Tuesday, May 8, 2018

The false dawn of micro-pensions

There is a disturbing irony in encouraging poor people, who barely manage to make ends meet just for physical survival, to save for old-age and insure themselves against diseases. Self-financed micro-pensions and micro-insurance, aided by the allure of modern technologies, are a fad in international development and impact investing. It is flawed on both philosophical and financial considerations.

The fundamental assumption with micro-pensions is that it is both desirable and possible for informal workers (or poor and lower middle-class) to save money from their current income to finance their pensions. 

The desirability condition is, at best, a benign paternalistic concern of outsiders for the welfare of the poor and informal workers during their retirement. I will leave this at that. The possibility condition is contingent on another assumption. These people have the incomes to save long-term for their pensions, and it is human behavioural and cognitive failings that prevent them from doing so. 

This assumption flies against the near universal evidence on the difficulty impossibility of long-term financial savings (pensions or insurance) among the poor. Forget the poorest, even the typical rural and urban informal worker in a low income country lives a virtual hand-to-mouth existence, barely surviving from month to month on their meagre wages. 

India, for example, has a pension and health insurance scheme for all formal sector workers which requires mandatory deductions from worker’s salaries. The mandatory deductions amount to slightly above 30% of the worker’s salaries, including the employer contributions. This is actually counter-productive because it deprives the badly stretched worker off money he badly needs today to meet daily needs and forces him to borrow at much higher cost from local money lenders for those needs, thereby likely making him more indebted. While the logic of making this voluntary at least for workers with monthly wages below Rs 15000-20000 is clearly understood, its politics very challenging.  

It is also for this reason that almost all developed countries have either lower mandatory deductions or higher government contributions for low income workers. In fact, this was a major component of the acclaimed 2004 Hartz IV reforms of Germany, often claimed as the cornerstone of Germany’s recent economic success. In case of the poor, it is almost always completely public funded social safety nets that provide pensions and health insurance. 

It is ironical that international development entities promote self-financed pensions and insurance for the informal workers even though it is an idea that is not even considered for their arguably far better off (both in relative and absolute terms compared to others in their respective countries) counterparts in developed countries. 

How many countries have self-financed pension schemes for informal workers? Is there any country at all that has this creature of innovation? In fact, how many examples of micro-pension business is there in any developing country? Is there any self-financing (or non-subsidised by governments) micro-pension company which has say, 100,000 regularly paying informal worker subscribers? Is there any micro-pension company in any country which has been in existence for even 10 years? Do we have entrepreneurs offering micro-pensions to the legions of part-time or contractually (hourly-wages) employed workers (say, McDonalds and Walmart workers), who form a very big share of the labour force in the US? Do we have impact investors offering financing for such entrepreneurs? If not, why?

This is a bit like Lant Pritchett’s example of women in rural India asking him how the women Self Help Groups were in the US! 

Even if we set aside the philosophical objection, there is the question of its financial viability. In order to be sustainable, a micro-pensions entity has to overcome the following constraints.

1. The country should have deep enough long-term investment opportunities. Pension funds will have very strict and low regulatory limits on equity exposure and that too to highly rated ones too. But in low income countries the supply of such instruments which are not very risky and which can generate a significant return (to cover inflation, costs and returns) is likely to be limited.  

2. These micro-instrument agencies are unlikely to have the expertise to manage these funds internally in a manner as to generate the required returns, thereby necessitating outsourcing of funds management responsibilities to asset managers, with the attendant high management cost. This is a problem for even established microfinance NBFCs in mature markets like India. 

3. Since poor people are unlikely to be able to make certain in-payments for long periods (and in case of micro-pensions are also likely to withdraw money at the earliest opportunity), the entity offering such instruments may have to offer the product with flexible terms. This would seriously limit the flexibility of its investment options.

4. Minimise customer acquisition and retention costs, as well as ensure reasonable average savings inflows for each customer, and that too among the most financially vulnerable groups of people

5. Overcome the business longevity risk and remain a going concern for a long time, in the range of decades, a critical determinant for a business like insurance/pensions. It is also not for no reason that large legacy institutions are, for good or bad, the ones who have been successful with penetrating the insurance and pensions market in developing countries. Successful pension and insurance companies don’t suddenly emerge overnight and grow big. The entry barriers are very high. They have to piggyback on existing credible platforms. 

6. Finally, as discussed earlier, success of these instruments will have to overcome the large body of evidence on poor people being unable to accumulate large amounts in cash (as against physical assets like house, livestock, gold etc), even through small periodic cash savings, required to sustain a pension or insurance scheme. 

There are the following costs associated with these constraints and the final investment returns have to offset them

1. Cost of routine operations (acquiring, retaining pensioners etc)

2. Outsourced asset manager cost (even if done in-house, the costs can be prohibitive, in terms of attracting and retaining talent etc)

3. Costs due to uncertain inflows and outflows associated with the nature of customers 

4. Reasonable profits for the entity

5. Inflation – typically high in all low income countries

In a typical case, the first four alone will aggregate to 10-15% returns, if not more. Add in a 10% inflation rate, and we are looking upwards of 20-25% rate of return over a very long-term for this to be commercially viable as a micro-pension entity. Can we imagine the enormity of this challenge? How many such asset managers (or any kind, much less those dealing with low risk instruments/asset categories) are there in any developing country who can generate such returns? And all this out into the future? 

As an illustration of a micro-pension program, MicroSave has this nice illustration of the Abhaya Hastham program of the Government of Andhra Pradesh for women self-help group members, which pays out Rs 500-Rs 2200 per month (depending on the age of enrolment, and in today's nominal rupee) by saving Rs 1 per day (or Rs 365 per year). As the graphic below shows, when the program reached 4 million clients, it required very significant top-up by government required to make it sustainable. 
Whatever the wonders of technologies like digital money and blockchains, we cannot escape the bitter reality that poor people have hardly anything to save. It is a constraint which cannot be relaxed. I cannot imagine that we are helping the poor by making them cut back on their basic human necessities to save penurious amounts for their old age. And that too by asking them to trust a financial model which does not stand the test of even a cursory scrutiny. 

The micro-pensions fad is yet another example of the unfortunate digression away from serious  debates on important development challenges like, in this case, fiscally sustainable and incentive compatible social safety nets. 

1 comment:

KP said...

Dear Gulzar,

This reminds me of an old argument about "pricing" services at government hospitals at "market" rates - which conveniently forgot that Willingness to Pay / Capability to Pay are the constraints in being poor. ( I cannot locate my old posts on your site,relating to this, however).

With our focus in these schemes being the much touted maxims of "moral hazard" and "adverse selection" - we have acquired a disciplinarian's attitude towards the provision of these services - trying to create a criteria for deserving. In a focauldian manner, disciplining those poorer is almost a unsaid rule in every market based policy, which remains the defacto principle in operation.

That said, in practical terms, we need to decide what the basket of rights / services of the pensioners are so that the state can cater to these within and with adequate market based choice.

These questions acquire an urgency - because market based individualism has broken down societal structures and our demographic dividend will very soon hurtle towards a demographic obligation of gigantic proportions.

Enjoyed your post.

regards, KP.