by Richard Coulson

“Unfunded pension obligations” is a clunky phrase, obscure except to accountants  and to actuaries forecasting life expectancy. To the average citizen, it only comes  alive when translated to read simply “promises to pay money you don’t have”.  Alarm bells start  to ring  when the public learns those  are promises  not just  from Abe  to Zeke but from Government to thousands of Bahamian employees and retirees. Our Prime Ministers and Ministers of Finance of both parties have done their best to keep those alarm bells muffled.

Government civil servants— police, teachers, clerks and senior office holders— as well as employees of some 25 state- owned enterprises like BahamasAir,  enjoy a pension on  retirement at the normal age of 65. What’s tough on our budget, and strangles our prospects for economic growth, is that these pensions are governed by  “defined benefit” (DB) plans  which promise  a fixed monthly payment until death, calculated on a formula combining  years of employment and salary level in their final years. Naturally, the total payments rise each year, as salaries increase, unions fight for more favorable formulas, and life expectancy creeps upward­.  The  over-all pension requirement is covered  on a pay-as- you-go-basis with a budget item charged each year. Nowhere can you find a figure for this amount,  since  our 400-plus-page budget document reports expenditures per-ministry and not per-function.

Our Government has never planned for the increases. Never have any major steps been taken to reduce the pay-out formula, to raise the retirement age, to establish a “fund” to cover at least part of the future increases, or, above all, to switch to a radically different type of pension known as the “defined contribution” (DC) alternative  which throughout  the world is sweeping away the  DB model well known to Bahamian pensioners.

The annual Article IV Report by the IMF shows  a good grasp of  our pension expense and future commitments. The latest, published in October 2017, indicated the combined unfunded pension liability of the Government, its companies, and the separate National Insurance Board  (NIB) at roughly $2.2 billion, and subject to rapid growth. Government workers have received  annual pension payments equal to about 1% of GDP and  7.3% of tax revenue.  These and related figures led IMF to comment that it was “inevitable” that Government would have to reform both public pensions  and the NIB system, which operates more like Social Security in the USA  making  payments regardless of details  of employment.  At least , NIB has accumulated a portfolio  of marketable securities to partially fund  its future commitments, while Government has irresponsibly left its own pension scheme without  one dollar of funding, relying totally on the annual budget subvention.

This unhappy state of affairs  has long been known  to our financial authorities. The IMF report for 2016 virtually mirrors the later one. As long ago as 2008 the Executive Director of our Securities Commission delivered an address with  comprehensive reform recommendations, and in 2014 the accountancy KPMG prepared its own study. The following year a special committee was convened  to advise on creating, for the first time,  pension  legislation for the private sector, but never issued a formal report. Thus I was astonished to see that in the 68-page Budget Report issued  by  new  Minister of Finance  Peter Turnquest  in May 2017 the word “pension” was not even mentioned, amidst  all the other up-beat proposals to improve  our financial structure.

In the USA,  over 40 years ago the switch to DC pensions began in  the private sector, so  that less than 3% of US salaried employees are now entitled to a  fixed DB pension.   The 50 states,  bearing an estimated $5 billion unfunded pensions, are now following the same path.

Beginning in 2011, with bitter political debate in  Wisconsin fought by the governor himself ,  a groundswell of political and financial thinking has been moving state pension funds steadily away from DB to DC  plans.  Pennsylvania  has taken the plunge, and California,  Illinois and New York  are studying ways to accept the inevitable.

The revolutionary nature of this change in the Bahamian environment  cannot be over- emphasized. Unlike the fixed monthly amounts  payable  under DB, with  DC the employer merely  pays the employee a percentage of his salary (say,  5%) and  offers him  a choice of investment options – debt or equity, conservative our aggressive — that he selects  and keeps in his own separate account. The employer often kicks in its own matching contribution, but again  the pensioner must decide how to invest  it. On retirement, his  account may be large or small, depending  on the investment policy he has chosen to follow.

For the first time, Bahamian workers, usually untutored in finance, will have to make investment decisions that will determine their future financial health. Unions may  object to the variable results inherent I the DC plans.

As the  chairman  of BCCEC  recently affirmed , bank deposits paying less than 1% are  no longer are a viable way to save for  the future.  Higher-yielding securities, like Government bonds or corporate preferred shares, plus common  equities with potential for capital growth, must now be on the horizon for all employees .  Fortunately,  they will not be left without help. We have at least a half dozen licensed  banks, securities dealers, and insurance companies, qualified to advise on investment policies and administer portfolios.  With thousands of new retirees  demanding   their services,   staffing  should rise,  as well as  a higher level of expertise. Our financial  services industry, whose relevance  for domestic clients has  stagnated,  should feel a strong breath of stimulation.

These   advisors will be encouraged to discover a range of new products  for their new clients.  Given the limited volume  of Government  securities and the paucity of equity issues listed on BISX—twenty in  total, fewer  than half of which trade actively—our local capital markets will be unable to satisfy demand.  In a positive step that the PLP always ignored,  Prime Minister Minnis  in his recent relaxation of exchange controls reduced to 5% the premium payable on exchanging B-Dollars  for US-dollars used for investment  purpose. The previous 12% premium destroyed any incentive  for Bahamians to consider foreign  securities traded on the NYSE or elsewhere.  With the up-front cost now reduced to 5%, they offer an  attractive, far more liquid, alternative to the small number of BISX equities, as well as a hedge against  B-Dollar devaluation—unlikely, in my opinion, but not unthinkable.

Even in the US, relatively few individual investors are “stock-pickers”; most prefer to invest in mutual funds with  portfolios  chosen by professional managers. A fascinating book, Empire of  the Fund–How We  Save Now, published in 2016, explains how mutual funds have grown  to dominate the savings platform for Americans. By 1951 , the first 100 funds were created ; now there are more than 8,000,  catering to every conceivable investment preference, holding about $6.9 billion in retirement savings.

Although the  wide public acceptance of mutual funds indicates that, in general, they are safe and reliable  vehicles for unsophisticated investors,  the cited book provides plenty of detail of how US fund shareholders have been scammed, misled or overcharged by fund managers.  The same may well be happening  here. Every fund has an “investment manager”, paid a fee based on size of and valuation of assets, who can manipulate operations for its  own benefit  rather than for the fund shareholders. Our Securities Commission must be given stronger powers to investigate fund  business and impose sanctions where needed.

Mutual  funds  are already offered  by several investment firms to their more affluent  Bahamian clients, but probably do not  exceed  $300 million total, principally in local stocks and bonds, as well as  a small selection of foreign securities that have been available for a few years under a special Central Bank “exemption” from usual exchange control restrictions.  However, a shift to DC pension plans  will lead to several thousand retirees looking for a home to place their  pension contribution allocations – possibly as much as B$50 million annually.  If the local capital market does not grow, much of this “new money” must  go to foreign securities enjoying the reduced 5% exchange premium.

Changing  Government pensions to the DC system, or some form of  “hybrid” mixture with traditional DB schemes (as often happens with state pensions across the USA),  will doubtless face its critics and require a vigorous education campaign. But it’s an  essential step toward rescuing our financial structure from the painful alternatives of pension default  (political  suicide) ,  new taxes, or inflation from massive new public borrowing.  On the plus side,  the cash released for personal investment can invigorate our capital markets and financial services sector.

January 17, 2018

Mr. Coulson has had a long career in law, investment banking and private banking in New York, London, and Nassau, and now serves as director of several financial concerns and as a corporate financial consultant. He has recently released his autobiography, A Corkscrew Life: Adventures of a Travelling Financier.