Informal Sector Pensions: Protecting millions of East Africans from old-age poverty
By Joseph Lutwama.
It is everyone’s desire to retire with a roof over their head and a decent income that will sustain them through their old age. However, very few ever realize that ideal, and it remains a dream that eludes millions in the region. Many East Africans never retire but die while toiling away as their productivity decreases. Economists and financial experts tell us that it is possible for one to save for retirement, and if those savings are invested well, they stand a better chance of reducing their old-age vulnerability and living their retirement dream. However, this is not the case in East Africa. Kenya, which has the highest pension sector coverage, sees only two out of every 10 working adults save for retirement. What could explain this paradox? In East Africa, the pension system is predominantly focused on the formal sector, leaving the informal sector largely unattended to. With levels of informal employment in East Africa as high as 91 percent, it follows that there would be such low levels of formal retirement savings.
According to the recently released World Bank publication Pension Systems in East Africa: A Deep Dive, there are five fundamental aspects that need to be addressed if the current formal pension systems across the East African Community (EAC) are to extend their frontiers to the informal sector. These are strengthening national identification systems, the business model, the payment mechanism, financial literacy, and government support. My chapter on East Africa’s experience with retirement schemes for the informal sector explores the challenges and opportunities of extending pension coverage to the informal sector from a regional perspective.
Let’s begin with the first dimension – identification. Increased access to formal pensions starts with a robust uniform national identification system. Electronic-Know Your Customer (eKYC) systems which allow for real time authentication and validation can further enhance this. These two systems will reduce the cost and time spent signing up new retirement savers, making it more profitable to provide services to low-income customers in the informal sector. All EAC countries have a national ID system, albeit at different levels of development, and except for Burundi all the EAC countries have digitized their national ID systems.
The current business model of formal pensions, which is the second dimension, where the saver’s contributions are matched by their employer’s contribution needs to be revisited. Such a model cannot work for the informal sector where most of the potential savers are self-employed, with low, irregular incomes. Voluntary schemes, which were aimed at mitigating these challenges, lack enforcement and incentives, reducing their effectiveness. One possible approach that could align pension products with customer behavior in the informal sector is to bundle formal pension plans with similar flexible products that are widely consumed by the target customer.
In most cases, the pension product will be offered as part of a customer retention strategy other than a direct product to the customer. This is the same principle occupational pension schemes follow where employees receive retirement savings from their employers if they continue to work for them. For example, if a microfinance bank which offers micro-credit products to clients in the informal sector entered a partnership with a pension fund manager, it could offer a pension plan to its clients who take loans of a certain size or duration. In this case as is the case with occupational pension schemes, the customer will continue to receive retirement savings as long as they continue to take out loans or other financial products from the microfinance bank.
The wide use of mobile money in East Africa presents an opportunity of a more accessible and affordable payment channel for formal pension products to the informal sector. Mobile Money Service Providers also provide a wealth of information about the customers that pension service providers can leverage to design more appropriate pension products for the informal sector.
Holistic financial literacy programs which go beyond public awareness and address issues of financial management, investment advice seeking, planning for the future, and making choices between different financial products will also be critical to increasing the levels of access to formal pensions to the informal sector. One of the reasons why many financial literacy programs are not yielding results is because they only focus on awareness rather than equipping the customer to make financial decisions.
Finally, given their low-income levels and intermittent cash flows, potential customers from East Africa’s informal sector may not sustainably contribute toward their retirement savings without a boost from their respective governments. In East Africa, Rwanda has taken this route, increasing monthly pension payouts across various categories of retirees. And while it is still early to assess the impact of this approach, it provides a practical blueprint applicable across the region. However countries model their social protection programs to guarantee long term economic resilience, micro-pension schemes remain a promising pathway to secure our elderly.
Joseph Lutwama is the Director of Programs at Financial Sector Deepening (FSD) Uganda.