Eastern Caribbean Currency Union: Selected Issues
Author: International Monetary Fund
Publication Date:
06 Mar 2007
eISBN:
9781451811704
Language:
English
Keywords:
ISCR; CR; income; cost of capital; per capita income; ECCU country; informal economy estimate; ECCU authority; ECCU sample; ECCU interbank market; ECCU scheme; Pensions; Pension spending; Wages; Aging; Caribbean
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This Selected Issues paper analyzes the income dispersion and comovement in the Eastern Caribbean Currency Union region. It finds that incomes are diverging, with the Leeward Islands converging to a higher income level than the Windward Islands. The paper examines the macroeconomic impact of trade preference erosion on the Windward Islands and demonstrates the substantial impact from preference erosion on growth, trade balances, and fiscal positions. The paper also analyzes the size of the informal economy in the Caribbean.

Abstract

This Selected Issues paper analyzes the income dispersion and comovement in the Eastern Caribbean Currency Union region. It finds that incomes are diverging, with the Leeward Islands converging to a higher income level than the Windward Islands. The paper examines the macroeconomic impact of trade preference erosion on the Windward Islands and demonstrates the substantial impact from preference erosion on growth, trade balances, and fiscal positions. The paper also analyzes the size of the informal economy in the Caribbean.

IV. Social Security in the Eastern Caribbean Currency Union50

A. Introduction

77. The defined-benefit social security schemes of the Eastern Caribbean Currency Union (ECCU) face major challenges. Established in the 1970s and 1980s, these schemes are maturing rapidly, as cohorts with a full-career contribution history begin to retire. They also face a rise in the elderly population that is much faster than in many other countries.

78. The ECCU’s social security schemes play an exceptionally prominent role in local economies. They offer comprehensive benefits to contributors, finance a sizeable share of domestic investment, and are major participants in the banking system. Presently, cash flow surpluses average about 3 percent of GDP per year, and accumulated reserves stand at around 40 percent of GDP, invested mostly in public sector assets and securities of other ECCU governments.51 Maturation of social security schemes and a rapid aging process underlie projections of a steep increase in expenditures, which are expected to rise at a much faster rate than income. As a consequence, the ECCU faces a significant macroeconomic challenge in managing the projected declines in these surpluses in coming decades.

79. In response to recent actuarial reviews that have concluded that many schemes are unsustainable, reforms are beginning to be introduced. St. Lucia has introduced legislation that will gradually extend the retirement age and raise the number of contributions required for eligibility. Other islands are starting to review options and some have discussed action plans with stakeholders.

80. This chapter provides an overview of the financial situation of the social security schemes in the ECCU, and implications for the broader economy. The chapter also discusses the role of social security schemes within the financial system, and outlines the challenges implied by current investment practices.

81. The rest of the chapter is as follows. Section B provides historical background on the evolution of national social security schemes, while the financial outlook of the schemes is described in Section C. Section D looks at the investment of social security reserve assets, while Section E examines the linkages between social security schemes and domestic financial systems in the ECCU. Section F compares the administrative costs of the schemes, while policy conclusions and reform options are set out in the concluding section.

B. Background on Social Security Schemes

82. All ECCU countries have comprehensive social security schemes that were introduced relatively recently (Table IV.1). Commonly referred to as National Insurance or Social Security, the schemes are similar in design and were, in most cases, preceded by a provident fund that provided lump sums at retirement. Initially focusing on old-age pensions, the schemes have been gradually broadened. They now offer a wide range of benefits, typically including invalid and survivor’s pensions, as well as benefits for sickness, maternity, and employment injury. The coverage has also been extended to the self-employed, either on a voluntary or mandatory basis. However, aside from the gradual expansion of scope, the basic structure remains that of a traditional defined-benefit scheme.52 There are two regional reciprocal agreements for the ECCU and the wider Caribbean Community and Common Market (CARICOM), the principal objective of which are to ensure regionally-mobile workers receive at least one pension.53 54

Table IV.1.

ECCU: Selected Indicators for Social Security Systems 1/

article image
Sources: National authorities; most recent actuarial reviews; and Fund staff estimates.

Unless otherwise indicated, figures refer to the year forming the basis for the most recent actuarial review—Antigua and Barbuda (2004), Dominica (2004), Grenada (2002), St. Kitts and Nevis (2002), St. Lucia (2003), and St. Vincent and the Grenadines (2004). Where applicable, projections refer to an intermediate scenario.

St. Kitts and Nevis and St. Vincent and the Grenadines include deposits held at banks majority-owned by the government.

Asset reserve plus present value of contribution income less expenditure calculated over the next six decades assuming a 5.5 percent annual discount rate.

83. From inception, these social security schemes have generated large surpluses, due to minimal expenditure in the early years.55 However, as the number of retirees and other benefit recipients grew, the margin between income and expenditure has been eroding. At present, the total of contribution and interest income still exceeds total expenditure in all countries; only in Dominica does expenditure currently exceed contribution income.56 Without policy changes, however, all schemes are expected to ultimately run deficits.

84. The most significant benefit provided by social security schemes is the age or retirement pension, which accounts for roughly 60 percent of total benefits. In most cases, pensions do not require retirement; plan participants need only meet the required number of contributions and a minimum age. The formula for calculating pensions is similar across ECCU countries. The most common model requires ten years of contributions to qualify for a minimum pension, representing 30 percent of the pensionable wage.57 The pensionable wage, in turn, is calculated as the average wage during the 3–5 year period with the highest wages during the last 10–15 years of employment. The rate of benefit accumulation is, in all cases, diminishing over time. The maximum pension, usually attained after 40 years of contributions, ranges from 50 to 70 percent of the pensionable wage.

85. Social security schemes also commonly offer short-term sickness, maternity benefits, funeral grants, as well as long-term invalidity and survivor’s pensions. All countries except Antigua and Barbuda offer employment injury benefits, which do not require prior payment of contributions but are restricted to employment-related occurrences (excluding the self-employed). In some cases, government employees receive more limited coverage than the general rule, as civil servants often collect overlapping benefits.

86. Contribution rates vary significantly across ECCU social security schemes, despite the uniformity of benefits, and are relatively low compared with other CARICOM countries (Table IV.2). Contributions are shared between employee and employer, with the latter usually paying a higher rate. Contributions are levied on the insurable wage, which encompasses most sources of employment income but is subject to a ceiling that varies considerably among countries. Contributions are notionally allocated to different branches—short-term, long-term, and employment injury—but they can easily be shifted from one branch to another.

Table IV.2.

ECCU: Social Security Contributions

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Sources: ECCU national authorities; Osborne (2004); OECD (2005).

As multiple of average insurable wage.

The contribution rate for public sector employees is 2 percent.

The contribution rate for public sector employers is 6.75 percent.

Includes all countries above plus Belize and Guyana.

This is the average of all contribution rates below the wage ceiling for 2005.

87. Actuarial reviews point to a number of design flaws of existing social security schemes. For example, there is a bias in favor those with short contribution histories. Current benefit formulae imply that rates of return on contributions are typically near 20 percent for the minimum participation period. These implied rates of return then fall sharply the longer a participant has contributed. The short 3–5 year period used for calculating the pensionable wage also means that pensions may bear little resemblance to lifetime earnings. Adjustments to the wage ceiling and pensions have been ad hoc, rather than automatic, and often large, leaving the level of pensions subject to uncertainty.

88. In some cases, the overlap with civil service pensions creates potentially very generous benefits for public sector employees. Indeed, it sometimes occurs that combined (social security and civil service) age benefits exceed the final wage, or that combined sickness benefits exceed the regular salary.58 This chapter does not address issues surrounding civil service pensions; however, it is worth highlighting that, on average, these benefits represented 2 percent of GDP in 2005 and, in some cases, will rise substantially in the years ahead.

C. Financial Outlook

89. Expenditure on social security schemes will continue to rise in the coming years. There are two principal causes:

  • Scheme maturation. Reflecting their longer contribution history, new retirees will receive substantially higher pensions than current pensioners. With a typical 40-year contribution requirement for maximum benefits, this process will continue for another one or two decades, depending on the date of inception of each national scheme.

  • Demographics. Like many other parts of the world, declining fertility rates and increasing longevity in the Caribbean will cause the number of elderly to grow as a share of the population. Currently, ECCU populations are relatively young compared with those of advanced economies. However, as outlined in Samuel and Velculescu (2003), demographic change is expected to occur much faster in the ECCU than elsewhere. For example, it is projected that the ratio of people aged 65 and older to those aged 16–64 will rise fourfold and approach that of the United States by 2050 (Figure IV.1).59

Figure IV.1.
Figure IV.1.

ECCU: Population Aged 65+ to 15-64 Years Compared

(Ratio)

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Source: U.S. Census Bureau International Database.

90. The latest ECCU actuarial reviews project a rapid increase in scheme expenditure relative to income. With no change in policy, all schemes are projected to begin incurring cash flow deficits and ultimately exhaust their reserves at some point between 2022 (Dominica) and 2062 (St. Lucia), as shown in Figures IV.2 and IV.3 and the text table below.

Figure IV.2.
Figure IV.2.

ECCU: Social Security Reserve Asset Projections

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Source: Fund staff estimates and projections.
Figure IV.3.
Figure IV.3.

ECCU: Social Security System Expenditures and Contributions, 1980-2060

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Sources: Osborne (2004), ILO (2005, 2004a, 2004b); Veira (2005); and Fund staff estimates.1/ For the purposes of these charts, it was assumed that nominal GDP will grow at an equivalent rate to contributions, as projected in the actuarial reports. This implicitly makes the assumption that, for constant contribution rates and a constant share of the workforce participating in the social security scheme, that wages as a share of GDP remain stable over the long-term.

ECCU: Key Dates in the Projections of Social Security Finances

article image
Sources: Most recent actuarial reviews; and Fund staff estimates.

On policies in place prior to January, 2007. Recently announced reforms are aimed at eliminating unfunded liabilities, and will substantially improve the financial outlook for Dominica Social Security (see Box IV.2).

91. One way to view the financial shortfall of social security is to consider the “actuarial balance” or net implicit debt. In this chapter, the net implicit debt is the present value of future expenditures minus the present value of future contributions and current reserves over a 60-year horizon (Figure IV.4).60 Estimates range from around zero in St. Lucia to 170 percent of GDP in Dominica, and—reflecting the large cash flow deficits that emerge in the coming decade—are even larger if calculated over a longer time horizon.

Figure IV.4.
Figure IV.4.

Net Implicit Pension Debt

(In percent of GDP) 1/

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Sources: ILO (2005, 2004a, 2004b); Roseveare et al. (1995); and Fund staff estimates and projections.1/ Figures for ECCU based on a 60-year horizon and a 5.5 percent discount rate. Figures for OECD countries refer to the baseline from Roseveare et al. (1995) and assume a 5 percent discount rate with a 75-year horizon.2/ Data unavailable.

92. The existence of very high public debt levels in the ECCU adds to the challenge of underfunded social security schemes. Since fiscal positions are already stretched and explicit public debt ratios are already very high, there is little scope for governments to fund future social security deficits. Consequently, especially in the countries with both large explicit and implicit debt—Antigua and Barbuda, Dominica, St. Vincent and the Grenadines, and, to a lesser extent, Grenada and St. Kitts and Nevis—far-reaching pension reform is urgently needed to avoid more drastic measures in the future.

D. Investment of Social Security Reserve Assets

93. Thus far, risk-adjusted returns on reserve assets within ECCU social security schemes have been satisfactory.61 Using Sharpe ratio calculations—mean excess return on the asset, divided by the standard deviation—most schemes have delivered returns that compare favorably to global financial asset benchmarks for the 15-year period through 2003 (Figure IV.5).62

Figure IV.5
Figure IV.5

Reserve Portfolio Risk-Adjusted Performance

(Sharpe ratio, 1988-2003) 1/

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Sources: Osborne (2004); Datastream; and Fund staff estimates and projections.1/ Mean excess return (over the US three-month risk-free rate) divided by standard deviation.

94. However, future performance may be less strong. Partly reflecting the dominance of domestic public sector assets in social security scheme portfolios, some schemes have begun to experience “underperformance,” in the form of arrears and the restructuring of public debt.63 The current asset allocation profile of ECCU schemes is also a poor match for liabilities, which increases funding risks.

95. ECCU social security investment policy has broad macroeconomic effects, for three main reasons. First, scheme reserves account for an average of 42 percent of GDP, larger than many other countries with partially-funded schemes (Figure IV.6). Second, reserves are overwhelmingly invested in domestic assets (Figure IV.7). Third, the nature of these investments—including deposits in local banks and loans to public enterprises—suggests that they can have distortionary effects on domestic capital markets and the broader economy.

Figure IV.6.
Figure IV.6.

Publicly-Mandated Social Security/Pension Fund Reserves

(In percent of GDP) 1/

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Sources: Palacios and Pallares (2000); Osborne (2004); and Fund staff estimates.1/ Regions include countries that run partially-funded defined benefit social security schemes.
Figure IV.7.
Figure IV.7.

ECCU: Social Security Reserve Portfolio Asset Allocations

(Percent of portfolio)

Citation: IMF Staff Country Reports 2007, 097; 10.5089/9781451811704.002.A004

Sources: The base year taken from the most recent actuarial reports, financial statements, and Fund staff estimates: Antigua and Barbuda (2004), Dominica (2004), Grenada (2002), St. Kitts and Nevis (2002), St. Lucia (2004), St. Vincent and the Grenadines (2004).

96. Most ECCU countries have adopted an investment policy statement (IPS). This is the formal document that establishes risk-return objectives, constraints, and performance reporting requirements. While these documents typically provide a “benchmark” asset allocation, the discretion of asset managers is often not described in detail. Where an IPS has been adopted, they tend to provide less than comprehensive coverage of these issues, and adherence to its principles is mixed. Indeed, where one exists, the typical IPS falls short of industry best practice and raises the risk of poor governance.

97. The benchmark asset allocation in the typical social security IPS is based on the recommendations of the Eastern Caribbean Central Bank’s (ECCB) Monetary Council, and reflects the priorities outlined by the ILO and ISSA (Table IV.3). Monetary Council membership is comprised of government ministers from each of the eight ECCU members and is not independent of government; this may be a relevant point if the independence of social security asset allocation is a valued objective. While these guidelines are not explicitly binding, they appear to have had a large influence on actual social security investment behavior.

Table IV.3.

ECCU: Recommended Investment Guidelines of the Eastern Caribbean Central Bank for Regional Social Security Systems 1/

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Sources: Nicholls (2002); and Fund staff estimates.

The guidelines were established in 1993.

Assuming deposits in state-owned indigenous banks are a form of public sector exposure.

98. In most cases the duration, or effective maturity, of social security reserve portfolios is very short and this presents an asset-liability mismatch. Most domestic bonds and loans tend to carry a maturity below 10 years, while the average duration of liabilities is over 30 years (Table IV.4). This means that as interest rates fall, the net implicit debt rises sharply (and vice versa). Diversifying towards ultra-long foreign bonds and equities would help to address this asset-liability mismatch. A number of OECD social security reserve funds have begun to address these issues, principally through a re-weighting of equities. For example, the weight of equities in the portfolios of schemes in Ireland, New Zealand, and Canada are now between 65–75 percent.

Table IV.4.

ECCU: Social Security Cashflow Duration (Years)

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Sources: ILO (2005, 2004a, 2004b); and Fund staff estimates.

Assumes that the duration of reserve portfolios is five years and that the discount rate declines by 50 basis points.

Calculations are unavailable.

99. Actual foreign exposure in reserve portfolios is very low, particularly for small, open economies that are vulnerable to economy-wide exogenous shocks (Figure IV.7). Numerous studies (starting with Levy and Sarnat, 1970) suggest that the optimal share of foreign assets in a diversified portfolio is far higher than that of the ECCU.

100. Liability matching also argues for greater foreign exposure in the portfolio of the ECCU social security schemes. Social security liabilities are denominated in domestic currency, but the typical ECCU country consumption basket is dominated by imports. The ECCU’s quasi-currency board arrangement pegs the Eastern Caribbean dollar against the U.S. dollar, but fluctuations against other major currencies, particularly the euro, given a relatively high degree of pass-through pricing, may have large effects on prices, wage earnings, and social security liabilities. Domestic fixed-income assets are a poor hedge against this risk.

101. There is inadequate reporting of portfolio risk and return performance. Given the broad range of objectives for a social security scheme, including “social utility,” a simple risk-return measure may be insufficient to describe performance. However, such measures should form part of a minimum reporting requirement, in line with international best practice. For example, there is scope to enhance the reporting of “tracking errors” which would show how the difference between the value of reserve assets and the present value of liabilities is changing over time. Reporting portfolio performance also allows a comparison against liability-specific, market-standard, or peer group benchmarks. This information should then influence the ongoing revisions to the investment policy statement, with particular regard to the investment process.

E. Linkages of Social Security Schemes with the Financial Sector

102. From their inception in the early 1970s, the ECCU authorities envisaged social security schemes playing a large role in regional capital market development. Indeed, their investment guidelines were developed in tandem with the regional capital markets initiative and appear to attach a very high weight to the objective of social and economic utility (Nicholls, 2002). Two important features suggest this. First, foreign investments (defined as outside CARICOM) should account for only 5 percent of the portfolio. Second, there is scope for very high exposure to public sector assets. Direct lending (including to public enterprises), can account for over half the recommended portfolio. If fixed deposits are also included, which often implies direct or indirect public sector exposure, this proportion rises to 75 percent of the recommended portfolio.

103. Although nearly two-thirds of social security reserves are held in public or government-backed fixed-income assets, social security involvement in regional capital markets has been limited. For example, on the regional government securities market (RGSM) social security schemes have accounted for less than 8 percent of successful bids. Bond issues on the RGSM have tended to be oversubscribed and social security funds have not been critical to the markets progress up until now. Instead, social security funds have been increasingly investing in nonmarketable instruments of public enterprises and state-owned banks.

104. The heavy investment reflects the effect of inflexible investment guidelines, which may distort domestic financial flows. ECCB guidelines stipulate around 30 percent of reserves should be lent domestically; in practice, nearly half of this allocation is taken up by lending to public enterprises. This reflects the fact that the private sector in many ECCU countries does not have the capacity to absorb and productively use social security surpluses.64 This has left the social security systems competing with the banks to lend and may mean that access to credit by public enterprises has been much easier than otherwise.

105. Social security systems’ heavy investment in bank deposits also raise potential systemic stability concerns. On average, ECCU social security schemes hold around 25 percent of their reserves in deposits with the domestic banking system (based on the most recent 2004 data). These are held almost exclusively in locally-incorporated banks, despite a large foreign bank presence throughout the region and a relatively competitive market for deposits. These banks are also heavily exposed to government on the asset side of the balance sheet—e.g., local banks exposure to the government amounted to 21 percent of total assets in 2005, about three times the level of foreign banks—implying that social security systems’ exposure to government is higher than would otherwise be the case. Moreover, banking system vulnerabilities, as reflected in underperforming asset ratios, also appear to be concentrated in local banks (Chai, 2006).

106. There is also the question of the impact on the banking system as social security surpluses dry up and, ultimately reserve assets are withdrawn to fund cash flow deficits. Although gradual, this process could create liquidity problems for particular banks since, in terms of maturity, local banks typically lend at relatively long maturities, with mortgages accounting for a large share of assets. A more developed ECCU interbank market would help to offset these liquidity pressures, but this market has remained fairly inactive.

F. Scheme Administration Costs

107. Administrative costs for ECCU schemes appear relatively high, even taking into account measurement issues (Table IV.5).65 An inability of small islands to exploit economies of scale is one factor keeping costs high, but other inefficiencies may also be important. In particular, costs could likely be reduced if schemes diversify portfolios toward foreign assets and outsource asset management.

Table IV.5.

ECCU: Social Security Administrative Costs Compared 1/

(In percent) 1/

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Sources: Mitchell (1998), Whitehouse (2001), James (2005), ILO (2005, 2004a, 2004b); Veira (2005); and Fund staff estimates.

Non-ECCU data taken from Mitchell (1998) and ECCU data for 2003.

Data taken from Osborne (2004) with other Caribbean restricted to CARICOM countries.

Latest actual year available from actuarial reports and Osborne (2004) for non-ECCU. Figure for the United States is for the average retail mutual fund.

The charge ratio assesses the reduction in net asset value assuming that funds earn the market rate of return (which will not hold precisely in a partly funded scheme). Assumptions are consistent for the non-ECCU sample in Whitehouse (2001), which are individual earnings growth of 3 percent, annual investment returns of 5 percent and a 40-year contribution history. The non-ECCU sample includes funded schemes in Chile, Colombia, Mexico, Australia, Sweden, and the United Kingdom.

108. In the longer term, there is the potential to pool administration resources and outsourcing. As noted earlier, social security schemes in the ECCU and the wider CARICOM area already operate under some reciprocal agreements, designed principally to ensure that workers that have been mobile across the Caribbean receive at least one pension (Henry, 2004). As the CARICOM Single Market and Economy (CSME) integration develops further, greater co-ordination across social security schemes may allow the ECCU to partially overcome the cost disadvantages associated with their size.

G. Conclusions and Reform Options

109. If ECCU countries want to maintain traditional defined-benefit social security programs, reform is unavoidable. There are a number of parametric reform options available, the scale and nature of which will vary depending upon the current design of the scheme and the degree of underfunding. Standard parametric reform options that have been pursued by many countries around the world include (Box IV.1): (i) increasing the retirement age; (ii) increasing contribution rates; (iii) streamlining benefits; and (iv) improving benefit predictability. In all cases, the earlier action is taken, the more gradual the changes can be introduced, reducing any potential negative impact on the economy. Two schemes have begun to institute gradual reform—St. Lucia and Dominica (see Box IV.2).

110. Reforms should also seek to broaden coverage. A large segment of the population typically falls outside the primary social safety net and increasing participation in social security should be a priority. This problem is well recognized but hard to tackle given the often informal nature of employment among nonparticipants. Still, making reporting and other requirements more suited to the self-employed and enforcing participation requirements more strictly could help boost coverage. This, in turn, would help ensure that the social safety net reaches the neediest and could lessen demand for government assistance in other areas.

111. There is scope to increase regional coordination. With increasing regional integration under the CSME and other initiatives, the scope for labor mobility between CARICOM countries is increasing. To underpin this beneficial development, the current agreements that provide for the portability of accumulated pension rights should be rigorously enforced. Greater harmonization, including any future policies that aim to increase coverage, could further facilitate labor mobility, while sharing of administrative structures could exploit economies of scale and lower costs.

Parametric Reform Options for ECCU Social Security Schemes

Increasing the retirement age. Participants would pay contributions for longer and receive pensions for a shorter period. Retirement ages in the ECCU average close to 61 years, and in all cases are quite low by both regional and international standards. Instituting a gradual increase, a process that has recently begun in St. Lucia, should be considered in all countries.

Increasing the contribution rate. Contribution rates are very low compared to many other countries with similar social security schemes. Barbados provides a regional example of a social security scheme reform that incorporated a large increase in the contribution rate, to a current level of 16.25 percent.

Streamlining benefits. While the replacement rate is not too high in an international context, reform in other countries has tended towards a lower rate. Also, there are many distortions, such as a bias in favor of those with short contribution periods and an excessive weight placed on the last few years of income when calculating benefits. A model with a linear accumulation of pension rights based on career indexed earnings would be more equitable and less distortionary. Steps should also be taken to eliminate excessive coverage, such as cases where sickness or age benefits for public sector workers can exceed the previous wage.

Increase benefit predictability. The common practice of irregular and large stepwise changes in wage ceilings and pensions in payment creates uncertainty. Instead, adjustments should be made on a regular and predictable basis, for example by indexing these amounts to aggregate earnings or CPI inflation. However, the benefits of predictability have to be balanced against the drawbacks from making the rules too rigid, as the government may need some flexibility to generate savings if an urgent need arises. A solution could be to have regular annual adjustments but leave some margin—e.g., +/- 2 percent relative to the benchmark index—to create a range for the required outcome.

Social Security Reforms in Dominica

In October 2006 the Government of Dominica approved an Action Plan of reforms that aims to eliminate all unfunded liabilities of Dominica Social Security (DSS). It proposes the gradual but steady implementation of reform measures, which will distribute the burden of reform across generations and minimize potential disruptions to the economy. These reforms will be reviewed regularly over time, as part of the regular actuarial review process, to ensure that they remain sufficient to eliminate underfunding. The Plan also seeks to ensure that pensions remain relevant, particularly for those likely to be most financially vulnerable in old age.

This Plan benefited from FAD technical assistance and actuarial reviews completed by the ILO. Most importantly, it also benefited from an open and comprehensive consultation process with stakeholders. The DSS report on these consultations suggest that, due in part to an active effort on behalf of the DSS to engage with stakeholders, the challenges facing social security were well understood. As a result, there was widespread consensus on the need for reform.

Reforms are wide ranging and those with the largest impact on financial sustainability include:

Increasing the employee and self-employed contribution rate from 3 percent and 7.65 percent respectively by 1 percent in 2007 and 2009. The eventual target is to raise total contributions, including those of the employer, from the current 9.75 percent to 15 percent.

  • Increasing the contribution ceiling by EC$1,000 to EC$6,000 per month, starting in 2008.

  • Reducing the pension accrual rate, i.e. the rate at which benefits are earned, from 2 percent to 1 percent per year for the contribution period between 10 to 20 years and reducing the maximum benefit from 70 percent to 60 percent of the final insurable wage, starting in 2008.

  • Increasing the number of highest earning years used in the calculation of the final insurable wage from 3 to 10 years, starting in 2008.

  • Increasing the minimum pension age by 1 year every 3 years to 65 years starting in 2009.

112. Potential gains from international diversification are large, implying a higher weight for international assets. This would also be consistent with a higher weighting for equities, which would improve asset-liability matching by extending asset duration and hedging against the earnings-indexed growth of liabilities. Limited domestic capacity implies that international assets be managed externally, perhaps passively tracking a benchmark to offset otherwise high administration costs.

113. Domestic investment policies could be narrowed to reduce distortions. Allowable social security investments in the domestic public sector could be limited to government bonds, as is the case in the United States. This would lower administrative costs, provide more space for private sector financial institutions in the domestic capital market, and reduce the scope for mismanagement. Moreover, social security-funded investments with social or developmental objectives could be allocated more transparently via the regular budget process.

114. There are a number of reform options available, and the need for reform is critical. All ECCU social security schemes have one aspect in common—the earlier that appropriate reforms are implemented, the less drastic the ultimate reform effort that is required, and the more smoothly it may be implemented. This will be important to limit the potentially disruptive impact of reforms on the broader economy, and ensure a degree of burden sharing across generations.

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  • Roache, S., 2006, “Domestic Investment and the Cost of Capital in the Caribbean,” IMF Working Paper, No. 06/152 (Washington DC: International Monetary Fund).

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  • Samuel, W., and D. Velculescu, 2003, “Social Security Issues in the Caribbean,” Eastern Caribbean Currency Union—Selected Issues, IMF Country Report 03/88 (Washington DC: International Monetary Fund), pp. 97–116.

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50

Prepared by Tobias Rasmussen and Shaun Roache.

51

Data and projections in this chapter are based upon the most recent actuarial reviews by the International Labour Organization (2005; 2004a; 2004b) for St. Lucia, Grenada, and St. Kitts and Nevis; by Veira (2005) for St. Vincent and the Grenadines; findings by IMF’s Fiscal Affairs Department for Antigua and Barbuda and Dominica; Osborne (2004); and Samuel and Velescelu (2003). The ECCU comprises Antigua and Barbuda, Anguilla, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

52

Most Caribbean countries offer basic health care at public facilities, but many are looking to establish more comprehensive national health insurance schemes. Unemployment benefits, currently only offered in Barbados, are also being considered throughout the region.

53

CARICOM has 15 full members (Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, Trinidad and Tobago) and five associate members (British Virgin Islands, Turks and Caicos Islands, Anguilla, Cayman Islands, Bermuda). The Organization of Eastern Caribbean States consists of the eight ECCU members and the British Virgin Islands.

54

The ECCU is covered by the Convention on Social Security in the Organization of Eastern Caribbean States, signed in 1991. In practice, this Convention has been superseded by the CARICOM Agreement on Social Security, which took effect in 1997. The main feature of these agreements is the ability of workers to aggregate their contribution history across signatory countries, enabling them to more easily meet minimum contribution requirements. Payments of benefits are prorated for each country. Similar agreements have been signed bilaterally with other countries, including Canada and the United Kingdom. See Osborne (2004) for more details.

55

There was no unfunded gift to the first generation of retirees, who were typically covered by legacy Provident Funds.

56

All data in this paper are on an accrual basis. The implicit assumption underpinning the choice of the accrual presentation is that all obligations to social security will eventually be repaid. Large government arrears mean that the social security scheme in Antigua and Barbuda is already now facing an overall deficit on a cash basis. Dominica was in a similar position, but that situation has recently been resolved and the government is now current on its obligations.

57

All schemes offer minimum pensions for qualifying contributors. This is a safety net provision to ensure low wage contributors receive a pension that is, at minimum, some fixed percent of average insurable earnings. This percentage ranges from 7 percent in Dominica to 19 percent in St. Vincent and the Grenadines.

58

In Antigua and Barbuda, for example, a civil servant who retires after 33 years of work would receive a government pension equal to 66 percent of final salary in addition to the social security pension of 49 percent of final salary, for a total replacement rate of 115 percent of final salary.

59

See the U.S. Census Bureau’s International Data Base available at http://www.census.gov/ipc/www/idbnew.html. Similar demographic developments are assumed in the ECCU actuarial reviews cited below. One major source of uncertainty pertaining to the demographic projections for the ECCU countries is the level of future emigration, as population outflow has been variable and at times extremely high.

60

It is calculated on an “open group” basis, which assumes that the scheme is a going concern that will operate indefinitely. The 60-year horizon is arbitrary, but this is the period used in the ILO’s actuarial reviews and provides a good indication of the financial health of the social security scheme over the lifetime of a new entrant to the labor force. Longer horizons would lead to larger actuarial deficits given that the ECCU schemes’ finances are worsening over time. For example, for both Antigua and Barbuda and Dominica the actuarial deficit through 2150 is projected to be almost twice as large as that over the 60-year horizon. There is insufficient data to estimate the 60-year actuarial balance for St. Vincent and the Grenadines, but the 30–year projection in Veira (2005) suggests that the financial situation there may be on par with that in Antigua and Barbuda.

61

Risk-adjusted returns imply a focus on the volatility as well as the level of return on assets. Although social security obligations are mainly long-term, schemes may also have to meet short-term obligations.

62

This is the latest date at which a cross-regional comparison can be made.

63

These cases include the government arrears in Antigua the Barbuda and Dominica mentioned above. In addition, a debt restructuring in one ECCU country has, in at least one instance, led to social security scheme haircuts in other ECCU countries, arising from cross-country exposure.

64

A number of reasons have been put forward for a relative lack of demand for loanable funds from the domestic private sector. One example is the high cost of capital, which lowers the incentive for domestic businesses to invest (see Sosa, 2006; Roache, 2006). High commercial lending rates are prevalent across the region and factors such as a prolonged, uncertain, and costly foreclosure process may by one potential explanation (Chai, 2006). Notably, most investment policy statements state that a government guarantee is acceptable as collateral for a loan, implying the same constraints do not apply to many statutory bodies.

65

Comparing administrative costs internationally can be treacherous due to differences in design and the mix of social assistance versus insurance (Mitchell, 1998). There is also no consensus on the appropriate yardstick; for example comparing costs to contributions or reserve assets, due to issues such as the maturity of the scheme (Whitehouse, 2001; Osborne, 2004). For example, as a percent of assets, ECCU costs are relatively low, but costs are likely to rise dramatically in the medium term.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Eastern Caribbean Currency Union: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2007: Issue 097
Publisher:
International Monetary Fund
ISBN:
9781451811704
ISSN:
1934-7685
Pages:
107
DOI:
https://doi.org/10.5089/9781451811704.002
  • View in gallery

    ECCU: Population Aged 65+ to 15-64 Years Compared

    (Ratio)

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    ECCU: Social Security Reserve Asset Projections

    (In percent of GDP)

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    ECCU: Social Security System Expenditures and Contributions, 1980-2060

    (In percent of GDP)

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    Net Implicit Pension Debt

    (In percent of GDP) 1/

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    Reserve Portfolio Risk-Adjusted Performance

    (Sharpe ratio, 1988-2003) 1/

  • View in gallery

    Publicly-Mandated Social Security/Pension Fund Reserves

    (In percent of GDP) 1/

  • View in gallery

    ECCU: Social Security Reserve Portfolio Asset Allocations

    (Percent of portfolio)

ECCU: Population Aged 65+ to 15-64 Years Compared

(Ratio)

ECCU: Social Security Reserve Asset Projections

(In percent of GDP)

ECCU: Social Security System Expenditures and Contributions, 1980-2060

(In percent of GDP)

Net Implicit Pension Debt

(In percent of GDP) 1/

Reserve Portfolio Risk-Adjusted Performance

(Sharpe ratio, 1988-2003) 1/

Publicly-Mandated Social Security/Pension Fund Reserves

(In percent of GDP) 1/

ECCU: Social Security Reserve Portfolio Asset Allocations

(Percent of portfolio)