Private sector pensions at risk

 When proposals to raise government revenue were presented in October one of the features that became apparent was the additional burden on businesses.

The suggested increase in a variety of fees from work permits, business premises fees and licensing fees to higher import duties to name just a few, effectively makes it more expensive to run a business.

The government, recognising this, suggested a suspension of the private sector employer’s pension contributions for non-Caymanian workers to at least partially offset the impact of increased work permit fees.

“The government felt that the increase to work permit fees across the board is supportable only by the removal of an existing employer expense, such as the pension obligation for work permit holders,” Premier Bush said at the time.

Minister for Education, Training and Employment Rolston Anglin confirmed to the Observer that pension suspension plans will “come in as suggested in October”.

However, he clarified that the suspension of employers’ pension contributions will also apply to Caymanians for a period of 12 months and be permanent for non-Caymanians.

Bush claimed in October that, in the cases of unskilled or trade labourers, the reduction of pension payments for employers would likely lead to savings for businesses, even with increased work permit fees.

As an example, an employer no longer paying $1,000 in pension contributions on a $20,000 a year salary and who would be hit with a work permit increase of CI$500 would save costs.

Pension suspension = Compensation cut
Using this example it becomes immediately clear who bears the cost of the proposed private sector pension suspension.

While business costs are reduced, the loss of $1,000 directly affects the worker.

Under the current pension law both the private sector employer and the employee pay an amount equivalent to 5 per cent of the worker’s salary into a pension fund.

While the employee’s portion is deducted from the salary, the employer’s contribution is paid on top of the wages.

As a result the employee’s total compensation, and the total cost to the employer, amounts to 105 per cent of the salary.

The elimination of the employer’s pension contribution would reduce the total compensation from 105 per cent of the salary to 100 per cent, effectively representing a 4.76 per cent cut in compensation for each private sector employee.

Losing pay or losing pensions?
In addition, pension plan members wishing to maintain the same size of pension coverage would have to contribute the employer’s portion out of their own salaries, lowering their take-home pay to 90 per cent of their salaries.

Without additional voluntary contributions made by the employee the pension suspension will significantly reduce the final pension payout for private pension plan members.

For instance an annual employer contribution of $3,000 would have a much higher value after it has been invested and generated a compounded return over a period of many years.

A Cayman pension plan provider calculated that, as a result of a one year pension suspension a 40 year old plan member, whose employer contributes $3,000 per year into the pension plan, would lose just over $15,000 before inflation by the time of reaching retirement age. The example assumed an 8 per cent annual return.

Mercer report
In 2007, the Mercer study reviewed the National Pensions Law from the year 2000 and made recommendations for change to the Cayman Islands pension system.

The report found the law had been effective at implementing a pension system in the Cayman Islands, but noted some challenges that remained.

These included the findings that based on current economic predictions the minimum pension contribution rate of 10 per cent of earnings – 5 per cent paid each by the employer and employee – was not sufficient to provide adequate retirement income security.

The report lamented “a lack of understanding regarding the need and level of retirement savings required to support a minimum standard of living in retirement”.

It recommended among others things to increase the contribution rate to 12 per cent and rise the retirement age to 65.

The proposed pension suspension is going to further reduce the gap between pension contributions and the needed final pension.

Criticism of the pension suspension
When the idea of a private sector pension holiday was first launched in June, the National Pensions Board criticised the plan in a letter to  Anglin.

Anglin said that it was natural for the National Pension Board to disagree on the matter, because it was looking at it purely from a pension perspective and not in terms of the business relief it offers.

In June the Cayman Islands Pension Providers Association, the organisation representing the six multi-employer pension plans in Cayman also sent a letter to the minister responsible for pensions.

CIPPA stated it could not support the idea of a pension suspension or pension holiday for a number of reasons.

The letter contradicted the general notion that in difficult economic times employer’s pension contributions should represent a variable that could be manipulated to reduce the operating costs of businesses.

Typically investments are cheaper and returns higher during an economic downturn than during a boom period. To restart pension contributions when investments are relatively more expensive would be counterproductive and jeopardise the success of pension schemes, CIPPA wrote.

The pension plan providers stated that a pension suspension will only exacerbate the current situation and that the “financial impact on a member’s retirement income by suspending pension payments has not been considered”.

Delinquent employers
In its letter to Anglin CIPPA also highlighted the issue of delinquent employers who illegally fail to make pension contribution payments either in time, in full or at all, saying that there are currently “approximately 700 employers who are delinquent on their pension payments in the Cayman Islands”.

Any suspension of pension payments would therefore be difficult to reverse, CIPPA stated.

In any case, if the pension law was changed this effort should be rather directed toward “changes that have already been identified as desirable and necessary by the National Pensions Board and the National Pensions Office, in consultation with CIPPA,” the pension provider’s association said.

CIPPA also quoted the findings of the Mercer report that a rate of 10 per cent pension contributions was insufficient.

Legal questions
Another matter that would be raised by a pension suspension is whether employment contracts would allow employers to stop paying pension contributions, even if  government changed the pensions law.

This will depend on the exact terms of each individual employment agreement. Even if legally possible, employers would have to decide if they want to burden their employees with a compensation cut.

What can employees do?
The idea that pension contributions could be reduced to stimulate economic activity or avoid other business cuts is not a new one.

Some employers in the US and Europe have given their employees the option to choose between pay cuts and the suspension of, in these cases, voluntary employer’s pension contributions.

The suspension of employers’ pension contribution will put essentially the same question to employees in the Cayman Islands: accept a lower pension pay-out or lower take home pay?

While most workers would instinctively prefer the suspension of pension contributions over a reduction of the take home pay, this may not always be the best option on the long term.

Most people are more concerned with what will happen next month rather than what will happen in 30 or 40 years’ time.

Governments, as it turns out, often think in the same way.

When facing the suspension of employers’ pension contributions pension plan members should seek advice from the pension plan providers to determine what the long-term effect of the suspension will be on their individual pensions.

Pension plan providers typically have pension calculators that can be used to calculate the effect of a reduction in pension contributions on the final pension payout.

Temporary suspensions may have a smaller effect, but a longer or permanent suspension will have serious consequences and may necessitate that workers make additional voluntary contributions to their pension plan to achieve pension payout that is sufficient at the time of retirement.

The ability to make these additional contributions is then also a question of affordability.