently adopt a more modernized asset management structure. This is critical in order to build up contributors’ assets, and based on the principle of compound interest, work towards assuring higher replacement income. Although management of the funds can continue to be centralized for the time being, more modern investment practices do exist and Mauritius could benefit from them. xiv. Mauritius may also wish to review the total value and composition of civil servants compensation (cash wage, in-kind benefits and all other fringe benefits including pension) vis-a-vis the private sector. Such a review would highlight the competitiveness of civil servant’s compensation relative to the labor market and its apportionment. Depending on the outcome of such a review, civil servants’ total compensation can be restructured to yield a disbursement pattern that is more evenly distributed throughout their lifetime, thereby affording a better match of their life cycle consumption needs. Also, once the modernized NPS details have been worked out, it might be efficient to cover the civil servants under the NPS, thus ensuring full portability of pension rights as well as removing barriers in labor movement between private and public sector.

xv. Third tier: regulation of voluntary supplementary pension. Regulation is needed; it should cover collection, administration, annuitization, and payouts, Under the single regulatory authority model that Mauritius is pursuing, caution is required so that the pension regulator renders overarching priority to maximizing the risk-adjusted returns of contributors, rather than subjecting pensions to domestic financial market development priorities.

xvi. A modernized pension system. Modernization of the three tiers of Mauritius’ pension system should result in a pension system more reliant on commercially managed contributory schemes and less reliant on direct government transfers as in the case of the Basic Retirement Pension. Should Mauritius choose to means-test the Basic Retirement Pension, lower income retirees would still have access to it and also obtain a 33.3 percent replacement rate from the mandatory scheme, even though this amount could be small. Average income retirees may or may not qualify for the Basic Retirement Pension, depending on the means-test chosen, but would obtain the 33.3 percent replacement income from the mandatory scheme, plus additional retirement income from private or occupational plans. Although higher income individuals would possibly get a 33.3 percent replacement rate (depending on if they fall below the contribution ceiling), the largest share of replacement income would come from voluntary provision.

V xvii. Periodic review of coherence and relevance of pensions policy. Mauritius challenge in the pension system has been institutional. Except for the nascent third tier, Mauritius had adopted well designed, thoroughly thought through pension schemes, which were unfortunately not managed according to original intentions. Oversight of the implementation of these schemes failed. Consequently, any modernized schemes need to address this problem. Although for the first tier the report discusses the institutionalization of indexation rules, for the second tier, the report recommends simplifying the structure and moving to commercial practices, and for the third tier, new regulations are under preparation, perhaps something more needs to be done. The report proposes for the Government to commit to a periodic review of pensions policy in consultation with the private sector and civil society.

xviii. Sequencing of Reform. While all three pillars need to be reformed, it is suggested that the reform should start with the mandatory and voluntary second and third pillar before progressing with a reform of the basic and first pillar. Three arguments can be advanced for this reform line: (i) The reform of the NPS - first stage - is relatively straight forward, with little technical requirements. Moving from the point system to the MDC system is largely a redefinition of individual rights in accounting terms. Changing the asset management of NPF requires political commitment but can rely technically on substantial international experience. The same applies for the introduction of a sound regulatory and supervisory framework for the third pillar. (ii) Having a functioning second and third pillar which delivers the promised benefits - higher replacement rate under the NPS and secured benefits under the voluntary scheme - will enhance the confidence of the covered population at large in a reformed earnings- related system. This should facilitate the reform of the unfunded basic scheme and the introduction of means- or affluence-testing, or the increase of the retirement age in parallel to enhanced labor supply of the elderly. Also, reforming BFW last allows for the investigation and technical preparation of means- or affluence-testing if such an approach were to be chosen. (iii)Reforming the pensions for the civil servants and public enterprises is going to take more time since it requires a review of the overall compensation package, establishing benchmarks from the private sector, a rethinking of the human resource policies and other related issues. Again, opening the reformed NPS to new entrants and offering existing member the option to convert on a voluntary basis will be much easier once a tested reformed system is in places.

xix. Political reform process. In order to move on the political reform process and to create a strong political buy-in, it is suggested to establish an inter-ministerial reform commission which is in charge of drafting a White Paper on Pension Reform. This paper should investigate reform options and motivate the Government’s selected reform proposal and sequencing. Based on comprehensive analytical preparations, institution building combined with strong communication efforts, the paper should be widely discussed with stakeholders before reform implementation takes place.

vi INTRODUCTION AND BACKGROUND

1. Mauritius has a relatively well developed pension system - much better than other countries at this economic development stage. It provides basic universal pensions to all elderly, mandates participation in an earnings-related system for private and public sector workers in separate schemes, and has a nascent voluntary and privately managed scheme. However, the system is under pressure and needs modernization early on to provide adequate, affordable and diversified pensions for the future elderly.

2. The main pressures are fiscal and result from demographic transition and rapid aging of population, the need for enhanced transparency and efficiency in benefit delivery and fund management of the private sector schemes, and for a reformed scheme which provides full mobility between the public and the private sector. A modernized system should allow for better coping with population aging while providing an enhanced poverty focus, reduced distortions on the labor market and better management of the accumulated reserves.

3. Mauritius is facing a demographic transition much sooner in its development cycle than other upper income and high income countries have experienced. The share of its over-60 population is expected to more than triple in the next 50 years. Such major changes in the population structure require a thorough look at retirement arrangements, as many industrialized countries have done over the last decade.

4. This chapter describes the demographic pressures that confront Mauritius. It provides a profile of the elderly today and goes on to outline the three-tiered pension system currently in place. The subsequent chapters deal with each tier of the pension system and specify the options that are available for their modernization. The concluding chapter discusses how reform ofthe pension system would benefit individual Mauritians. It goes on to discuss the institutional changes that would need to be brought about to ensure the proper functioning and support of the proposed modernization options.

1. WHY MODEmIZE THE PENSION SYSTEM?

5. The population of Mauritius is ageing rapidly. Improvements in living standards over the past twenty years have increased longevity and put Mauritius on the path of having a much grayer population in the future. In 50 years time the age profile of the population will be dramatically different from what it is today. Table 1 provides the summary statistics. The share of the country’s population over sixty years of age is expected to increase from almost 9 percent in 2000 to 25 percent in 2050. Commensurately, the old age dependency ratio (the number of elderly who depend on each 100 employment-age Mauritian) will increase from 13.5 persons in 2000 to about 45 persons in 2050. Without adequate planning for retirement, these demographics can manifest into a fiscal burden that requires either excessive taxation or excessive deficits to finance, neither of which would be advantageous to Mauritius. Early action on the part of

1 Mauritius, given its growing economy and rising earnings and the country’s capacity to generate savings, could help mitigate these dire prospects.

Table 1. Demographic Statistics 1998 1999 2000 2005 2010 2020 2040 2050

Total Population (thousands) 1,167 1,179 1,191 1,251 1,307 1,402 1,498 1,506

Population shares (percent) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Under 14 25.9 25.7 25.6 24.2 22.5 20.9 18.7 18.3 15-59 65.4 65.5 65.6 66.2 66.0 62.8 57.3 56.3 Over 60 8.7 8.8 8.9 9.6 11.4 16.3 24.0 25.4 lOld Age Dependency Ratio (in percent) 13.4 13.5 13.5 14.5 17.3 25.9 42.0 45.1

Life Expectancy at 60 (in years) Men 14.9 15.3 15.8 16.2 16.5 17.4 18.7 19.5 Women 19.1 19.6 20.0 20.5 21.1 22.3 23.5 24.3 Source: PROST output.

6. Mauritius can already ill-afford unchecked expenditures. The central government debt of Mauritius is estimated at close to 50 percent of GDP; parastatal debt is an additional 20 percent. Continuation ofpension policies that increase the burden on public finances would endanger the fiscal stability of the country or force prioritisation. Already, over the past ten years, basic pension expenditures as share of the Community and Social Expenditure of the budget have increased from 18 percent to 28 percent in real terms, pension expenditures have more than tripled, while the recurrent budget envelope has increased by only 70 percent over the past decade.

2. WHOARE TODAY’SELDERLY?

7. Socially and economically, today’s elderly Mauritians are those who have worked to build the country into the upper-middle income economy it is today. The majority of the elderly have worked under difficult conditions in the sugar sector, in light manufacturing in the export processing zones or in tourism and, at best, have a primary education. Although the over-sixty age group comprises almost 9 percent ofthe total population, it is worth noting that more than half of them are under 70 years old, i.e. they are relatively young. 1

’ This section draws largely on the papers by Duncan and Valenti (2001) and Lau Thi Keng (2001) which rely on the1996197 household survey and a 2000 supplementary survey. A summary of the analysis in those documents is presented in Appendices I1and X.

2 Table 2. Household Poverty and Pension Access (1996/97 Household Survey) Pov. Line Access to uension schemes Household type Pov. Line w/o BRP BRT’ R S D No elderly adults in household 9.5 9.5 0.5 2.1 3.3 6.2 Single elderly adults 33.7 51.7 100 20.2 3.9 10.7 Elderly couple 18.6 47.8 100 54.0 4.4 1.8 Elderly with single non-elderly 16.3 27.0 100 34.2 12.5 9.2 Elderly with non-elderly couple 8.0 12.1 100 28.3 9.4 7.5 Elderlv with multiple non-elderlv 6.4 10.8 ---100 33.6 10.6 Full sample 9.4 11.8 28.3 10.6 5.0 6.5 Note: Poverty Line set at 50% of median equivalized income for analytical purposes. Mauritius does not maintain and official poverty line. Poverty Line figures in percent of households within each household type that fall below the poverty line. Poverty Line w/o BRP: simulations ofpoverty rates of various household types while subtracting the basic pension from their retirement income. Access to pension schemes: BRP: share of households receiving basic retirement pension; R: share of households receiving income related pensions (NPF, NSF, Occupational schemes); S: share of households receiving survivor’s pensions; D: share of households receiving disability pensions.

8. Mauritius’ elderly people are disproportionately poorer than the rest of the population. Analysis of the 1996197 household survey suggests that household with elderly have two or three times the poverty risk as compared to household with no elderly (table 2). Today, the majority of elderly Mauritians live with other individuals in households that include at least one non-elderly person. Such living arrangements benefit from economies of scale and from a broader basket of incomes, with the greater share of their income attributable to earned sources such as salary, self-employment etc. As such, the elderly living with the non-elderly have a higher equivalized income per capita than those who live alone or as an elderly couple.2 Table 2 gives an indication. Single elderly adults stand out as having substantially higher poverty rates than other categories of households. They consist, overwhelmingly, of females. Elderly couples also appear to be poorer than households where there are no elderly person^.^

3. A SYNOPSIS OF THE 3-TIERED PENSIONSYSTEM

9. Mauritius already has in place an extensive system of protection for the elderly. The country gradually developed it pension system as economic growth made caring for the elderly more affordable, while assuring the country’s economic stability. Currently, the system consists of a flat, universal old-age pension which is funded by general revenues, twin mandatory earnings-related schemes for private sector employees (National Pension Fund and National Savings Fund - the former aiming at a replacement rate of33.3 percent, while the latter provides a lump sum payment at retirement), civil service and parastatal

’ Equivalized per capita income adjusts households’ members’ per capita income to take into account the presence of children and elders. The underlying hypothesis is that there are scale economies that are exploited when individuals live together, and this should be reflected in the per capita income calculation. Analysis of poverty using an expenditure aggregate maintained the same poverty ranking. The reader is referred to Box A1.I in Appendix I.

3 schemes and largely unregulated private occupational schemes and individual voluntary plans. Table 2 indicates the access of households to different types of pensions. All households with elderly have access to the basic pension while about 20 - 54 percent of elderly households have access to income-related pensions. Table 3 provides a synopsis of the structure of the system (a more detailed one is provided in Appendix 111) while Table 4 illustrates pension system payouts.

Table 3. Structure of Mauritius’ Pension System Coverage’ Funding Benefit Structure Issues

1ST TIER Basic Retirement 0% Government -20%~ DB Sustainabilityl Pension Equity 2NDTIER National Pension Fund 44% 9% of wages (non 33.3%~ -DB Structural/ sugar); 13.5% of Asset Mgmt wages (sugar) National Savings Fund 44% 2.5% of wages da DC Asset Mgmt Civil Servants’ Scheme 11 % Government 66.7%f DB Equity/ Sustainability Parastatals Schemes 2.5%2 Parastatal 66.7%f DB Equity 3m TIER Private Schemes Individual da DC 15% } Regulation/ Occupational Schemes DBIDC Supervision

Notes: ‘Contributors as share of labor force in 1998; Mauritian labor force was estimated at 507,000 for 1998. 2Contributions for family protection schemes. w: percent of economy average wage; v: average lifetime earnings of individuals;j final salary of individuals. A more extensive table is the Mauritian pension system is presented in Appendix 111. DB is Defined Benefit and DC is Defined Contribution.

10. The Basic Retirement Pension or Old Age Pension. The most important component of the pension system in Mauritius, in terms of both coverage and government outlays, is the basic pension. Introduced in 1951, the basic pension offers a flat rate of payment to every person aged 60 years or over. A residency test is the only determinant of eligibility. The basic pension is currently Rs. 1,575 a month, which is about 20 per cent of the economy’s average full-time earnings. Outlays, financed from consolidated revenue, were Rs. 2.9 billion in 1998-99, equivalent to 3 per cent of GDP. The Ministry of Social Security and National Solidarity administers the basic pension. Table 2 indicates that all elderly Mauritians have access to the basic pension. It also suggests that the basic pension is instrumental in reducing poverty as it plays a very important role in the composition of the income for the lowest decile of the population in terms of income di~tribution.~

The basic pension is administered through the National Pension Fund. The overall costs of administering the basic pension and the contributory pensions, including investment costs, is within international norms. For 1998/99 the administrative cost of the NPF amounted to Rs. 5 1.4 million while the investment costs came to Rs. 22.1 million; in total, the two costs amount to 0.5 percent of fund assets, 9 percent of contributions, and 30 percent ofbenefits paid out.

4 Table 4. Total Pension Payouts: First and Second Tier In Millions of 1998199 Ruuees 1992193 1993194 1994195 1995196 1996197 1997198 1998199

Total payouts 2,497 2,666 2,800 3,054 3,767 3,956 4,392 Total Payouts in percent of GDP 3.2 3.3 3.4 3.6 4.2 4.2 4.4

Payouts from tax & non-tax rev. 2,435 2,605 2,718 2,956 3,651 3,795 4,180 Basic (BRP) 1592 1662 1749 1940 2542 2644 2930 Civil service 843 943 969 1016 1109 1151 1250 Pension 522 580 608 634 705 748 788 Lump-sum 210 264 251 262 267 250 301 Survivors etc. 111 99 110 119 136 153 161 Payouts from contrib. Schemes 62 61 82 99 116 161 212 National Pension Fund 1/ 62 61 82 99 115 150 184 National Savings Fund 0 0 0 0 1 11 28 Source: Whitehouse and Piggott, Pensions in Paradise

11. The National Pension Fund (NPF). The National Pension Fund ("F). The second most important component of the country's pension system is the contributory pension of the NPF, which began operating in 1978. The scheme was designed as a partially funded PAYG ( Pay As You Go) points system, whose objectives were to: (i) provide replacement income to workers outside the civil service and (ii)build up a fund for national development. Originally, the scheme was intended to deliver a 33.3 percent replacement rate with a 9 percent contribution. By design, the scheme was to offer a pension commensurate to the number of points purchased during employment. For those employed in 1978, at the initiation of the scheme, a subsidy was provided. Those 40 years of age and above obtained a doubling of their contribution points. Hence the cohort retiring in 1998/99 was the first to retire with a full pension (although the subsidy represented half of the pension). For those under the age of 40 in 1978/79, the subsidy is equivalent to the number of years they had been employed prior to joining the NPF. It is also equivalent to their average annual contribution to the NPF. So far, payments from the NPF have been very small, amounting to less than Rs. 200 million in 1998/99, just 0.2 percent of GDP. But as the fund matures, and with the onset of demographic transition, payouts are projected to increase dramatically. Employers contribute 6 percent of wages, and employees 3 percent.' After a full 40 years of contributions, the scheme is supposed to deliver a pension of one third of their average lifetime earnings. Individual earnings in earlier years are revalued to protect the pension against the inflation that has taken place between the time the contributions are made and the time the benefits are withdrawn. Although the original intention appears to have been to index individual earnings in earlier years in line with economy-wide earnings, actual indexation has been lower than prices and much below earnings growth.

12. Almost all private-sector employees in Mauritius are required to belong to the NPF scheme. Exceptions include very low-paid workers, members of the civil service, local- s The sugar sector's total contribution is 13.5 percent.

5 government and parastatal employees, and those sugar-industry workers who, when the scheme was introduced, elected to remain within the already established Sugar Industry Pension Fund (SIPF). Membership of the NPF currently stands at about 220,000 out of a total workforce of a little over 500,000.6 The Ministry of Social Security and National Solidarity administers both the basic pension and the NPF, but control over contribution rates, investment of fund assets and benefits, lies within the Ministry of Finance.

13. The National Savings Fund. A second mandatory pension system is the NSF, formerly known as the Employee Welfare Fund. Employers are required to contribute 2.5 per cent of wages to this fund, and members receive the resulting accumulation as a lump sum at retirement. The NSF shares many features of the individual-account systems in other countries. However, there is no direct provision for members to convert their retirement accumulation into an annuity stream and neither members nor employers have any direct control or choice over how funds are invested.

14. The Civil Service and Parastatal Pensions. The civil service pension pays two- thirds of final salary after 33.3 years of service (400 months). The scheme is non- contributory and all benefits are paid from the budget. However, benefits for widows and orphans - provided under the administratively separate Civil Service Family Protection Scheme - are contributory. The civil service plan has some 50,000 contributors and the local government schemes have a further 5,000. There are currently 20,000 civil service pensioners, and a further 10,000 survivors’ pensions are currently payable. Outlays are R1.25 billion, or 1.3 per cent of GDP.

15. Publicly owned corporations, commonly known as parastatal enterprises, operate underfunded defined-benefit schemes. Parastatal pension funds offer benefits similar to those provided by the civil service scheme. The public corporations themselves are the designated fund sponsors and contribute to the appropriate fund at a rate varying between 15 and 27 per cent. The pension funds are invested with the State Insurance Company of Mauritius Ltd.(SICOM).

16. Private voluntary pensions. Private voluntary pensions have been part of Mauritius’ retirement-income landscape for many years, but coverage of workers employed in the private sector remains low. However, private pensions, both individual and occupational are largely unregulated in Mauritius. Payouts from pension funds registered with the Controller of Insurance totaled Rs. 250 million in 1996-97. But the largest pension funds are managed by employers themselves rather than being sub- contracted to insurance companies. In the absence of trust law, these funds take the legal form of ‘associations’ and must, therefore, register with the Registry of Associations. No estimate of the benefit value of these funds is available.

While there were 220,000 employees for whom employers had submitted contributions to the NPF, an additional 70,000 individuals had submitted at least a single monthly contribution payment to the NPF. The latter, in exchange for the single monthly contribution payment, are entitled to a monthly pension (at 60) of about just under US$2.0. Projections undertaken in subsequent chapters of this report regarding the NPF have this liability into account.

6 17. Other formal safety nets. Aside from the aforementioned pension schemes, Mauritius also has a very limited safety net for very poor individuals, regardless of their age. Under the social assistance scheme, there were 487 cases in 1998/99 of basic pension recipients who were paying rent and qualified for an average social assistance benefit of Rs. 735 per month. Of these cases, 88 percent were women. Another 74 recipients of the basic pension were those with dependents who each received, on average, Rs. 532 per month. Social assistance scheme is means tested, and for the elderly, serves as a top-off to the basic pension scheme.

4. THE WORLD BANKAPPROACH TO PENSIONS

18. The World Bank has four principal concems about pension systems in a country.’ The report adopts the prism of accumulated World Bank experience in assisting many countries with pension modernization. The approach seeks to diversify the economic and political risk inherent in pension systems. Economic risk can come from fiscal concerns, particularly of unfunded schemes, and from constraints to economic growth stemming from, taxation, labor market and investment implications of unfunded and contributory schemes. Economic risk also comes from redistributive concerns, should the elderly and poor have insufficient income during their old age. Political risk comes from politically motivated decisions that are made outside the country’s financing capacity.

19. As a strategy to minimize economic and political risk, this approach suggests maintaining a small and efficient unfunded redistributive component to meet the needs of the poor, and a dual funded (and privately managed) component for income maintenance. The dual character of the funded component aims to assure moderate replacement income via a mandatory scheme, and to provide opportunities for private provision to meet individual or labor market needs for supplementary pensions.

CONCLUSION

20. The demographic transition is likely to place a major fiscal burden on Mauritius if the country does not take early actions to mitigate its impact. The country’s precarious debt level does not leave much room for maneuver, in particular if the country wants to use the available public resources for improvements in other social sectors such as education, health and social welfare. Mauritius already has a three-tiered pension system in place, which mirrors the structure perceived as most beneficial by international experience. Mauritius’ good growth prospects provide ample opportunity for wages to increase and for Mauritians to prepare now for their own retirement. Yet, in order to be able to do so, this requires the NPF to have much more transparent benefit design with effective and prudent fund management, that obstacles for mobility between private and public sector workers eliminated, and that the voluntary pension schemes be better regulated and supervised.

This section draws extensively on Robert Holzmann “The World Bank Approach to Pension Reform”, International Social Security Review, 53(2000), No. 1, 11-34.).

7 CHAPTER 1. TIER ONE -THE REDISTRIBUTIVE SCHEME

1.1. Mauritius’ basic pension scheme is also the principal transfer instrument of the country’s extensive welfare system. Financed from consolidated revenue, the scheme is viewed by many Mauritians as an entitlement in compensation for the last twenty years of labor-intensive employment that has elevated the country to its upper-middle income status today. Today the basic pension amounts to Rs. 1,575, or approximately 20 percent of the average wage.8 Under the current system, the scheme’s costs are expected to increase gradually to almost 11 percent ofGDP by 2050. This poses a critical financing problem for Mauritius.

1. THEEXISTING SYSTEM

1.2. The basic pension contributes substantially to reducing poverty among most elderly people; nevertheless some recipients still remain below the poverty line while others do not need the pension. Simulations suggest that the basic pension reduces the share of poor single elderly adults by 35 percent, of elderly couples by 61 percent, and of the various categories of elderly living with the non-elderly from anywhere between 30 percent and 50 percent. Yet single elderly females, who account for about 0.5 percent of the population, have poverty rates two to three times the national average of 10 percent. Overall, the basic pension is quite effective, comprising a large share of the lower decile retirement income. On the other hand, evidence from the 1996/97 Household Survey suggests that the upper income deciles ofthe elderly rely much less on the basic pen~ion.~

1.3. Pension increases have been, in effect, discretionary despite the Figure 1.1 Value of Basic Pension for Under 75s availability of indexation rules. Although the basic pension is indexed 25 i T 1600 m 1400 to wages, annual adjustments suffer p 20 1200 a f from poor information on wage f 15 1000 behavior.lo To compensate, usually on 9 800 g ;10 600 a 5-year basis, government accords a 400 2 (non-statutory) correction to the 15 200 0 pension along-side the scheduled 0 86 87 88 89 90 91 92 93 94 95 96 97 98 99 annual wage adjustment. Figure 1.1 Rel. to wages -C- In real terms indicates that sharp increases in the

The basic pension payout is staggered. Under the 2001/02 budget it has increased to Rs. 1,575 for those between 60 and 90, Rs. 6,015 for those between 90 and 100, and to Rs. 6,825 for those 100 and above. Mauritius does not maintain and official poverty line. The poverty line for this report was calculated at 50 percent of median equivalized household income (see Appendix I1for further discussion). loIn Mauritius nominal wages are adjusted annually by a tri-partite negotiation mechanism which brings together government, labor, and the private sector. Wages for entry level, and unskilled employees, are usually adjusted according to price increases over the previous year, while higher level employees are accorded smaller increases. Pensioners are accorded the full increase. Wage increases are applicable to the “basic salary” of each occupational category, and do vary by economic sector.

8 basic pension monthly payouts have occurred on two distinct occasions, coinciding with national elections." It also shows the evolution of the basic pension over time in real terms. The basic pension has become more generous over time owing to the discretionary increases. The consequences of a discretionary policy are poor predictability of the fiscal costs to the system, and public pressure for occasional payout hikes.

Projectionsfor its future

1.4. Continuing current eligibility criteria and indexation practices in the presence of a demographic transition would create a fiscal hazard. With Mauritius' old age dependency ratio expected to double in twenty years and to triple in about thirty five years, the fiscal burden of maintaining current indexation practice of the basic pension will become unsurmountable. As share of the GDP , basic pension expenditures would increase by 50 percent in about twenty five years and peak in forty years.12 The implicit pension debt ofthe current practice is estimated at 22 1 percent of GDP. Implicit pension debt (IPD) is defined as the present discounted value of future pension obligations; the IPD is discounted at 8 percent and is presented relative to GDP in 1998. The IPD of the intended policy (wage indexation) is estimated at 135 percent of GDP. Table 1.1 on page 11 shows projected expenditures till 2050.

1.5. Adjustment on the revenue side could be stijling. Preliminary simulations suggest that, over the projection horizon, Mauritius would need about 1.5 percent of GDP a year henceforth to stabilize public debt and meet the additional expenditure obligations on the basic pension imposed by the demographic transition. This could be stifling given the international competition that Mauritius' private sector currently faces. 13

2. ARE THE BASIC PENSION'S POLICY OBJECTIVESSTILL RELEVANT TODAY?

1.6. Sustainability analyses suggest that it would be prudent for Mauritius to reduce basic pension expenditures. Prior to discussing options for reducing expenditures, Mauritius should consider the relevance and necessity of the basic pension as it stands today Le. its universality, its payout at 20 percent of average wage, and its retirement age at 60 years. Mauritius may also wish to consider, based on its own experience, the need to

" In 1990191 the payout grew at 17 percent over the previous year, and in 1996197 it grew at 50 percent over the previous year; both increases outpace any necessary price adjustments. I' Past practice has been modeled as the average annual increment of the BRP over the past 14 years (this is equivalent to wage growth plus 2 percent). l3 Given a starting fiscal deficit of about 6 percent of GDP, central government debt about 50 percent of GDP, and maintaining non-interest expenditures at 20 percent of GDP (Le. without considering the impact of the demographic transition on pensions or other reprioritization), gradual revenue adjustments from the current 18 percent of GDP to 21.5 percent of GDP in four years would be needed to ensure sustainability (keep the debt to GDP ratio at around 50 percent of GDP for the next 50 years). Adding the impact of the demographic transition to the simulation, under current indexation practices, tax revenue would have to stabilize at 1.5 percent of GDP more, at about 23 percent of GDP, or 4.5 percent of GDP more than currently stands.

9 introduce fundamental institutional changes that will assure sustainability of any new policy.

1.7. The advent ofthe demographic transition comes at a time when Mauritius is indeed changing economically and socially. Several factors need to be taken into consideration, Mauritians are living longer than before. When the basic pension scheme was designed, life expectancy at 60 was 11 years for men and 15 years for women. Today life expectancy at 60, has increased by about five years, to 16 years for men and 20 years for women.

Some Mauritians already work beyond their 6dhyear. Not all Mauritians think of retirement similarly. Those in the urban areas and from the service sectors tend to work for more years than those in the rural areas and in the manual-labor sectors. Those in manual labor sectors also tend to begin work sooner in their lifetime, and often seek retirement earlier. Finally, Mauritians also use the basic pension to invest in income- generating activities after their 60th year.

The economy is already changing. The Mauritian economy is transforming itself into a service economy. In the past 10 years alone, the share of employment in the primary sector has fallen from 16 percent to about 9 percent and in the secondary sector it has also decreased fiom 45 to 43 percent; to the contrary, tertiary sector employment has increased from 38 to 48 percent. Given the less difficult working conditions, does a universal benefit under the scheme remain necessary?

Some elderly andpoor need a higher basicpension. Surveys have suggested that there is a small share of elderly and poor for whom the basic pension is the sole source of income. Modernization of the scheme could also have to address this concern by raising the pension for those in need.

3. BEFOREDECIDING, SOME FUNDAMENTALS MUST BE IN PLACE

1.8. Two factors need to be kept in mind to ensure sustainability of any basic pension modernization option. a Institutionalize the wage-indexation mechanism. The runaway increases in the basic pension payouts over the last 15 years suggest that Mauritius may wish to adopt an institutional mechanism that would eliminate discretion in the indexation. It would be important that indexation occurs around a non-disputable wage index, with possibly a formula to smooth variations from one year to the next.14

a Upgrade the social assistance scheme. Any reduction in expenditures for the basic pension scheme, whether by increasing the retirement age or by targeting, will imply a lower direct transfer to the population as a whole, given the propensity ofthe elderly to share their pension. To continue support to the non-elderly poor, an effective social

l4 In a rapidly growing economy like Mauritius’, price indexation makes the elderly feel relatively poorer. Wage indexation, on the other hand, would assure that the beneficiary’s social standing during retirement.

10 assistance scheme will be necessary: this would increase social aid expenditures, and offset some of the gains made under the modernization of the basic pension.

4. THEOPTIONS FOR kfODERNIZATION

1.9. Mauritius has several options. Mauritius has several options to meet its pension obligations to the elderly and poor and at the same time reduce the fiscal impact of the pension. The present section lays out feasible options which have taken into consideration likely fiscal gains and what could be socially a~ceptab1e.l~The fiscal impact of the various policy options is presented in table 1.1. Mauritius’ options are grouped into three categories: raising the pensionable age, limiting eligibility, and/or reducing the benefit level to all. The options exclude explicit discussion of differential pensions for the very old because it is felt that medical benefits (the primary justification given for differential pensions) may more efficiently be provided by the health system and also because differential pensions can be regressive (in wealthier countries, a stage which Mauritius is approaching, it is the wealthier who live longer). The aging of the population is also likely to make the differential pension bill very expensive in the future.

Table 1.1. Pension Expenditures as Percent of GDP (Percent of GDP at Droiection vear) Description ZPD 2000 2005 2010 2020 2030 2040 2050 Intended policy 135 3.1 3.2 3.4 4.4 5.5 6.4 6.8 Current practice 221 3.3 3.7 4.2 5.9 7.8 9.6 10.9 Option I.1 Flexible pensionable age 107 3.1 2.8 2.1 3.3 4.3 4.9 5.5 Option 1.2 Mandatory retirement at 65 111 3.1 3.0 2.9 3.3 4.2 4.8 5.2 Option 11.1 Affluent test -- top 20% 101 3.1 3.2 3.3 3.9 4.7 5.3 5.5 Option I11 Poverty Top-off 107 3.1 3.1 2.9 3.6 4.4 5.0 5.3 Option IV Combine Options 1.2 and 11.1 89 3.13.2 3.1 3.2 3.8 4.1 4.5

Note: IPD is the Implicit Pension Debt, which is defined as the present value of pension liabilities discounted using a discount rate of 8 percent per annum and is expressed as share of 1998 GDP. Source: World Bank staff estimates

4.1 Option I:Raise pensionable age

1.10. Option 1.1 Flexible pensionable age. Mauritians are already working beyond their 60th year, depending on their employment background. Mauritius may wish to permit a choice in the pensionable age. One possibility is presented in table 1.2. The idea is to develop a schedule according to which individuals could retire at any time after 55 years of

l5 The section does not discuss the option of maintaining a universal basic pension and using the tax system to claw-back from the higher income earners. The very low number of income taxpayers, about 75,000 individuals pay income taxes in Mauritius or less than 2 percent of the labor force, makes this an unlikely source of savings on basic pension expenditures. Although this would be an attractive option to consider, instituting an effective income tax system should be seen as part of the country’s global tax policy and its implementation capacity. Additionally, as other parts of this paper will indicate, it is imperative that Mauritius not postpone its pension modernization efforts till, when and if, an effective income tax policy is implemented.

11 age. According to the present sample schedule, once the scheme is gradually implemented, individuals could obtain the basic pension at 55 years of age, at a monthly payment equivalent to 7.5 percent of the average wage, or they could wait for 15 years and earn a pension equivalent to 35 percent of average wage, or take the pension anytime in between at reduced benefit rates. Currently the basic pension payout is equivalent to about 20 percent of the average wage; under the proposed scheme, a pension equivalent to 20 percent of the average wage would be granted at 63 years of age. The schedule of table 1.2 assumes a linear progression between the pensionable age of 55 years and 65 years of 1% percent, and of 3 percent between 65 years and 70 years. The scheme is approximately actuarially fair based on the existing scheme. The IPD for this scheme is 107 percent of 1998 GDP compared to the IPD of 221 percent of 1998 GDP for current practice. Table 1.1 presents the projected expenditure path of this proposal. In the outer years, the option produces expenditure of 5.5 percent of GDP, roughly half of current practice.

Table 1.2 Sample Schedule for Flexible Pensionable Age Pensionable Age 55 60 65 70 Payout (as % of average wage) 7.5% 13.75% 20% 35%

1.1 1. Option 1.2 Phased mandatory increase in pensionable age. Mauritius could introduce a gradual mandatory increase in the retirement age over a 20 year period. The gain in that policy, over the present one, will be a savings of 1.3 percent of GDP by 2010. Similar to Option I.1, this option saves almost 5.7 percent of GDP in the outer years over current practice. The IPD of this proposal is estimated at 111 percent of GDP, about half the current practice.

4.2 Option 11: Limit eligibility

1.12. Mauritius may wish to limit elegibility of the basic pension to only those in need by determining a cut-off income and a for BRP recipients. The cut-off income is the level of non-BRP reirement income beyond which recipients will not be granted the full BRP. The taper is the rate at which the basic pension will be taken away from them. These choices will determine the savings that Mauritius can gain from reforming the scheme by limiting eligibility.

1.13. Table 1.3 presents simulations, based on the 1996/97 Household Budget Survey, of savings in payouts from various cut-off and taper combinations and the resulting poverty levels. An example may be useful to illustrate the tapers. If the cut-off is set at Rs. 750 and the taper is set at 25 percent, then for every Rupee of non-BRP income above Rs. 750, a quarter of the BRP is withheld. Under of this arrangement, if an elderly person had income from various sources of Rs. 2,000, they would receive a BRP equivalent to 1500 - (2000 - 750)*25% = 1187.5. The total retirement income including BRP would be 2000+1187.5 = 3187.5. Alternatively, with a cut-off of Rs. 750 and a taper of 50 percent, retiree with BRP of Rs. 2,000 would obtain an BRP of 1500 - (2000 - 750)*50% = 875. The total retirement income including BRP would be 2000+875 = 3875. Table 1.3 shows that a BRP cut-off of Rs. 1,500 and a taper of 50 percent would result in an 18 percent

12 savings in payouts in the simulation (see Savings in Payouts subtable). The poverty impact of this policy would depend on the household category. For non-elderly households, the poverty rate stays at 9.5 percent, while for households with multiple non-elderly it increases to from 6.4 to 6.8 percent. Recall that table 2 in the Introduction and Background section of the paper which gave the poverty rates of various household types.

Table 1.3 Simulations of Savings in Total Payouts and Poverty Impact from Limiting Eligibility in the Basic Retirement Pension

Savings on Total Payouts pension withdrawal rate (per cent) cut-off 0 25 50 100 Infinity

RO 0 23 32 40 50 R250 0 21 29 35 44 R750 0 17 23 28 36 R1,500 0 13 18 21 25 R5,000 0 5 7 7 8

Poverty Impact from Limiting Eligibility in the Basic Retirement Pension

pension withdrawal rate (per cent) Pension withdrawal rate (per cent) cut-off 0 25 50 100 Infinity cut-off 0 25 50 100 Infinity

i. non-elderly only households iv. elderly and single non-elderly

RO 9.5 9.5 9.5 9.6 9.6 RO 16.3 18.5 21.2 24.0 26.0 R250 9.5 9.5 9.5 9.5 9.6 R250 16.3 18.5 20.4 21.9 25.1 R750 9.5 9.5 9.5 9.5 9.6 R750 16.3 18.2 19.6 20.4 22.9 R1,500 9.5 9.5 9.5 9.5 9.5 R1,500 16.3 16.5 17.3 18.5 18.9 R5,000 9.5 9.5 9.5 9.5 9.5 R5,000 16.3 16.3 16.3 16.3 16.3

ii. single elderly households v. elderly and non-elderly couple

RO 33.7 35.4 42.1 46.1 48.3 RO 8.0 8.6 8.8 9.2 10.0 R250 33.7 34.3 37.1 42.1 47.2 R250 8.0 8.3 8.5 8.8 9.0 R750 33.7 34.3 34.3 37.6 42.7 R750 8.0 8.3 8.3 8.5 8.8 R1,500 33.7 33.7 33.7 33.7 36.0 R1,500 8.0 8.2 8.3 8.3 8.5 R5,000 33.7 33.7 33.7 33.7 33.7 R5,000 8.0 8.0 8.0 8.0 8.0

iii. elderly couple households vi. elderly with multiple non-elderly

RO 18.6 19.5 22.1 31.9 38.9 RO 6.4 6.9 7.5 8.6 9.0 R250 18.6 19.5 20.4 26.5 34.5 R250 6.4 6.8 7.2 8.2 8.9 R750 18.6 18.6 18.6 18.6 24.8 R750 6.4 6.8 6.8 7.2 8.1 R1,500 18.6 18.6 18.6 18.6 18.6 R1,500 6.4 6.6 6.8 6.8 6.9 R5,000 18.6 18.6 18.6 18.6 18.6 R5,000 6.4 6.4 6.6 6.6 6.6

Notes: Poverty headcounts based in an income level of 50% of median per capita income (based on Actual Expenditures in 1996197). All poverty figures are expressed as the percentage of adults in each family group below 50 per cent of median per capita equivalised income (R2,228 per month). Within each of the panels (i)to (vi), poverty rates are calculated for different combinations of pension threshold and pension withdrawal taper. Data: HBS Mauritius 1996-97. *Cut-off in non-BRP monthly per capita income. A withdrawal rate of infinity means that the entire basic pension would be lost once non-BRP income passes the cut-off. Source: Duncan and Valenti (2001).

13 1.14. Typically, when benefits are restricted from the top end of the (non-BRP) income distribution the method is refered to as “affluence testing” while when benefits are aimed directly at those at the lower end of the (non-BRP) income distribution, the method is refered to as “targeting”. Below two examples of limiting elegibility are presented using simulations of the 1996/97 household survey.16 Ofthe matrix of options, we choose two as illustrative cases.

1.15. Affluence-testing. Mauritius could restrict benefits from the top end of the @re- BRP) income distribution. If it restricted benefits to the top quintile, or those with non- basic pension income above about Rs. 5,000, the savings on pension payouts over universal access will be about 8 percent, using the simulation of the 1996/97 data. The poverty impact is neglegible. The implicit pension debt is estimated at about 10 1 percent of GDP.

1.16. Targeting: Grant benefits to the bottom end of the income distribution @re-basic pension) by introducing the cut-off at Rs. 1,500 with a 50 percent taper (as in the example above). This could attain a savings of 18 ercent on total basic pension payouts, based on 1996/97 payouts and income distribution.’ Simulations on the poverty impact suggest that it will be negligible, affecting primarily elderly and single non-elderly households.

1.17. Determining eligibility of the basic pension remains a political decision which needs to be considered along with the practical feasibility of each option under consideration. Mauritius maintains multiple exemptions on income taxes, with the result that less than 2 percent of the labor force files tax return, making the implementation of an affluence test difficult. However, suggestions have been made to use the NPF (particularly with an increased ceiling), civil service, and parastatal pension payouts as a means to detect pre-basic pension retirement income. This recommendation merits further investigation should government choose to adopt the affluence test route.

1.18. Ofthe two alternatives, targeting seems the most efficient, concentrating the benefit to those truly in need. However, its administration can be costly, especially given the nascent stage of the social assistance scheme in Mauritius. Additionally, targeting can be socially controversial since it can create a stigma for the recipients of the basic pension, thereby creating pools of elderly who need the pension but do not receive it.

4.3 Option III: Limiting payouts - universal basic pension plus top-up

1.19. On a temporary basis, Mauritius may wish to allow the basic pension payout to fall in real terms and to introduce a supplementary scheme for the elderly and poor. This proposal allows universality of the basic pension scheme to be maintained, although the

l6 The poverty impact is presented as illustrative since the future income status of the elderly will depend heavily on the policies undertaken in the second tier scheme. The simulations are based on continuation of current policy. ” A cut-off of Rs 1,500 with a 50 percent taper means that for those with non-BRP retirement income ofRs. 1,500 or above, for every Rupee above the cut-off, half of a Rupee of BRP is taken away. This means that elderly with non-basic pension income of Rs. 1,500 would get the fill BRP (of Rs. 1,500) while those with non-basic pension income ofRs. 4,500 would receive no pension payout.

14 approach may not be the most efficient, or the most equitable." As an example, the basic pension can be allowed to deteriorate to about 15 percent of the average wage, from the current rate ofabout 20 percent. The necessary accompaniment ofa heavy social assistance package from which the elderly who fall below the poverty line would benefit, has not been modeled. This proposal, presented in Table 1.1, has an IPD of 107 percent of GDP, comparable to Option I.1.

4.4 Option IV: Any combination of the above

1.20. Mauritians may choose to arrive at any combination ofsolutions which will address the financing constraint as well as maintain equity and efficiency. For instance, gradually increasing the retirement age to 65 within the next twenty years and implementing an affluence test, would bring down the IPD from 221 percent of GDP under current practice, to 89 percent ofGDP with the combined policies. A key criterion for the ultimate choice of a single or a combination of options would be the fiscal impact and sustainability of the policy, as well as equity consideration.

SUMMARY

1.21. Fiscal pressures from the basic pension are likely to rise dramatically should current indexation practices continue and present policy objectives remain unchanged. Despite the basic pension scheme's success in reducing poverty among the elderly, the scheme is arguably inefficient (granting access to those who are not in need while leaving the elderly poor in need), inequitable (indirect taxes make up the largest share of recurrent revenue, and those tend to be regressive), and has suffered from poor governance (as demonstrated by the discretionary indexation practices adopted in the past). Solutions to the fiscal pressure problem require curtailing expenditures by increasing the retirement age, curtailing eligibility ( by means testing or affluence testing), or by reducing the benefit level. The fiscal benefit obtained from increasing the retirement age is likely to be the greatest and would best match the higher life expectancy in the country today. It would also give Mauritians the choice of when to retire, as employment options become more plentiful, the economy becomes even more service oriented, and people start to feel wealthier. Part of the savings from the basic pension modernizarion will likely be absorbed by (i)the need to possibly make a one-time adjustment to the pension payout under a means-tested scenario and (ii)social aid scheme, with the objective of aiding the non-elderly in need.

'' There is a second option for reducing payouts, and that is curtailing payouts to married couples. Currently in Mauritius' elderly receive fill pensions whether they are married or single. In some European countries married elderly receive a pension equivalent to 150-175 percent of the pension for single elderly, attempting to reflect the scale economies from living in partnership. This policy is very reasonable and very attractive from an economic perspective and could result in a substantial reduction on the fiscal burden. A detailed analysis of the fiscal and poverty implications of the policy are discussed in the background studies to this paper.

15 1.22. Reforming the basic scheme will not be easy in terms oftechnical requirement and political support. At the technical level, this requires, inter alia, an improved database for tracking the vulnerable elderly, progress in direct tax collection and record keeping, and well-developed mechanism to means- or affluence-test in a transaction-cost efficient manner. At the political level, this require comprehensive discussions with all stakeholders and strong communication measures about reform need and implementation. The political support for any selected reform measure, however, can only be facilitated if individuals have confidence that there is a transparent and functioning second and third pillar which meet their old-age income needs in a credible manner.

16 CHAPTER 2. TIER TWO - MANDATORY INCOME MAINTENANCE SCHEMES

2.1, Income maintenance schemes are mechanisms for individuals to smooth lifetime consumption. Given individuals’ strong preferences for consuming “today” rather than “tomorrow”, and market failures in the insurance area, it is prudent social policy to require part of the income maintenance mechanism to be mandatory, and part to be voluntary, as currently occurs in Mauritius. l9 Income maintenance schemes are the primary income replacement mechanism in a three-pillar system as discussed in the Introduction. The high volumes of savings required to be reallocated over individuals’ lifecycles in an economy implies that income maintenance schemes can form critical vehicles for allocating savings and risk. Given their sheer size, they can also contribute to destabilizing the economy should they be managed poorly; as such, the management of pension assets can pose a critical governance problem.

2.2. Mauritius’ two large income maintenance schemes, the funded dual package (NPF and NSF) for private sector employees and the unfunded scheme for civil servants and parastatal employees form the second tier of Mauritius’ pension system. The current chapter focuses on the National Pension Scheme as the centerpiece of Mauritius’ employment-related pensions policy, and, in particular, examines structural issues of the NPF and issues of asset management. This chapter calls for a new and more transparent benefit design linked with a better management ofNPF assets which eventually should be handed over to the private sector. The chapter also considers the position ofthe NSF and takes a brief look at the civil servants scheme.20 The civil servants scheme provides very generous benefits and needs to be reformed as part of a review of civil servants total compensation that brings it in line with the private sector, and as a policy of full mobility between public and private sector workers that is needed in a modernizing economy. The chapter separates discussion of the integrity of the NPF scheme and management of the assets.

1. THENATIONAL PENSIONSCHEME

1.1 Poorperformance and its causes

2.3. The National Pension Scheme has been failing to deliver on its promise.. The NPF has promised a replacement rate of 33.3 percent of the lifetime average salary for a full 40 years ofcontributions ofan individual. Having been initiated in 1978/79, the NPF is a young scheme whose first cohort of contributors with a full pension has graduated in l9 The mandatory income replacement schemes have an important function to guard against market failures in provision ofreplacement income insurance on the part ofthe insurance industry and against myopia on the part of the individual. See “Averting the Old Age Crisis”, World Bank 1994. 2o Although the chapter does not explicitly discuss the higher contribution of the sugar sector into the NPF, all projections of the financial sustainability of the fund have taken explicit consideration of the higher contribution and higher expected benefits of the sugar sector employees. A more detailed analysis of the NPF and NSF structure and management is presented in Appendix IV.

17 1998/99, with doubling of their contributions.21 The replacement rate of a person of average wage retiring in 1998/99 comes to 26 percent, instead of the promised 33.3; under- indexation of the payouts to inflation -as is the current practice- would deteriorate the replacement rate to 15 percent. A person in the same cohort earning 1.5 times the average wage during his or her working life would obtain a replacement rate of about 16 percent before adjusting for inflation. Given the subsidy of the double contribution, the internal rate of return for beneficiaries retired in 1998/99 with a full contribution is 3.3 percent; it would have been around 9 percent if they obtained the full 33.3 percent replacement rate, had the parameters of the point system been indexed to earnings. More striking is that the system is poised to deliver substantially less than promised to those that will have contributed a full 40 years under current indexation practices-and will retire in 201 8/19. With the current poor indexation practices, an individual that earns average wages retiring in 2018/19 would get a replacement rate of about 12.5 percent without taking inflation into account and 7.5 percent if we factor in the under-indexation of inflation.22

2.4. ..due to the opacity of a complex points system.. The NPF is structured around a complex points system (Appendix IV provides some details). Monthly contributions, equivalent to 9 percent of wages, buy a number of pension points. The contribution is subject to a wage ceiling: at the time of design, the wage ceiling stood at about 170 percent of the average wage. At retirement, a contributor’s accumulated points are converted to an annuity, paying a monthly pension until death. Designers of the NPF had adequately provided for the contribution ceiling and the purchase price of points to be indexed to earnings, so that as earnings grow (in a growing economy), the total amount of contributions rises, in proportion to the pension relative to earnings at retirement. Similarly, to address changes in life expectancy over time, either (i)the contribution rate or (ii)the ratio between purchase and sale price of points was expected to change. Finally, it was anticipated that the annuity will be indexed to earnings growth.

2.5. ..and to the poor management it encourages. Indexation of parameters has not kept pace with the scheme’s original design. With rising earnings over the past twenty years, the contribution ceiling is now at 80 percent of the average wage, and point costs have increased by only 30 percent, compared to earnings adjustment of 170 percent. In addition, the contribution is made on the “base salary” and not on the totality of the employee’s earnings. Furthermore, the rising contribution rate and the ratio of purchasehale price of points have both remained constant, despite increase in life expectancy at 60 years of age of another 10 years between 1978 and 2000. The result of underindexation is that the pension payout is smaller than foreseen by the scheme’s designers and less relevant to retirees. This contributes to the perception expressed by a variety of contributors that their mandatory NPF contribution is seen more as a tax than an opportunity for consumption smoothing at retirement. Given however the foresight of

” These are those individuals who already had 20 years of employment prior to the creation of the scheme in 1978179, joined the scheme at inception, and were promised a doubling of their contributions. Although these individuals have contributed for only 20 years, the doubling of their contribution amounts to them acquiring a full pension at retirement. ’’ Should the system’s parameters be henceforth indexed to wages (adopted in July 2001), then the replacement rate for the average wage earner retiring in 2018/19 would increase to about 25 percent.

18 designers to maintain the system, the poor performance is attributed to poor management and poor oversight, i.e. governance.

Table 2.1 Projections of the Finances of the NPF - Introducing Wage Indexation of Parameters Henceforth (Millions of 1998/99 Rupees) 2000/01 2005/06 2010/1 1 2015/16 2020/21 2030/31 2040/41 2050/51 Inflows 1,988 2,264 2,623 3,132 3,625 4,569 5,281 5,761 outflows 592 871 1,268 1,787 2,437 4,117 6,288 8,948 Balance 1,396 1,393 1,356 1,345 1,187 452 -1,007 -3,187 Fund assets 18,115 21,466 24,857 27,842 29,963 29,095 19,556 -3,187 %GDP 17.1 15.7 14.7 13.6 12.3 8.7 4.5 -0.6

Memo-with current practice (Le. henceforth underindexation of parameters) Fund assets (in %GDP) 17.1 15.7 14.3 12.9 11.4 8.4 5.9 3.7 Note: Inflows consist of contributions, other revenue, and investment returns. Outflows include pension payouts, other payouts, administrative costs (which include the Old Age pension) and asset management costs. Source: World Bank staff estimates using PROST (see Appendix XI for details).

1.2 Managing the Assets of the NPF

2.6. The NPF is sizable.. The NPF has accumulated about Rs. 18 billion or about 17 percent of GDP since its inception in 1978/79. It is large enough to have a significant indirect impact on the economy beyond the impact on pensions itself. The NPF also has a sizable social significance, being a common fund for all Mauritian formal private sector workers independent of social, cultural, or economic background. The national solidarity symbolized by the NPF is particularly important for older workers who helped put Mauritius on the development map and younger workers with poor education who are at risk of social exclusion.

2.7. ..due to the current and planned underpayment of beneficiaries.. Should present indexation policies continue, the fund balance would turn negative closely after the projection horizon, but by substantially increasing the poverty risk ofretirees and reducing the confidence of the public in the fund.23Should the system’s parameters be henceforth indexed to wages, see table 2.1, the fund balance would turn negative slightly before the projection horizon ends. Should the system’s parameters continue to be indexed at a rate of about 3.5 percent below wage growth, as is current practice, see table 2.1 (memo item), the fund balance would turn negative after the projection horizon ends.

2.8. ..and to good asset returns, which nevertheless have come at significant opportunity costs for the NPF beneficiaries. Authorities have estimated that the fund is earning about 3-4 percent a year over inflation; however, this is slightly below per capita income growth. On average, publicly managed funds all over the world have been earning 8 percentage points a year below per capita income growth. However, privately managed funds obtain substantially higher returns. These returns have ranged from around 3 per cent

23 Present indexation policies have been modeled as indexing parameters at the rate of inflation --(this is for retirees that get in 2018/19 a replacement rate of 12%).

19 above per capita income growth in Canada and Hong Kong to nearly 8 per cent in the United Kingdom, averaging nearly 6 per cent. Improving returns will be critical for making the NPF more relevant to private sector employees.24

2.9. The publicly managed NPFposes a risk to the economy. Concentration ofpension assets in government securities is a common investment strategy of publicly run pension funds. In Mauritius, close to three-quarters of fund assets are in Mauritian government ~ecurities.~~This serves as a captive source of government finance. The consequences are several-fold: (a) the availability of NPF resources likely encourages government consumption, (b) the resource and risk allocation features ofthe market are not allowed to operate, (c) portfolio risk is concentrated on the local economy, and of course, (d) risk- adjusted return to contributions is not maximized. The investment position of the NPF is determined by investment guidelines, and the supporting Board structure which is made up mostly of members of the civil service. The NPF’s investment guidelines do not place the risk-adjusted returns as the paramount priority of asset management. Rather, fund management aims to meet a variety of objectives, including development objectives of the country.

1.3 The Need for Reform and Standard Optionsfor a Second Pillar

2.10. Further to the discussion in chapter 1, Mauritius may find it prudent to maintain a mandatory income replacement scheme in order to diversify the economic and social risk of the country’s pension system. Several factors suggest that Mauritius can build its mandatory income replacement scheme around the existing NPF: (i)the NPF represents national solidarity in Mauritius, (ii)NPF has accumulated about 17 percent of GDP in assets, and (iii)the NPF has accumulated significant experience in pension fund administration. The NPF needs to be strengthened with two objectives in mind: (i) ensuring adequate replacement income, (ii)minimizing the contingent liability ofthe state, and (iii)eliminating captive sources of government finance. These objectives can be attained by: e aiming for an approximate replacement rate of about a third of average income from the mandatory scheme with more modern asset management practices e assuring adequate opportunity for individual savings and occupational schemes

2.11. Two broad models for pension systems exist, the dejned benejt and the dejned contribution, each of which would imply an advantage over the existing system in Mauritius. Defined benefit schemes, in theory, provide clear information of the level of benefit that a participant will have, and assign the risk to the guarantor of the scheme.

24 A series ofthe rate ofreturn on NPF assets (based on market value) over the past 20 years is not available. The data on international comparisons are for various years, so the comparison should be seen only as indicative. 25 The Investment Committee for the NPF considers liquidity, security, return maximization and national development in making investment decisions. The investment guidelines for the NPF specify that 70 percent of the surplus funds are invested at commercial rates (domestic and overseas) and 30 percent in social areas. Ceilings on the fund value exist for housing (20%), Development Bank of Mauritius (15%), stock exchange (lo%), overseas investment (25%), government stocks (50%), and for local authorities and other organizations. The investment guidelines for the NSF do not include national development as an objective.

20 DeJined contributions schemes pay to the participant the rate of return on accrued contributions. Risk is borne by the participant.

1.4 Strengthening the National Pension Scheme

2.12. Mauritius’ starting point in strengthening the NPS is the accumulation of about 17 percent of GDP in NPF assets and the opportunity to fully-fund as large a share as possible of the fund’s future liabilities. In moving to any strengthened NPF scheme, Government (and/or the NPF) has to the recognize either (a) contributors’ acquired rights (i.e. what past contributions have bought towards the 33.3 percent replacement rate), or (b) contributors’ past contributions with a particular rate of return. 26

2.13. Transparency on the recognition of past NPF participation of current contributors (not current beneficiaries) will be a critical element of confidence-building in any modernized program. The points system is a defined benefit scheme, and as such contributors have acquired rights. As discussed previously, poor indexation has diminished the value of those contributions but left the fund with sizable assets. Table 2.2 presents various levels of recognition of past NPF participation. The level of generosity of the recognition will depend on what is affordable, public perception of past rights, and on any opportunities for negotiation created in the modernization process.

Table 2.2 Recognition of NPF Participation By acquired rights Original according to number of years contributed to the NPF, towards 33.3 percent replacement rate in 40 years. Reduced according to existing points system valuation By past contributions Market return indexing past contributions to a market interest rate Inflation Compensation indexing past contributions to a zero real interest rate (this is equivalent to the implicit rate of return on contributions)

2.14. Of the menu of recognition choices in table 2.2, current PROST simulations suggests that Mauritius can only afford to recognize past contributions at the implicit NPF rate of return of zero real interest rate. That is, past underindexation has led to lower contributions than would be necessary to fulfill the defined benefit promise of 33.3 percent replacement rate. However, the existing assets suffice to: for contributors, recognize the initial contractual subsidy (doubling of contributions) and adjust contributions for inflation for beneficiaries, continue to pay benefits, indexed henceforth to prices.

2.15. Should this conversion take place in 2002/3, the liability to existing contributors (recognizing the subsidy but crediting past contributions at a real interest rate -the equivalent to the existing management practice of the NPF) is estimated to be Rupees 24

26 The purchase of each point entitles each contributor to 1/120 of his average lifetime income at retirement.

21 billion. The implicit liability to existing retirees is estimated to be Rupees 4 billion in 2002/3. At that time, the assets ofthe NPF would be expected to be Rupees 24-26 billion, depending on the rate ofreturn on assets.27

2.1 6. A Two-Stage Approach for Mauritius. Given the aforementioned considerations on recognition ofpast participation in the NPF and asset accumulation, and the imprudence of assuming additional risks for the state under another defined benefit scheme, Mauritius may wish to move in the direction ofa defined contribution system. This move needs to be balanced with (i)the social significance ofmaintaining a cohesive “National” pension fund and (ii)the institutional readiness of the regulatory and supervisory structure to ensure contributors and beneficiaries are protected under any future scheme. Consequently, a two- stage approach may be considered. Mauritius can maintain the cohesion of the NPF but eliminate the points system and at the same time introduce commercial practices to asset management. In standard pension terminology, given the level of asset accumulation ofthe fund, this would be a fully-funded provident fund (contributory scheme with centralized asset management). Subsequently, as the regulatory structure for pensions is developed, a more modern defined contribution structure can be developed.

Stage One Stage Two Scheme Provident Fund Defined Contribution Structure (Mauritian Defined Contribution)

Asset Public Mgmt & Private Management Management Commercial Practices

2.17. It should be stated that the present second tier proposal relies heavily on NPF information regarding the size of the assets. It is critical that this be verified with a mark- to-market analysis of NPF assets. In the event NPF assets come to less than 17 percent of GDP, Mauritius, may wish to issue recognition bonds to contributors or find other direct sources offinance. It would be critical to mitigate any risk of diluting fund assets, to make a transparent determination of any additional funding needs, and to develop a financing plan. The rest ofthis section develops this proposal in some detail.

21 Appendix V presents an alternative approach to rights recognition and transition from the current points system-based defined benefit scheme to a defined contribution scheme. The approach recognizes the original formula for acquired rights of each participant (first option of table 2.2 above). However, it anticipates better asset management in the future (under commercial practices and a new regulatory framework) and much higher asset returns. It chooses not to compensate all younger contributors for acquired rights because they can start anew in a defined contribution scheme and be better off that if they had stayed in the existing system (because of higher asset returns and compound interest). The approach offers partial rights recognition and an option to join the new system for some middle aged workers, and it grandfathers older contributors by keeping them in the existing system.

22 1.4.1 Stage One

2.18. Mauritius may wish to restructure the NPS into a kind of defined contribution scheme, Asset management could still remain in the public sector but commercial practices can be introduced.

0 Structural Component: Restructure the NPS

2.19. A Mauritian Defined Contribution (MDC) Scheme. Mauritius may create individual accounts for each contributor based on their past (including employer’s) contributions, and thus formalize the de facto structure of the NPF. Employees and employers would continue to contribute monthly, although not towards the purchase of points as is currently done, but simply towards the accumulation of savings towards retirement. Interest would be credited to the individual accounts based on the actual net returns to MDC assets (after accounting for administrative and asset management costs).28 An individual’s account balance would represent to them their share of the MDC assets, although they would not have the right to (i)make direct investment decisions regarding the management of the assets in their accounts and (ii)to cash-in the assets prior to retirement. At retirement, individual’s accumulated assets would be converted into an annuity based on life expectancy at retirement

0 Asset Management Component: Modernize the Public Fund Management

2.20. In the short term, Mauritius could take steps to improve asset management by the public sector. Crucial for such an improvement is a clear fund objective which concentrates only on maximizing the rate of retum for an agreed level of risk, and the irrevocable separation between strategic asset allocation and individual investment decisions. With the development of the appropriate regulatory and financial infrastructure a rising share of asset management can be outsourced to the private sector.

0 Fund objective In order for the NPF to meet the best interest of contributors, a critical change in asset management policy would have to be made so that the single objective of the asset managers would be to maximize risk-adjusted returns for contributors given short-term liquidity considerations. Given the relatively small size of the Mauritian economy, diversification would mandate a strong international investment strategy. Existing mandates ofsupporting the development objectives ofthe nation would have to be eliminated.

0 Investment board A modernized institutional structure will be needed in order to govern management of NPF assets according to new fund objectives. It will be necessary to compose an investment board predominantly with private sector members (experience in finance and insurance sectors will be necessary), with independence from government and with independence from the interests of the domestic securities industry. The board would determine an asset mix policy that can deliver acceptable risk adjusted returns, set mandates for each asset manager

~ *’MDC administrative costs should not include administration costs ofthe basic pension scheme.

23 and establish performance benchmarks against which each asset manager would be monitored.29 Asset management Actual portfolio decisions to implement the strategies can be made by in-house or external asset managers. It will ultimately suit the contributors the best if external asset managers compete for the opportunity under a transparent and competitive process as the appropriate regulatory infrastructure is developed. 2.21. Establishing a new governance structure for asset management in the short term, would create the institutional infrastructure for developing a more diverse portfolio and for one that would capture better returns. In addition, it would give new credibility to the National Pension Scheme.

Box 2.1 Capital Market Development and Building Equity for the Pension System: What Comes First? Mauritius’ capital market is relatively small and illiquid and cannot sustain large investments from the NPF. Market capitalization was about 31 percent of GDP in 2000, while NPF assets amounted to about 17 percent of GDP in 2000. The turnover ratio for the capital market was 5.5 percent in 2000, much lower than turnover ratios in other countries with similar market capitalization, suggesting that the market is not very liquid. An analysis of the capital market suggests that both stock characteristics (market capitalization, volatility, disclosure, concentrated shareholding) as well as market structure (trading rules, regulatory structure) are responsible for poor liquidity. Although improvements in market structure can be made, the NPF will likely benefit immediately from diversification in international equities. In the meantime, modest investments in the domestic market would also be advisable, while with improvements in market structure, and once a liquid and deep market exists, investments in index funds can be considered. Yoource: Ajay Shay, Policy Issues for the Equity Market in Mauritius (July 2001).

2.22. For the first stage, the annuitization process, converting accumulated points individual account balances at retirement into actuarially fair pension payments till death, could be continued to be undertaken by the National Pension Fund.

Communication Component: Ownership and Transparency

2.23. Authorities could immediately increase transparency of the system, by issuing annual statements regarding the actual contribution of employers and employees, the size of individual’s accounts, returns credited to those accounts, and the expected pension given clear assumptions (economic growth, life expectancy, post-retirement indexation, etc.) at various future ages (say 55,60, and 65).

29 The CPP Investment Board (Canada) is considered best international practice and may be a good reference case for Mauritius. The reader is referred to Appendix VI for a discussion.

24 0 Elaboration of Stage One

2.24. Some technical issues. Relevance of the MDC for contributors will require that under the MDC the contribution base be extended to cover all earnings (base salary, supplemental salaries, bonuses, etc) and that the contribution ceiling be raised, over time, closer to the original level of 170 percent of average wage. Second, the minimum pension needs to be adjusted, from a one month contribution period to a five year period and should be actuarially fair.

2.25. The benefits of an MDC. For the individual the principal benefits of the MDC would be the removal of the opacity regarding the value of accrued balances brought by the under indexation of the point system. For Mauritian society, the proposal would maintain the integrity of the NPF and NSF and the national solidarity it represents.

2.26. The risks of an MDC. Three critical risks are identified in moving towards an MDC. The first is the risk that the NPF’s assets are in fact valued at a level less than currently expected; this can, and should, be investigated immediately by doing a mark-to- market analysis. The second critical risk -as estimated from Bank experience from transitions-is that should Government engage in negotiations regarding the recognition level of NPF contributions, then the end-game agreement will likely involve an over- compensation of contributors; this would result because the most resistant contributor would have to be convinced. Alternatively, it could be said that Governments typically overpay in order to overcome political constraints. Finally, the risk is that the transitionary Stage-One will remain the permanent nature of the second pillar. To gather the gains from better asset management, contributors have to be able to exercise choice in asset management providers, and this is coming in Stage Two.

2.27. An unprecedented opportunity. Mauritius should not miss the opportunity to fully fund contributor’s liabilities in the NPF. The preliminary estimation suggest that NPF assets are sufficient to recognize past contributions (adjusted for inflation). Mauritius would be well advised to sequester those funds and allocate them to individual accounts, to assure integrity of those assets and the Fund. Mauritius may wish to issue recognition bonds to contributors or seek other financing sources outside the NPF (but through the budget) in the event that (i)the mark-to-market analysis reveals insufficient funds to cover existing liabilities, (ii)the move to an MDC involves a negotiation which creates liabilities above current asset levels, or (iii)unexpected financing needs arise, such as financing the Voluntary Retirement Scheme of the sugar sector should it result in recognition of rights under a different formula than ‘Inflation Compensation’ discussed under the proposed MDC.

2.28. Pensionable age. Moving toward the MDC system guarantees actuarial fairness and provides flexibility for the retirement age. Individuals who choose to work beyond the age of 60 will continue to make contributions and will retire with higher pensions by virtue of the actuarial adjustment. Calculation of the pension benefit is dependent on the remaining life expectancy which leads to an automatic adjustment of labor supply and actual retirement age in accordance with the lengthening life-span and individual

25 preferences. That is, it does not need a political decision about retirement age increase to balance the system.

2.29. Disability and survivors pensions. The move to an MDC system requires rethinking on the provision ofthese two benefits. For disability it provides an opportunity to delink it from old age pensions and to establish a standalone system, perhaps integrated with accidence insurance. For widows/widowers pensions, it allows the establishment of individual rights for the non- or part-time working spouse, thus avoiding the survivors benefit trap. There are different’design on how this can be achieved and there are ample examples from international experience.

2.30. Several efforts made to modernize asset management. Foreign investment has increased and now comprises about six percent of fund investment. Importantly, a foreign asset manager has been contracted to manage these investments. According to government officials, there is growing recognition of the need for diversification as the fund continues to grow over the next decade. Growing awareness of the potential long term financing problems of the system are also a positive development driving policymakers towards a lasting solution.

1.4.2 Stage Two

2.3 1. Mauritius will benefit from moving to a full-fledged defined contribution scheme, having gained confidence in the individual accounts under Stage One and after a functioning regulatory and supervisory framework have been successfully established.

0 Structural Component: Move to a Defined Contribution Scheme

2.32. A move to a fully funded privately managed defined contribution system can be made once the regulatory environment permits. Mauritius can envision providing more individual choice by granting NPF members the ability to choose among different private funds mangers depending on their age profile and risk preference. As economic development raises Mauritians’ income in the years to come, the need for representing national solidarity with a fund may diminish and stable opportunities of a well-functioning economy may take its place. Individual choice may become of utmost priority to keep the economic dynamic going.

e Asset Management Component: Choice under a Regulatory Framework

2.33. The necessary regulatory infrastructure would have to be put in place to ensure that individuals’ retirement income is managed under the best practices. This could take time to develop given the need to acquire consumer confidence and the regulatory expertise. Overseas investment either for both the short and medium term would require gradual planning and a solid pre-announcement policy to avoid an adverse impact on the foreign exchange markets. 30

30 A further discussion of international developments in asset management relevant to Mauritius is presented in Appendix VI, Regulatory and supervision issues are developed in Chapter 111.

26 2.34. Annuitization. Currently the NPF undertakes the annuitization of contributors’ benefits at retirement and is expected to continue to do so under the proposed MDC Scheme. As Mauritius converts to a defined contribution scheme, annuity design and provision would be an important aspect of the reform to keep in mind. Annuity calculations are complex and subject to a great deal of uncertainty. Options for lump sum payments to beneficiaries need to be taken into account. Prices should shift to reflect changes in both life expectancy and long-term interest rates. There is a risk that government annuity prices would be subject to inertia and political manipulation to the detriment of contributors and beneficiaries and, perhaps, at great cost to the public sector. As such, direct government provision of annuities is considered risky.

2.35. Nevertheless, government regulation is required in order to (i)minimize the possible impact on public sector outlays that can come from exploitation of the basic pension -under-reporting of NPF benefits to qualify for a possibly targeted BRP pension, (ii)the annuity market confronts asymmetric information between buyer and seller, and if standard annuity purchase is not mandated, adverse selection effects will inhibit market efficiency, and (iii)a domestic annuity market in a country the size of Mauritius is likely to have very few suppliers and the market may therefore not be competitive; this would require further study.

2.36. These obstacles could be overcome by stipulating a standard annuity and tendering internationally for an annuity rate as each cohort retires. Subject to prudential supervision and solvency guarantees, such a process is likely to be effective in overcoming concerns about the payout phase in a mandated defined contribution plan.31

1.4.3 What a strengthened NPF can mean for contributors

2.37. Sustainability and replacement income with improved asset management The replacement rate granted by such a system would depend on the return on assets, which in turn would depend on the institutional structure of the asset management. We assume two scenarios, a conservative and a more likely one. Table 2.4 presents the interest rates and financial flows associated with the two scenarios. Each scenario assumes a rate of return on assets under the current or marginally improved institutional structure (while reforms are designed) until 2002, a minor improvement in the institutional structure till 2005, and a “permanent” improvement in the institutional structure for asset management beyond that.

3’ Owing to their importance in the drawdown of accumulated assets at during retirement, and the market failures, annuities markets are the subject of significant research. A recent study that surveys recent experience in Latin America is by Robert Palacios and Rafael Rofman, “Annuity markets and benefit design in multipillar pension schemes: Experience and lessons from four Latin American countries” (World Bank, March 2001).

27 Table 2.4 Prqiections of the Finances of the National Pension Fund - Conversion to a MDC In millions of 1998/99 Rupees and 2002103 2005/06 2010111 2015116 2020121 2030131 2040141 2050151 percent Scenario A - likely Real return on investments (%) 1.9 3 3 3 3 3 3 3 Current balance 1,704 1,869 2,232 2,647 3,022 3,687 4,045 4,227 Fund balance 19,805 23,009 29,583 37,248 45,716 63,755 82,590 98,380 as %GDP 16.8 16.8 17.5 18.2 18.7 19.1 18.9 17.6

Scenario B - high Real return on investments PA) 3.8 4.5 4.5 4.5 4.5 4.5 4.5 4.5 Current balance 2,418 2,379 2,881 3,487 4,049 4,985 5,297 4,921 Fund balance 26,108 25,723 34,676 45,250 57,121 82,674 108,430 126,401 as %GDP 18.2 18.8 20.5 22.1 23.4 24.8 24.9 22.6 Note: Assumes conversion takes place in year 2002//03. Source: Bank staff estimates.

2.38. The resulting replacement rates for various types of contributors are presented in table 2.5 below. The table indicates that the MDC yields weighted average replacement rates of 27.7 percent or 35.2 percent under different asset return scenarios (under the assumption on the ceiling for the MDC is maintaining at 80 percent ofthe average wage).

Table 2.5 Replacement Rates for a New Entrant on 2005 for a Mauritian Defined Contribution Scenario A Scenario B Male Female Male Female Low income 27.6 29.4 41.9 46.9 Average income 26.2 28.1 39.5 44.6 High income 26.2 28.1 20.2 24.7 Weighted average 27.7 35.2

Existing points system parameters indexed at current practice Weighted average 28.0

Existing points system parameters indexed at wages Weighted average 31.2 Note: Replacement income here results from the PROST package and is expressed as percent of individual’s income prior to retirement; it should not be compared directly to replacement rates on average lifetime earnings.

1.4.4 The heart of the modernization approach

2.39. It is anticipated that the benefits to the proposed system would come in the form of higher replacement rates to contributors (originating primarily from the higher returns to NPF assets). There would be several macroeconomic and fiscal implications as well. First, the contingent liability that currently sits with government, in the defined benefit scheme, would be mitigated. Additionally, allowing market forces to attract NPF assets would improve resource allocation and risk mitigation in the economy. (There may be a drawback if government has to increase interest rates to attract NPF assets, as assets are more freely

28 moving towards the local market.) Finally, national solidarity symbolized by the NPF is maintained as necessary.

2.40. Although the transition could take several years to be implemented, it would be critical to initiate the diversification in asset management immediately. The current proposal relies critically on attaining higher market returns early on, and is the factor that makes NPF modernization possible and not costly today.

2.41. The Benefits and Risks of a Two Stage Approach The primary benefit of the two stage approach is its gradualness in (i)allowing time for individuals to get accustomed to a new system and (ii)allowing time for the institutional capacity to be built. Its risks, and this is critical, is that the reform will lose momentum and may be left half way, leaving individuals with no choice.

1.5 The National Savings Fund

2.42. The National Savings Fund The NPS is a pure defined contribution scheme and as such, poses no structural problems. Given the three tiered approach of pension system, with the private sector employees relying more and more on the third tier, it may not be reasonable to have two separate mandatory second-tier instruments. As the NPF becomes restructured into an MDC with more modern asset management guidelines, it would be reasonable to collapse the NFS into the newer scheme.

2. PUBLICPENSION SCHEMES

2.43. Civil Service and Parastatal Schemes. There are two main Public Sector Schemes in Mauritius: (i)the civil service scheme which covers civil servants such as employees of the central government, schools and local authorities (This scheme is unfunded, with pension benefits being paid out of government revenue) and (ii)the statutory body pension funds, which cover employees of statutory bodies, including the parastatal entities (These have accrued some reserves with real assets, but it is not clear if these assets are sufficient to cover the corresponding liabilities.) Detail of their implementation are covered in the Introduction and Ba~kground.~~

2.44. Based on the World Bank’s projections, pension expenditure for the civil service scheme will rise steadily, from the current level of 20 percent of the covered wage bill to around 30 percent in 15 years time, and will reach 50 percent by 2050.33The total implicit pension debt (for liabilities accrued to date) exceeds 1/3 of Mauritius’ GDP. Given their limited coverage (slightly over 10 percent of the labor force), the public sector pension debt lays a sizeable claim on Mauritius’ scarce public resources.

32 A krther discussion on reform of public sector schemes worldwide is presented in Appendix VII. 33 Most of the data for the civil service scheme was extracted from the government payroll system and obtained through the Accountant General’s Office, or was provided by the Government Pensioners’ Report. Details on staff covered under local authorities and para-statal schemes were not available, but one could assume similar characteristics.

29 2.45. These projections give a Chart 2.1 Pension Expenditure for the Civil general indication ofthe direction and Service Employees, 2000-2050 magnitude of expenditures and are (Wage indexed -; Price indexed-) believed to be sufficiently robust within a reasonable range of assumptions about the membership. The strength of the civil service is assumed ' to remain constant throughout the projection period. Ad hoc pension increases have always been granted in the past - in relation to price changes or wage increases. Figure 2.1 below shows the expenditure patterns under both scenarios.

The need for reform

2.46. Generous Benefit Levels. The public sector schemes promise more generous benefits than their private sector counterparts. Whereas an average full-career, private- sector worker can retire with a replacement rate of 53 (20 from the BRP and 33 from the NPF), a civil servant will receive a replacement rate of 87-2/3 (20 from the BRP and 67- 2/3 from the civil service pension scheme. Civil servants also enjoy a number of other benefits: (i)the required number of years for a full pension is only 33-1/3 years (vs. 40 years for the private sector employee); (ii)a replacement rate that is based on final salary at time of retirement ( vs. average lifetime earnings adjusted to price increases, at best, with significantly below earnings growth for the private sector worker); (iii)periodic pension increases that are above inflation or in line with wage increases (vs. price adjustments only for the private sector worker); and (iv) retirement can commence 10 years earlier than the private sector worker with no penalty.34 While these benefit levels are not excessive when compared with the neighboring countries in Africa and South Asia, they are considerably higher than civil service benefits in OECD countries The high pension benefits may reflect the traditional backloading in public sector compensation, and the not too competitive overall compensation package for civil servants. However, such compensation structure is inefficient since it often fails to attract qualified young staff, has a questionable incentive structure and impedes the mobility between the public and private sector. This calls for a review of the overall pay structure and its benchmarking against the private sector as a precondition for a comprehensive reform ofthe pension scheme.

34 Although annual increases to civil servants' pensions are made according to the Cost of Living Adjustments (COLA), or more recently referred to as Salary Compensation, over the medium term, the trend data suggests increases to civil servants' pensions above inflation, and this most likely reflects the Pay Research Bureau 5-year salary adjustments to civil servant wages which is also applied to civil service pensions.

30 2.47. Labor Mobility and Pension Portability. The current system discourages public sector employees from leaving their jobs before retirement, because full pension benefits are vested only ifthe retiring employee is 45 years of age or older, and has 15 years of service, or more.35 Those who do not meet the age and service requirements are only entitled to a lump-sum payment of one year’s salary upon termination and will not be entitled to inflation adjustments on accrued pension rights between the date ofleaving and the date ofretirement36. The lack ofpreservation ofpension rights and their full purchasing value, albeit not unique to Mauritius, results in low public sector turnover, which restricts the healthy intake of new talent and the removal of non-performers. A healthy turnover will however assume greater importance as Mauritius moves forward into a new socioeconomic era and a highly skilled and more efficient workforce will be required to keep pace with the community it serves. To remove these disincentives, concerted international efforts to provide greater portability of pension entitlements are underway - by integrating public sector employees into the national retirement income scheme (see Appendix VII) or introducing defined contribution schemes, or both.

2.48. Building a Trustworthy, Effective and Efficient Civil Service. As Mauritius moves forward into a new socioeconomic era, the public sector workforce is expected to become more efficient and effective to keep pace with the community it serves. It is also the government’s duty to ensure that management and administration within the civil service will be transparent and trustworthy. Simply reducing the pensions of civil servants to abate any emerging fiscal crisis may demoralize workers and lead to adverse behavior, such as lack of accountability, deterioration in productivity and passive attitude to responsibilities On the other hand, the government can adopt a “win-win” reform strategy that promotes an open, flexible and equitable civil service with compensation packages designed to attract, retain and motivate civil servants based on a competitive, performance- based reward system. Such a restructuring can facilitate the process of integrating civil servants within the NPF as suggested in the previous section, although details on how to harmonize civil service pay with private sector earnings and ensure a smooth transition will need to be studied carefully. It would be advisable to commission a study/survey on allowances and salary structures of other public sectors, and to assess the experience of comparator organizations in Mauritius with comparable job grades and skills requirements to determine the competitiveness ofthe remuneration package.

SUMMARY

2.49. The income-maintenance tier ofMauritius’ pension system requires modernization. The private sector scheme is delivering a lower pension than originally intended due to the under indexation of NPF parameters, with the existing points-based defined benefit scheme. The shortcoming in pension payout will be more pronounced for future beneficiaries as the subsidy to original members is diminished. This will create an

35 Although a Portable Pension Fund has been set up to cater to pension mobility of public sector employees, it has been reported that fewer than 10 individuals have made use of the Fund. 36 Such lump-sum payments are worth significantly less than the present value ofthe accrued pensions.

31 increasing contingent liability for the state. Concurrently, the NPF has accumulated a sizable asset base, amounting to approximately 17 percent of GDP. Asset management is in public hands. The current institutional arrangement is resulting in a very risky investment strategy ofconcentration in the domestic economy and renders NPF assets as a captive source of government finance. More importantly, it does not seek to maximizing risk adjusted returns in behalf ofNPF contributors.

2.50. The sizable asset base ofthe NPF presents an opportunity for ensuring a reasonable replacement income for contributors (based on higher risk-adjusted returns resulting from better asset management) and improved management of the economy. A two stage approach is recommended: first, to maintain the integrity of the fund and move towards funded individual accounts with improved asset management by the public sector (Mauritian Defined Contribution Scheme) and second, move to a pure defined contribution system with competitive, commercially based, asset management under a new regulatory structure. PROST simulations suggest that NPF assets suffice to compensate members for past contributions (including inflation adjustment). However, a mark-to-market analysis is required to confirm the actual value of the NPF assets. To avoid diluting existing NPF assets, the fund can attribute rights and ownership to contributors as early as possible. In the event the mark-to-market analysis reveals a shortfall in assets needed to transfer to beneficiaries under the new scheme, or additional resources are needed for unexpected expenditures (such as to finance the VRS), it is recommended that recognition bonds or budgetary sources are sought to directly finance the need. It is anticipated that the proposed two stage approach will result in (a) higher replacement rates than the existing system with poor indexation, (b) approximately equal (under moderate asset returns) replacement rates with a points-system (but henceforth indexation of parameters to earnings) but lower liability for the state, and (c) higher replacement rates than the points-system (under more competitive asset management and better asset returns). Under the current proposal of strengthening the NPF, the necessity for two separate mandatory private sector schemes seems reduced. Consequently, the NSF can be folded into the renewed and strengthened second tier scheme.

2.51. Mauritius’ public sector scheme is overly generous and inequitable relative to the benefits provided by private sector schemes. The schemes deliver a 66.7 percent replacement rate on final salary (compared to less than 33.3 percent replacement rate delivered under the contributory NPF scheme). The scheme is also costly and inequitable: it absorbed (for 1998) about one-fourth of central government expenditures on pensions, equivalent to more than one percent of GDP, to benefit about 30,000 beneficiaries, compared the remainder three percent of GDP which benefits 145,000 beneficiaries. It is recommended that (a) pension benefits be reviewed together with the public sectors’ compensation policies, and (b) once the NPF is modernized, new members of the public sector join that scheme while existing members may be offered the option to elect a compensation package with more competitive cash compensation but reduced pension rights.

32 CHAPTER 3. TIER THREE - VOLUNTARY INDIVIDUAL AND OCCUPATIONAL SCHEMES

3.1. Voluntary schemes complete Mauritius’ elaborate three-tiered pension system. They allow companies and individuals to complement the mandatory contributory scheme to suit labor market tendencies and individual preferences. While such systems have a long tradition in Mauritius, they are largely unregulated and unsupervised. Establishing an appropriate and modern regulatory and supervisory structure is necessary to increase the confidence in and coverage under such schemes. This in turn will contribute to the development of voluntary savings institutions that can be used for opting-out under the public MDC system.37

1. VOLUNTARYSCHEMES INMAURITIUS

3.2. Mauritius has a long tradition of voluntary (occupational) pension schemes. Voluntary pension schemes date back to the 1940’s. They consist of plans established by private companies to provide pensions for their employees. By August 1998, 914 schemes had been established, with membership ranging from less than a dozen to several thousands in each scheme. It is estimated that about 30,000 employees are covered by voluntary occupational schemes, which is equivalent to about 5 percent of the total labor force or roughly 15 percent of private sector labor force. The number of beneficiaries, the actual level of benefits and other information such as asset portfolio strategies are extremely difficult to estimate, since the data is neither collected nor published by any organization. Most funds are managed by insurance companies (in fact by one particular company) while a few have an in-house management. These include some of the largest economic groups, the Sugar Industry Pension Fund and most banks. Almost every pension scheme is organized as a defined-benefit system, with most of contributions coming from the employers. While there has been some recent movements towards converting them into defined-contribution systems and allowing for some contributions from employees, this trend is very slow. Investment returns differ widely depending on the managing strategy, but, as an indicator, it can be pointed that the average for the funds managed by the insurance industry is around 12.5% annually.

3.3. Regulation of voluntary schemes scant and supervision is extremely limited. Mauritius is rather unique in that despite the advanced three-tiered pension system, the its regulation of the first tier is inadequate in coverage and in supervision. Three major pieces of regulation govern the quality of services delivered by the corporate and financial sector in the area of pensions: the Employees Superannuation Fund Act (1954) governs the creation of pension funds for employees; the Insurance Act (1987) governs long term insurance; and the Income Tax Act (1995) grants tax exempt status to Superannuation

37 Since the drafting of this report, Mauritius has created a Financial Services Commission to regulate the financial services industry, and is in the process ofpreparing a Private Occupational Pension Bill to provide a legal and regulatory framework for private sector occupational pension schemes, which will address many of the issues raised in this chapter.

33 Funds, and has been amended in 1996 introducing requirements to obtain this exemption and in 1999 to introduce portability of new funds introduced. The existing set of regulations is supervised by limited staff at the Registrar of Associations and the Controller of Insurance. It is understood that limited investigative capacity is available and based on limited staffing, unavailability of information, and limited information management capacity.

3.4. The risks from poor regulation and supervision are increasing. Should private pension funds continue to grow, the risks from poor supervision will be large, with significant problems of fairness, safety and serious negative effects on the labor markets. To counter these risks, the authorities are in the process of designing a Financial Services Authority that will incorporate regulation and supervision of voluntary pensions.

2. DESIRABLEFEATURES OF REGULATIONAND SUPERVIS~~~V

3.5. An independent supervisory agency.. Mauritius needs to create a strong Pension Supervisory Agency. It is advisable for this agency to be a governmental organization, with political and financial autonomy, and no direct link to any ministry. The agency could well be part of the Financial Services Supervision Agency under design. The authority of the supervisory agency must be shielded from political pressures. The primary aim of pension supervision must always be to protect the long-term stability and security of members’ funds. To provide this protection, the Agency can be run by a Director selected among members of a Board by the Government. This Board can be composed by representatives of different sectors (Ministries, Parliament, Labor Unions, and Employers Associations), with a majority from government officials. All members could serve for a fixed term that would not coincide with normal election cycles of government; removal from their Board positions should be possible only through a formal process. To further provide political independence, the Agency should have financial autonomy. Thus, it is recommended that the Agency expenses must be financed with supervision fees. This would not only isolate the agency from general budget problems, but it also avoids cross- subsidies to pension fund members when not all the population participates in the system. The law should establish the level of this fee, as share of contributions, which should suffice to cover operating costs of the agency. The organizational structure of the Supervisory Agency should follow the design of the four main areas of supervision necessary to produce a comprehensive review of pension funds performance, a public information department and other support areas, such as IT, human resources and administration departments.

3.6. ..with high quality staff would be necessary. High quality staffing will be critical to the agency. The agency will be competing with the industry to hire a relatively few trained professionals and to train others with the right aptitude. To attract and retain a qualified workforce, the supervision agency must offer competitive wages and benefits (such as holidays, health insurance, bonuses, et cetera). This will probably result in higher wages than those offered to officials in other government areas, and can be expected to create some interagency conflicts.

34 3.7. A “Regulation with Supervision Approach ”. The final goal for Mauritius should be to develop a “Regulation with Supervision” approach, where rules are clearly presented and enforced. To achieve this, a comprehensive, detailed body of regulation should be issued, probably in replacement of the current Superannuation Funds Act. In addition, a new governmental agency should be created to supervise the compliance of these regulations, substituting in some aspects the current roles of the Tax Commissioner, the Insurance Controller and the Registrar of Associations. 38 Areas of regulation coverage are: licensing, tax exemption status, complementarity with NPF benefits, disability and survivors benefits, actuarial assessments, disclosure to fund members, disclosure to supervision, requirements for membership service, portability, non-discrimination, asset investment diversification, asset investment and conflicts of interest, asset investment and custodianship, asset valuation.

3.8. Supervision. Mauritius, in designing the new regulatory structure, would find it advantageous to exercise supervision in the following areas: Institutional: licensing of funds; de-licensing, on-site inspection, audits. Financial controls: collection of contributions and transfers between funds, asset valuation procedures (particularly instruments with no market price); investment limits by type of instrument, risk rating level, issuer; custodianship. Membership: enrollment, portability, disclosure to members, members complaints. Benefits: disability qualification and membership level; beneficiaries’ complaints; definition and control of procedures to apply for benefits; definition of technical basis for annuity calculations; control ofaccuracy of benefits paid as annuities. Public information. and Fines and penalties.

SUMMARY

3.9. The current regulatory environment for voluntary schemes is inadequate to protect individuals’ and companies’ pension plans and is inadequate to assure that voluntary provision forms a critical component of Mauritius’ pension strategy for the elderly. It will be important for Mauritius’ forthcoming financial services authority to cover the aforementioned areas of supervision and regulation if the role of public schemes (non- contributory and contributory) are to be complemented by individual and company initiatives.

38 Tax treatment of pensions is discussed in the Appendix VIII.

35 CHAPTER 4. A STRATEGIC DECISION

4.1. Mauritius has an opportunity to shift the emphasis of its pension system fkom an unfunded scheme (the BRP) to a contributory scheme (MDC). In doing so, Mauritius would strengthen the country’s fiscal stance while assuring retirement income for citizens. Under current proposals, Mauritius can assure that the elderly and poor are at least as well off as they have been up till now (because the basic pension scheme would be more affordable) and working Mauritians have adequate replacement income from mandatory and voluntary components. By separating the policy objectives of the three tiers and making the proposed institutional changes, Mauritius would mitigate the economic and political risk of the pension system. By introducing competitive asset management (and gradually opening the possibilities for overseas investment) the portfolio risk of the pension system as a whole would be diversified, and higher returns could be sought for contributors. Changes in asset management practices will also have a positive impact on the domestic financial sector as well as improve governance of the economy.

4.2. This final section summarizes what a modernized pension system would mean for the individual, reiterates the challenge of institution building as a corner stone for reformed pension scheme, and outlines a proposal about the sequencing of reform and its main building blocks.

1. WHAT MODERNIZATION MEANS FOR THE INDIVIDUAL

4.3. Mauritius’pension system is poised to deliver more. This section indicates what a modernized pension system can mean for Mauritians. Chart 4.1 is indicative of the replacement rates that a modernized pension system would yield to low, medium, and high income Mauritians. The chart is only indicative and should be interpreted with caution, because it is based on reference information from the 1996/97 Household Survey. Although Mauritius needs to decide on the most desirable option for reducing basic pension expenditures, the chart for illustrative purposes is based on a targeted basic pension and an MDC based on combining the existing NPF and NSF mandatory savings schemes.39

4.4. Despite the caveats, the chart is pertinent in providing an illustration of individual’s likely benefit structure under a modernized pension system independent of the particular options chosen for each tier. The system should aim to deliver for the poor, a sizable basic pension and high replacement rates from employment (if formally employed), for the

39 Chart 4.1 assumes that elderly have income sources other than the basic pension and the contributory pensions. This assumption is necessary because in order to model targeting the basic pension to those with over non basic pension income below Rs, 1,500, the basic pension and with a taper (50%), an estimation of all non-basic pension income is needed. An estimation of this income was obtained from the 1996197 household survey which indicated the share of non basic pension income that individuals in the various income ranges have at their disposal. Interpretation of the results requires caution. ‘Voluntary’ indicates an estimated replacement rate of income other non-contributory and contributory pensions based on the 1996197 survey results.

36 average wage earner, minimal or no poverty protection and about a third or slightly more replacement rate, and for the better off, no poverty protection but a sizable replacement rate from the mandatory pillar. In addition, all three categories of individual should be expected to make voluntary provisions for additional pension income.

Chart 4.1 Indicative System Performance Beneficiary Replacement Rates

100 90 80 70 CVoluntary ...... 60 0 NSF 50 NPF 40 W BRP 30 20 10 0 Low Inc Mid Inc High Inc Beneficiary’s income

4.5. Less than average-wage earners: protection from poverty. Individuals earning less than average wages during employment years would be expected to benefit from the basic pension. Such individuals would obtain the basic pension which would be equivalent to about 20 percent ofthe average wage. In addition, their replacement rate from contributing to the NPF and the NSF could amount to about 30 to 40 percent of their average lifetime earnings. Together, for a Derson who earned half the average wage during his or her working life, the basic pension would amount to 40 percent of their salary and would be added to the approximate 40 percent replacement rate from the second tier. It must be noted, however, that since about 75 percent ofthe wage earners fall below the NPF ceiling (now at 80 percent of the average wage), the less than average-wage earners would form the bulk of retirees in the future. This would be expected to change. These individuals would not be expected to accumulate much in voluntary or occupational schemes, although the options would be open. Other income sources could be available to these individuals and are reflected in the ‘other’ category on the chart.

4.6. Average-wage earners: a 1/3 replacement income and a protected environment for supplemental pensions: In Mauritius, individuals who earn average wages are better off than the majority of wage earners. The extent to which these individuals are likely to benefit from the basic pension will depend on the targeting mechanism chosen. A targeted basic pension would deprive the average wage earner of most, if not all, of the basic pension. Because the impact of the taper would depend on all non basic pension income, the exact contribution to the pensioner’s income of the basic pension is difficult to determine. Nevertheless, chart 4.1 suggests that the basic pension will contribute a

37 relatively low replacement rate for the average wage earner. This is not inappropriate, and in fact, may be considered superfluous, as the average wage earner finds himself within the last quintile ofper capita income di~tribution.~'The ability for the contributory schemes to deliver a high replacement rate (close to 1/3 of a contributor's average lifetime earning) will also depend on the contribution ceiling. In the present simulations, this has been increased to 170 percent of the wage average earnings. Average wage earners would also be expected to contribute to voluntary personal schemes, once regulation and strong supervision practices are- established, providing increased transparency and giving them greater confidence in private instruments. Average wage earners are also expected to benefit from occupational schemes.

4.7. More than average-wage earners: a regulated environment to support personal voluntary provision: With a targeting policy for the basic pension, upper income retirees are not expected to receive the basic pension. High income individuals are expected to rely on the mandatory contributory scheme, although less than average wage earners, and on voluntary schemes. It is not anticipated that public policy will concentrate on designing mechanisms that will help in attaining high replacement rates for the wealthy. It is, however, expected that regulation and supervision of the third tier will grant confidence in the system, thereby allowing for better use of available financial market instruments.

4.8. Coordination of first and second tier retirement. Government policy would need to consider the possible interaction between the retirement ages of the basic pension and the mandatory private scheme. A flexible pensionable age for the basic pension needs to be coordinated with a similar approach for the mandatory private savings side. It would not make sense to grant the basic pension to individuals still employed in the formal sector. However, these issues need to be discussed once Mauritius decides on the appropriate pensionable age and basic pension scheme options.

4.9. The aforementioned system yields replacement rates in line with other countries and is affordable to Mauritius. A survey of 52 countries (East Asia and the Pacific countries, Latin America and the Caribbean countries, and the high-income OECD countries) showed that replacement rates for the public mandatory second tier were around 40 percent of average wage. Although many types of systems deliver these replacement rates, the present analysis has shown that Mauritius is poised to deliver that category of second tier replacement rate without incurring higher public sector deficits.

2. THE CHALLENGEOF BUILDING NEWINSTITUTIONS

4.10. The real challenge has been institutional. Mauritius' experience with the basic pension and the National Pension Fund suggests that the primary factor contributing to the poor state of the pension system is poor governance and poor institutional quality.

40 Should a crude affluence test be introduced, by which the top 20 percent ofthe elderly distribution does not receive the basic pension, individuals with income equivalent to the average wage and above would likely not receive the basic pension.

38 Although the rules for indexation of the basic pension and of the NPF were known, there has been persistent gross under-indexation. For both the basic pension and the NPF, it can be said that Mauritius has lacked the mechanisms to enforce the “rules” and to uphold accountability for their enforcement.

4.1 1. The real challenge will remain institutional. Today’s predicament in pensions policy stems from the upkeep rather than the design of the pension schemes. In order to assure the viability of any pension system, institutional mechanisms designed to guarantee their upkeep need to be in place. In order to hold public agencies charged with the upkeep of pension schemes accountable to their task, information needs to be released publicly.

3. A PROPOSAL FOR NEXTSTEPS: SEQUENCING, TO-DO LIST, AND POLITICAL PROCESS

4.12. Reform sequencing While all three pillars need a reform, it is suggested that a reform should start with the mandated and voluntary second and third pillar before progressing with a reform of the basic and first pillar. Three arguments can be advanced for this reform line:

(i) The reform of the NPS - first stage - is relatively straight forward, with little technical requirements. Moving from the point system to the MDC system is largely a redefinition of individual rights in accounting terms. Changing the asset management of NPF requires political will but can rely technically on substantial international experience. The same applies for the introduction of a sound regulatory and supervisory framework for the third pillar. The to-do list of this step includes the market evaluation of NPF assets and model calculations of transforming accumulated points into individually allocated amounts.

(ii) Having a functioning second and third pillar which delivers the promised benefits - higher replacement rate under the NPS and secured benefits under the voluntary scheme - will enhance the confidence of the covered population at large in a reformed earnings- related system. This should facilitate the reform of the unfunded basic scheme and the introduction of means- or asset-testing, or the increase of the retirement age in parallel to enhanced labor supply of the elderly. Also, reforming BRP last allows for the investigation and technical preparation of means- or affluence-testing if such an approach were to be chosen.

(iii) Reforming the pensions for the civil servants and public enterprises is going to take more time since it requires a review of the overall compensation package, establishing benchmarks from the private sector, a rethinking of the human resource policies and other related issues. Again, opening the reformed NPS to new entrants and offering existing member the option to convert on a voluntary basis will be much easier once a tested reformed system is in place.

39 4.13. To-do Zist Any reform requires major preparation which comprises analytical work, capacity building and communication strategies.

(i) The list for the analvtical work is long. It comprises, inter alia: On the basic pension, the options for means testing and affluence testing need to be explored in greater depth. The revamping of the social aid scheme needs to be considered (as a basis for means- testing), as would self selection on the part ofrecipients. On affluence testing, the option of using the NPF administration for reporting of non-BRP income should be given serious consideration, especially given the limited reach ofdirect taxation. Already, the NPF needs to collect more detailed information on total income ofthe contributors apart from just the basic salary. Such information could be put to use in screening BRP recipients. Regarding the NPF assets, a mark-to-market study needs to be undertaken to assess the market value of the NPF according to internationally accepted accounting principles. This would be necessary prior to taking any decision concerning the direction of the NPF. Should the assets be greater than currently estimated, it would be good news for the contributors; should they be less, an important financing requirement would have to be addressed. In line with the current proposal for the NPF, the regulation of the annuities market would have to be undertaken as part of the FSA. This would be preferable to having the NPF convert individual contributions to an annuity at retirement.

(ii) Capacity-building The modernization options discussed in this report necessitate capacity building in several areas. For the basic pension, aside from the targeting capacity discussed above, the statistical agency would have to track wages to form the basis ofthe annual indexation exercise. Although the capacity does exist, the index has to be unanimously accepted by taxpayers and government as the basis for the annual exercise. Finally, related to the basic pension modernization, reduction in payouts due to targeting will reduce the size of transfers to the non-elderly poor. Considerations for equity and political prudence suggest that this social assistance scheme be urgently modernized to care for the non-elderly.

(iii) Communication strategy Bank involvement in pension reform in many countries across the world has shown that public discussion about the challenges to the pension system and the options for its modernization is important. It is much easier for pension modernization to succeed with buy-in from potential beneficiaries from an early stage of the design process. It is, therefore, important for Mauritius to formulate a communication strategy that will draw attention to the implications of non-action on pension modernization, i.e. fewer social services and higher taxes, as well as the possible gains to various current and potential beneficiaries, in the form of greater choice and higher replacement rates on the NPF and NSF. In order to facilitate this process, it would be important to develop the capacity of the media to analyze and communicate policy issues and options, and to present independent analysis of the government’s and other proposals,

4.14. Political process Government may wish to appoint a special interministerial commission that will articulate a vision of an integrated, multi-tiered pension system with affordable yet adequate replacement rates, including the division of responsibilities between the private and public sectors. This could be done in the form of a white paper

40 with proposals from the commission suggesting how the Government should proceed to reform the system, stating the preferable and feasible alternatives for specific issues. The draft white paper could then serve as the basis for further debate by stakeholders to reach consensus on a reform agenda and on the suggested reform sequence.

4.15. Such a commission would require the support of a working secretariat which will consolidate the work of the various consultants and government agencies, put together material for commission meetings, and identify areas where technical assistance would be needed. A draft work plan for the commission with clearly defined tasks, the responsible parties and the expected output can ensure that the reform agenda will move along in an orderly fashion.

41

APPENDICES

43

APPENDIX I: SELECTED POVERTYMEASURES

A1. An analysis of the 1996/97 Household Budget Survey suggests that approximately 9 percent of the population of Mauritius is poor. There appears to be large variability in poverty rates between households that fall under the poverty line. However, that variability, as well as the ranking, of poor households remains unchanged when using either an income or expenditure aggregate.

Table Al.l Relative Poverty Line Set at 50 Percent of Median Income and ExDenditure Income Expen. Head %of Pov. Head- count Poor Gap count

Households with no children Elderly adult households 27.0 5.3 6.1 16.9 Single adults 11.5 0.5 3.1 7.7 Single adults with elderly 13.6 3.6 3.2 14.5 Couples only 4.3 1.1 1.0 5.3 Couples with elderly 4.9 0.9 0.8 6.3 Multiple adult households 3.9 4.7 0.9 5.8 Multip. adult h/h with elderly 3.4 2.3 0.7 9.3

Households with children Single parents 39.9 5.1 14.2 29.6 Single parents with elderly 23.6 2.3 6.4 20.6 Couples w/ children 10.6 34.8 2.3 9.8 Couples w/ children & elderly 8.9 4.3 1.7 10.6 Multiple adult h/h wkhildren 9.3 25.3 1.9 11.1 Multip. adult wlkids & elderly 8.7 9.6 2.3 14.0

ALL 9.4 100 2.1 10.5

A2. The data suggest that elderly adult households, single parent households, and single parent with elderly households have the greatest share of their populations below the poverty line. These household categories are also those that have the greatest depth of poverty. At the same time, the households that make up the greatest share of the poor are couples with children and multiple adult households with children.

45 APPENDIX 11: A PROFILE OF THE ELDERLY

A3. Today’s elderly Mauritians are those who have worked hard to build the upper- middle income economy we see today. The majority of them have a primary education at best and have worked under difficult conditions in the sugar sector, light manufacturing in the export processing zones, or tourism. This section explores how the elderly are faring as compared to working Mauritians, in order to assess public policy priorities.

Composition of the Elderly

A4. More than half of elderly Mauritians are between 60-69 years of age, and still capable of leading productive lives. About 8.8 percent of Mauritius’ population of 1.2 million, is over 60 years old. Of this, more than half are between 60-69 years old and about 30 percent are between 70-79 years. Of these elderly persons, 44.6 percent are male and 55.4 percent are female.

Living Arrangements

A5. Elderly Mauritians are more likely to live in larger households. Eighty percent of elderly Mauritians live in a familial context in households that include at least one non- elderly person. This may be with their children, a brother or sister, or with another relative (most frequently a niece or nephew). Around 8 percent of elderly adults live alone (single elderly adult) although, in most cases, they live near a relative. The remaining twelve percent of elderly adults live in couples, either with a partner who is also elderly (elderly couple), or with one who is non-elderly (elderly with single non-elderly). It is worth noting that the number of female elderly adults living alone is almost four times greater than the number of male elderly adults living alone.

Table A2.1 Household Characteristics

H/h heads Ethnic comnosition. Hh P s Mh Fh H M G S

No elderly adults in household 72.1 71.9 4.1 88 12 73 70 72 60 Single elderly adults 2.9 0.7 1 21 79 2 2 4 3 Elderly couple 1.8 0.9 2 90 10 1 2 3 2 Elderly with single non-elderly 5.4 3.4 2.6 67 33 5 5 6 10 Elderly with non-elderly couple 7.5 7.9 4.3 84 16 8 8 6 9 Elderlywith multiple non-elderly 10.3 15.2 6.1 @ 14 1 -13 8-15 ALL 100 100 4.1 85 15 100 100 100 100

Notes: Hh: proportion of households; P: proportion of people in households; s: size of household; Mh: percentage of households where the head is male; Fh: percentage of households where the head is female; H: composition of Hindu households; M composition of Muslim households; G: composition of general population households; S: composition of Sino-Mauritian households. The household composition by ethnic groups is as follows: 49 percent Hindu, 16 percent Muslim, 33 percent general population, and 2 percent Sino-Mauritian.

46 A6. The table also indicates that the patterns of household composition among different ethnic groups are broadly similar, with the exception of the Sino-Mauritian community which overall shows a larger share ofelderly adults living with others.

Income

A7. Elderly Mauritians who live with others are better off than those who live alone. Elderly Mauritians living with non-elderly relatives benefit from economies of scale and enjoy a higher equivalized4' income per capita than those who live alone. Table A2.2 indicates that although in simple per capita terms elderly adults living in a familial context have the lowest incomes, once adjustments are made for the lower resource requirements for children and larger households, these households have the highest incomes. In fact, it is the single elderly adults living alone who have the lowest incomes. For Mauritius, the larger the size of the household, the higher is the per capita income of the individuals within it, as larger households tend to benefit from a broader income basket and owe a greater share oftheir income to earned sources (salary, self-employment etc.). Elderly only households tend to rely mostly on transfers, of which pensions make up more than 50 percent. As expected, all households have access to the basic pension entitlement - this is a feat for any social program - but access to earnings-related pensions is restricted to only about a third ofthe household^.^^

Table A2.2 Household Income Per capita income Income shares Pension access Simple B&J E PROT p/T BP R SD No elderlyadults in household 4,067 6,301 73.3 0.6 12.6 10.7 2.7 2.2 0.5 2.1 3.3 6.2 Single elderly adults 4,395 4,395 3.0 1.6 24.7 17.6 53.1 50.7 100 20.2 3.9 10.7 Elderly couple 4,349 5,354 9.5 2.5 19.1 12.0 57.0 56.8 100 54.0 4.4 1.8 Elderlywith single non-eld. 4,066 5,338 34.3 1.8 17.2 13.2 33.5 32.0 100 34.2 12.5 9.2 Elderlywithnon-eld. couple 3,640 5,739 55.6 1.1 13.8 10.1 19.4 19.0 100 28.3 9.4 7.5 Elderly with multiple non-eld. 3.381 5.839 64.6 0s 12.3 7.2 15.4 15.0 100 33.6 10.6 Q ALL 65.8 0.8 13.4 10.6 9.4 8.8 28.3 10.6 5.0 6.5

Notes: PCI: Per capita income; B&J: per capita equivalized income with coefficient of 0.7 for additional adults and 0.5 for children. Share of income from: E: earned sources; P: property; R: imputed rent; 0:other receipts; T: transfers. p/T: share of total transfers coming from pensions. Share of households receiving BP: basic pension; R income related pensions; S: survivor's pensions; D: disability pensions.

A8. Elderly adults living alone are mostly women and are at the greatest risk of poverty. Table A2.1 indicates that whereas 85 percent of all households are headed by males, households with a single elderly adult consist mostly of women. There are almost four times more elderly women living alone than elderly men living alone and Table A 2.2 indicates that they receive the lowest per capita equivalized income ofall the categories of households. Elderly women living alone are also the ones who depend most heavily on

41 Equivalized per capita income is a measure of per capita income that accords lower weights to individuals other than the first in a household and to children. The principle is that there are economies of scale that are exploited when individuals live together, and should thus be reflected in the per capita income calculation. 42 It is not clear why 54 percent of elderly couples have access to income-related pensions, which seems like an outlier relative to the group.

47 income from pensions and have the highest risk of poverty. Another category at risk, where there are disproportionately more women heading households than in the rest of the household sample, is that of an elderly adult living with a non-elderly adult. As Table A2.2 indicates, this category appears to have the second-lowest equivalized per capita income.

A9. The basic pension is not equally important to all Mauritians. Figure A2.1 indicates that public transfers, and the basic pension in particular, do not represent a large share of income of the upper deciles of households.

Figure A2.1 Percentage of Over-Sixties Income from Different Sources

per cent of total income

self-employment)

30 40 60 80 120 160 200 240 above income, upper limit of range per cent of GDP per capita (approx.)

Relative Well-being

A10. Some groups of elderly have disproportionately higher poverty rates than the rest of the population. Using a poverty line of 50 percent of median equivalized income, single elderly adults and elderly couples living alone stand out as having substantially higher poverty rates than households with no elderly ersons. Elderly couples also show up as being poorer than non-elderly-adult households.R

AI1. The basic retirement pension contributes substantially to poverty reduction among some groups of elderly. A simulation of household incomes in the absence of the basic pension suggested substantially higher poverty rates for all categories of households with elderly, but particularly for single elderly adult, elderly couple, and elderly with single non-elderly households. A simulation of removing the basic pension from the top quintile of the population indicated no measurable increase in poverty.

43 Analysis ofpoverty using an expenditure aggregate maintained the same poverty ranking.

48 Table A2.3 Household Poverty

Pov. Sh.of Pov. w/o Line Poor Gap BRP No elderly adults in household 9.5 72.8 2.1 9.5 Single elderly adults 33.7 2.5 9.1 51.7 Elderly couple 18.6 1.7 2.9 47.8 Elderly with single non-elderly 16.3 5.9 4.0 27.0 Elderly with non-elderly couple 8.0 6.7 1.7 12.1 Elderlv with multiple non-elderly -6.4 -10.5 -1.5 -10.8 ALL 9.4 100 2.1 11.8 T3. IO T3.2 T3.5 Note: Poverty line at 50 of median equivalized income.

Continuation of Work after 60 Years of Age

A12. In urban areas more than a third of the elderly continue to work beyond the age of 60. Depending upon the physical condition of the elderly and upon the financial needs of the household, elderly persons continue to work well beyond the age of 60. In elderly couples the husband often continues to work because of financial necessity, particularly when his wife has not reached the age of 60 and does not yet get her pension andor when she needs medical treatment. The fact that there are more working elderly persons among those who live alone or as an elderly couple than there are among those who live in families, seems to indicate that elderly adults living in families receive more financial support than those living alone. Yet 13.6 percent ofthose living in families still engage in some informal professional activities. Helping in shops and tabagies, selling cakes and vegetables, and subsistence activities like growing vegetables or rearing animals are also practiced to supplement the family income. The main reason given for continuing to work is insufficiency of income and this is particularly acute for those who rely exclusively on the Basic Retirement Pension (BRP) and do not benefit from other contributory pensions.

AI3. Many pensioners experience an improvement in their financial situation after they cease work in their oflcial profession. Once they are assured of the BRP as a secure source of income, many elderly persons start an informal activity if they do not have any major health problems. This allows them to lead an almost normal life without a marked decline in living standards.

Expenses

Housing Expenses

A14. Around 92 percent of elderly adults do not have to pay rent for their housing and, out of these, two-thirds oficially own their homes. Most elderly adults have built their own houses with the help oftheir grown-up children, and the housing unit is thus considered to be a kind of familial property rather than an individual one. Also, many elderly persons living in low-cost housing settlements “citks ouvriBres ”, have become owners oftheir own

49 homes on account of a broad initiative of the government in the 1980s. Some 1.5 percent of elderly persons have to reimburse housing loans that were taken by them earlier.

A15. A major concern of pensioners is how to meet fixed housing expenses. Although most elderly persons do not have to pay rent for housing, they incur other fixed expenses linked to housing such as charges for electricity, water and municipal taxes. For many elderly persons these payments are a major source of concern. In order to avoid paying a surcharge for the late payment of bills, which would be financially disastrous, many elderly persons have to accord top priority to the payment of these charges.

Medical Expenses

A16. Even though treatment at the hospitals is free, a large majority of elderlypersons incur medical expenses. Two thirds of a sample of elderly persons had incurred medical expenses during the three months before the survey spending, on average, a sum of Rs.2000 over the period. However the amount spent on medical expenses by the elderly varies greatly depending on the type of ailment that afflicts them. Although 39 percent say that they would go to a public dispensary on account of their inability to pay for private consultation, 13.5 percent say that they would consult a private doctor.

A17. It is in the case of illness or incapacity that single elderly persons find themselves in a very dijficult position. Those who need permanent medical care represent almost 18 percent of elderly persons. In most of the cases (85%) someone from their own family provides the care, whereas in others (15%) someone from outside is employed for this. Although the monthly expense varies widely (between Rs.350 and Rs.5000) the average expenditure on providing for care is around Rs.1400.

Expenses on Food

A18. A quarter of the elderly do not contribute directly to the food expenses of the household even ifthey do contribute to other expenses. The great majority of those who do contribute to food expenses spend between Rs.lOOO to Rs.2000 per month. The highest average monthly expenditure incurred on food is by households where there is a single elderly person living with a non-elderly person, and the lowest average expenditure is incurred by those living alone.

Contribution of the Elderly in Raising the Per Capita Income of the Household

A19. In low-income households, the personal income of the elderly tends to subsidize other members of the household. In 85 percent of the households with less than Rs.5000 per month, the income of the elderly contributes to raise the per capita income of the family. In households with an income of Rs.5000 to Rs.10,000, the income of the elderly subsidizes the other members in 52 percent ofthe cases. This contribution usually takes the form of payment of the fixed charges linked to housing (electricity, water) andor education of the grandchildren. Above a monthly household income of Rs.10,000 the inverse is the case, with the other members of the household tending to subsidize the

50 elderly, albeit to a smaller extent, as the personal income of the elderly rises too on account ofrent, high pension and/or business income.

Financial Helpfrom Children

A20. Less than 10 percent of the elderly state that they receive any Jinancial help on a regular basis from their children. Many elderly people consider this situation to be normal stating that their married children have their own families to care for and growing expenses to meet. Those who live alone generally receive half as much help for medical expenses as those who live in a family. Yet elderly parents do receive spontaneous help from their children in the form offood, clothes or medicines.

Technical Note on the Choice of Equivalence Scale

A21. Empirical studies of poverty equivalize household incomes by an index proportional to a weighted sum of household size. However the principal problem with a linear equivalence scale is that it fails to recognize the possibility for economies of scale in household consumption and welfare. One response to this concern is to apply a non-linear equivalence scale factor to household income. Some scales distinguish between the first and subsequent adults in their formulation. So, for example,

E,, E,, = 1 + a,.@,- 1) + a,.N,.

The OECD recommend a scale ofthe form described in (1 .2), witha, set to 0.7 for each extra adult and a, set to 0.5 for each child.

A22. In similar vein, Banks and Johnson (1996) apply a non-linear scale ofthe form

where a is the adult equivalent cost of a child, and y is a factor between 0 and 1 which reflects the strength of the economy of scale in household consumption. This method of equivalization again respects the idea that (i)children are less expensive than adults, and (ii)two may live more cheaply than one in per capita terms. This latter scale maintains a continuously diminishing relationship between household size and the per adult equivalent expenditure or income necessary to attain a given level ofwelfare.

A23. As with the earlier scales, a parameterization is required for a and y. Table 3.1 compares the Banks & Johnson scale with the OECD scale, for three alternative parameterizations. The two classes of scale appear to differ only for larger households. This is a feature of the scale parameter in the Banks and Johnson version, which makes it progressively “cheaper” to live in large households.

51 Table A2.4 Alternative Equivalence Scale Parameterhations Equivalence scales:

OECD Banks and Johnson a=0.5 ~~0.7a=0.7 y=0.7 y=0.7 y=0.9

Single parent, one child 1.5 1.3 1.4 1.5 Single parent, three children 2.5 1.9 2.2 2.5 Two adults, one child 3 2.2 2.5 2.9 Two adults, two children 2.2 1.9 2.0 2.2 Two adults, four children 2.7 2.2 2.4 2.7 Three adults, two children 3.7 2.6 3 .O 3.5

Conclusions

A24. The profile of the elderly has shown that in Mauritius the elderly are more likely to live in extended living arrangements during their retirement, primarily with non-elderly family members. Such living arrangements make both the elderly and the non-elderly members better off. The elderly contribute the basic pension and the non-elderly contribute a diverse income basket, while both benefit from the economies of scale that come with extended living arrangements. Furthermore, we have seen that the basic pension itself prevents a large share of both the elderly and the non-elderly from living in poverty. Despite the success of the basic pension, single elderly women have disproportionately higher poverty rates than the rest of the elderly and the population in general.

52 tI a(5 APPENDIX IV: THENATIONAL PENSION SYSTEM

A25. The NPS has yielded lower replacement rates than planned. The NPF was designed to provide a replacement rate of 33 1/3 percent to the average wage earner.44 At inception (1 978/79), the scheme offered a subsidy to the first cohort ofalready-employed Mauritians that joined.45 Yet due to inadequate indexation (discussed in the next section), the scheme has delivered less than it promised. In effect, it could be said that for current pensioners, the doubling ofthe contributions promised at entry has been eroded by the poor indexation of the parameters of the system during the contribution period, so that in the end, beneficiaries are getting a pension commensurate to their contributions (but not double, which was the promise at entry). Figures A4.1 and A4.2 present snapshots of the current system. Figure A4.1 shows that for the average wage earner (represented by 1 on the x- axis), the NPF was originally intending to give 33 1/3 replacement rate; however current indexation practices have led to a replacement rate of close to 25 percent. Should current indexation practices continue (and the pension not be adjusted to prices for the life ofthe retiree), the pension would have a replacement rate of about 15 percent of the average wage earner. For someone earning 175 percent of the average wage (represented by 1.75 on the x-axis), the scheme, as designed, intended to offer a replacement rate of 33 1/3 percent, while current indexation practices would render about 17 percent, and taking account of under-indexation in the future would render a replacement rate closer to 12 percent. Figure A4.2 shows how retirees would be faring relative to those still employed. The maximum pension obtainable under the scheme as originally designed was about 55 percent of average earnings, for the high- income earners. However, indexation practices have reduced replacement rates to about half, and taking into account the likelihood (past practice) ofnot adjusting payouts to prices, would leave beneficiaries much further behind, from a social and economic standpoint, relative to the working population.

A26. NPF assets, amounting to 15 percent of GDP, used as a captive source of government finance undermine fiscal stability. Anticipating the forthcoming discussion, the availability of a large amount ofpension assets almost exclusively to the public sector creates a softer financing constraint for public sector financial managers and could lead to greater indebtedness of the country. Like many publicly managed pension funds, the NPF has invested disproportionately large amounts in public sector assets. This has the additional implication of representing an opportunity cost to the private sector, and concentrating almost all ofits risk in the Mauritian economy.

44 After a full 40 years of contributions at 9 percent of wages, assuming life expectancy of about 11 years at 60 years of age 45 For those of 40 years of age and above, this amounted to a doubling of their contributions, so that those individuals who had contributed from their 40’ till their 60” year (for 20 years), would retire at 60 with a full 40 year’s worth of contributions and a full pension. For those under 40, the subsidy was (and remains) smaller. Assuming contributions from scheme inception till retirement, it amounts to “filling-in” the years of non-contribution (which would be less than 20) with the equivalent of the average of past contributions. Consequently, all contributors to the NPF retiring after 1998199 retire with a full pension.

54 Figure A4.1 Cohort retiring in 1998/99: NPF Figure A4.2 Cohort retiring in 1998/99 fairing pension replacement rate relative to own relative to those still employed: value of NPF earnings pension relative to economy-w ide average earnings pension, pension DroDortion of proportion u I /nd hid a original average 0.35 - scheme 0.6

0.3 - 0.5

0.4

0.3

0.2

actual, plus 0.1 0.05 - for post- indexatio 0 0 0.25 0.5 0.75 1 1.25 1.5 1.75 2 0 0.25 0.5 0.75 1 1.25 1.5 1.75 2 individual earnings as proportion of average individual earnings as proportion of earnings average earnings

A27. The diminished relevance of the NPF can precipitate social and fiscal risks. The risks would be, on the social side, the risk of having private sector employees with inadequate income at retirement, and on the fiscal side, the risk of mounting pressure to increase the basic pension (beyond poverty-alleviation objectives). Given the centrality of sound fiscal management to Mauritius in attracting and maintaining foreign investment, such a risk could have disproportionately large repercussions. The country's foresight of introducing a second pillar now requires follow-through as the fund needs fine-tuning to regain its intended role.

A28. Poor performance comes from an unnecessarily complex - and risky - points system. An understanding ofthe points system is required. The structure ofthe NPF can be briefly summarized in Diagram A4.1. The diagram presents components of the points system and of asset management. Individuals purchase points by making monthly contributions to the NPF during their working life. Their contribution depends on the contribution rate (9 percent, 6 percent by firm and 3 percent by individual), the contribution ceiling (the income beyond which contributions remain the same), and the salary definition (whether contribution is made against all payments). With a 9 percent contribution rate for 40 years, the average wage earner expects a replacement rate equivalent to a 33 1/3 oftheir average lifetime salary.

A29. Critical in a points system are (i)the price at which points are purchased during the working life, and (ii)the price at which points are sold at retirement. If life expectancy changes and the contribution rate does not change, the purchase price of a point should increase or the sale price of a point at retirement should fall to maintain actuarial fairness. The NPF was designed under a different set of demographic hypotheses (a life expectancy of 11 years after retirement) and failure to take this explicitly into account has led to the reduced effectiveness of the NPF. The present section examines the following issues: the salary base, against which income is measured (bonuses and income other than the base

55 salary are excluded from the pension calculation), the ceiling, determining the proportion of income against which the contribution is made and determining the proportion of an individual’s income that pension is being bought against, indexation ofthe cost ofpension points and indexation of the sale price of pension points. Of additional -but still high- importance are the decision-making process in asset management and the overall legal status ofthe funds and the responsibility of government.

...... 1...... Ge il i na...... ~ --=d...... !ZZ” i...... Dec.i3ion-mak.!n!! ...... ! ~ -::: ...... b-

-b Payout

...... h?--Td ...... L ...... I...... Administration ...... c.... $2:- j Partial salaiv Indexation I8 :...... , / i,...... , L ...... Valuation I 1

Management of Parameters

A30. Parameters have not been indexed according to initial design principles. The NPS was designed with annual indexation ofthe ceiling, point cost and point values to earnings in mind. In practice, we see from chart A4.1 that the ceiling has been indexed at less than prices. It started at 170 percent ofthe average wage and has fallen to about 80 percent ofit. The cost of points has been kept constant, as has been the contribution rate. Effectively, this means that, with unwillingness to change the contribution rate, the system has not been adjusting to increases in life expectancy. The end result is that the cohort retiring in 1998/99, the first one with a full pension, the effective replacement rate is much less than 33 percent, as indicated in figure A3.1. For a male entering the NPF in 2005 and retiring in 2045, the replacement rate would be 27.7 percent of the final salary, without accounting for inflation throughout the retirement period, while for a female it would be 34.6 percent.

Chart A41 Chart A42 Chart A43

I I I

56 A31. Given the under-indexation of the point system, the NPF does not appear to be in financial difficulties. Should present indexation policies continue, the fund balance would turn negative closely after the projection horizon. Under alternative assumptions, should the ceiling and points parameters be indexed to wages from now on, the current balance would turn negative in 2035 and the fund reserve in 2049.46

Table A41 Projections of'Finances of the National Pension Fund - Continuation of Current Policies (1998/99 prices) per cent ofGDP 1998/99 1999/00 2000/01 2005/06 2010/11 2015/16 2020/21 2030/3 1 2040/41 2050151

Contributions 891 924 953 1,086 1,186 1,286 1,359 1,491 1,613 1,766 Other revenue 218 165 108 123 134 145 154 169 182 200 Investment returns 1,165 1,294 927 907 928 1,021 1,085 1,102 1,016 829 (-) Pension spending 248 272 296 429 614 826 1,048 1,479 1,878 2,191 (-) Other payouts 40 43 47 65 90 116 141 182 210 219 (-) Admirdmgmt costs 72 75 77 88 96 104 110 120 130 143 Balance 1,914 1,993 1,568 1,534 1,448 1,406 1,299 981 593 206

Memo Fund assets 16,764 17,474 18,122 21,345 24,245 26,486 27,945 28,046 25,552 20,602 GDP 17.5 17.4 17.1 15.6 14.3 12.9 11.4 8.4 5.9 3.7 Note: Index ceiling and points to prices; retirement age 60; 1 percent real return on assets. The base year data (1998/99) are version available at time ofestimation.

Management of Assets

A32. The NPF has accumulated about Rs. 17 billion, or about 16 percent of GDP, since its inception in 1978/79. The NPF is also socially significant as it represents national wealth accumulated for social insurance. It is viewed as a common fund for all Mauritian formal private sector workers, independent of social or economic background. The inter- generational transfers established by subsidizing the workers that entered the NPF at inception, and intra-generational transfers implied in partially funded PAYG schemes in the future, together represent a national solidarity in Mauritius. The solidarity is particularly important for older workers that helped put Mauritius on the development map, and younger Figure A4.3 Portfolio of the workers with poor education that are at risk of social 1 NPF (February 2000) exclusion. Abroac 4% A33. The NPF has been gaining respectable returns on assets, but at some opportunity cost. Authorities have estimated that the fund is earning about 3-4 Deposits percent a year over inflation. On average, publicly 10% managed funds all over the world have been earning 8 percentage points a year below per capita income Sector growth. Thus the NPF's return is higher than that of 70%

46 Under the current corrected indexation polices, assuming a real rate of return of 3 percent, the current balance would turn negative in 2047, and the fund would dissipate beyond the investment horizon.

57 other publicly managed funds.47However, privately managed funds (outside of Mauritius) obtain substantially higher returns. These returns have ranged fiom around 3 percent above per capita income growth in Canada and Hong Kong to nearly 8 percent in the United Kingdom, averaging nearly 6 percent.

A34. What are the current asset management arrangements? Management of the NPF portfolio is, by law, the responsibility of the Minister ofFinance. The Minister is assisted by an investment committee, which since 1999, has been advised by an investment advisor.48 The committee operates on the following guidelines in defining an asset management strategy, as indicated by the NPS: liquidity, security, return, and national development. Recent initiatives have been made to give a greater role to the Investment Committee whose responsibility is to decide on all matters pertaining to the investment of the portfolio and the surplus funds. The Minister of Finance no longer has any input into the process. However, there are two elements missing to bring the present arrangements to international standards. First, a priority to maximize return on assets subject to a given risk level, and second, clarification of accountability of the multiple roles the Minister of Finance and the investment committee play, namely, broad policy decision-making and choice ofinvestments.

A35. The present institutional arrangements for asset management have led to a portfolio concentrated on the public sector. Close to three-quarters of find assets are Mauritian government securities of one kind or another, and there is an insignificant allocation to equities and international investments. Public sector management of assets like the NPF have been known to encourage government consumption, concentrate portfolio risk only to the local economy, and inhibit resource allocation to the best use as determined by the market, and perturb the risk allocation mechanisms ofthe market. At issue is also whether the present management structure is poised to deliver higher return with the appropriate safeguards and controls.

‘’ Iglesias, A. and Palacios, R.J. (2000), ‘Managing Public Pension Reserves, Part I: Evidence from the International Experience ’, Pension Reform Primer series, Social Protection Discussion Paper no. 3, World Bank, Washington, DC. 48 The Investment Committee includes nine members. They comprise four representatives from the Ministry of Finance: the Financial Secretary [Chair], the Director of the Management Audit Bureau, the Accountant General, the Director for Public Finance; two representatives from the Ministry of Social Security, National Solidarity and Senior Citizens Welfare and Reform Institutions: the Permanent Secretary, and the Principal Accountant; a representative from the private sector employers; a representative from the trade unions; and an actuarial adviser.

58 APPENDIX v: ANOTHEROPTION TO CONVERT TO A DEFINEDCONTRIBUTION SCHEME

A36. Synopsis. This appendix presents a particular approach to the rights recognition of NPF participants and transition from the current points system-based defined benefit scheme to a defined contribution scheme. The approach is different than the one presented in the main text of the paper and is presented for illustrative purposes. The approach recognizes the original formula for acquired rights of each participant (rights to a third of average lifetime earnings after forty years of contributions). However, it anticipates better asset management in the defined contribution system (under commercial practices and a new regulatory framework) and much higher asset returns. The approach therefore chooses not to compensate all younger contributors for acquired rights under the existing system, because they can start anew in a defined contribution scheme and be better off than if they had stayed in the existing system (because of higher asset returns and compound interest). The approach offers partial rights recognition and an option to join the new system for some middle aged workers, and it “grandfathers” older contributors by keeping them in the existing system.

A37. Conversion to a defined contribution plan carries with it three structural innovations. First, for a period, some existing older fund members would have to have their benefits guaranteed, presumably by the government. Younger members could be bought out, probably quite inexpensively, since they have a long time horizon to accumulate the higher expected returns anticipated under a properly managed defined contribution plan. Second, if a conversion to a defined contribution plan were to be undertaken, special attention would need to be paid to the structure of the retirement payout. Third, a decision would have to made on whether, and in what way, a minimum pension guarantee would be offered. Each of these issues is now considered.

A38. The transition to a defined contribution system can take place at many different speeds. Some countries have forced all workers, including those just below pensionable age, to take out a defined contribution, individual pension account. But with only a few years to retirement, only a small amount of contributions will be made. And there is only a short period over which investment returns can accumulate. With such small accumulations, it is unlikely to be worth the administrative effort. So a common policy is to leave older workers - typically above 40 or 50 - in the existing program, and introduce defined contribution accounts solely for workers below a cut-off age.

A39. Many existing members of the labor force have accumulated pension rights under the old system, which raises the problem of how those rights should be met. Governments have generally committed to either paying a stream of pension benefits after retirement age, related to past contributions, or to making a one-off payment at retirement that the member uses to buy an annuity. Either option makes only a small difference to the flow of future obligations. An alternative is for the government to pay up-front a lump sum into individual accounts in recognition of their accrued rights. This is often rejected because it brings spending forward in time, and can be prohibitively expensive. But Mauritius, with

59 the reserve of the NPF, would be better placed to choose this option. The advantage is that the benefits of the transition to the new system arrive more quickly and the lump sums mean that individual accounts start with a meaningful accumulation.

A40. This report has already set out the impact of under-indexation of pension points and the contribution floor and ceiling on pension benefits. The simulation of the transition assumes full indexation to earnings of all these components in the future. Thus, the valuation of accrued rights should be seen as an upper bound, since if current practice were to continue, accrued pension rights would be much smaller.

A41. An individual of, say 20, with one year of contributions, will have accumulated 1/120th of pay that year, uprated in line with economy-wide earnings to retirement. If his or her earnings grow in line with the economy as a whole, then pay at retirement will be nearly 2.7 times earnings at age 20 (with 2.5-per-cent-a-year real earnings growth). So the pension earned at age 20 will be worth 2.2 per cent of current salary (1/120 x2.7) or 0.8 per cent of final salary (1/120th). If our example individual were then to spend a complete 40 years in the current NPF system, he or she would get a third of final salary in pension. But in a defined contribution system, the pension value would be determined by investment returns up to retirement. With a five per cent real return and the same nine per cent contribution, the pension fund would accumulate more than six times final salary, enough to buy an annuity worth 50 percent of final salary.

A42. Thus, a 20-year-old would get a much better deal from the new defined contribution system, and the same is true of most workers above age 20. Figure A5.1 estimates forward-looking pension benefits under the two types of regime. A 40- year-old, for example, would receive a pension of 162/3 percent of final salary - i.e., half of one third of final pay - for spending the next twenty years in the defined benefit NPF. Under the defined contribution plan, contributions of 9 percent of earnings a year would give an accumulation sufficient to buy a pension of 19.3 percent of final salary. The dotted line on the chart shows the net gain from the transition. The additional pension is equivalent to a little over 2.5 percent of final salary for a 40-year-old. The net gains are larger for younger workers. This is because the defined benefit NPF pays a constant accrual for each year of service by dint of the uprating procedure for earlier years’ earnings. Defined contribution schemes, in contrast, are ‘front-loaded’, meaning that accrual of benefits is faster in earlier years. This is a consequence of compound interest: earlier years’ contributions spend longer invested and earning returns. So a 27-year-old, for example, would have a pension 10 percent of final salary better than the defined benefit scheme if they remained in the defined contribution scheme until retirement. For the oldest workers, moving to a defined contribution scheme would cut their pension benefit by a very small amount.

A43. Most workers under the age of 40 or 50 would be rational to choose a defined contribution plan with a nine-per-cent contribution rather than the defined benefit plan offering a third of final salary after a full 40 years’ contributions. But a transition on this basis - with existing pension rights fully protected and all future contributions flowing into defined contribution accounts - would be costly. The NPF would still have to meet existing defined benefit obligations with a much smaller flow of contributions.

60 Figure A5.1. Projected Pensions Under a Defined Benefit and a Defined Contribution NPF by Age at the Time of Transition pension, per cent of final salary 50

40

30

20

10

0 20 25 30 35 40 45 50 55 60 age at transition

A44. However, the government can reduce these liabilities in recognition of the extra pension that younger workers will build up in the new program. Figure A5.2 repeats the net gain from the transition, again as a dotted black line, from Figure AS. 1. The solid black line shows the value of accrued rights in the defined benefit scheme. This is linear, because the model assumes that individual earnings grow at the same rate as economy-wide earnings, which are in turn used to revalue earlier years’ pay in the benefit formula. The difference between the two (the gray line) shows the net compensation that people would need to receive so that they would obtain exactly the same total pension value after the transition. For a 3O-year-o1dyfor example, with 11 years’ contributions, accrued rights are 11/12Oths of final salary, around nine per cent. The extra pension that they would earn from being in a defined contribution scheme in the future, rather than the existing system, is exactly the same. Thus, 30-year-olds would get exactly the same pension from the new regime ifthey received no compensation for their existing defined benefit rights.

Figure A5.2. Valuing Accrued Pension Rights in the Transition to a Defined Contribution System per cent of final salary

40 50 1

age at transition

-20 J

61 A45. For younger workers, the net compensation curve is negative. They have the largest gain from the transition - because of the compound-interest effect - and the smallest loss - because they have accrued only a few years of defined benefit rights. It would be possible but complex to devise a way of using this excess return, by diverting some of younger workers’ contributions out of the defined contribution system, to pay for existing defined benefit liabilities..

A46. The recommended transition would therefore be that: 0 People under the age of 30 are automatically transferred to the defined contribution system. They will get a better total pension despite the fact that their (relatively small) accrued rights would not be recognized. 0 People between the ages of 30 and 45 would have a choice of remaining in the existing NPF scheme for the remainder of their working lives, or moving to the defined contribution plan. Compensation for accrued rights could be either via a retained defined-benefit entitlement or a transfer of funds to the new plan. Table A5.1 is an illustrative schedule for the first option. 0

Table A5.1. Illustrative Compensation for Accrued National Pension Fund Rights by Way of Preserved Defined Benefit Right Current age Compensation 30 or less no payment 31 rights based on up to 2 years’ contributions 32 rights based on up to 4 years’ contributions 33 rights based on up to 6 years’ contributions .. . until 39 rights based on up to 18 years’ contributions 40-45 all existing rights paid; option to join new scheme 46 plus all existing and hture rights paid; remain in existing svstem

e Table A5.2 gives, in the middle line, illustrated values for the scale of the lump- sum transfers into people’s accounts that would compensate for accrued pension rights by age. The values are the proportion of people’s average salary (so far) that would need to be paid into their accounts. The last line of the Table gives a very rough approximation of the aggregate sums involved, based on the number of NPF contributors in each age band. In the absence of earnings data for NPF members, it assumes that all current members have paid contributions for each year since age 20 and that their earnings are at or above the NPF contribution ceiling. 0 This approximation process will bias the result upwards: most people earn less than the ceiling and might have incomplete contribution records due to unemployment, self-employment etc. But there will also be a downward bias because of people who have contributed in the past but are not currently contributing. Moreover, these simulations ignore survivors’ pensions and administrative costs. Nevertheless, they give a useful indication of the

62 magnitudes involved. Summing across the last row of Table A5.2 for example, suggests that a total transfer of Rs 2.75 billion from the current NPF fund to the individual accounts of all 30-to-45 year olds would be needed. Although a substantial sum, it represents just 17 per cent of the NPF’s accumulated assets. And it buys with it a complete termination of NPF pension claims from everyone under age 45. This is an upper bound on the estimate of costs, because the recommendation is that the switch to the new scheme is voluntary for this age range. Most countries’ introduction of a defined contribution pension plan has involved some element of individual choice. There is no ‘right’ choice of cut-off age, below which all workers have to join the new scheme and above which no one has the opportunity to join. It would be arbitrary because people of a single cohort are heterogeneous both in their family circumstances and their preferences and it might lead to political or legal challenges of the reform.

Table A5.2. Illustrative Compensation for Accrued National Pension Fund Rights by Way of Lump-Sum Transfer to Defined Contribution Accounts Age 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 _____~ Lump-sum transfer 7 12 17 22 28 34 41 48 56 65 73 83 93 104 116 (% average pay) Approximate cost 30 50 80 100 110 130 160 190 210 210 240 270 300 330 370

0 Finally, people aged over 45 at the time of transition would continue to be covered by the NPF’s defined-benefit structure. However, their rights would be properly specified with the cost and value of pension points and the contribution ceiling and floor indexed to earnings in the future.

A47. The calculations in this section are necessarily preliminary. If this route were chosen then we would provide more detailed and precise advice on the structure of compensation. Nevertheless, this section has given a valuable flavor of the magnitudes involved in the transition to a funded system. With compensation for accrued rights that reflect the extra pension that would be earned in a defined contribution system, the existing regime’s obligations to workers under the age of 45 might be ended at the one-off cost of Rs.2.75 billion. All or most workers under the age of 45 would then obtain a pension benefit as good as or better than the current regime offers. Also, people’s individual accounts would start with a meaningful balance, so spreading the burden of administrative expenses of the new plans.

A48. Simulations using the World Bank’s Prost model show that the transition to a funded NPF could be accommodated relatively easily. There would be an immediate cut in contribution revenues to the scheme, which would peak at a maximum of 0.6 per cent of GDP if all workers under the age of 45 switched to the funded option. Even with a lump- sum transfer of funds to members’ individual accounts, the balance of the fund along with the (reduced) contribution and investment income would be sufficient to finance the remaining liabilities.

63 APPENDIX VI: DEVELOPMENTSIN ASSET MANAGEMENT

A49. By June 30, 2001, reserves managed by the NPF amounted to 24.1 billion rupees. These assets are significant relative to the size ofthe pension liabilities ofthe scheme. As a result, investment performance continues to be a significant determinant of long run financial sustainability of the pension scheme. Higher returns would allow current contribution rates to finance promised benefits over a longer time horizon while poor returns would seriously compromise the prefunding policy. This is the first and most direct motivation for improving how these funds are invested.

A50. However, it is also large relative to the economy and therefore, likely to have an important indirect impact beyond the pension scheme itself. For example, moderate changes in asset allocation ofthese funds can loom large given the small volumes oftraded securities on domestic capital markets and scarcity of other long term savings. In short, decisions made by the National Pension Board and its Investment Committee have important repercussions on the allocation of capital and therefore on the overall economy in Mauritius.49

A51. Some analysts have pointed out that large contractual savings sectors (mainly insurance and pensions) can exert a positive influence on the development ofthe domestic financial sector. Early empirical evidence seems to lend support to this hypothesis, at least where assets have been primarily held by the private sector.50 However, positive effects have not been observed where public pension funds predominate.

A52. In fact, public pension funds have not generally produced good returns across the world. Moreover, the international experience has led to concerns on at least two fronts. The first danger is that the typical tripartite governance structure may not result in efficient allocation of capital and may actually distort this important process. This can take place, for example, when investment objectives include conflicting objectives such as providing loans to state-owned enterprises or economically targeted investments (ETIs). Another danger is that funds are channeled back to central governments leading to increased government consumption.

A53. Most public pension funds, including the NPF, concentrate their holdings in government securities or deposits in state-owned banks. In Mauritius, roughly three- fourths ofthe invested assets (excluding buildings) are invested this way. The figure rises to more than 82 percent if loans to the Mauritius Housing Company are included. While difficult to prove, it is likely that the availability ofthis source of captive credit allows the Government to spend more than it would have otherwise.

A54. With this type of portfolio, it is difficult to achieve long term rates of return that exceed the growth of NPF liabilities which grow with the incomes of members of the

49 The membership of both the Board and the Investment Committee is tripartite, Le., composed of employers, employees and Government. 50 See for example, Lefort and Walker (2001) and Catalan and Musalem (2000).

64 scheme. At the same time, increased investment in domestic and foreign securities (bonds and shares) which currently represent only about 12 percent of the total invested assets, is difficult in light of the limited supply of these instruments. Aside from issues of liquidity, increasing the domestic share portion of its portfolio would make the NPF the dominant shareholder in the country, raising important corporate governance issues.

A55. Problems with concentrated market power and the need for insulation of public funds from political factors have been cited as one argument for decentralized and competitive pension schemes such as those introduced during the last two decades in Latin America or Eastern Europe. At the same time, a handful of countries facing similar dilemmas have sought to mimic the advantages of these schemes by formulating special governance structures and investment policies for public funds.

A56. In 1998, the investment of pension reserves of the Canadian Pension Plan (CPP) was handed over to a new entity, the CPP Investment Board (CPPIB). The CPPIB is governed by a separate statute and its Board has an “arms’ length” relationship with government. Board members are professionals with background in finance, pension fund management and other related areas. It is not representative and does not include politicians, union leaders or employers’ representatives. Its explicit mandate is to maximize returns subject to a stated level of risk tolerance, and investments for other purposes are prohibited. Asset management is contracted out to private financial institutions and results are monitored and widely reported. Fiduciary, accounting and reporting standards are in line with best practice in the private sector.

A57. Similar experiments are unfolding in Norway and Ireland. The Norwegian Petroleum Fund started investing surplus oil revenues based on similar commercial principles in 1996 in order to offset the projected costs of an ageing population. Like the Irish Pension Reserve Fund, established in 2000, it invests almost all reserves abroad. While the rationales differ somewhat (the Norwegian fund has clear macroeconomic considerations), investment in liquid and well regulated capital markets abroad is seen as a way of avoiding many of the potential conflicts which arise when a single fund of this size is invested in relatively shallow domestic capital markets. It also sidesteps the potential temptation to finance larger government deficits.51

A58. Several steps in the direction of these pioneering reforms have been taken in Mauritius. For example, foreign investment has increased and now comprises about six percent of investment. Importantly, a foreign asset manager has been contracted to manage these investments. According to government officials, there is growing recognition of the need for diversification as the fund continues to grow over the next decade. Growing awareness of the potential long term financing problems of the system are also a positive development driving policymakers towards a lasting solution.

51 In the Irish case, the concerns over the long term integrity of the arrangement led reformers to prohibit altogether investment in domestic government bonds.

65 A59. In order to succeed however, significant changes are needed in at least three areas - governance, investment policy and asset management arrangements.

0 Governance. The traditional tripartite governance arrangement has generally failed to produce good results in many countries facing a wide variety of constraints. A new governance structure that separated the management of reserves from the other functions of the pension scheme, and was run by trained professionals is more likely to succeed in the future. A ‘manager of managers’ arrangement, with the proper assignment of responsibility and liability and independence from government would be free to pursue the best interests ofthe fund and its members.

0 Investment policy consistent with this arrangement would prohibit investments with objectives other than maximizing risk-adjusted returns. The professional board described above would be responsible for overall asset allocation and decisions about risk tolerance that would be related to the long run financing of the fund and the duration of its liabilities. As in the Canadian example, a transition arrangement that would minimize the disruption to government finances (as the fund shifted its asset mix away from government bonds) could be defined. Finally, the use of investment strategies designed to minimize the potential for political interference (such as the use ofindex tracking funds) could be emphasized.

0 Asset Management Arrangements. Importantly, the role of the Board would be limited to deciding the overall asset allocation strategy and monitoring the performance ofits fund managers in implementing the same. The asset management function would be largely contracted out to private managers in a transparent and competitive process.52 Their performance would be monitored against relevant benchmarks and over reasonable time horizons in accordance with best international practice. All of this would require adherence to improved valuation standards and accounting practices.

A60. Improving public management ofpension reserves in Mauritius would increase the financial health of the current defined-benefit scheme and would increase returns to individual account holders in the event of a shift towards defined-contribution schemes, assuming these remained centralized. It would also help minimize the potential fiscal and financial sector distortions mentioned above. Accompanied by better accounting and reporting standards, it would also make it easier for members of the scheme to evaluate performance and hold Board members accountable accordingly.

52 In Ireland and Norway for example, this selection process involves several rounds. In the first stage, which was handled through the Internet to reduce costs, proposals are submitted by large numbers of potential managers. These are assessed on strictly objective criteria to arrive at a short list. Another round takes place and finally, the Board awards the contract to individual managers. Charges on find assets are a major criterion for selection.

66 APPENDIX VII: PUBLIC SECTOR SCHEMES AROUND THE WORLD

Trends in Civil Service Reform

A61, In many ways, the financial stresses faced by civil service pension schemes are quite similar around the world. Most countries had undergone extended periods ofmassive expansion of public employment, typically in the seventies and the eighties, immediately followed by periods of stabilization or even contraction in some instances. Such a phenomenon is quite evident in that the ratio of pensioners to covered employees has been rising dramatically over the last decade. This is further exacerbated by the use of liberal early retirement programs to reduce wage bill expenditures, resulting in an explosion ofthe pension expenditures ofmost countries.

A62. Since most of the civil service pension bill is paid (or supplemented) by government revenues, many of the solutions adopted are also similar to those of statutory national pension schemes. It is therefore not surprising that reform policies designed to manage civil service pension expenditures do not differ markedly from measures to restore fiscal balance in national pension systems. As such, amendments/modifications to the provisions of civil service schemes that are being considered generally take the form of (i) reducing pension liability through parametric changes (Le., lowering benefit entitlements); (ii)gradually shifting towards some form ofadvance funding ofbenefit obligations or cost- sharing with employees; (iii)designing systems that allow greater pension portability; and (iv) harmonizing compensation components (cash payments and fringe benefits) to attract, retain and motivate civil servants.

A63. Reduce pension liability: Many countries have undertaken steps to reduce their civil service pension liabilities by introducing higher retirement ages and/or longer service periods, increasing required employee contribution rates, lowering rates of benefit accrual, and changing the post-retirement indexation policy so that pensions will increase in accordance with price increase instead of wage increase. Korea increased the employee share ofthe contributions, shifted from wage to price indexation and reduced benefit levels for new employees. Italy also shifted from wage to price indexation and introduced limitations on early retirement. Brazil, Greece and Portugal all reduced the benefit accrual rates.

A64. Advance funding or cost sharing with employees: Civil service pension schemes in many countries, particularly in the South Asia and Africa regions, are very often totally unfunded (Le., no contributions from either the employees or the government) and there are no backing assets. Of late, several countries realized the need to analyze how to achieve some level of advance funding (at least partially) ofbenefit obligations. This may take the form of requiring employees to start contributing to the system, governments to contribute systematically, and/or establishing reserves so that investment earnings from pension funds can reduce the ultimate cost ofthe schemes. In a recent World Bank survey, 14 out of 82 civil service pension schemes now have either partial or full funding, and 23

67 out of the 82 schemes require some level of employee contributions. Also, countries such as India, Pakistan, and China are in the process of designing schemes which require civil servants to start contributing to their pension benefits.

A65. Pension portability: Historically, civil service pension schemes were established as a form of reward for long service. Hence most benefit designs for these schemes are “backloaded”, with little in terms oftransfer of pension rights in case ofearly departure, to encourage lifetime employment. However, as countries develop socially and economically, what used to be reward for long service becomes a barrier to labor mobility - prohibiting the flexibility that is generally available through natural attrition, to attract new blood which is vital to allow the civil service to be modernized for the 21” century. Beginning with the 1980~~many industrialized countries realized the need for the civil service to be modernized, and started a trend to integrate civil service pension systems with national social security systems. Integration of civil service plan benefits into national social insurance plan benefits occurs to varying degrees in different countries. In the most complete sense ofthe term, total integration takes place when civil servants are treated no differently from private sector employees, as in Argentina and Peru, and throughout eastern Europe where preferential schemes no longer exist. A less complete form of integration occurs where a civil service pension system is operated by the State much like any other occupational pension plan in the private sector. Examples of this type can be found in the United Kingdom, Japan and other industrialized countries. Overall, an increasing number of civil service plans are being integrated in one way or another into national pension systems. In countries where integration has occurred, 60 of these integrated pension system frameworks were implemented after 1980.

A66. Some countries like Chile, Uruguay, Peru and Jordan have taken steps to terminate the civil service preferential scheme for new employees as part of the process of implementing pension reform for their national systems. Others such as United States and Hong Kong have established fully funded defined contribution schemes for new employees to allow for full portability ofpension rights.

A67. Holistic civil sewice reform: Instead of focusing exclusively on lowering the civil servants’ wage bill by downsizing the civil service workforce, an increasing number of countries have turned their efforts towards a more holistic approach - one that takes into consideration the total compensation package as well as other employment parameters. The analysis of civil service pension reform should therefore go beyond comparisons of civil service pension provisions or cost-sharing arrangements between the State (as employer) and the employee. In order to gain a better understanding ofthe pension reform situation in any country, one needs to study additional elements such as (i)public-private wage rates and earnings; (ii)different kinds of fringe benefits including free (or below cost) medical services; and (iii)working conditions and stability of employment. Hong Kong is the most recent example that has undergone a thorough reform of its civil service, by carefully studying its human resource policies including appointments, pay and benefits, promotion and exit policies. Such a holistic approach takes into consideration the proper apportionment between cash pay and fringe benefits, its comparability with the private sector, as well as other public sector remuneration policies around the world.

68 APPENDIX VIII: TAXATIONOF PENSIONS

A68. The personal income tax system plays an important role in the pension system of most OECD countries. First, savings in funded pension schemes are typically afforded a generous tax treatment relative to other forms of saving. Second, these countries’ income tax systems are progressive. Since pensioners generally have lower gross (before-tax) incomes than workers, they pay less income tax. Consequently, net replacement rates, after taxes and social contributions, are higher than gross replacement rates. Third, many countries offer pensioners a more generous tax treatment than they do workers, with additional allowances, longer zero-rate bands and so on.

A69. In Mauritius, the limited reach of the personal income tax constrains its role in pension policy. Basic tax allowances are high relative to earnings, and potential taxpayers have a broad range of generous allowances, deductions and exemptions to reduce and even eliminate their income-tax liabilities. All taxpayers, for example, have a standard allowance of Rs.50,000 plus a standard deduction of 12 percent of their income. Consequently, there are only 75,000 income-tax payers out of an adult population of one million (Table A8.1). Moreover, the personal income tax raises little revenue: just 8 per cent of total taxes or 1.3 percent of GDP. OECD countries, in contrast, raise an average of 8 percent of GDP in personal income tax, which accounts for 22 percent of total tax revenues. Because of the generous allowances and exemptions, even the richest pay income tax on a small proportion of their incomes. For example, people facing a marginal tax rate of 30 percent pay only 12.4 percent, on average, of their incomes in tax.

Table A8.1 Personal Income Tax: Number of Taxpayers, Total Income, Taxable Income, Tax Paid, and Effective Average Tax Rate by Statutory Rate of Personal Income Tax Statutory Taxpayers Gross income Taxable income Tax paid Effective tax rate rate (%) (number) (R mn) (R mn) (R mn) PA) 5 41 4 1 0 1.2 15 22 290 2 636 536 45 1.7 25 12 771 1885 566 74 3.9 30 23 282 7 164 3 742 89 1 12.4

Total 58 384 11 689 4 845 1010 8.6 Source: Income Tax Department tabulations

A70. By international standards, the tax treatment of all forms of savings and investments in Mauritius is exceptionally generous. Short-term bank deposits are exempt from income tax up to a Rs.75,000 limit, equivalent to 1% times average earnings. Medium-tem deposits (three years or more) are exempt with no limit. Life insurance premia are fully deductible and receipts at the end of these contracts are not taxed either. The system also treats investment in owner-occupied housing generously. Interest payments on a secured loan are deductible up to Rs.100,000 a year. So, a married couple, with two lots of deductibility, could deduct interest payments on a mortgage well in excess

69 of R2 million (at current interest rates). This tax regime, therefore, ensures that capital income is untaxed. In fact, the government subsidizes capital income to a significant degree.

Possible Tax Treatments for Pensions

A71. This section goes back (briefly) to first principles to look at possible ways oftaxing pensions. There are three points at which saving in a funded pension (or any other savings instrument) can be taxed: 0 when employers or employees contribute; 0 when investment income and gains accrue; and 0 when benefits are paid out.

A72. Four of the eight basic possible tax combinations are shown in Table A8.2 It looks at a contribution of 100 made five years before retirement, with a proportional tax of 30 percent (the highest rate in the Mauritian system, but also the most common: see Table A8.1) and annual returns of 10 percent a year.

A73. The first system exempts contributions and fund income but taxes the pension in payment. Hence the name “exempt, exempt, taxed” - (EET). The second is TEE: contributions are made out of taxed incomes, but benefits can be withdrawn tax-free. In this simple framework, these have the same effect: a choice between consuming 70 now, or saving and spending 113 in five years’ time. The two also deliver the same present value of revenues for government. But under EET - the ‘classical expenditure tax’ - revenues are deferred until retirement, while under TEE - called the ‘pre-paid expenditure tax’ - they are received immediately.

Table AS.2 Some Alternative Tax Regimes for Pension Saving EET TEE TTE ETT Contribution 100 100 100 100 Tax 0 -3 0 -3 0 0 Fund 100 70 70 100

Returns 61 43 28 40 Final fund 161 113 98 140

Tax -4 8 0 0 -42 Net pension 113 113 98 98

Notes: EET: exempt, exempt, taxed; TEE: taxed, exempt, exempt; TTE: taxed, taxed, exempt; ETT: exempt, taxed, taxed.

A74. The other two systems tax pensions twice. Bothtax investment returns, and the first taxes contributions and the second, withdrawals. Again, these two systems - called the ‘comprehensive income tax’ - are equivalent in this simple case. The reward for saving is lower than the expenditure tax: 98 to spend in five years rather than 113. The post-tax rate

70 of return is the same as the pre-tax rate ofreturn (113=70~1.1 ’), when expenditure is taxed, but is 7 rather than 10 percent under the comprehensive income tax (98=70x1 .0755).

A75. There is no reason to alter the basic structure of Mauritius’ current tax treatment of pensions. A comprehensive income tax would treat savings like any other good or service. But savings are a means to future consumption, and this is particularly obvious when earnings are deferred to provide retirement income. Around half of OECD countries have an expenditure tax treatment ofpensions. Another eight countries offer a slightly better tax treatment. In places such as Ireland, Portugal and the United Kingdom, this is because lump sums are tax-free, as is the case in Mauritius.

A76. Returning to the illustrative calculations, the tax-free lump sum means that the effective tax on pensions in Mauritius is negative. The individual faces a choice between consuming 70 now or 125 in the future rather than 113. The net of tax return is now 12.3 rather than 10 percent before tax. This implies an effective marginal tax rate of minus 7% percent.

Table AS.3 Some Illustrative Calculations for Mauritius Fully taxed Tax-free lump Tax-exempt in sum retirement Contribution 100 100 100 Returns 61 61 61 Final fund 161 161 161

Tax -48 -3 6 0 Net pension 113 125 161

A77. However, few pensioners pay any income tax at all, even those that were taxpayers during their working life. First, because pensioner incomes are typically lower than working age incomes, a full career in an occupational pension scheme would give two- thirds of final pay. Second, because ofthe additional exemptions granted to pensions. The elderly have a standard allowance of Rs.100,000 rather than Rs.50,000 with the standard deduction of 12 percent of income on top. Together, these effects mean that income-tax payers of working age face a tax treatment of pension saving that is effectively EEE. The effect (illustrated in the final column of Table A8.3) is to give people a choice between consumption or consuming 161 in the future through pension saving. This is equivalent to an annual 18 percent post-tax rate of return, compared with 10 percent before tax. The effective marginal tax rate is minus 30 per cent.

Recommendations

A78. With the limited reach of the income tax system at the moment, the cost of these exceptionally generous tax concessions is not large. However, the increased cost ofpaying for pensions as the population ages, and other pressures on public budgets, imply that the scope of the income tax may increase in the future. It is better to deal with these anomalies

71 now - before costs get out of control - since few people will be affected. We recommend the following changes: 0 The income tax treatment ofthe elderly should be aligned with that ofthe working population, with a gradual removal of the additional allowance and the additional basic deduction. 0 Lump-sum distributions from pension should be taxed to reflect the revenues the government would have received had the whole pension been taken as an annuity stream. The tax system should not distort people’s choices over whether to take their pension benefit as a lump sum or as an annuity.

A79. However, the tax rates on lump sums should be lower than the taxpayer’s marginal income tax rate to reflect the fact that taxes are paid up-front rather than over a longer period with an annuity. For a taxpayer at the 30-per-cent rate, actuarial calculations indicate that the appropriate tax rate on the lump sum would be around 20 percent.

72 APPENDIX IX: FINANCIALPROJECTION METHODOLOGY, ASSUMPTIONSAND DATASOURCES

I.Introduction

A80. The Pension Reform Option Simulation Toolkit (PROST - version 10) is a generic PC-based projection model developed by the Social Protection Unit of the World Bank. This model has been used to analyze and project reform options for the pension systems in Mauritius. PROST model has been developed in VBA and can be used with the Windows 95/98/NT operating systems in conjunction with the Office 97 or later platforms.

A8 1. The program can be used to simulate the evolution of a country’s pension system, generally over long periods of 100 years or more. As with any simulation model, the outcome from PROST depends largely on the nature and quality of data as well as on the set of assumptions being used for the simulations. Since PROST has been used in some 46 countries to provide quantitative input for pension policy discussions, its methodology has proven to be sufficiently robust and its flexibility has permitted easy adaptation to specific country circumstances for sensitivity testing and comparisons under a wide range of economic and policy scenarios.

A82. This annex summarizes the key assumptions used with the PROST simulations that pertain to the pension systems in Mauritius. Although an actuarial review was prepared by the UK Government Actuary’s Department, due to the differences in methodology, assumptions and data, results in nominal terms may not be strictly comparable between the two exercises. Nevertheless, conclusions from the two sets of analyses are quite similar. Furthermore, as with any simulation exercise, the output from PROST should not be quoted in absolute terms without proper reference to the underlying assumptions.

A83. Data and assumptions used in preparing the estimates of Mauritius’ pension system were compiled based on information from many sources. Some of the data was obtained from the National Pension Fund (NPF) financial reports. Publications and statistical yearbooks presenting economic, labor, social and demographic data were also used as references including the Digest of Demographic Statistics, the Economic and Social Indicators: An Occasional Paper and the Labor Force Sample Survey 1999 published by the Central Statistical Office (CSO).

11. Structure of PROST

A84. PROST consists of an input workbook and five output modules. The input filehemplate is an Excel workbook with six embedded worksheets that contain a large number of defined variables. Each of the five output modules contains various Excel worksheets with graphical presentations of key results. PROST begins with a top-down approach, first projecting the population, then determining the size of the labor force and the number of employed persons. Depending on the method chosen, the number of contributors can be derived either from the general population or the labor force.

73 Beneficiaries are then determined based on the retirement pattern and the number of contributors in each age cohort. Financial flows can then be calculated based on the resulting revenues and expenditures.

Figure A9.1: Projection Methodology

I Population

I

~ Labor Force and Employed Persons/

1 Contributors and Beneficiaries i I

’ Funds at End of Year t: L __I__--__/

The Input File

A85. Data must be entered for the base year and the end year of the simulation horizon. Information for intervening years can be inserted if there are anticipated changes that may alter the linear relationship between the base year and the final year. The program is equipped to handle both “stock)’-based as well as “jZow”-based calculations. With the “stock” method, the current pools of contributors and beneficiaries are expressed as percentages of either the overall population or employment; thereon, new retirees and the newly disabled are derived based on the stock of contributors by age cohort, taking into consideration assumed retirement ages, length of service, and the historical retirement pattern. With the “flow” method, the increments (or decrements) of different categories are computed first. These incrementddecrements are then aggregated with the beginning stock of contributors and beneficiaries. Data requirements under the input templates are summarized as follows:

0 General Input information about the economy (inflation rate, real interest rate, real GDP growth, etc.) as well as parameters on the pension system (current benefit expenditures, retirement age, accumulated reserve fund, etc.).

0 Population Input the age structure ofthe population in the base year along with age-specific fertility and mortality rates as well as migration information for the simulation horizon.

74 0 Labor Input the labor force participation rates, unemployment rates, evasiodexemption rates, earnings profile for the simulation horizon.

0 Pension Input pension system information for the base year including the age structure of the contributor and pensioners. Pension coverage rates, replacement rates for new beneficiaries according to the relevant formula(s) will also be required for the simulation horizon.

0 Reform Input relevant parameters to reform the system including switching patterns, acquired rights, replacement rates before and after reforms, provisions under notional accounts as well as a funded defined contribution system.

0 Profiles Input profile data for specific individuals including gender, years of service, earnings and mortality profile.

The Output File

A86. PROST generates five output modules. Each module contains a number of Excel worksheets and graphical summaries on key indicators. The output modules are arranged as follows:

Population Key output includes population pyramids, life tables (by sex and Projection year), life expectancy changes and demographic indicators such as population dependency rates.

Demographic Projections of labor force, employment, contributors and Structure beneficiaries, demographic structure, length of service at retirement, head counts of contributors and beneficiaries including system dependency ratios are calculated.

Financial Flows Macroeconomic trends, wage distribution, contribution revenues and pension payments are calculated, financial balance and the implicit pension debt are then projected for each year. The number of pensioners are separated into two categories -the existing stock and those entering payment status.

Finances of Financial balance, replacement rates from each pillar and the Multipillar aggregate results ofthe reform are calculated.

Individual Illustrations are presented using individuals under a pay-as-you- Accounts go contributory scheme, affordable replacement rate, defined contribution and multi-pillar schemes.

75 III. Mauritius’ Population Projections - Assumptions and Data Sources

A87. Simulation Horizon: The start of the simulation horizon was 1998 (base year), the year for which the most complete documentation was found for all the variables needed for PROST. National data was obtained from the 1999 Digest of Demographic Statistics by the Ministry of Economic Development, Productivity and Regional Development. Detailed data pertaining to characteristics of contributors and pensioners were derived from computer printouts produced by the National Pensions Fund Financial Database. The ending year for the simulation horizon was 2050 (end year) - a period viewed to be of adequate duration to demonstrate the emerging trends of the pension systems in Mauritius.

ASS. Population Structure: 1998 population data for Mauritius, including age structure and gender composition was extracted from the 1999 Digest of Demographic Statistics by the CSO and corroborated with information from the World Bank’s Population Unit database.

A89. Mortality Rates: Age-specific mortality rates (in five-year age groups) including projected improvements in mortality (in five year intervals) for the years 1995-2050 were provided by the World Bank’s population Unit. These mortality rates were used to calculate the probability of dying by age cohort (age 0 to age 100) for both men and women every year during the simulation horizon. Both current and projected life expectancies at various ages were compared against Mauritius’ own projections for overall reasonableness. Key demographic indicators are shown in Table A9.1 below.53

Table A9.1: Projection of Life Expectancy Changes (Average Remaining Years of Life Expected at Specific Ages) -1998 -1999 2000 2005 2010 2020 Male

Life Expectancy: At Birth 66.2 66.9 67.6 68.2 68.8 70.1

At Age 20 48.3 49.0 49.6 50.1 50.7 51.9

At Age 60 14.9 15.3 15.8 16.2 16.5 17.4

At Age 65 12.0 12.3 12.7 13.1 13.4 14.2

Female

Life Expectancy: At Birth 74.0 74.6 75.3 75.9 76.7 78.3

At Age 20 55.7 56.3 56.9 57.5 58.2 59.6

At Age 60 19.1 19.6 20.0 20.5 21.1 22.3

At Age 65 15.5 15.9 16.4 16.8 17.3 18.4

A90. Age-spec@ Fertility Rates: The age-specific distribution of fertility rates was also provided by the World Bank Population unit for the years 1995-2050. It is important to

53 Mortality tables used are available upon request.

76 note that there is no consensus among demographers as to whether Mauritius’ total fertility rate would continue to decline or remain at the current level of around 2.0.54

A9 1. Sex Ratio at Birth: The number of boys born per 100 girls was assumed to remain constant at the current level of 105 and in accordance with the statistics published by the Central Statistical Office.

A92. Net Migration: It was assumed that migration in net terms will not affect the total population nor its structure.

A93. Projected Population 1998-2050: Based on the above adjustments, the population of Mauritius is projected as follows:

Pt=Po + B - D + I- M where, Pt: population in year t, PO:population at the beginning of the year, B: number of births in year t, D: number of deaths in year t, I:number of immigrants in year t; M: number of emigrants in year t. Table A9.2 shows the projected population and the corresponding population old age dependency rate.55

Table A9.2: Population and Old Age Dependency Rate (1998-2050)

1998 1999 2000 2005 2010 2020 2030 2040 2050

Total Population (in thousands) 1,167 1,179 1,191 1,251 1,307 1,402 1,466 1,498 1,506

Male 583 589 594 622 648 690 116 727 729

Female 584 590 591 629 659 712 750 711 777

Share 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

0- 14 25.9% 25.7% 25.6% 24.2% 22.5% 20.9% 19.5% 18.7% 18.3% 15 - Retirement Age 65.4% 65.5% 65.6% 66.2% 66.0% 62.8% 59.7% 57.3% 56.3% Retirement Age and over 8.7% 8.8% 8.9% 9.6% 11.4% 16.3% 20.8% 24.0% 25.4%

Old Age Dependency Ratio 13.4 13.5 13.5 14.5 17.3 25.9 34.7 42.0 45.1

54 Tables of the age-specific fertility assumptions used are available upon request. 55 The ratio of older persons (age 60 and older) to working age individuals (ages 15 to 59).

77 Figure A9.2: Mauritius' Aging Population Male Female

Source: PROST output file

IV. Labor Force Projections

A95. Labor force statistics were derived from the digest on labor force statistics published by the CSO (1999). Total labor force was estimated at about 500,000 in 1998, of which 462,000 (3 10,000 males and 150,000 females approximately) are employed. See Figure A9.3 for the labor force participation rates used in the projections. Unemployment rates were on average 4percent for males and 12 percent for females in 1998.

A96. Assuming Mauritius does not experience any expansion of its labor force and that the labor force participation and unemployment rates shown above remain unchanged, it is expected that Mauritius's employed workforce will increase from the 1998 level of 462,000 people to nearly 560,000 in 2015, then increase much more gradually to 576,000 by the year 2050. This pattern reflects primarily the natural growth trend in the population. Nonetheless, since the projections expressed old age pension coverage as a percentage of the total population, the assumption that there would be no systemic changes in labor force participation rates throughout the simulation period does not affect the overall dynamics of the projections.

78 Figure A9.3: Labor Force Participation Rates by Age in 1998 males (solid), females (dashed) 1 120%

12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 63 66 69 72 75 18 Age

Source: Labor statistics, CSO (1999)

V. Contributors, Pensioners and Coverage

A97. Basic Pensions: This is a non-contributory, defined-benefit system. All eligible residents are automatically covered. No individual contributions are required. Information on Social Security Statistics was obtained from the Economic and Social Indicators: An Occasional Paper (Issue No. 315) published by the CSO. Data on number of beneficiaries of basic pensions and amount paid for the years 1994-1999 was presented. Details pertaining to the age and gender of these beneficiaries were not available but were assumed to resemble the age structure ofthe general population.

A98. Contributory Pensions: Information on contributors and beneficiaries under the contributory pensions scheme was obtained from computer printouts produced by the NPF for the years 1996, 1997 and 1998. It should be noted that due to the nature of data collection in the NPF, the exact age and gender distribution of the stock of contributors in 1998 is not available. However, an estimated 272,800 contributors contributed to the NPF of which about 110,000 are females. ( See Figure A9.4 for the distribution of the age structure of the 1998 contributors extrapolated from the provided printouts.) Coverage for the contributory pension as a fraction of employment is assumed to be stable at around 55-65% of the employed population throughout the simulation horizon.56

56 These assumptions were based on the fact that the indexation of the floor at inflation and the indexation of the ceiling at less than inflation (due to the differential increments proposed by the tripartite committee on the different wage levels) - would tend to work against coverage increases attributable to events like increased labor force participation etc.

79 Figure A9.4: Distribution of Contributors in 1998, Men (clear), Women (solid)

n

MX

Source: Bank staff estimates based on printouts from the NPF database

A99. Age-salary Distribution: No reliable wage data exists for the economy-wide average wage in Mauritius -though tentative calculations based on household surveys and ‘large establishment’ surveys estimate that the average wage should be in the order of about Rs. 6000 per month. For the NPF, due to the nature of the ceiling and floor on covered wages, the effective covered wage is estimated slightly below Rs. 3000 per month in 1998. The age and gender specific distribution of wages is interpolated from incomplete contribution records on file at the NPF. Females covered by the NPF, on average, earn about Rs. 2000 a month whereas males earn about Rs. 3900 per month.57

Figure A9.5: Age-Earnings Profile of Contributors, men (solid), female (dashed) (normalized relative to earnings of20 year old male)

300% -al E 250% 0 0 L 200% 8 B 150% ul .-F E 100% al c 0 50%

0% zEi2 UJUJmmm Age Source: Bank staff estimates based on extrapolated data from household surveys

57 Earnings for male and female contributors of all ages were normalized relative to the earnings of a 20- year-old male contributor (considered as a proxy for minimum wage) and are expressed in percentages ofthe 20-year-old male contributor.

80 A100. BeneJiciaries: Table A9.3 summarizes the evolution of beneficiaries under the two systems over the period 1994-1999.

Table A9.3: Evolution of Beneficiaries

Beneficiaries 1994 1995 1996 1997 1998 1999 Non Contributory Basic Retirement Pension 98,647 101,665 103,804 107,106 108,784 109,571 Basic Widows Pension 19,496 19,692 19,942 20,428 20,795 21,153 Basic Invalid's Pension 15,363 15,809 16,130 17,405 17,506 18,864 Basic Orphan's pension 1,043 984 860 889 737 719 Basic 'other' pension 17,102 16,651 16,511 16,213 15,870 16,232 Contributory Contributory Retirement Pension 21,999 23,547 25,280 27,262 28,295 29,797 Contributory Invalidity Pension 2,053 2,184 2,335 2,636 2,603 3,125 Contributory Widow's Pension 4,347 4,623 4,992 5,387 5,777 6,155 Contributory Orphan's Pension 111 110 104 108 91 104 Industrial Injury Allowance 720 760 852 865 917 868

Source: Bank staff estimates based on extrapolated data from printouts from the National Pension Fund

A101. Under the Basic Pension Scheme, anyone who reaches the age of 60 and meets the residency requirement of 40 years is eligible to receive an old-age pension. Therefore, it was assumed that age 60 would be the average retirement age under this scheme. In the early years of the projection period, it was assumed that everyone who reaches age 60 would draw the benefit. In the later years, by 2050, due to globalization and labor mobility, a small proportion of the population - up to 8percent of total population over the age of 60, would not have the required years of residency to draw the pension.

1998 1999 2000 2010 2020 2030 2040 2050

Total Contributors (in thousands) 272.9 280.2 286.1 317.8 329.0 327.0 320.7 317.6 Male 162.1 166.2 169.5 187.2 192.6 190.9 187.1 185.2 Female 110.8 114.0 116.5 130.6 136.4 136.1 133.6 132.4 Old Age Pensioners (in thousands) 31.0 32.9 34.3 53.9 84.9 114.4 136.0 147.2 Male 16.8 17.7 18.3 28.1 44.9 60.9 72.2 77.1 Female 14.1 15.2 16.0 25.8 40.0 53.6 63.8 70.1 System Dependency Rate 11.3 11.8 12.0 17.0 25.8 35.0 42.4 46.3

A102. The Contributory Pension Scheme was established in 1978. Many contributors (those age 40 and above at the time) were given contribution credits to enable them to qualify for pension benefits from the Contributory Pension Scheme. Therefore, most

81 retirees have been retiring with the effective contribution credits of 40 years. Hence, it was assumed that old-age pensioners under the Contributory Pension Scheme would retire on average at age 60 with 40 years of service.

A103. Macroeconomic assumptions: Economic indicators used for years 1998-1999 are based on actual data. For years 2000 and after, macroeconomic assumptions used by PROST were derived from World Bank forecasts taking into account historical indicators and projections from expert sources. These economic parameters were used in conjunction with the assumptions concerning the population and the labor force to project the future financial conditions of the pension system.

Table A9.5: Key Macroeconomic Assumptions (% per annum)

Macroeconomic Trends 2000 2005 2010 2015 2020 2030 2040 2050 Real GDP Growth 5.2% 4.8% 4.0% 3.8% 3.5% 3.0% 2.5% 2.5% Real Wage Growth* 5.2% 3.5% 3.7% 3.7% 3.4% 3.2% 2.7% 2.7% Inflation Rate 4.5% 3.5% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% Real Interest Rate 3.4% 3.5% 3.7% 3.7% 3.4% 3.2% 2.7% 2.7% Source: World Bank staff estimates Note: In order to mimic the compressed nature ofthe ceiling and floor on covered wages under the Contributory Pension Scheme, an assumption was made that the effective real wage growth is equivalent to 1% real per annum.

VI. Pension System Financial Flows

A104. In projecting the financial flows of Mauritius’s old-age insurance system, revenues and expenditures had to first be determined.

Figure A9.6: Calculation of Revenues

I Revenues I

Contributions Direct government contributions

Contributors in age group X Average wage of age group x Contribution rate

A105. Revenues: The following chart shows a schematic view of the calculation of revenues and sources. As the Basic Pension Scheme is financed solely through the budget by general revenues, no contribution revenues will be collected from the covered population. For the Contributory Pension Scheme, contribution revenues were calculated based on the prescribed national average contribution rate (9 percent for about 85 percent

82 of members while the sugar industry opts to pay a higher contribution rate of 13 percent in exchange for higher benefit rates). For the purpose of this projection, no differentiation was made between employer and employee contributions.

A106. Expenditures : The following chart shows a schematic view of the determination of benefit amounts and other sources of expenditures.

Figure A9.7: Calculation of Expenditures

Expenditures I I I I I 1 Other Expenditures Administration Costs

I Newly retired Pension formula Agels ex H Length of service Stock Last year's pension

I Indexation factor I

A107. Pension benefits payable under the Basic Pension Scheme are targeted at 20 percent of the economy wide average wage and are supposed to be indexed to nominal wage growth. Historically, the actual rates of increase had been in excess of wage growth. For the purpose of this projection, it was assumed that the target replacement rate would be 20 percent ofthe economy average wage with increases in line with nominal wage growth.

A108. The Contributory Pension Scheme is a defined-benefit system that follows a point system, The accrual equivalence is approximately 1/120th per year of contributory service. Thus, it is expected that a full career worker would have accrued approximately 1/3rd of career average earnings as a pension benefit.

A109. Fiscal Balance: From the revenue and expenditure streams of payments, current balance and fund reserve were calculated. Current balance is defined to be the difference between revenues and expenditures. Any fund reserve would accumulate based on the following: A(t+l) = A(t) * (l+r(t)) + I(t) - E(t) where, A(t) is the amount of fund reserve at the beginning of the year A(t+l) is the amount of fund reserve at the end of the year r(t) is the assumed portfolio return for the year t I(t) is the revenue for the year t E(t) is the expenditure for the year t

83 A110. At the beginning of 1998, the fund reserve was estimated to be around Rs. 15 million (based on book value). As the reserve is invested primarily in fixed income instruments, a conservative assumption was adopted that the real return (net of inflation) on investments would be around lpercent per year. This is consistent with the historical returns generated throughout the 1990s when return on investments had been around 2 percent per year.

84 APPENDIX X: PENSION CONSULTATIONS

A11 1. This appendix draws partially on the Open Conference on Pension Modernization, held in Mauritiusfrom March 6-8, 2001 and on subsequent discussions, as well as on the report by Dr. Jean Claude Lau Thi Keng entitled “Mauritius: Informal Pension Arrangements.”

A112. For many Mauritians, the non-contributory Basic Retirement Pension (BRP) or Old Age Pension is the real pension and is often referred to as “ le Grand Pension ”. It is considered to be the citizens’ rightful reward, given by a grateful government and society, for a lifetime of labor, as well as a just recompense for their contribution to the country’s development. It is felt that it is equally due to women who have never worked outside the home, for they have raised children who are, in turn, working for the country. In contrast, contributory pensions are not perceived as pensions at all, but rather as personal investments, much on the lines of a savings bank account.

A1 13. In keeping with this view, many hold that the BRP should be a personal allowance. Unfortunately, they feel, this is seldom the case. In the lower socio-economic groups, particularly in the case of composite households where there is a high percentage of members with no earned income, such as widows, schoolchildren, unemployed or disabled persons, or those with irregular income such as fishermen, helpers or seasonal workers, the BRP of the elderly is often used as a substitute for other types of social protection (widowhood, educational aid, unemployment or invalidity allowance) which, it is felt, members of the household ought to otherwise receive.

A114. The BRP system itself, which increments pension according to age, is not considered fair. Although the amount paid as BRP increases at two age-steps (at 90 and 100 years old), a pensioner would have to wait for 30 years before benefiting from an increase in pension. Many view this as unattainable, or if they were ever to reach it, feel that they would be either too old or too ill to enjoy the gain.

A1 15. Many Mauritians are also comfortable with the retirement age level (currently set at 60); raising the retirement age generates much controversy. Many Mauritians considered that manual work, such as that undertaken by laborers and fishermen, wears down people more rapidly than office work. Moreover, manual workers often tend to start working as early as 13 or 14 years of age. As a result, more manual workers cease their professional activities before the age of 60, as compared to office employees, and feel that their contribution to the country is complete. Thus, raising the retirement age would have a disproportionate effect on workers and laborers.

A1 16. Given the general perception of Mauritians of the BRP as a well-earned reward for their labors, the issue of its reform is bound to raise concerns that the rights of the workers may be jeopardized. The government, on its part, has called for an open, public debate on the subject and emphasized that reform of the pension system will not only increase benefits to the most needy, but will also release the much-needed resources for subsequent improvements in the health, education and transport sectors.

85