This Selected Issues paper on Nigeria highlights challenges faced by the country in building on the achievements of 2004. The authorities will have to maintain macroeconomic stability while implementing ambitious structural reforms aimed at reducing the costs of doing business in Nigeria and supporting faster growth and poverty reduction. The government’s ambitious and broad-based medium-term economic reform strategy and the National Economic Empowerment and Development Strategy aim to break with the misguided government-led development paradigm of the past that created a difficult environment for the private sector.


This Selected Issues paper on Nigeria highlights challenges faced by the country in building on the achievements of 2004. The authorities will have to maintain macroeconomic stability while implementing ambitious structural reforms aimed at reducing the costs of doing business in Nigeria and supporting faster growth and poverty reduction. The government’s ambitious and broad-based medium-term economic reform strategy and the National Economic Empowerment and Development Strategy aim to break with the misguided government-led development paradigm of the past that created a difficult environment for the private sector.

III. Pension Reform in Nigeria56

A. Introduction

91. Nigeria launched a major reform of the pension system with the passage of the new Pensions Act in June 2004. This act seeks to establish a contributory, fully funded scheme for both the public and private sectors, based on individual accounts that will be privately managed by designated pension fund administrators, with pension funds assets held by pension assets custodians. It replaces a range of largely unregulated and highly diverse pension arrangements, including the pay-as-you-go pension systems for federal government employees; the partially funded, defined-benefit scheme administered by the Nigeria Social Insurance Trust Fund (NSITF) for workers in private sector firms with at least five employees; and, private firms’ own funded pension schemes.

92. The goal of this paper is to analyze the Nigerian reform, its potential benefits, and its drawbacks. Toward that end, the paper will briefly review the literature on old–age security and other countries’ experiences with similar reforms. With that framework, the paper will explore the rationale of Nigeria’s pension reform, its implications, and the basic challenges ahead.

B. Pension Reform: Issues and Country Experiences

93. The policy issue of old-age security has been receiving increased attention worldwide as populations age and problems with existing schemes (including informal ones in less developed countries) surface. In recent decades, there has been a generalized drive to reform existing old-age security programs, including by replacing all or part of public (mainly defined-benefit) social security schemes with privately managed, defined-contribution systems based on individual accounts, in line with the 1994 study by the World Bank, Averting the Old-Age Crisis. That study identified three major objectives for old-age security systems (saving, redistribution, and insurance) and argued for differentiated government roles in light of evidence suggesting that multi-objective public schemes are problematic for both efficiency and distribution reasons (see below). It recommended a three-pillar system: (i) a mandatory publicly managed pillar financed with taxes and with the unambiguous and limited function of alleviating old age poverty (redistribution objective) and coinsuring against multiple risks; (ii) a mandatory and fully funded privately managed pillar linking individual savings with pension benefits; and (iii) voluntary occupational or personal savings plans. While the redistribution and saving objectives would be dealt with separately, the insurance objective would be addressed in all three pillars.

94. The mandatory and fully funded, privately managed pension scheme should yield substantial benefits but requires a strong regulatory framework. Some benefits are directly associated with the drawbacks of publicly managed pay-as-you-go pension systems, a critical problem of which is that it does not clearly link contributions and benefits. That problem, combined with population dynamics, has frequently led to the promise of generous benefits that end up being financed with increasing taxes on labor and/or higher public sector debt. High labor taxes have led, in turn, to several distortions in labor markets, including lower employment, an expansion in the informal sector, increased tax evasion, and even strategic manipulations by workers to avoid costs but maximize pension benefits. In addition, the private sector should use more flexible and modern practices than the public sector in the management of pension funds. The second pillar would also have some benefits of its own, including increased transparency of fiscal liabilities, higher private capital accumulation and financial market development, and improved accountability (in fact, it should be more effective, in principle, to have the public sector rather than other public entities, regulate and supervise private operators). The 1994 World Bank study deemed a strong regulatory and supervisory framework a prerequisite for the second pillar to keep investment companies financially sound and to limit pension funds’ exposure to risk.

Table 1.

Some Major Pension Reforms (Defined-Contribution Systems)

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Source: A. Schwarz and A. Demirguc-Kunt (1999).

95. Other countries’ experiences with private fully funded pension schemes have, thus far, been relatively positive.57 Many Latin American countries,58 as well as some transition economies,59 have transformed their pensions systems into funded systems under alternative arrangements. Preliminary evidence from the relatively young (with the exception of Chile) reforms suggests some generalized benefits in terms of financial sector deepening, higher gross returns on pension contributions, and higher participation rates (number of affiliates to the new systems). In Chile, the aggregate value of resources managed by pension funds rose from 1 percent of GDP in 1981 to 55 percent of GDP in 2001, the offer of financial instruments expanded substantially in size and variety, and there was evidence of increased “institutional capital” (a better legal framework, increased professionalism in the making of investment decisions, and increased transparency and integrity) in the capital markets following the pension reform (Walker and Lefort, 2002). The real average annual investment return surpassed 10 percent between 1981 and 2002, and replacement ratios were then estimated at 75-80 percent.

96. A few countries have sustained fiscal discipline, thereby, consolidating their achievement of long-term fiscal savings through the pension reform, which enables them to deal with the associated short-term and transitional costs. In addition, fiscal adjustment maximizes the impact of the pension reform on aggregate saving. In Chile, an explicit objective of the reform was to increase saving; hence, the government tightened up on other expenditure to achieve a fiscal surplus net of expenditure on social security. An added benefit of these reforms is that their implementation allowed governments to deflect the political problems associated with increasing taxes and cutting benefits under the old systems and to undertake more meaningful discussions about the sustainability of old-age security schemes.

97. Despite their substantial benefits, the reforms implemented by the Latin American countries and transition economies have had their share of problems. Some reforms failed mainly because short-term and transition costs were not addressed. For example, in Bolivia, which did not address the residual liabilities of the pay-as-you-go system or implement fiscal adjustment, the pension reform has increased the vulnerability of its public finances.60 More specific problems that have been identified are the failure to increase coverage ratios (measured as the ratio of active contributors to affiliates), the persistence of high administrative charges from private operators, and limited diversification in the investment of pension funds.61 All those problems could translate into long-term fiscal costs through the activation of minimum pension guarantees and/or lower pension benefits and higher-old age poverty. In Chile and Peru, there have been intense debates about pension funds’ insurance and management charges, which seem to be higher than the charges of other financial instruments and those of pension funds in other countries. Increased competition and regulatory flexibility have been proposed as efficient ways to reduce charges.

C. Nigeria’s 2004 Pension Reform Act: Implications and Challenges

98. The pension system before the reform consisted of costly and poorly managed schemes for public workers and a centralized, partially funded, defined-benefit scheme supplemented by unregulated and unsupervised occupational (corporate funded) schemes for private sector workers.

Previous pension system and the need for reform

99. The noncontributory pay-as-you-go defined-benefit scheme for the public sector became increasingly costly and unsustainable. The fundamental problem with the old system was that benefits were very generous. Civil servants were eligible for a separation gratuity after 5 years of service and a pension after 10 years of service. At that point, the gratuity amounted to 100 percent of final salary, while the pension was 30 percent of salary, with each additional year of service increasing the gratuity by 8 percent and the pension benefit by 2 percent. After 35 years of service, a worker qualified for maximum benefits — that is, a gratuity equal to 300 percent of final salary and a pension equal to 80 percent of final salary. In addition, benefits were adjusted after retirement by the Salary and Wages Commission to bring the benefits of existing pensioners in line with the benefits received by new retirees. Therefore, benefits were implicitly indexed to wages, because initial benefits were also linked to wages. The minimum retirement age was 50 (benefits were deferred until the age of 50 for those who left service earlier), with mandatory retirement at 60 years.

100. In addition, the public sector had a myriad of special schemes with more generous provisions. Terms were different—and more generous—for certain categories of workers, including military personnel, judges, and university professors. In fact, university professors could work until age 65 and qualify for a pension equal to 100 percent of their final salary. Military workers, on the other hand, could accrue benefits at the same rate as civil servants but were allowed to retire after only 10 years of service.

101. Because of the generous benefits, arrears accumulated as the public sector had difficulty paying current retirees their full benefits. Appropriations for pension benefits have fallen short of prescribed benefits during most of the recent years. A report by a special cabinet committee estimated that total arrears for federal retirement systems amounted to N85.5 billion as of May 2002 (Table 2), most of which was owed by federal parastatals. Those estimates have not been updated, but are thought to total between N100-200 billion (12 percent of Nigeria’s 2004 GDP), not including arrears accumulated by state and local governments and their parastatals. As a result of the arrears, the old pension system was actually much less generous than it was designed to be.

Table 2.

Nigeria: Federal Pension Liabilities, May 2002

(In billions of naira)

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Source: IMF (2003).

102. Public pension schemes were plagued by administrative problems. The accumulation of arrears was also a manifestation of weak public expenditure management (as pension obligations were treated as mere expenditure items in the budget instead of as an insurable risk that required actuarial analysis and projections) and poor administration of the public pension schemes (the approval and payment of annuity benefits were subject to long lags). Part of the administrative problems derived from the absence of an integrated personnel and payroll system that allowed the creation of employment records.

103. Workers in the private sector were covered either by a centralized, partially funded scheme or by funded schemes set by their employers. The Nigeria Social Insurance Trust Fund (NSITF) managed a partially funded, defined-benefit scheme for workers in private sector establishments with at least five employees.62 Contributions to the NSITF were 10 percent of gross earnings (6.5 percent contributed by the employer), while the retirement pension rate for a worker who reached the age of 60 or more was 30 percent with 120 monthly contributions and 60 percent for 360 monthly contributions. In addition, some firms funded their own occupational pension schemes, including defined-benefit schemes. One problem with the private schemes was that they were largely unregulated and unsupervised. Therefore, no figures are available regarding their coverage and size.

Main Features of the 2004 pension reforms act

104. The Pensions Act passed in June 2004 establishes a new pension scheme that is contributory, fully funded, and based on privately managed individual accounts, with the associated assets held by pension assets custodians. With the passage of the Pensions Act, Nigeria is at the forefront of low-income countries in the implementation of such a scheme.

105. Regarding coverage, the law makes it mandatory for employees of the public service of the Federation and the Federal Capital Territory, as well as for employees in private firms (with five or more employees), to join the contributory scheme when they begin working. Existing pensioners, judicial officers, and workers with three years or less before retirement are exempted from the scheme. Also, workers from state and local governments and associated parastatals are not affected by the new provisions.

106. Under this system, public sector employees’ contributions are a minimum of 7.5 percent of their monthly emoluments (basic salary plus housing and transport allowances), but military personnel contribute 2.5 percent. Public entities have to contribute 7.5 percent, but 12.5 percent for the military. Employers and employees in the private sector contribute a minimum of 7.5 percent each of the employees’ monthly emoluments. Employers are obligated to deduct and remit contributions to a pension fund custodian (PFC) within seven days, and the PFC should, in turn, immediately notify a pension fund administrator (PFA) of its receipt of the contributions. Contributions and retirement benefits are tax-exempt.

107. Each employee opens an individual account with a PFA of his or her choice. This individual account belongs to the employee and remains with him or her through life: the employee may change employers or pension fund administrators (once a year, maximum), but the account remains the same.

108. Employees can withdraw funds from individual accounts only at the age of 50 or upon retirement thereafter. Lump sum withdrawals, however, would be allowed only when the amount remaining in the account is sufficient to set up programmed withdrawals or annuities of not less than 50 percent of an individual’s monthly remuneration at the time of retirement. When an individual retires, he or she can use the balance after the lump sum payment to program monthly or quarterly withdrawals, to purchase an annuity for life through a licensed life insurance company with monthly or quarterly payments, or both.

109. The act specifically precludes taxing contributions and distributions.

110. According to the law, all employees (public and private) who have contributed for at least 20 years are entitled to a guaranteed minimum pension. The minimum pension amount will have to be specified by the government from time to time based on the recommendation of the National Pension Commission. The guaranteed minimum pension can be considered an explicit component of a first pillar of old-age security in Nigeria. However, the act does not specify who is responsible for the minimum pension.

111. In addition, the law mandates that employers maintain life insurance policies in favor of their employees for a minimum of three times their annual emoluments. This provision replaces survivor benefits for younger workers who do not accumulate a substantial retirement account.

112. A difficult issue linked to the transition to the new system has to do with the accrued pension rights of workers who shift to the new system. Public sector workers under the unfunded pay-as-you-go scheme will receive non-negotiable bonds redeemable upon retirement in an amount equivalent to the accrued benefits under the old scheme. In anticipation of the redemption of such bonds, the government has established the Retirement Benefits Bond Redemption Fund at the Central Bank of Nigeria and financed it with the equivalent of 5 percent of its total wage bill.63 In the case of the public sector’s funded schemes and the private sector, employers have to credit the employees’ individual savings accounts with any funds to which they are entitled; in the event of a deficiency, employers will have to issue a written obligation with repayment terms agreed on with the employee concerned.

113. Private schemes could continue to exist provided that they are fully funded, any shortfall is covered within 90 days, and the pension funds and assets are held by a PFC. Alternatively, the employer could also ask PENCOM to be licensed as a closed PFA. NSITF will establish a PFA that will also be regulated and supervised by PENCOM. Retirement savings accounts based on contributions to NSITF must remain with the PFA of NSITF for at least 5 years. Thereafter, each beneficiary will be free to determine which PFA will manage these funds on his or her behalf.

114. The National Pension Commission (PENCOM) is the entity charged with regulating and supervising of the pension schemes and has the power to formulate, direct, and oversee the overall policy on pension matters in Nigeria. PENCOM also has the mandate of ensuring the safety of the pension funds by issuing guidelines for licensing, approving, regulating, and monitoring the investment activities of pension funds’ administrators and custodians. It comprises representatives from the government and labor, pensioners, and employers.

115. PFAs will have to be licensed by PENCOM to open retirement savings accounts for employees, decide on how pension funds should be invested in line with PENCOM’s directives, maintain accounts on all transactions, provide regular information to the employees or beneficiaries, and pay retirement benefits to employees. PFAs must be limited-liability companies with the sole objective of managing the pension funds, with a paid-up share capital of N150 million, and with professional capacity to manage pension funds and administer retirement benefits. However, PFAs will not be allowed to hold the pension funds assets to safeguard the pension scheme. Rather, PFCs will have custody of pension fund assets and responsibility for executing transactions with instructions from the PFAs. PFCs must be limited-liability companies with a minimum capital of N2 billion (a shareholder bank must have a minimum net worth of N5 billion) to be granted an operating license. They are required to issue a guarantee for the full sum and value of the pension fund and assets they hold or will hold.

116. The investment of pension fund assets will be subject to specific guidelines from PENCOM and will include securities issued or guaranteed by the FGN and the CBN, securities and shares issued by listed corporations, bank deposits and securities, and foreign instruments (in line with the CBN is foreign exchange rules and with presidential approval). PFAs and PFCs will be allowed to deduct “clearly defined and reasonable fees, charges, costs and expenses” from the income earned from investing pension fund assets.

Table 3.

Structure of Recently Reformed Pension Systems (Including Nigeria)

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Source: J. Devesa-Carpio and C. Vidal-Melia (2002).

Nigerian Pension Reform Act, 2004.

In percent of GDP. Data from Brooks and James (1999).

Implications of the reform

117. The reform establishes a mandatory and fully funded privately managed pillar focused on old age savings. However, the new scheme allows for voluntary (and not taxed) contributions (the third pillar under the 1994 World Bank framework). There is no mandatory publicly managed pillar financed with taxes and with an explicit redistributive function, but there will be a minimum pension guarantee that is not yet clear how it will be financed. In addition, there is no coinsurance against a multitude of risks, but the new system provides for an employer-financed life insurance policy.

118. The reform improves the sustainability and reduces the vulnerability of the pension system for future pensioners. By fully funding the pension scheme, Nigeria reduces its vulnerability to adverse demographic trends and increases the probability that it will have the resources to pay benefits when workers retire. In addition, individual and privately managed retirement accounts with fully portable benefits should increase workers’ confidence in the pension system.

119. However, Nigeria has not dealt explicitly with the unsustainability of benefits under the old PAYG system. The level of benefits for current pensioners, public sector employees within three years of qualifying for benefits, and even the accrued pension rights of current workers moving from the old to the new system are, in principle, protected by the pension reform legislation and cannot be adjusted even though they are recognized as being too generous. The inability to tackle this issue raises questions about equity and the transition costs of carrying two systems, as explained below.

120. The equity issue that arises has to do with the treatment of future public sector pensioners relative to current ones. In fact, the reform implies a reduced level of pension benefits for future public sector workers. Based on simulations undertaken by World Bank and IMF staff, the 15 percent contribution rate for federal government workers would result in a replacement rate at retirement (defined as the fraction of previous wages that initial pension benefits replace) for new workers of about 40 percent, compared with at least 80 percent for current pensioners. In addition, the new workers have to make part of the contributions into the new system. It could be argued that arrears and/or delays in distributing benefit payments to current pensioners reduce their effective replacement rate, but this asymmetry could lead to pressures to adjust future benefits (for example, through a higher minimum pension guarantee). However, the Pensions Act implies that these arrears will be satisfied in full, making the de facto benefits for current workers extremely generous.

121. The long-run fiscal savings from the reform will be limited if the benefits under the old pension system are not scaled down. In the short term, pension-related fiscal outlays will be substantially higher than under the previous scheme because the government will have to (i) deposit its contribution to the individual retirement accounts (equivalent to a fixed percentage of its wage bill), (ii) pay pensions to existing pensioners until they die, (iii) contribute an equivalent of 5 percent of the total wage bill to fund the future redemption of bonds issued in recognition of accrued pension rights under the old system for active workers migrating to the new system, and (iv) cover any shortfall to finance the actual redemption of such bonds as active workers retire.64 The last three items are referred to as transition costs and are basically linked to the level of benefits under the PAYG system. Over time, those outlays should fall, and the government’s pension bill should be lower than under the previous PAYG system. In net present value terms, however, preliminary simulations done by World Bank and IMF staffs in 2003 suggested that the new system would cost only 10 percent less than the PAYG system if the benefits under the old pension system were not reduced.65

Table 4:

Simulation of Long-term Fiscal Costs

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Source: WB and IMF, 2003.

122. The minimum pension guarantee could create a substantial contingent liability for the government. The amount of this guarantee (for both public and private workers) still has to be determined by PENCOM. However, even if the objective of reducing old-age poverty is justified, the proper design of a guarantee is complicated by some difficult choices. First, its redistributive impact will depend on the coverage of the fully funded pension system, with the chance that mostly urban, formal, and relatively higher-income segments of the labor market benefit from such a policy. Second, it would be hard to define consistent thresholds for different segments of the labor market. Third, for those workers whose calculated pension is not close to the minimum pension, the guarantee would provide an incentive to retire as early as possible after accruing 20 years of service. In addition, if benefits for current beneficiaries are not revised, political pressures could build up to guarantee comparable benefits under the new pension system.

123. The reform could increase the rate of saving in the economy and lead to a deepening of capital markets. The national saving rate will increase as long as the increase in saving in funded retirement accounts is not offset by reductions in other forms of public or private saving. Two facts increase the probability that other forms of saving will not decline: much of the new saving will be done by low- to middle-income workers, who probably have relatively few financial savings, and public sector workers are not contributing to the old pension system. Regarding public savings, the sharp increase in oil revenue that is taking place at the same time as the pension reform is projected to boost the savings rate despite sizable increases in spending.

Remaining challenges and the authorities’ agenda

124. One critical challenge facing Nigeria ahead is the development of a comprehensive regulatory and institutional framework. The Pension Act provides a general framework but not the detailed laws and regulations that will still need to be prepared. In addition, PENCOM’s regulatory and administrative capacity need to be further developed. These will be difficult tasks, given capacity and governance constraints in Nigeria.

125. PENCOM is undertaking several activities in this area, concentrating on (i) the establishment of a regulatory and supervisory framework, including rules and regulations that govern the creation of custodian and investment management institutions that can hold and manage pension assets without exposing members to the risk of poor returns or losses of principal; (ii) the establishment of its own institutional structure and the recruitment and training of staff and management; (iii) the development of an IT strategy and acquisition of core software applications for surveillance and analysis; (iv) full-scale audit, reconciliation, and actuarial valuation of pension entitlements for federal government employees and retirees, and (v) the development of a strategy to reduce benefit arrears.

D. Conclusions

126. Nigeria decided to tackle the unsustainability of the pay-as-you-go scheme for public employees and the diversity of pension schemes for private workers by introducing a uniform, contributory, fully funded, and privately managed pension scheme. The pension reform, as currently designed, creates substantial short-term fiscal costs, and, apparently, limited savings in long-term fiscal costs. It also implies a sizable reduction in benefits for future pensioners relative to current beneficiaries. These problems suggest that there are strong equity and fiscal reasons for reducing both statutory benefits for current pensioners and documented liabilities for workers shifting from the old to the new system. At the same time, however, the lowest-income beneficiaries should be protected through the implementation of progressive cuts in statutory benefits.

127. The reform’s potential benefits in terms of improved management of pension funds and financial deepening will depend critically on the establishment of adequate technological, institutional, and regulatory frameworks. They should help monitor the activities of private operators and ensure that future pensioners participate actively in saving for their old age. The authorities’ agenda in these areas in coming months is ambitious and would benefit from the support of the World Bank, which has substantial expertise in this area.


  • De Ferranti, D., et. al., 2002,The Future of Pension Reform in Latin America”, Finance and Development

  • International Monetary Fund, 2003,Nigeria. Pension Reform: Issues and Options”, (unpublished and confidential)

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Prepared by Mauricio Villafuerte.


For detailed references see, for example, Schwarz and Demirguc (1999), Devesa-Carpio and Vidal (2002).


In 1981, Chile introduced a fully funded, privately managed, defined-contribution scheme as the primary pension provider. Peru and Colombia (1993) decided to keep the pay-as-you-go definedbenefit scheme as the primary system. Argentina (1994) retained a pay-as-you-go defined-benefit scheme for the primary system, but introduced the option of a fully-funded defined-contribution scheme as a mandatory supplementary system. Uruguay (1995) retained the pay-as-you-go as the primary system, but made the fully funded defined-contribution scheme a mandatory second pillar for those of moderate income and optional, but subsidized, for those with low incomes. Mexico (1995) set up a system like the Chilean one, but with public and private fund management. El Salvador (1998), Bolivia (1997), and Costa Rica (2000) also carried out reforms.


For example, Croatia, Estonia, Hungary, Kazakhstan, and Poland.


Admittedly, some countries chose not to eliminate the old system as a way to reduce short-term and transition costs. However, the coexistence of old and new pension schemes creates problems, including political ones. In addition, the transition to a funded pillar never got off the ground in some countries, such as Nicaragua, because of the budgetary implications.


This is often the result of limits on investing abroad or high exposure to single parties (in particular the government).


It replaced the National Provident Fund, which was a savings scheme with meager monthly contributions and that was plagued by poor compliance by employers and inadequate benefit payments and one-off lump sum benefits to claimants.


Without quantification, it is unclear if this contribution will be adequate.


The 2005 federal government budget includes an allocation of N125 billion for pension-related with outlays, compared N70 billion in 2004.


International experience shows the importance of carefully planning how to address the transition costs of the pension reform. For example, in Bolivia, pension costs are placing a high and increasing pressure on the budget because no provisions were made to address the residual liabilities of the PAYG system or to adjust in other spending or revenue items.