Addressing Prior Pension Obligations
Pensions and Labor Restructuring
Pensions: Implementation Steps
Implementing agencies face several challenges related to pensions. First, dealing with the accumulated liability of pension benefits that have already been promised and earned by current workers often is essential to determining whether privatization is feasible. Accumulated pension obligations may take a variety of forms, some of which may not be readily apparent in the financial records and statements of an infrastructure enterprise. Workers in potential PPI enterprises quite often are enrolled in the pension plans of civil servants or participate in the so-called provident funds established to provide some mechanism for mandatory retirement savings for salaried or formal sector workers.
In other cases special supplementary arrangements have been created to provide additional benefits to workers in industries of strategic significance (such as transportation, defense, and law enforcement), for workers in difficult or dangerous occupations, or for workers in highly skilled or high-pay industries. These benefits may be in the form of supplements to existing public social security programs or special-purpose pension arrangements to provide benefits to workers in a particular enterprise or industry. Both are often operated on a largely unfunded or "pay-as-you-go" (PAYGO) basis in which obligations are treated as a current operating expense rather than paid from reserves or asset pools to which payment is made at the time a future obligation is incurred.
This generally leads to circumstances in which, on an economic if not legal basis, there is a large liability for future benefits that are not accounted for and for which funds have not been set aside. When workers are covered by special-purpose pension arrangements, they can be legally enforceable obligations. When they participate in public or civil servants' programs–although these may function on a PAYGO basis, they are likely to perceive accrued pensions as implicit obligations that must be settled when an entity is privatized.
Accrued pension liabilities typically are not fully (if at all) reflected in financial statements. These obligations, often referred to as arrears or unfunded pension liabilities, can be substantial. In industries with declining labor forces or aging worker populations, past pension obligations may be the single largest liability when properly measured and may represent a multiple of the market value of an entity. For these reasons PPI investors may be reluctant to take over an entity until they are assured that accrued pension obligations are fully resolved.
Second, pensions are a central concern as well as an effective tool in restructuring a labor force through downsizing. Providing early retirement programs or establishing arrangements in which workers can retain or access some of the value of their accumulated pension benefits is commonly used to provide incentives for voluntary departures or to achieve work force reductions in the least disruptive or controversial manner. These strategies have significant financial implications and may have substantial political and social policy consequences so they must be carefully developed with consideration for their objectives and costs. (Those considerations are discussed later in this module.)
Finally, designing the pension program to meet the future needs of a privatized entity is a key element of its viability as a going concern. In nearly all circumstances, including those in even the most fully developed economies, access to a reliable means of saving for retirement and providing old-age income security are crucial aspects of attracting and retaining high-value added labor. Workers in key management positions or with particularly valuable skills may be attracted to PPI candidates solely on the basis of the access they provide to reliable pension programs. This is especially true in developing or transition economies in which there are few competing alternatives available.
The way in which pension programs are structured in anticipation of or following privatization inevitably involves tradeoffs between controlling costs and providing sufficiently generous benefits to recruit and retain an appropriate work force. Available is a range of choices in the design of a pension program that will need to be carefully considered in the context of the type of workers required, the consequences of the choices made, the usefulness of the choices as a labor management tool, and the pattern and level of associated costs.
Some types of pensions are very effective in attracting younger, educated workers, often those with highly valued and marketable technical skills. Other types are more effective in retaining older workers or key management staff. Some pension arrangements have lower or more predictable costs, whereas others enable sponsors to constrain cash outlays in early years but may involve greater uncertainty about their long-run expense. These choices and tradeoffs are essential to the value and viability of a privatization candidate and are discussed further below. (See also the case of Morocco rail presented in box 5.11.)
In 1996 the government of the Kingdom of Morocco approached the World Bank for support for the restructuring of the state-owned railway, Office National des Chemins de Fer (ONCF). A key element of the restructuring was the conversion of the enterprise from a public corporation to a joint stock company. Although the ratio of staff costs to traffic revenue was better than that of most European railways at the time, it was still too high to ensure a sustainable financial position for ONCF, especially in the face of stiffer road competition. Labor costs were to be brought down to about 30 percent of operating revenues; this would involve a reduction in personnel from 13,800 in 1995 to 10,000 in 2000.
Corporatization would not be possible, however, without changing the pension arrangements. The ONCF pension plan was an internal fund, more favorable than the common system applied to private enterprises, with pension benefits paid directly by ONCF. Retirees were paid their rights directly from the yearly staff and employer's contributions plus a variable amount paid by ONCF to match the deficit. The system placed a major burden on ONCF finances. The high cost of the pensions was the result of very generous arrangements. The plan rules set the normal retirement age at 55 years (50 for drivers, compared with 60 years in the national retirement fund), and offered proportional early retirement after 21 years of service, an annual contribution rate of 2.5 percent, a high reference wage, wage-based indexing, and supplementary allowances and reversion of pension rights for family members. These benefits were unsustainable and would require an annual contribution rate of 50 percent if it were even to achieve a real financial yield of zero percent. Measures to change ONCF's pension system were urgently needed because the downsizing program, plus a staff age profile leading to steadily increased retirements (the number or retirees increased by about 200 annually), would make the plan even less tenable.
Source: World Bank 1996d.