Social Security in Ghana

MPSM609

Lecture 4

By Stephen A. Yeboah

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Universal Programs
Universal programs provide social welfare benefits to all legal residents.
These universal programs share several characteristics with social insurance:
 Benefits are prescribed in law and
 Participation is compulsory.

They differ in other important ways.

 Financing for universal programs usually comes from general revenues;
 Eligibility is tied to residence rather than previous earnings or contributions;
 Financing for the program is not planned for separately from the planning for other types of government
expenditures.
 Since there is no separate financing arrangement, there is no possibility of advance funding through accumulation
of reserves.

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Other types of pension schemes in the country

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Other types of pension schemes in the country

GHANA UNIVERSITIES
CAP 30 SUPERNUATION SCHEME

GUSS

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 GHANA UNIVERSITIES SUPERNUATION SCHEME

GUSS
Established on 1st January 1976

Institutional Membership
i. University of Ghana, Legon (Act 79, 1961)
ii. University of Science of Science and Technology, Kumasi (Act 80, 1961) now KNUST
iii. University of Cape Coast, Cape Coast (Act 390, 1971)

Non-University Institutional Membership

i. Ghana Atomic Commission Act 204, 1963
ii. Council for Scientific and Industrial Research, NLCD 293, 1968
iii. National Council for Higher Education, NLCD 401, 1969
iv. Ghana Standards Board, NRCD 173, 1973
v. The Environmental Protection Council NRCD 239, 1974
vi. Ghana Institute of Management and Public Administration, SMCD 14, 1976

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Financing for social protection

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 Financing for social protection

There are different sources of financing for social protection. These include:
 Aid from international donors,
 Revenues of national governments,
 Private,
 Community,
 NGO financing,
 Household saving
 Out of pocket expenditures.

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 Options to finance social protection
There is a wide variety of options to expand fiscal space and generate resources for social protection, even in the poorest
countries. Specifically, seven financing options have been identified, all supported by policy statements of the international
financial institutions and the United Nations. Governments around the world have applied these options for decades (IMF,
2016; Roy et al., 2007; Heller, 2005). These seven options to expand fiscal space are:

1. Extending social insurance coverage and contributory revenues. Social security contributions paid by workers and
employers play a crucial role in financing social protection. The flow of contributions generated by social security systems
is generally the most important option to extend fiscal space.

Most countries in the world have some form of contribution-based social insurance system, covering a wide range of
policy areas such as employment-related protection (i.e. unemployment and employment injury protection), family and
children protection, old-age and disability pensions, and health insurance, among others.

Many Emerging Market Economies (EMEs) are successfully extending social security coverage by adapting contributory
mechanisms to facilitate the coverage of workers in non-standard forms of employment and in informal jobs, increasing
contributory revenues and progressing toward formalization of those in the informal economy.

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2. Increasing tax revenues. Taxes are the main source of funding for social assistance programmes and non-contributory
social protection policies for those who cannot contribute. Tax revenues can be achieved by modifying/altering different
types of tax rates – e.g. on income, consumption, corporate profits, financial activities, property, imports/exports, natural
resources – or by strengthening the efficiency of tax collection methods and overall compliance. Tax measures that are
regressive or jeopardize inclusive development should be avoided.

 Most AEs allocate resources to non-contributory social assistance from general tax revenues.
 Many developing countries are also using taxes to finance social protection: for example, Bolivia, Mongolia and
Zambia are financing universal pensions, child benefits and other schemes from mining and gas taxes (ILO, 2016a).
 Ghana, Liberia and the Maldives have introduced taxes on tourism to support social programmes.
 Gabon has used revenues from VAT on mobile communications to finance its universal health-care system.
 Algeria, Mauritius, and Panama, among others, have complemented social security revenues with high taxes on
tobacco;
 Brazil has introduced a temporary tax on financial transactions to expand social protection coverage (ILO, 2016b).
 Other countries use revenues from lotteries to supplement social security spending (e.g. China’s Welfare Lottery or
Spain’s ONCE Lottery for the social inclusion of the blind).
 China introduced residential property taxation in 2011, aimed partly at reining-in speculation and strong price
appreciation in the property sector, and partly to address the country’s widening wealth gap and provide local
governments with a significant revenue source.
 Mexico passed a significant tobacco tax increase in 2010; the government succeeded due to a well-coordinated
campaign by tobacco control advocates.

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3. Reallocating public expenditures to social protection objectives. It includes assessing ongoing budget allocations
through public expenditure reviews, social budgeting and other types of budget analyses; replacing high-cost, low-impact
investments with those with larger socio-economic impacts; and eliminating spending inefficiencies; and/or tackling
corruption. For examples, many EMEs have reduced or eliminated fuel subsidies and used the proceeds to extend
social protection programmes.

For example,
 Costa Rica and Thailand have reallocated military expenditures to universal health (Duran and Pacheco, 2012;
Global Partnership for Universal Social Protection, 2016).
 Ghana, Indonesia, Iran and many other developing countries have reduced or eliminated fuel subsidies and used
the proceeds to extend social protection programmes.
 Starting in 2005, Indonesia gradually phased-out its fuel subsidy, while extending social services, including cash
transfers.

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 Options to finance social protection
4. Managing debt, by borrowing or restructuring existing debt. It involves active exploration of domestic and foreign
borrowing options at low cost, including concessional, following careful assessment of debt sustainability.
For countries under high debt distress, restructuring existing debt may be possible and justifiable if the opportunity
cost in terms of worsening deprivations of vulnerable groups is high. More than 60 countries, including Advanced
Economies (AEs) and EMEs, have successfully re-negotiated debts, some directing debt servicing savings to social
programmes.

In recent years, more than 60 countries including Advanced Economies (AEs) and EMEs, have successfully
renegotiated debt and over 20 (e.g. Ecuador and Iceland) have defaulted on or repudiated public debt, directing debt
servicing savings to social protection programmes.

These sources of finance can be complemented by the following additional options:

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 Options to finance social protection

5. Using fiscal and central bank foreign exchange reserves. This includes drawing down fiscal savings and other
state revenues stored in special funds, such as sovereign wealth funds, and/or using excess foreign exchange
reserves in the central bank for domestic development.

Chile, Norway and Timor Leste, among others, are tapping into fiscal reserves for social investments; Norway’s
Government Pension Fund Global is perhaps the best-known case.

6. Eliminating international illicit financial flows. By cracking down on money laundering, bribery, tax evasion, trade
mispricing and other financial crimes that are both illegal and deprive governments of revenues needed for social
protection and the SDGs.
Estimated at more than ten times the size of all development assistance, a colossal amount of resources illegally escapes countries
each year. To date, little progress has been achieved, but policy-makers can devote greater attention to cracking down on money
laundering, bribery, tax evasion, trade mispricing and other financial crimes that are both illegal and deprive governments of revenues
needed for social protection and the SDGs.

7. Adopting a more accommodating macroeconomic framework. Entails permitting higher budget deficit paths
and/or higher levels of inflation without jeopardizing macroeconomic stability.

A significant number of developing countries used deficit spending and more accommodating macroeconomic
frameworks during the global recession to attend to pressing demands at a time of low growth and to support
socio-economic recovery

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 Options to finance social protection

 Options should be carefully examined, including the potential risks and trade-offs.
 Most governments adopt a mix of these policies.
 National social dialogue is best to generate political will and articulate optimal national solutions in macroeconomic,
fiscal and social protection policies.
 Other crucial policy issues on social protection financing include:
 The important role of social contributions as a source of financing,
 complementing general taxation;
 extending social security coverage to those in the informal economy through specific strategies;
 the advantage of systems based on solidarity and collective financing for sustainability and equity;
 the role of the State as the financial guarantor of last resort;
 the need for designing financially and economically sustainable systems;
 tackling gender inequalities;
 the importance of social dialogue,
 transparency in governance, and
 sound financial and administrative management.

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 BASIC METHODS OF FINANCING SOCIAL SECURITY PROGRAMS
When a pension scheme is set up, one of the major questions to be resolved is the method of financing the scheme. By
this is meant the arrangement according to which resources will be raised to meet the expenditures (on benefits, and
possibly on administration as well) under the scheme, as they arise. In other words, this refers to the system governing
the amount and timing of the contributions to the scheme.

Unlike short-term benefit schemes with relatively short qualifying periods – pension schemes mature very slowly, that
is, over many decades. Therefore, the financing systems adopted have to take account of that phenomenon.

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Financing social security programs

Conceptually, there are two basic ways of financing a social security program:
(1) Payroll taxes/contributions, aimed to support provident funds and insurance programs, and
(2) Transfers from government budgets according to the social approach.

I. Provident fund method

Under the provident fund method, employees pay premiums/contributions, which, with additional contributions by their
employers, accumulate as savings for future contingencies, such as retirement. There is no pooling of risks: everyone
receives what he/she accumulates.

Examples
• Malaysia (1951),
• India (1952),
• Singapore (1955),
• Ceylon (1958),
• Nigeria (1961),
• Tanzania (1964), and
• Ghana (1965).

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 Financing social security programs

II. Insurance method

 Under the pure insurance method, participants pay premiums on their salaries and wages to cover their own risks;
there is no redistribution of wealth in the participating group.
 However, often social insurance programs involve standardization of contributions and risks so that everybody pays
the same contribution.
 The premium paid by each participant is not rigidly bound to the amount of the risk, as in private insurance, so that
the social insurance program averages the risks of all individuals.
 On the other hand, many insurance programs provide for redistribution of wealth in the participant group as in
benefiting married persons more than bachelors and low-paid workers more than higher-paid workers.
 Some redistribution results when contributions are made by temporary workers or others who do not qualify for the
benefits. Other redistribution results from the payment of benefits larger than the premiums paid, for example,
benefits to persons who join the scheme late in life.

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Financing social security programs
III. Social method
 The social method aims at providing benefits based on need and financed by those who are best able to pay.
 This system considers the financing of social security programs as a general government function supported by
general taxation, with benefits which favor the needy. Benefits, therefore, are not bound to the payment of
premiums.
 General programs financed through progressive tax systems may have merits, not only on grounds of equity but
also, when fully financed from the general budget, on grounds of lower cost in eliminating the cost of assessment
and collection of social security taxes. Costs of assessment and collection of social security taxes appear high in
some countries.
 Not all social security programs can be properly organized according to the social method.
 For some programs (e.g., work-injury and unemployment protection), it seems more appropriate to use the
insurance basis because of the high degree of risk dispersion. In fact, if these programs were financed by general
taxation, the industries with a high risk coefficient would be favored against other industries, a distortion that would
not be approvable on grounds of efficiency.
 General programs of family allowances financed out of consolidated revenues are in force in the United Kingdom,
Canada, and the Scandinavian countries, where programs cover the entire population.
 Contributory systems are in effect in most of the other European countries, in 20 French-speaking African
countries, and in some Asian and Latin American countries, such as Cambodia, Iran, Israel, Lebanon, Argentina,
Bolivia, Brazil, Chile, Colombia, and Uruguay.
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 Financing social security programs

Financing of long-term benefits

(1) Defined-benefit scheme (DB scheme)
 Periodical payments based on a set benefit formulae in the law (or regulations)
 Contribution rate set afterwards to secure long-term financing

(2) Defined-contribution scheme (DC scheme)

 Contribution set beforehand
 Lump sum payments based on the accumulated amount and investment return

Pros and cons

Defined-benefit scheme (DB scheme)
 Benefits adequacy secured and benefit predictable (except for future political risks)
 Financing challenges ahead

Defined-contribution scheme (DC scheme)

 Financing challenges only in the investment of reserves, especially in the case of promising higher investment rate of
return (RoR) than the real one.
 Benefit adequacy problem, both in terms of amount and the periodicity remains.

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 Financing social security programs

The Basic Demographic and Economic Parameters

The future course of a retirement pension scheme is determined, in the first instance, by the demographic and economic
characteristics of the population initially covered.

The two key functions which describe the demographic development of a retirement pension scheme are:
 Active population function A(t);
 Retired population function R(t).

The two key functions which characterize the financial development of a pension scheme are:
 Expenditure function B(t); (benefits expenditure in year t) which represents the amount of pension benefits received
by the retired population in the year
 Insured salary function S(t). (amount of salaries received by the active population in the year  )
 Contribution Function C(t)

For the discussion of financial systems, two additional functions are introduced:
Contribution rate function c(t) , which characterizes the financial system; such that C(t) c(t)* S(t)
Reserve function V(t), which represents the excess of inflow over outflow, accumulated in the past with interest rate i

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 Financing social security programs
The Theoretical Basis of Financial Systems
 Social security schemes, which are sponsored by national governments, are assumed to be of infinite duration,
 That is, it is taken for granted that there will be a regular flow of new entrants indefinitely into the future.
 Because of this, financial systems for social security pension schemes are based on the so-called open fund
approach, which considers the initial population and future entrants as a single group for this purpose.
 Any financial system essentially aims at achieving an equilibrium between income and outgo of the scheme - without
necessarily equating contributions to current expenditure, which is only one way of achieving the equilibrium.

Fundamental equation of equilibrium and reserve function

Any financial system aims at achieving an equilibrium between income and output of the pension scheme such that

( ) − ( − 1) = ( − 1) + c( ) ( ) − ( )
Where, ( ) is the reserve function in the year , which represents the excess of inflow over outflow accumulated in
the past with interest rate

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 Financing social security programs

The Pay-As-You-Go Financial System

Pay As You Go refers to an approach whereby no funds are accumulated or reserved in advance to meet future pension
benefits.
In a PAYG pension system the contribution rate is determined in such a way that the sum of the contributions payed in
each year is equal to the benefits payed in the same year. Alternatively, the contribution rate could be determined in
order to guarantee the equivalence between the contributions paid for a specific number of years and the pension
benefits for the same years.

The PAYG system is based on the assumption that

(t) (t) = (t) ∀, ( ) − ( − 1) = ( − 1) + c( ) ( ) − ( )

so from the equation of equilibrium we have ( ) = 0 ∀.

In a PAYG system we have for each year : ( )= ( ) ( )= ( )

This indicator is considered as the contribution rate needed for the payment of current
So that benefits on the assumption that the costs are financed from current total contributory
earnings.

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 Financing social security programs

The Pay-As-You-Go Financial System

The PAYG system is based on the assumption that

Annual Contribution Income = Annual Benefits Expenditure

That is (t) (t) = (t) ∀,

The Annual Contribution Income and the Annual Benefits Expenditure can be expressed as follows:

Annual Contribution Income = (t) (t) = (t) NC(t)*AW(t)

Annual Benefits Expenditure= B(t) = NB(t)*AB(t)

where:
NC(t): Number of contributors
AW(t): Average salary of contributors
c(t): PAYG cost rate
NB(t): Number of beneficiaries
AB(t): Average benefit

So that (t) NC(t)*AW(t) = NB(t)*AB(t)

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 Financing social security programs

The Pay-As-You-Go Financial System

Mathematically this product is equal to the ratio of total pension expenditure to total insurable earnings

Thus ∗
= 
∗

This can also be expressed further as :

∗
=  ∗
∗

∗

: Demographic ratio - the ratio of pensioners/beneficiaries to active contributors

: Financial ratio - the ratio of average pension to average insurable earnings

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Furthermore

Let E(t) be the total expenditure incurred during year t, consisting of the total benefit payment B(t) and the
administrative expenses A(t)

(i.e., E(t) = B(t) + A(t).

Since E(t) s the sum of the total benefit payment B(t) and the administrative expenses B(t), the PAYG cost rate is
written as the sum of the net PAYG rate (or PAYG benefit rate), denoted by c(t) and the PAYG administrative cost
rate, denoted by m(t).

PAYG benefit rate PAYG administrative cost rate

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 PAYGO RATES
18.0%

16.0%

14.0%

12.0%

10.0%

8.0%

6.0%

4.0%

2.0%

0.0%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Net PAGO PAYGO Benefits

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 Financing social security programs

Financing of long-term benefits

Other financing methods
Preparing for aging beforehand, by levying higher contribution rates than PAYG cost rate and relying on
investment return on the reserves as well as advance savings.

(1) General average premium / contribution (GAP) method

Constant contribution rate for a long period, sometimes assumed as forever.

(2) Scaled premium / contribution (SP) method:

Constant contribution rate (for a certain period)

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Scaled Premium System
Under this financing method, a contribution rate, called the Scaled Premium, is determined so that the contributions and
interest income are adequate to meet the expenditure over a specified period of equilibrium. When the total income is no
longer sufficient to cover the expenditure during the period, the contribution rate is raised to a new Scaled Premium for
another period of equilibrium starting from that year.

 The scaled premium system is normally applied for financing long-term benefits, i.e. pensions.
 Scaled premium systems are systems of partial funding.
 In their most generic definition, all systems of contribution rates which are increased throughout the life-cycle of a
pension scheme on a step-by-step basis (where the duration of the individual “steps", are called the periods of
equilibrium).
 In a more narrow definition (the Thullen scaled premium (TSP) ), the contribution rate is calculated for a defined period
of years, i.e. the period of equilibrium (which often ranges from 10 to 25 years), with the objective of equating at the
end of the period of equilibrium: the income from contributions and the investment income and the expenditure on
benefits and administration.
 The TSP scaled premium contribution rate must be recalculated for each subsequent period of equilibrium.
 As the necessary assumptions regarding mortality, invalidity, wages, interest and other factors are likely to
change in course of time, it is necessary, in practice, to reassess the scaled premium contribution rates even
during the period of equilibrium.

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General Average Premium (GAP)
The general average premium (GAP) system is based on the concept of a constant contribution rate
applicable throughout the subsequent lifetime of the pension scheme.
Under the General Average Premium (GAP) method/system, the contribution rate is set such that a level rate
will be payable throughout the lifetime of the scheme i.e. the present value of the benefit expenditure over the
present value of future salaries. This method is used given the need to have a stable contribution rate. The
rate required under this system is stable if the assumptions are borne out in practice.

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From the point of view of the funding level
 The PAYG system is at the lower extremity of the range of the practicable financial systems for a pension
scheme.
 It involves an almost continuous increase in the contribution rate.
 Moreover, the contribution rate will reach a relatively very high level when the scheme attains financial
maturity. Finally, practically no reserve will accumulate.
 The GAP system has the advantage of a perpetually level contribution rate, but this means that a relatively
high rate will need to be applied right at the outset.
 From the point of funding level, it is customary to regard the GAP system as the upper extreme of financial
systems applicable to social security pension schemes. Thus the system will lead to the accumulation of a
substantial reserve.

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 (Total amount of benefits in a year)
CRPAYG (PAYG contribution rate) =  ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
(Total amount of wages in a year)

(Present value of benefits for a certain period)
CRSP (Scaled premium in a period)  =  ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
(Present value of wages in a certain period)
(Present value of benefits for a long period)
CRGAP (General average premium (GAP)) =  ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
(Present value of wages for a long period)

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Advantages and disadvantages of pay-as-you-go (PAYG) pensions

Advantages
1) Simplicity and transparency
2) Low administration costs
3) Progressive redistribution
4) Wide coverage
5) Do not inhibit the mobility of labour
6) Low risk

Disadvantages
1) Budgetary burden
2) No “choice”
3) Over-commitment to a specific level of pensions
4) Resistance to tax funding
5) Sustainability

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 Advantages and disadvantages of fully-funded (FF) pensions

Advantages
1) Higher returns from professional equity investment
2) Saver has independence and choice
3) Increases savings and growth
4) Promotes the development of financial markets, and effective
5) corporate governance
6) Automatically adjusts the level of pension to available returns

Disadvantages
1) Regressive impact on the distribution of income
2) High administration costs
3) Limited coverage
4) Uncertain return (high risk)
5) Need for a social security safety net
6) In some cases limit mobility of labour (occupational pensions)

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