Strengthening Social Security System

The reform agenda recently implemented was undertaken to strengthen the financial soundness of the Social Security System (SSS) and provide a structure for higher benefits for future pensioners. In order to fully comprehend the rationale for the reform agenda, a number of facts need to be understood.

Fact No. 1

SSS is based on what is called a “defined benefit” system in contrast with a “defined contribution” system.

SSS provides benefits, such as sickness and maternity allowances and pension, that are predetermined using a formula based on the number of contributions paid and a member’s monthly salary credit (MSC) and not dependent on the amount of contributions or the investment earnings generated by SSS.

Every member who enters the program is assured of the type and amount of benefits that can be obtained from the system under certain conditionalities.

Given the set of defined benefits and the old contribution rate, there exists a wide gap between the amount of contributions collected from each member and the benefits he could avail himself of.

Let us consider two cases: First, a member who paid the minimum contribution amount of P104 monthly and second, one who contributes the maximum amount of P1,560 monthly, both for 10 years.

Since these members are eligible for pension, let us assume for simplicity’s sake that they received pension for only 10 years. Including some additional assumptions in the availment of sickness and maternity allowances, the resulting benefit payout for the minimum contributor is P15 for every peso contributed while for the maximum contributor it is P6 for every peso of contribution.

Unfunded liability

Obviously, there is a wide gap between the amounts received in benefits and the amount of contributions.

This gap is what we refer to as the “unfunded liability.” This means that for every member that enrolls into SSS, an unfunded liability is created and once we add up all this we derive what is called the “unfunded liability” of SSS. It does not therefore mean that the system is losing money.

It just means that it has to look for ways and means to close the gap through initiatives, such as the continuous higher growth of assets or an increase in contribution rates. A recent Asian Development Bank study has also observed this same imbalance.

Fact No. 2

The contribution rate increase will reduce the unfunded liability. As can be observed in Figure 1, we can think of the total amount of future benefits to be paid out as well as operating expenses, valued as of 2011, in terms of an empty glass that we need to fill up.

Based on the updated actuarial study in 2011, the size of this glass is P3.6 trillion. If we value as of 2011, all of the future contributions to be collected this will amount to P2.2 trillion or capable of filling up 62 percent of the glass.

The other important component in filling up the glass is the assets of SSS, which was P294 billion in 2011, contributing 8 percent. All told, as of 2011, we can only fill up the glass up to 70 percent—62 percent from contributions and 8 percent from assets.

The remaining 30 percent or P1.1 trillion is what is referred to as the unfunded liability or the amount we need to raise to support the guaranteed benefits of all members.

3 ways

There are three ways to correct this predicament.

Reduce the amount of benefits, which is an unacceptable choice.

Grow the assets of SSS much faster and bigger by creating the proper environment conducive for the organization to generate higher levels of performance.

Increase the amount of contributions by raising the contribution rate.  See Figure 2.

As can be observed in Figure 2, the recent increase in contribution rate from 10.4 to 11 percent will increase the amount of total contributions valued in 2011 by P219 billion to P2.5 trillion.

The positive effect is that total contributions will now fund the requirement by 67 percent, thereby lowering the unfunded liability by 5 percentage points to 25 percent or P908 billion. The incremental increase in benefits is due to the upgrading of the MSC ceiling.

Fact No. 3

The magnitude of unfunded liability is not a constant amount and will continue to grow year after year as we expand members. The actuarial study assumes an 8-percent discount factor to value both the future benefits and future contributions to year 2011.

Inversely, the unfunded liability will also grow by 8 percent annually or roughly P72 billion. This means that there will be a continuing challenge to take appropriate action, to prevent the occurrence of a crisis down the road.

The other way of illustrating this condition is to present this in terms of the life of the fund. Based on the actuarial study as updated in 2011, the life of the fund is up to 2039 without any increase in contribution rate.

This means that the fund can  support the amount of future benefits with the projected future contributions and growth of assets only up to 2039.

What will happen is that as we approach that year, the amount of benefits granted will be much higher than the contributions collected thereby running down the assets until it dries out by 2039.

Extended fund life

The recent increase in contribution rate is expected to lengthen the life of the fund by four years or up to 2043. This translates to a fund life of 31 years from 2011. But “what is the ideal fund life?”

In the SSS Actuarial Valuation Report, a formula was constructed to determine the desired fund life, taking into account the length of time of the member from entry point up to retirement and the life expectancy of the member after retirement.

Ideal fund life

Based on this formula, the ideal fund life is 65 years. It may be of interest that the US Social Security Administration has a valuation period set at 75 years. Considering the desired fund life of 65 years, the current situation of 31 years, even with the increase in contribution rate, will still be a long way to go.

Continuous efforts should be exerted to bring about small adjustments in contribution rates until the desired fund life is attained.

Nonetheless, in spite of the recent increase, the SSS contribution rate as shown in Figure 3 is still almost half that of the Government Service Insurance System (GSIS) and much less than those of India, Malaysia and Vietnam.

Equally important, the base on which the contribution rate is computed or MSC is much lower than those of the GSIS, Malaysia and Vietnam, indicating that the two countries collect much higher level of contributions.

In terms of actual amounts, the 0.06-percent contribution increase will mean additional monthly payment of P6 for the minimum contributor and P90 for the maximum contributor. For those earning P8,500 the incremental increase is P51. For the employed, who account for 74 percent of total SSS membership, half of the increases will be shouldered by employers.

Fact No. 4

The growth of the unfunded liability was brought about by the past administrations’ propensity to increase pension benefits not only once a year but sometimes twice a year without taking into account the deterioration of the fund life, as can be observed in Figure 4.

Consequently, this had, by 1999, resulted in a considerably reduced fund life of up to 2015. Only because of two contribution increases in 2003 and 2007 was the fund life subsequently lengthened to 2039.

However, there is absolutely nothing wrong with granting pension increases as this addresses the need to regularly adjust the pension amount to compensate for the loss of purchasing power due to higher costs of living. It requires that the system finance the increase through higher revenue so as not to reduce the fund life.

Fact No. 5

The unfunded liability is not a reflection of the financial performance of the institution. In fact, SSS in the present administration has performed exceedingly well compared with the past as seen in Figure 5.

Asset growth, an important component in reducing the unfunded liability, has expanded by P106 billion from 2009 to the present or 11 percent annually. This can be attributed to higher membership coverage and above-benchmark income yields.

Our marketing efforts and prudent dispensing of benefits have led to growing positive surplus of contributions over benefit payouts. In addition, the streamlined organization has improved operational efficiency in spite of higher transaction volumes and greater number of members.

Fact No. 6

The amount of monthly pension is highly dependent on the  MSC and the number of contributions. It is based on the highest amount computed using three formulas as defined in the SSS charter.

P300 plus 20 percent of the average MSC plus 2 percent of the average MSC for each year in excess of 10 years.

40 percent of the average MSC

Minimum guaranteed pension of P1,200 if credited years of service (CYS) is greater than 10 years but less 20 years or P2,400 if CYS is at least 20 years.

Numerous complaints have been aired regarding the small amount of pension granted by SSS.

Average monthly pension

Currently, the average monthly pension amount is P3,100 given to some 1.8 million pensioners, one million of which are member-pensioners and the balance are death benefits to beneficiaries. Worthy to note is that the pension benefit of SSS does not end with the death of the member. It is also given 100 percent to the beneficiary until his or her death.

As can be observed from the formulas, the critical factor is the MSC—the higher the MSC the higher the pension amount. It was P15,000 before and now P16,000.

The last time an increase in MSC was made way back in 2003. This means that a worker whether he earns P16,000 or more will only be assessed on the basis of P16,000. As such, the pension as computed by the above formulas will be a specific amount increasing only by the additional percentage due to the length of the service.

The rationale behind the move for an increase in MSC was to allow pension amounts for future pensioners to become significantly bigger. The P1,000 increase in MSC will require higher contributions now but will undoubtedly improve benefits by at least 7 percent.

This is expected to impact some 2 million of our members and provide opportunity for others who will gradually be moving up the higher MSC levels.

Fact No. 7

The contributions paid to SSS are not an expense but in reality savings for the future. There is a common misconception that contribution to SSS is an expense similar to payment for utilities, such as electricity and water, and therefore viewed as a burden on the worker.

As explained, the amount of benefits derived, particularly the monthly pension is substantially more than the contributions paid.

Secondly, the pension payouts not only benefit the member but also the beneficiary at 100 percent in case of the member’s death.

In addition, in case the member does not qualify for pension because of a lack of qualified number of contributions, the total amount of contributions plus interest is given back at retirement age. There is absolutely no loss to the worker as this is money saved for the future when earning capabilities at that point are much less.

The other component of the reform agenda is the increase in the pension benefit. Current efforts are geared toward evaluating the system’s capacity to absorb the additional cost on a sustained basis.

P69-B payments yearly

The system dispenses P69 billion in pensions annually and a mere 5-percent increase in pension benefit will already result in an additional annual outlay of P3.5 billion. Once the evaluation is finalized, we will decide whether to make a pension increase.

In conclusion, the reform agenda was initiated with the goal of strengthening the structure of the system, the benefit of which will be felt much more beyond the present administration. It was never conceived to produce a panacea but rather a movement toward strengthening the institution that 30 million members depend on.

Since the start of 2011, we consulted with various groups, both employers and workers in order to explain the rationale behind this program. We have utilized various media channels, including forums during provincial visits to communicate to our stakeholders.

It was only when we gained the endorsement of the umbrella organization of both employers and workers that we presented our proposal to the President for approval as mandated by our charter. We continue to hope that the succeeding administrations will take on this initiative so we can assure our members, the private labor force, continued delivery of benefits and better service.

(Emilio de Quiros Jr. is president of the Social Security System.)