Addressing Prior Pension Obligations
Pensions and Labor Restructuring
Pensions: Implementation Steps
This section discusses how pensions can be used in labor restructuring because such adjustment is often a major part of any process of privatization.
The implementing agency may face difficult pension issues and negotiations with workers and unions during work force restructuring. Pensions can often represent a large portion of the compensation package for workers in these enterprises, especially if workers are enrolled in generous industry-specific or civil servant defined-benefit plans. Pension arrangements can also be adjusted to provide incentives for workers to leave employment voluntarily or used to cushion the impact on those who may be separated involuntarily. Various approaches with many feasible combinations are possible for integrating pensions into a labor restructuring strategy. These approaches can be considered in the context of two major categories: early retirement programs and voluntary departure incentives.
The least disruptive and contentious way to restructure a work force is to induce voluntary early retirement. Whether this is practical is a question of cost and of targeting the availability to redundant workers while retaining those who are essential to a going concern. Whether the benefits are enough to induce employees to volunteer for early retirement will depend on the type of plan offered (defined-benefit or accumulation), the levels of benefits promised, the vesting arrangements, participant eligibility, and other rules of the program– as well as employees' assessment of alternative employment options.
Early retirement can be structured in three main ways–by providing:
Each of these three options is considered below.
With the first option, the worker who retires early receives an immediate pension payment but at a reduced level. A typical adjustment that is "actuarially fair" is to provide the same benefit formula for each year of service but then to reduce it by 5 percent for each year below the normal retirement age. Smaller percentage reductions may provide a similar equivalence if life expectancies are lower, as is often the case in developing countries. Care must be taken, however, to ensure that the longevity factor used is consistent with the characteristics of the affected workers, who may differ from the broader population. The estimation of an appropriate offset should be a relatively straightforward calculation for an actuary who has completed the evaluation of defined-benefit plans as discussed in previous sections. Pensions may remain at a reduced level until the worker reaches normal retirement age, or they may remain at a reduced level until death. An alternative approach that can be combined with adjustments in the benefit level to achieve lower initial reductions (and thereby strengthen incentives) is to eliminate or constrain the indexing of benefits until normal retirement age.
Statutory provisions may apply, too. For example, under Egyptian social security regulations workers who are aged 50 or above can receive a retirement pension if they retire early. However, the pension is reduced significantly from what they would receive if they retired at age 60 (the normal retirement age). The amount of reduction is determined by a complicated formula that distinguishes between basic and variable components of wage. The loss of benefits amounts to 66 percent of full benefits for retirement at age 50, 57 percent at age 53, and 40 percent at age 57 (Assaad 1999, p. 141).
The second option is a pension that is available immediately and enhanced to cover the opportunity cost of forfeited future benefits. With this option, the enhancements may take the form of crediting the employee with more years of service than have been worked (added years) or of giving an additional lump sum to purchase an annuity for an extra pension benefit (the lump sum may be linked to years of service or to years remaining until normal retirement age).
Although such enhancements create a powerful incentive for early retirement, their costs must be carefully evaluated. What may appear to be small additions to credited years of service can have large consequences for the funding status that will need to be paid in the future.
With the third option for early retirement, payment of the regular benefits begins when the worker who has taken early retirement reaches normal retirement age, but there may be a lump-sum incentive payment at the time of early retirement. At Brazil's RFFSA, for example, the company continued to pay the employer's and employees' contributions to the national social insurance system for workers who took early retirement (for a maximum of five years, or until the worker reached age 55). In addition, the worker received six months' salary during the first six months after early retirement.
There are several cases where governments have been so generous in their pension arrangements that the plans led either to excessive long-term liabilities on government or to the departure of too many staff through early retirement. Essentially these are cases where the implementing agencies have solved their immediate problem by transferring the financial obligations either to the new owner or to a future government. Examples include Sri Lanka Telecom (Salih 2000), Chile Rail, and a similar case in Australia's rail sector where too many employees took early retirement and had to be rehired later under contract.
Even where severance payments are the core element of voluntary departure plans, some compensation for past pension contributions may also be necessary. This can be a lump-sum payment or an obligation to pay a pension in the future, or a mix of the two. In general, the objective is to make plans as simple as possible, although complexities may arise if there are several classes of employees, different pension schemes, and different incentives required for different groups of workers.
An alternative to providing early retirement that may better target incentives to specific groups of workers or may entail lower costs is to make retroactive changes to eligibility and vesting rules. These rules, which are often very specific to the pension plan, can significantly affect the incentives and motivations for workers accepting early retirement or voluntary departure.
Eligibility rules can be based on age or based on years of contribution or service. For example, only workers over the age of 60 may be eligible to retire, or only workers who have a minimum of 20 years of contribution to the pension plan can qualify for early retirement.
Work force restructuring can result in amendments to the rules of the plan. In the case of PPI in Côte d'Ivoire rail, negotiations with unions resulted in the years of work required for pension eligibility being reduced from 20 to 15 years. This enabled a larger portion of the work force to depart or be separated while still preserving the right to future benefits without the expense of paying out immediate benefits.
Implementing agencies should avoid the temptation to offer generous benefits today.
Vesting rules in pension plans are often based on years of service; for example, until workers have accrued five years of service they cannot receive full benefits. Like eligibility rules, vesting rules and conventions can influence workers' decisions and their willingness to adopt early retirement. Although there is a trend to more immediate vesting, many plans still have long vesting periods. Vesting rules can act as a disincentive to workers leaving voluntarily.
The vesting arrangements may also need to be considered as part of the total compensation package. For example, if the principle to be used in downsizing is last-in/first-out, the redundancy package may have to take account of forgone pension contributions because the affected employees are unlikely to have fully vested benefits.
The details of these rules can significantly affect workers' benefits. For example, in the electricity restructuring and privatization in Orissa, India, the former Orissa State Electricity Board (OSEB) included employees who had been deputed from government service. As for the Grid Corporation of Orissa (GRIDCO), when the board was unbundled and restructured into generation, transmission and distribution companies, the eligibility rules were less beneficial for these deputees than for OSEB employees. Specifically, OSEB employees had their years of service in OSEB carried over to count toward a GRIDCO pension, whereas former government employees had to have worked for 10 years within GRIDCO before becoming eligible for a GRIDCO pension (Ray 2001).