By Simon Cawdrey, Cayman Compass Columnist
It’s time to talk about pensions again. Before going into detail, some quick reflections on why
pensions in Cayman are so dis-loved, and why the distaste is quite unique.
In most developed countries, individuals consistently contribute as much as possible into their
pensions, going right up to the legal maximum. Cayman couldn’t be more different. Here the
thought of contributing to a pension generates ennui at best and hostility at worst.
But why?
In most countries, with an income tax system, contributing to a pension is a pre-tax payment,
meaning that pension contributions reduce your tax bill while enabling you to receive tax-free
capital growth. In other words, there’s a huge economic incentive for people to contribute to a
pension – an incentive that doesn’t and can’t exist in Cayman.
Against this backdrop, it is perhaps more obvious why Cayman is in the situation it is. If people
had an economic incentive to care about pensions, they probably wouldn’t be so disliked and
there would be more concern paid to their existing flaws. As it is, despite the woeful situation of
the pension system, the regulations and the plan options available, there never seems to be
enough interest or angst to effect change. Hopefully this article can motivate more to care about something that impacts every single one of us and is, unfortunately, under-appreciated.
The basic problems
Three flaws exist in Cayman’s system:
1. Contributions are too low;
2. The retirement age is too young;
3. The regulations prevent optimal investment strategies being followed.
The result is that the government will have to fund more people as they age, which is a hidden
financial burden and not properly being accounted for (although recently acknowledged at least).
The valid counterargument (in some instances) is that many people don’t rely on the pension
system for their retirement because they have invested in property or other assets.
Good news for these people as they have taken responsibility for planning for their future and
will be better protected against the economic vagaries of retirement and have much less to worry about.
One problem with this argument is that it only applies to a tiny minority of people. A second
problem is that home ownership only helps in retirement if people are willing to sell their houses
and downsize, thereby freeing up capital, since owning a house won’t pay for groceries.
Some options
What about those who don’t self-prepare? One perfectly valid approach is for government to tell individuals they must prepare for their own retirement and then if they fail to do so, warn them, in no uncertain terms, that there will be no safety net.
In a theoretical world this approach should work. The threat of destitution later in life would be so pressing and worrisome that everyone would prudently prepare by saving money today and investing it for the future. Unfortunately, humans rarely conform to economists’ theoretical models.
What we know, all too well, from economics and psychology, is that humans are generally terrible at preparing for the future. Take a very Cayman example: We all know what hurricanes can do, yet there’s a huge rush 48 hours before any storm to stock up on non-perishables at the supermarket, instead of preparing at the start of hurricane season. Simply put, it’s because humans are bad at preparing for the future.
If we are so bad at preparing for hurricanes, which happen at predictable times of the year and with known ferocity, then it is perhaps no surprise that we are even worse at preparing for retirement. After all, no one who isn’t retired has ever experienced retirement. We have all experienced at least one hurricane season so we know what we should do, but still don’t do it. Only when we retire, can we learn to regret the decisions we made in our 20s, 30s and 40s.
But, by then, it’s far too late.
With this approach binned, we are left with two other options. One of the remaining two we shall call the “government option”. In this scenario we recognise that we are all terrible at preparing for retirement so why bother? Instead, we make it government’s problem. Government will provide a minimum level of income to ensure no one is below the ‘poverty line’ in retirement. That way the problem is managed by an entity that can take professional advice and plan for the long term.
Can you hear the alarm bells ringing?
First do you trust the government to adequately manage its affairs for the next 30 years, so your retirement is safe? Second, what if they get it wrong? Are governments such good stewards of money that this is the best option? Third, how do they pay for it? In Cayman, the majority of revenue the government collects comes in the form of tourism taxes, financial services taxes and import duty. Imagine if one of those experienced a sustained slowdown.
The ability of government to meet its obligations is dependent on factors over which it has no control. Government can’t control the number of tourists, it can’t easily control the number of people who live here and therefore import goods, nor can it control financial markets. Thus, the viability of a pension system run by the government is subject to such incredible unknowns that it seems perilous to rely on such an approach. Bear in mind the earlier point about Cayman’s government not even properly accounting, today, for its future liabilities.
Let’s return to Cayman’s current, much maligned, system
Before going there, a quick bit of maths to set the scene. Imagine you want to retire on $60,000 a year. How much needs to be in your pension account? The number, according to the actuaries, is almost a million dollars. Have a look at your pension account. Is it showing a balance of $200,000? That means you will retire on $15,000 a year. Could you possibly, in Cayman, live on that amount? Of course not! And yet, many may not even have $200,000 in their account, meaning their retirement prospects are even worse.
Many people in Cayman will retire on incomes that are woefully inadequate and suffer forms of hardship because of this. This will force the government to help out with ex-gratia payments or subsidies. But those subsidies are not accounted for by the government. They are not remotely in the government’s forecasts because this is often considered a ‘private sector problem’. But poverty, caused by poor government policy, can’t simply be washed away as being a problem for the private sector. Private sector employees vote, too, and if poor and retired, they will demand government support. Therefore, we need to fix the current system since government won’t be able to afford to fix the future problem.
Read full article here: Cayman Compass
Simon Cawdery, CFA, is an investment manager and governance professional who lives and works in the Cayman Islands. He writes regularly for the Compass on business and finance matters.