In the past, when one fathomed the thought of retirement in Zambia it was inevitable to recite the idiom from American poet Robert Frost, who once wrote, ‘some say the world will end in fire, some say in ice. From what I have tasted of desire, I hold with those who favor fire.’ The life after retirement of the workers of today are in the hands of the numerous pension funds that manage the contributions with the sole purpose of repaying back to the contributors. However, if these monies are not managed prudently there lies chasm between survival and destitution in the life after employment.
Retirement income is an extremely important component of every individual’s life cycle. According to David Blake’s paper, it can come from one of the four pillars of support in old age: unfunded state pensions (that is, transfers from the current working population via the tax system), funded private pensions (that is, from savings accumulated in private sector pension schemes), direct private savings, and post-retirement work. Throughout the world, governments are looking to funded private pension schemes to solve the problem of providing pensions to their ageing populations. There are two main types of funded scheme: the defined benefit (DB) scheme and the defined contribution (DC) scheme.
By their distinct nature, the two forms of pension schemes have different investment philosophies that ensure a return and a preservation of capital for the pensioners. A DC scheme mostly invests only in the financial assets, bonds, financial derivatives, commercial paper and common stocks. A DB scheme invests in portfolios containing: financial paper assets and other forms of investments.
The pension liabilities at any time are equal to the expected present value of the future pension payments from the scheme assuming the scheme member remains in the scheme until retirement. By definition, the surplus is always zero with a DC scheme. The surplus risk i.e., the volatility of the surplus with a DB scheme depends on both the difference between the volatilities of the pension asset and pension liability values and on the correlation between these values. According to Blake’s paper, the main sources of these volatilities during the accumulation stage are uncertainties concerning future investment returns, real earnings growth rates and inflation rates. This is because investment returns determine the rate at which contributions into the pension fund accumulate over time, the growth rate in real earnings determines the size of both contributions into the scheme and the pension liability at the retirement date, and the inflation rate influences the growth rate of pensions after retirement.
Good or bad investment performance by DB and DC pension schemes have very different consequences for scheme members. With DB schemes, the investment performance of the fund’s assets is of no direct relevance to the scheme member, since the pension depends on the final salary and years of service only and not on investment performance. The scheme member can rely on the sponsoring company to bail out the fund with a deficiency payment if assets perform very badly i.e., the member exercises the implicit put option against the sponsor. In extreme circumstances, however, it is possible for a firm and possibly the scheme to become insolvent. Of course, if the assets perform well, the surplus is retained by the sponsor who exercises the implicit call option against the member in this case.
However, investment performance is critical to the size of the pension in the case of a DC scheme: scheme members bear all the investment risk in such schemes. Scheme members, especially personal pension scheme members, can find themselves locked into a poorly performing fund, facing very high costs of transferring to a better performing fund. In addition, the type of funds in which personal pension scheme members invest can and do close down and then the assets do have to be transferred to a different fund.
In this section, we examine the investment performance of pension scheme assets, beginning with those of DC schemes.
The Pension industry in Zambia is largely a two pillar system – the compulsory pillar and the voluntary pillar. All employed individuals in the formal sector are compelled to contribute to one of the three public schemes namely the Public Service Pension Fund (PSPF), the National Pension Scheme (NPS) managed NAPSA and the Local Authority Superannuation Fund (LASF). This pillar is effectively not under the supervision of the Pensions and Insurance Authority but in the proposed bill all statutory pension schemes are expected to be supervised by the Pensions and Insurance Authority. On the management of pension funds, the industry has seven (7) pension scheme managers and six (6) pension scheme administrators.
The voluntary pension pillar is comprised of Trusts that are established by employers and are supervised by the Pensions Insurance Authority. The current pension fund landscape has close to 250 registered pension schemes in Zambia. The combined market size of $4bn. With a monthly net asset of $35mln to $40mln. Return on average net assets year under has been 19%. This is above the annual inflation rate of 6.6%. The country’s GDP is an approximate of $20bn, implying the pension funds hold assets which is a 20% of the total GDP.
Having postulated the mechanics of pension funds and their diverse investment strategies, we turn to their current appetite for property investment. Its common knowledge that there’s a construction binge in Zambia with Lusaka city leading the charge. Interestingly, pension funds have moved in the property investment space with zeal and tenacity though oblivious to the fact that this could be a property bubble. Is there a property bubble in commercial property investment space? Is the pensioners’ money safe in case the property bubble burst? Financial insight asks the questions because history has shown us what happens in the event of bubbles. We are hopeful it’s not.
The various pension funds in Zambia have been investing in property heavily, there are some flagship property investments that can be spotted in Lusaka and other metropolitan cities in the Copperbelt. Malls, Office parks, hotel boutique parks and housing structures have been financed by pension funds. All these investments have an estimated payback period with a corresponding rate of return. The past decade Zambia had experienced above 6% GDP annual growth rates that enabled a growth in business and a subsequent demand for commercial property. However, the growth rates have dampened to around 3%, with a projected target for 4% in 2017. The drop in the GDP growth rate numbers are a signal and a direct positive correlation to the drop in the rental charges on most commercial properties. A closer inspection of the rental charges show a sharp decline; in the review periods 2014/2015 most commercial property were pricing a one-square meter at $15, however, by 2017 there’s has a downward re-pricing to $8 per square meter. The current prices show the more palatable price levels in tandem with the level of economic activities. If the macro economy continues on the downward trajectory or we continue to have weaker growth numbers then we likely going to see a burst in the property bubble. The most susceptible will be the public pension funds. Unlike the public pension funds, private pension funds have more astute investment teams, which have been prudent in the levels of property investment. The most efficient of these are African Life Financials and Kwacha Pension Fund.
In the end then, are the pension funds as well as retirees going to prefer fire or ice when bubble burst?