Bahrain’s Social Insurance – Part 2: How Do We Get Out of This Mess?

pensions

In our previous article, we listed the main reasons behind the deficit being faced by Bahrain’s Social Insurance Organization. We are now going to discuss the remedies being discussed by Parliament and the Shura Council to resolve the issue.

In order to put things into perspective, we need to get some figures from the SIO’s latest statistical report which could be found on their website. According to the report, the average age of insured Bahraini males working in the private sector is 34 years old and their average salary is 729BD. The average age of private sector employees going into retirement is 48 years old and their average pension is 638BD. Therefore, in order to make things simple, let’s take the example of Mohammed who is a 34-year-old Bahraini male earning a salary of 729BD. Mohammed already has 7 years of service under his belt and is planning to retire at the age of 48 and is expected to receive a monthly pension of 638BD. He is expected to live until the age of 78 so he will be receiving a monthly pension for a total of 30 years.

Bearing in mind that the SIO receives 18% average salaries as contributions to the retirement plans (12% from the employer and 6% from the employee – 1% from the employee goes to the unemployment fund), how many employees are required to cover Mohammed’s retirement salary?

To answer this question, we simply have to multiply the average salary by the percentage of contributions for 20 years and then divide Mohammed’s monthly pension for 30 years by the resulting figure.

729 x 18% x 12 x 20 = 31,492.800 BD

(30 x 12 x 638) / 31,492.800 = 7.293 employees

So we will need 8 employees to cover the pension that is going to be paid to Mohammed. Accordingly, we should expect the number of contributors to be eight times the number of pensioners in Bahrain. The reality of the matter is however, we have 92,657 registered contributors in Bahrain while there are 30,477 pensioners. This is a ratio of roughly 3:1 rather than the required 8:1.

To solve this dilemma, we should explore all viable options.

Option 1: Increase Pension Contributions

Let’s assume that we decide to increase pension contributions from the current 18%. How much should we increase it by?

Solving for the pension contribution in the previous example, we get the following equation:

(30 x 12 x 638) / (729 x ? x 12 x 20) = 3 employees

The required contribution percentage would be 43.75%!

Taken on its own, this is clearly not a viable option.

Option 2: Reducing the Pension Salary

Parliament and the Shura Council are currently discussing reducing the pension salary by 10%. The proposed schedule for pension salaries according to the number of years in service is tabulated below.

Years of Service Current Pension Salary as a Percentage of Employee Salary Proposed Pension Salary as a Percentage of Employee Salary
20 40 36
25 50 45
30 60 54
35 70 63
40 80 72

 

Now let’s try to calculate the pension that the SIO’s fund will be able to sustain in light of the current challenges.

Solving for the pension salary in the Mohammed’s example results in the following equation:

(30 x 12 x ?) / (729 x 18% x 12 x 20) = 3 employees

Solving for the pension salary we find that it will have to drop from 638BD to 262BD! This is a drop of around 59% whereas the proposed reduction is merely 10%. Clearly, this won’t be enough to cover the deficit if implemented on its own.

Option 3: Increase the Minimum Required Years to Retirement

This option, although clearly not preferred by employees, could have the greatest impact. Not only will we increase contributions, but we will also reduce the years of pension payments. Solving for the increase in number of years generates the following equation:

((30 – ?) x 12 x 638) / (729 x 18% x 12 x (20 + ?)) = 3 employees

The resulting increase in number of years is 11. So instead of allowing Mohammed to retire at the age of 48, he will only be able to retire at the age of 59 – basically eliminating the option of early retirement. This is inline with what the Shura Council and Parliament are discussing however it will undoubtedly increase the unemployment rate in Bahrain since the rate of new retirees is positively correlated to the number of new job vacancies in the market.

 

The Easy Way Out

There is always the option of having the government bridge the gap in deficit, the question that has to be asked is how? The slump in oil prices hit Bahrain hard and the small island kingdom is now facing the very real risk of devaluating its currency as its foreign exchange reserves are currently covering only around one month of goods and services imports.

Sure, there might be a light at the end of the tunnel with the prospects of shale oil over the horizon. However, until that is certain, Bahrain will depend on the soon-to-be introduced VAT in order to meet its financial obligations, develop its infrastructure, and even finance its shale oil refinery. Should the government start diverting VAT revenue towards financing collapsing schemes such as the SIO’s pension fund would exhaust this resource and force us all to forego the many benefits that would have been gained.

Conclusion

Poor funding positions, insufficient contributions, expensive benefits and increasing economic and demographic pressures mean that the current pension scheme is unsustainable. Pension benefits are generous and contributions have been set years ago without actuarial consideration. All of the remedies presented in this brief study are bitter to say the least and would only put a band aid on a gushing wound. The pension fund is in dire need for reform and the government has 3 levers to play with in their path to reform:

  1. Increase contributions
  2. Reduce benefits
  3. Delay benefits

All options are equally difficult to implement without social, political, and financial implications.

In our next article, “Bahrain’s Social Insurance – Part 3: Complete Overhaul”, we will discuss out-of-the-box solutions that have not been discussed by the legislators to resolve the Pension Fund problem.

Written by:
Munther Al-Arayedh, MBA, CPA

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