Informal sector pensions… making the products attractive
How to bring in the informal sector into the organised pension scheme is an issue that should seriously occupy the attention of players in the industry, particularly on what can be done to make the scheme attractive to the target market. This is important given the unique characteristics of the informal sector, which must be taken into consideration in designing their products to ensure acceptability.
The National Pension Commission (PenCom), who will soon bereleasing the framework for micro pension scheme, must ensurethat these concerns are taken care of.
Experience in other markets show that successful informal sector pension scheme, which has largely been voluntary comes with incentives that make it attractive to the target market.
Informal sector workers according to experts are generally those with low incomes or self-employed, working in very small (unregistered) companies or the household sector, often on a part-time basis (and migrant workers) in industries such as agriculture, construction and services. They are compared to workers in the formal sector who normally join either mandatory or voluntary pension systems, or both by modern structured pension systems.
They do not have access to pension plans organised or run by employers, may lack official registration papers or other documents, which could help the relevant authorities target them for other schemes, may change job frequently and often live and work in rural areas where financial infrastructure is poor or non-existent. These workers may also come from lower income and uneducated groups, meaning their knowledge and understanding of pension and saving products is limited and their resources for long-term savings low. Hence, gaining access to a structured pension system is a challenge for these workers.
Therefore in order to encourage more people in the informal sector to join the structured pension system, it may be useful to target those who are capable of extra savings.
Hence, before launching the proposed micro pension system, those who are able to put aside additional money and are therefore most likely to be the new entrants to the system should be reviewed and considered for pilot test.
Research studies could be conducted to identify and analyze the main concerns of this identified group, their income profile, social characters, etc.. With this information, it should be possible to design products to be as attractive and flexible as possible, and adapted to the specific needs of the targeted group, according to experts.
Financial education campaigns may also be used to promote participation in the new system. The benefits of introducing a new system are consequently more likely to be maximized, according to report on Pension Coverage and Informal Sector Workers, an OECD document.
According to the report, in addition to flexibility in terms of contributions, flexibility in terms of withdrawals may be necessary to encourage informal sector workers to participate in pension arrangements. Given in many countries, these workers are from vulnerable groups of society, having access to long-term pension savings may be required to cover periods of unemployment, for emergency spending (such as on health care) or for other life essentials, such as housing. Some pension systems do therefore allow for withdrawals in specific circumstances. For example in Australia early withdrawals from some funds are permitted in limited exceptional circumstances on compassionate grounds or in cases of severe financial hardship.
However, this flexibility needs to be balanced with the risk of leakages from the system, with large withdrawals leading to insufficient balancesupon retirement.
Tax relief on pension contributions is also another way to encourage pension participation, particularly for the voluntary schemes. Consequently, when introducing the pension arrangements to increase(voluntary) contributions, tax policy has been frequently used as a tool in many countries (where by pension contributions and investment income are tax exempt whilst pension benefits are taxed as ordinary income). Such a deferred tax policy is designed to encourage pension contributions, given that even a small deduction from accumulated pension assets (e.g. via tax charges) at the early accumulation stage can make a big difference to eventual pension wealth when compounded over 40 years.
One of the main reasons why informal sector workers do not want to participate in voluntary pension systems
(and in some cases even comply with mandatory schemes) is that they find the strict criteria involved too onerous, e.g. in terms of contribution requirements, investing policies and requirements on governance structure of pension fund itself etc. In order to encourage participation of this particular group of population, it may therefore be necessary to relax some requirements to a level which is consistent with the situation relating to informal sector workers, experts say.