Thursday, January 29, 2015 04:25 PM / ARM Research
We continue our series of cut-outs from our core strategy document – The Nigeria Strategy Report, but direct our focus towards developments in the pension space in H2 2014 and the likely impact of these changes on the industry.
Less than two weeks after passage by the National Assembly, the revised pension reform bill received the president’s assent, ushering in a number of long awaited changes in the new Pension Reform Act (PRA) 2014. In the first instance, contribution rates for employees and employers have been reviewed upward to a minimum of 10% and 8% of emolument, respectively, from 7.5% for each previously. Furthermore, the new Act broadens coverage to include employers with as little as three employees (vs. five under the 2004 Act) as well as extends the scheme to states and local government employees. Whilst the reduction in number of employees is likely geared at capturing part of the informal sector, we believe significant awareness campaign will be required to make any significant inroad.
Based on our estimates, the upward review in contribution could raise monthly contributions by ~
N7.4 billion to ~ N40 billion. Furthermore, the extension of coverage to state and local government could significantly boost monthly contribution, as enrolments increase. However, one concern, based on pension history, is the likelihood of irregular or delayed remittances limiting overall impact. A particularly important inclusion into the law is the provision that allows first time home buyers to utilize part of their pension fund (as to be determined by PENCOM) for equity contribution in mortgage transaction. While this sprinkles some optimism for real estate demand, we believe the impact might be tempered by existing impediments including access to, and cost of, finance.
In contrast to the 2004 Act, the 2014 PRA’s empowerment of the regulator to impose sanctions on erring companies would help to consolidate on the existing law and addresses numerous implementation challenges facing the contributory scheme. On this wise, the confirmation of the hitherto acting Director General of PENCOM as substantive head of the commission effective October 1, 2014, on nomination by the president and confirmation by the senate, gives the leadership adequate backing to kick-start enforcement and monitoring as well as fast track implementation of pending initiatives such as multi fund structure and RSA holders transfer window. Additionally, in contrast to the old law, employers that fail to provide the required life insurance cover shall be made to pay the resultant death claim arising from non-compliance with employees’ life insurance policy. Indeed, while insurance companies are the likely beneficiaries of this provision, a relatively high compliance level suggests only marginal increase in premium, on the back of this provision. As part of government’s efforts aimed at increasing the economic impact of long term retirement savings, interests, profits, dividends and other incomes accruing to pension funds are now exempted from all forms of taxes.
In our view, the speedy passage of the bill, ratification and subsequent confirmation of acting Director General signal well intentioned clear policy direction—with minimal alteration of existing policy drives and focused leadership to consolidate on reforms.
Table 1: Summary of Major Changes in PRA 2014
Source: Pension Reform Act
PFAs nibble at equities but FI benefits most from increased inflow
Total pension assets rose 13% in 2014 through October to
N4.6 trillion, largely reflecting contribution which we estimate accounted for more than 70%. AUM growth of 3.3%, over the first four months of H2 14, tracks behind the 4.4% in corresponding period in H1 14 mainly on the back of faster decline in equity holdings. However, relative to the 12% downturn in domestic market over the period, the 7% in PFAs’ equity holdings in the same period, hints at increased inflow into the equities. Examining trends over the period, it would appear that PFAs looked to take advantage of market downturn in Q3, given the inverse movement in PFAs equity holdings and NSE ASI, but stayed out in October after domestic market declines accelerated.
Indeed, not for the Q3 purchases, the contraction (150bps over H2 14) in equity holdings share of AUM to 14.2% would have been larger. More in line with historic trends, PFAs continue to favour FGN securities with holdings increasing 7.5% to
N2.3 trillion in H2 14 and the class now accounts for 62% of total AUM (+240bps from H1 14, and likely increased further by year end as downturn in equities persisted. Asset allocation amongst other asset classes remained largely unchanged. From a broader view, the concentration of ever-growing PFA funds in usual traditional assets reflects the high risk averseness of players despite the very long-term nature of their liabilities suggesting investments should be skewed in favour of equities. On this wise, while recently issued investment guideline is a positive and should engender the channeling of pension funds to infrastructure developments, lack of framework to guaranty the safety of the retirement savings remains a concern. In our view, Pension Fund Administrators’ preference for FI will continue until the full adoption of IFRS in the valuation of bonds holdings.
Figure 1: PFA Asset Allocation
Full IFRS Implementation via backdoor?
The Financial Reporting Council of Nigeria (FRC) held firm to its December 2014 deadline for pension fund assets to be marked-to-market daily. Currently, PFAs mark all assets to market prices daily, except bond portfolios which are valued at amortised cost, irrespective of classification. This has helped taper volatility of overall asset value and beyond its investment characteristics, the relative stability bonds provide to fund prices also underpins why the class is so favoured by PFAs. Under IFRS, PFAs would be required to mark-to-market bonds that have been classified as either trading or available-for- sale (AFS). Given recent volatility in the fixed income market, it would appear that PFA fund valuations are set for a bit of a hit. While this increases scope for some reclassification, for instance from available for sale portfolio to held-to-maturity auditors are likely to be on the lookout for any misclassification aimed at masking poor performance, after the Financial Reporting Council already sanctioned some auditors for not assessing pension fund accounts on mark-to market basis in 2014. Setting aside the likely increase in fund price volatility, the commencement of mark to market on PFA’s bond holdings from 1st January 2015 has the potential benefit of heightening competition amongst PFAs, and ultimately driving better allocation optimisation amongst available asset classes.
Police Pension transfer…..an harbinger for transfer window
The granting of operating license to NPF Pension Limited in August 2014 doused the tensions of police pension breakaway in the existing scheme as mulled by police officers. To facilitate the smooth take off of the new licensed PFA which has assets estimated at
N305billion, the commission provided an operational framework that guides the transition of existing Nigerian Police Force personnel to NPF Pension Limited. Based on the framework, PFAs are to immediately submit their plans for transfer of these assets to NPF, while the regulator has given a 4 month window, till end of March 2015, for list of verified police personnel to be forwarded to their respective PFAs. Allowable assets for transfer are cash, money markets, treasury bills and FGN bonds with transfers scheduled to commence from January 2015. Going by the phased approach that facilitated the relatively smooth exit of the military and SSS pension, we expect a similar pattern to help ameliorate operational transfer challenges for the NPF pension. Nevertheless, we foresee challenges around the form in which assets are to be transferred, particularly as equities, which account for nearly 15% of total assets, have been excluded. In a sense, this implies that equity holdings for existing PFAs, particularly those with high number of police personnel, would likely increase, in some cases, beyond respective comfort levels—a development which puts the NPF Pension in better stead. We expect PFAs to raise objections to this restriction, which if foisted could trigger sell-off of equity positions to fund the obligation and keep asset allocation in line with comfort. In any case, it is likely that the completion of the police officers RSA transfer from PFAs will serve as litmus test to gauge the industry readiness for the long awaited transfer window and multi fund structure which has since been in pipeline and can now be fast-tracked as key reforms are completed.
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