Size is not what marks out Sri Lanka’s retirement savings fund, the Employees’ Trust Fund (EPF), although its enormity is impossible to ignore. By end-2015, it managed retirement savings topping Rs1.67 trillion, while the smaller Employees’ Trust Fund (ETF) – also government managed – held Rs223 billion (Rs0.22 trillion) in retirement savings.

Together, at Rs1.88 trillion, this savings pool is equivalent to 35% of customer deposits (Rs5.4 trillion in deposits) at Sri Lanka’s commercial banks at end-2015. Combined commercial banking sector’s assets by 2015 were Rs6.9 trillion.

Sri Lanka’s two retirement funds, EPF and ETF, are independent of each other, have differing governance structures and founding objectives. Private sector and government corporation employees contribute 20% and 3%, respectively, of their earnings to these. A portion of an employee’s EPF savings are reflected as a deduction from gross pay, and the rest, including a 3% ETF contribution, is labeled as an employer contribution.

This is just illusory, because for employers, the 23% staff retirement outlay is part of employee remuneration. For employees, forced retirement savings are part of their earnings, although they often don’t realise this. But more on that later.

For this story, we mean retirement savings as including both EPF and ETF. Challenges confronting ETF, the smaller of the two, are similar to ones EPF faces. So references to EPF in the headline and elsewhere are implicit of ETF too. The government – sensibly – has proposed merging the two funds. Retirement savings are also referred to as pension assets, although Sri Lanka does not offer financial instruments converting a savings lump sum to a lifetime pension.

In recent election campaigns, some politicians asked pointed questions about the state of retirement savings. So, probing the issue now is not without precedent. The EPF has been treated above politics, not to prevent them from dipping fingers into it, but to not draw attention to their hands already in the pot.

Fixing pensions is the next great reform opportunity, easily as significant as the privatisation of state businesses. Both these have tremendous impacts on a government’s financial health and free up resources for investing in important areas like education, healthcare and infrastructure.

Sri Lanka’s Rs1.88 trillion in retirement savings is relatively large and growing rapidly by the standards of countries in a similar stage of development. Pension assets under management (AUM) in Sri Lanka were the equivalent of 14% of GDP in 2012. By end-2015, it was the equivalent of 16.2% of GDP. In advanced economies with long histories of saving for retirement, AUM is equivalent of 70% of GDP or higher.

In Asia, it’s mixed. Thrift is central to some cultures, while in others, government coercion has helped drive retirement savings to levels topping 70% of GDP. Singapore and Malaysia stand out for their savings success. Pension assets under management as a percentage of stock market capitalisation are even higher in Sri Lanka than in Singapore and Malaysia, where state-controlled retirement savings have a long history. In 2012, where comparative numbers available (Figure 2), pension assets were the equivalent of 45% of Sri Lanka’s stock market capitalisation. Since then, AUMs have risen and is now equivalent to 68% of the Rs2,760 trillion market cap in October 2016.

Two factors are at play here: the relative underdevelopment of the stock market, which does not represent some of the economy’s most vibrant sectors, and the fact that Sri Lanka is still at a demographic dividend stage, when pension fund accumulation is faster due to the growing workforce.

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learly, the retirement savings pool here is sizable. But if size is not what marks out Sri Lanka’s retirement savings, what does? Their inability – despite claiming 23% of contributors’ earnings – to provide a reasonable retirement pot to retirees is what marks out Sri Lanka’s retirement savings system.

In the fund’s Investment Policy Statement, the Central Bank’s Monetary Board, the EPF’s custodian, identifies ‘providing a reasonable and sustainable return to members while minimising risk and ensuring safety and growth’ as the fund’s aims.

By any reasonable measure, the EPF, and by implication the Monetary Board, hasn’t delivered a reasonable and sustainable return while minimising risk. EPF has returned, net of headline inflation, to 1.39% annually during the 25 years ending 2013. This return ignores how relevant headline inflation, as represented by the Consumer Price Index (CPI) and the preceding Colombo Consumers Price Index, is for the 2.4 million contributors. EPF has 16 million account holders, including those with multiple and inactive accounts.

EPF’s annual accounts for 2012 and 2013 have been presented to parliament, however, these cannot be downloaded from EPF’s website. Its 2011 accounts show that 120,000 retirees took home Rs50 billion in EPF savings. This sounds grand, but the horror quickly settles when one realises that each new retiree received an average Rs416, 000.

Private sector workers are being stung twice. Besides saving for their own retirement with EPF, their taxes fund pensions of others who haven’t saved for retirement themselves. The second sting is that the government – although wards assigned to ensure coerced retirement savings meet objectives – has been systematically stealing to advance their narrow political agendas and pay for epic transgressions. Skimming, diverting or denying retirement saving returns is a misuse of fiduciary authority and would amount to a criminal breach of trust if it happened in the private sector.

This should justifiably be the cause for indignation. However, the EPF has been positioned as some fuzzy state largess. Its contributors don’t expect the level of transparency about the EPF balance as they would expect about their bank savings accounts.

In instances that a financial institution faces a liquidity crisis, regulators swiftly intervene to restore confidence in the governance if even by sidelining or removing directors. Journalists highlight the plight of pensioners whose savings are withheld and write about directors tried in court for negligence or criminal breach of trust. But, unnervingly, the EPF’s unscrupulous management, luckily for them stealing from it, remains above the din of this everyday fray.

Sadly, most people saving for retirement – ignorant about how the system is gamed against them – continue to be ludicrously optimistic. They harbour many fantasies like funding a child’s higher education, hosting a reception party, celebrating another kid’s marriage and even upgrading their residence out of their retirement pot. Unless reforms address this challenge, future retirees will also be realising – often too late – that unless their retirement pot is far bigger — a standard of living close to the one enjoyed just before retirement is simply unattainable.

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etirement is a relatively new concept. People used to work regardless of their age, until war or disease felled them. The rare survivors to old age, unable to farm, maraud or trade in goods to survive, had to have enough gold buried in the backyard or depend on the kids.

In the modern world, a few details have changed. Access to medical care and the absence of random conflict make it possible for everybody to expect to go gray. People no longer bury their savings. Instead, savings of job holders in Sri Lanka are commandeered into government-managed funds, to be made available during the graying years.

Retirees now expect to spend at least a quarter of their life at leisure, and as life expectancy rises over the next few decades, time in retirement could increase to a third of a person’s lifespan. On top of the extended average lifespan, the other long-term trend impacting retirement planning is the increasing share of older people in the population.

Demographists say the share of those over 60 years, who make up 12.5% of the Sri Lankan population today, will rise to 24% by 2040. In 2070, the over 60s will be 33.5% of the population. The first retirees beyond 2070 will enter the workforce in under a decade.

A longer average lifespan and a growing share of older people are the obvious twin challenges facing retirement planning in Sri Lanka. The third challenge – unrelated to demographics but crucial for future retirees – is the ability of retirement savings to meet the reasonable aspirations of savers: something Sri Lankan ones have failed abjectly at, so far.

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here are two types of retirees: those who save for their retirement and those that don’t. State pensions, funded out of tax, will pay a monthly pension for the one million government employees in their grey years. Government employees make up 12% of Sri Lanka’s 8.5 million workforce. Of the rest, the 2.4 million working in the private sector and semi-government institutions contribute the equivalent to 23% of earnings from government-managed retirement savings.

Retirement planning challenges most people because they are unable to figure how much of their income to squirrel away to afford an adequate standard of living. Deferred gratification is bedevilled by assumptions like the level of inflation, investment returns, interest rate during working life and after retirement, periods of unemployment, retirement age and the availability of social safety nets.

So, is the compulsory saving of 23% of earnings in Sri Lanka really inadequate?

There is a simplistic rule of 20. If you want (in retirement) an annual income of Rs200,000 (Rs16,600 monthly), a pensioner will need a savings pot at retirement that is at least 20 times this amount, i.e Rs4 million. A retiree can withdraw 5% of the pot annually for 20 years. A pensioner expecting a 30-year retirement and Rs50,000 monthly income will require a Rs18 million retirement pot.

Pensioners may feel that saving 23% of one’s income should have been adequate, but inflation and higher-than-investment income have eroded the buying power of savings. Now that the corrosive effect of inflation on savings has been overcome due to greater fiscal responsibility, EPF savers should demand reforms that will ensure that their savings will grant them a comfortable retirement.

Retirement savings schemes here are the most restrictive. They are mandatory, the investment risk is borne by the plan member (a defined contribution scheme), they are state controlled and not open to competition, and contributors don’t have a choice of funds to pick from. Ideally, reforms will address all these restrictions, and in a first round, they should address three main ones: governance, investment strategy and administration.

Systematic stealing of EPF resources happened in a few stages. The first was stealing through ‘Rupee loans’. In the 1990s, the government escalated its issuance of a non-tradable security called ‘Rupee Loans’, of which the EPF was the main buyer. These attracted lower-than-market rates and Rs23 billion in Rupee loan debt was held by the EPF in 2013 amounting to 1.6% of its then investments. At their peak in 1997, Rupee loans were 91% of the EPF’s Rs138 trillion in assets. In addition to lower-than-market interest rates, non-tradability meant a smart fund manager couldn’t generate capital gains from interest rate volatility. An independently managed EPF would have refused to invest in Rupee loans, forcing the issuer – the government – to rethink budget deficit funding.

Asia’s pension managers responded to the challenge of offering a reasonable pension pot to retirees by focusing on yields. They boosted allocations to high-yield asset classes like equities by diversifying investments to include foreign assets. Sri Lanka is a late starter on the first and isn’t even considering the second option.

When it did happen, EPF fund managers diversifying into high-yield assets were so sloppy after the war ended that they had completely missed the opportunity. Stocks rose 125% in 2009 and 96% in 2010. Think tank Veritè Research pointed out how the EPF’s stock market gained 3.7% and 4.2% in those two years, including mark-to-market gains/losses on equity.

Veritè observed that, had the investments performed as well as the market, the internal rate of return would have been 103% instead of the 4.1% achieved. The quantum of investment would have an expected market return of Rs54billion instead of the Rs2.2 billion achieved. In those two years, government securities earned an annual interest between 14% and 15%, and would have earned more than the higher-risk equity investment.

Some of the EPF’s equity investment decisions have also, tragically, undermined pensioners weighed towards overcoming economic shocks and bailing out troubled ventures.

When the Central Bank was in the throes of a balance of payments crisis in 2012, desperate to attract foreign capital, the EPF sold its entire holdings of John Keells Holdings PLC and Aitken Spence PLC, the bluest of Sri Lankan blue chips, to foreign investors. JKH’s and Aitken Spence’s share prices have risen substantially in the years since. It’s not unusual that a retirement fund can hold shares of well-managed, growing firms for as long as those conditions remain unchanged. Instead of savers here, savers elsewhere in the world benefited.

Financial market investments are certainly risky, as listed equity has demonstrated over the last two years of low returns. But higher risks also offer the chance for higher returns. Over longer terms, any reasonable fund manager will be able to generate an equity premium.

At least a couple of the EPF’s other investments in the past few years are expensive bailouts that won’t meet members’ retirement aspirations. They are a Rs500 million (equivalent to 0.5% of the fund’s value at the time) investment in hopelessly unprofitable SriLankan Airlines, which reported a record Rs28 billion loss in 2014 and a Rs10 billion loss last year, and the troubled The Finance Company, where the share price has tanked since the investment.

A minister recently claimed that SriLankan Airlines’ lease of seven new Airbus A330-300 aircraft – already in service – is 30% higher than market rates. The cost of leasing newer A350 aircraft, which the government is trying to cancel, is also similarly inflated, the minister claimed.

For incompetent and corrupt politicians, dipping into or stealing retirement savings has been convenient.

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aced with a growing crisis of Marxism in Germany, Chancellor Otto Von Bismarck introduced the concept of a pension. Of course, staving off more radical Marxists alternatives was blurred in the assertion that pensions were promoting worker wellbeing and supporting economic efficiency. Bismarck was no idiot. When he introduced these reforms in 1889, defining retirement as commencing at age 70, very few benefited because average German life expectancy was far lower. In some ways, the provident fund (EPF) set up in 1958 was a Bismarckian exercise; average life expectancy then was 58 years. Now, life expectancy in Sri Lanka is closer to 75 years.

The EPF’s investment management by the Monetary Board is a conflict of interest with its other agency function of managing public debt. On the one hand, the Central Bank has to ensure the government borrows at the lowest possible cost, while also providing the highest possible return to EPF contributors (92% of EPF funds are invested in government debt). EPF funds in government hands have certainly made public infrastructure and services more ubiquitous. However, the burden of economic advancement isn’t one 2.4 million EPF contributors should be asked unfairly to bear out of their retirement savings.

Usually, wards delivering patchy governance would be apprehensive about putting on a bravura demonstration of stonewalling. However, the Central Bank has shown little restraint to do that to critics of dismal governance practices at the EPF. Instead of hastening the publication of long-delayed EPF annual reports and improving transparency, detractors were confronted with hubris and absolutism by the bank’s then-governor Ajith Nivard Cabraal. Occasionally, life does provide the perfect metaphor.

EPF contributors have been watching with stupefied incredulity the magisterial denials, the dismissal of criticism and spreading the blame. The first step towards making their EPF savings relevant to future retirees is improving governance, including transparency; improving oversight; eliminating the agency conflict of the Monetary Board as investment managers; and ensuring accountability for advancing retirement savers’ interests. This is the first and most urgent reform, improving governance and eliminating the conflict of interest of the Central Bank’s Monetary Board’s involvement in retirement savings management.

Defined contribution-type retirement savings schemes – a category EPF falls into because the lump sum saved reflects the investment returns of the money paid in – can be further split into two. The first, defined contribution schemes delegating the investment process to professional managers. This is the most common type. The second defined contribution savings model, as in America’s 401(K) plans, grants the saver freedom to move the money in the account among selected mutual funds.

Second, critical reforms the government must deal with are the burden of unfunded pensions or pay-as-you-go (PAYG) schemes.

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ri Lanka’s unfunded state pension represents a loose government contract with generations of future taxpayers.

The outlook for future state pensions is dire. Veritè Research has estimated, if pension obligations are limited to just the current employees, the existing present discounted value of implicit outstanding pension debt to be equivalent to 90% of GDP. That nearly doubles what we have come to consider as Sri Lanka’s fiscal debt to 170% of GDP.

Those who have retired and receive a tax-funded pension cannot be expected to give that up. However, more than a million government employees can be expected to transition to a defined contribution system. Latin America – led by Chile 35 years ago – has demonstrated that such a transition is possible.

Transferring the pension burden from taxpayers (PAYG) to a defined contribution scheme cannot happen overnight. The longer the record of the PAYG scheme, the greater its benefit and difficulty unwinding those. The transitional burden is massive. This is because the generation in government jobs who will lose their pensions will have to then contribute to the pensions of current retirees or ones about to retire.

Politicians are timid and fickle too. They know the challenge will have to be faced one day, but are satisfied to do nothing if that day won’t arise before the next election. There is nothing like an imminent crisis for reform. Paradoxically, the economy is now lifting out of a crisis, an opportunity has just passed.

Latin America’s experience with pension reforms suggests that – well handled – to transition to funded individual pensions can be politically successful.

Chile’s pension system is worth highlighting. Employees deduct and pay an employees’ retirement account at least 10% of wages and commissions. Workers are promised a pension of 70% of their last income, assuming a 4% return on investment on the savings. Contributors have to pay for at least 80% of their working lives. If they take a break or don’t contribute for any other reason, the pension in retirement will be lesser. For the self-employed, the scheme is voluntary in Chile and most don’t contribute.

The idea behind Chile’s reforms has been successfully replicated in the region. It can be adapted to local contexts.

Third, reforms can offer the option for savers to allow approved private portfolio managers to invest a portion of their EPF under the fund’s continuing custody. Malaysia’s EPF, which covers over 5 million private sector workers (about half the country’s workforce), has implemented a number of successful reforms.

In Sri Lanka, the EPF is managed as a giant monolith. There is no regard for the differing risk appetites of members based on how long they have for retirement. When the EPF buys a stock as a long-term investment, even a saver who will be retiring in a few weeks is exposed to the short-term risk. Such a structure is nonsense.

EPF savings is the only retirement strategy for most private sector workers. However, except for a receipt-sized statement confirming their member balance, there is no information on what constitutes their portfolio and how each asset class is performing. Policy and administrative reforms must ensure that member portfolios are optimised for returns.

Managers of mutual and insurance funds over decades have shown their ability to deliver good returns, even during challenging market conditions. It’s time pension fund policy ended the practice of sugarcoating the EPF and took future retirees’ needs seriously.

Young Sri Lankans, who overwhelmingly work in the private sector, will start feeling the burden of saving for their own futures and paying for others. This may be a counterweight to government employees keen to protect their PAYG benefits. Pension reforms can’t be done with a sweep, like the privatisation of an unprofitable government business. It should also not leave people destitute in their grey years.

However, a road map that recognises the complexity, consults with stakeholders and a campaign explaining the benefits alongside the unsustainability of the current model will be critical.

However, the case for change is compelling. It will take a bold set of people to carry this through.