Military pension fund in overhaul

The Philippine''s AFP-RSBS scraps a pipedream of living off its own interest, moving towards a partially funded system.

"This is a pension fund in the making," says Cleofe Melchor, assistant vice president in the legislative reform office of the AFP Retirement and Separation Benefits System, the pension fund of the Philippine armed forces.

By that she means the AFP-RSBS is taking steps to abandon the guiding credo of the system to attain 'self-sufficiency,' so that instead of relying on government money or salary contributions from soldiers, it could live solely off its investments.

The system was founded in 1976 by a decree from then-President Ferdinand Marcos, who was in the processing of building up the armed forces and realized the need for retirement benefits. The government kicked in an initial Ps200 million and since then every active employee of the military has contributed 5% of their monthly salary. The fund has now amassed only Ps14 billion ($280 million), which has never been enough. While the pension fund has struggled to establish itself, the government defence budget has paid benefits.

Meanwhile the AFP-RSBS has stumbled with some poor investments. Initially it stuck with just government bonds, but in the early 1990s entered the roaring stock market. And in the mid-1990s, at the peak of the Asian boom, the fund dived into real estate. Today a disastrous 80% of its assets are tied up in Philippine property - golf courses, land banks, housing projects - much of which since the financial crisis has become worthless.

Even before this, the AFP-RSBS had a very long time horizon to meet its goal of sustainability: 2040. Today its managers have realized the dream is unattainable.

In the meantime, members are grumbling. For them, the system is just a tax. Upon retirement, the AFP-RSBS returns their contributions plus interest, while the government itself pays the benefits. The system faces irrelevancy.

Moreover, the pension debacle is creating an unnecessary security headache for the government. Over time, more of the 100,000-plus members will retire. At a time when the military must face threats such as Abu Sayyef and Communist insurgents, it cannot afford to have a growing share of its budget spent on pensions when it needs to upgrade its training and equipment.

The system has a few options. One is to boost performance. In the early days it outsourced fixed-income management to a few local fund managers, but in the boom years brought this function in-house. It could outsource, but at this point prefers to do so only if it invested overseas. This is allowed, but politically it is difficult for Philippine government institutions to do so, lest they face charges of giving capital to foreigners instead of investing at home.

Instead, the system wants to reinvent itself as a meaningful institution for soldiers. Unlike other government-backed pensions systems in the Philippines, the AFP-RSBS does not use its assets to provide loans to members. But members want access to their money. So the system is developing a loans programme, says Melchor.

Most likely these will take the form of salary loans so a soldier can afford education or housing for his family, or to start his own small business.

More fundamentally, the system is considering getting rid of the defined benefit, pay-as-you-go model in favour ofááa new, two-tier scheme. The first tier would consist of a fully funded DB plan, in which the government would contribute to individual member accounts designed to prevent bureaucrats or politicians from tapping them.

The second tier would be a defined contribution plan that continues the current 5% provision on members.

The AFP-RSBS is preparing a draft law to submit this year to Congress. It is also receiving support from the World Bank to research how militaries in other Asian countries finance their pension obligations. Passing the legislation will be difficult, because it requires the government to regularly contribute to the system. Nonetheless, the system itself is clearly in danger of extinction if nothing is done - and that would hand the government an even bigger bill.

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