Contribution Of Pension Industry Investment To Capital Formation In Nigeria (2007 – 2020)

Project and Seminar Material for Economics

Abstract

This study examined the contribution of pension industry investment to capital formation in Nigeria. The study spanned from 2007-2020 which is 13 years study. The independent variables used for the study are total contribution, return on investment, administrative cost and pension savings while the dependent variable is Gross capital formation. Time series data obtained was from World Bank Development Indicators, National Bureau of Statistics and Central Bank of Nigeria Statistical Bulletin (2020). The result shows that the p-value of total contribution (TC) is 0.949, return on investment (ROI) is 0.005, administrative cost (AC) is 0.011 and pension savings (PS) is 0.000. All the independent variables (ROI, AC, PS) have significant effect on Gross capital formation in Nigeria because their p-value are less than 5% significant level except total contribution (TC) which is greater than 5% significant level. The normality test suggest that the series distribution is normal as the p-value is 0.684 which is greater than 5% significant level, we accept H0 which states that the residuals are normally distributed and it is desirable and further connote that the influence of other omitted and neglected variables is small and at best random. The study concludes that pension reform have significant effect on capital formation in Nigeria.

Table of Content

Chapter One

1.0 Introduction

1.1 Background to the Study
1.2 Statement of the Problem
1.3 Objectives of the Study
1.4 Research Question
1.5 Research Hypothesis
1.6 Significance of the Study
1.7 Scope of Study
1.8 Limitation of the Study
1.9 Definition of Terms
1.10 Organisation of the Study

Chapter Two

2.0 Literature Review

2.1 Conceptual Framework
2.2 Concept of Capital Formation
2.3 Pension Reform
2.4 Divisions of the Pension Scheme
2.5 Types of Pension Reform Options
2.6 The Problems and Challenges of Pension Fund in Nigeria
2.7 Contribution of the Pension Fund Scheme
2.8 Theoretical Framework
2.8.1 The Chilean Model
2.9 Empirical Review

Chapter Three

3.0 Research Methodology

3.1 Research Design
3.2 Model Specification
3.3 Method of Data Analysis
3.4 Nature and Source Of Data
3.5 Apriori Expectations

Chapter Four

4.0 Results and Discussion

4.1 Result
4.2 Discussion Of Results

Chapter Five

5.0 Summary, Conclusion and Recommendation

5.1 Summary
5.2 Conclusion
5.3 Recommendation
References

Chapter One

1.0 Introduction

1.1 Background to the Study

Capital formation (physical capital stock) matters for the rapid economic development of any country (Shuaib &Dania, 2015). However, economic development may be measured through building of capital equipment on a sufficient scale to increase productivity in agriculture, mining, plantations and industry on the one hand. While on the other, capital is required to construct schools, hospitals, roads, railways, standards of living, research and development (R & D), etc. (Jhingan, 2006; Ainabor, Shuaib & Kadiri, 2014).

Gross capital formation leads to technical progress which helps realize the economies of large scale of production (or economies of scale or operation) and/or increases specialization, in terms of providing machines, tools and equipments for growing labour force. Thus, the accumulated capital enables the acquisition of new factories alongside with machinery, equipment and all productive capital goods. In addition, to the construction of capital or mega projects and/or utilize (diverting) the gross capital formation into educational sectors, health sectors, etc.

Capital formation is analogous (or prerequisite) to an increase in physical capital stock of a nation with investment in social and economic infrastructures. Gross fixed capital formation can be classified into gross private domestic investment and gross public domestic investment. The gross public investment includes investment by government and/or public enterprises. Gross domestic investment is equivalent to gross fixed capital formation plus net changes in the level of inventories. Capital formation perhaps leads to production of tangible goods (i.e., plants, tools & machinery, etc) and/or intangible goods (i.e., qualitative& high standard of education, health, scientific tradition and research) in a country.

Pension has increasingly attracted the attention of policymakers in many countries as a means of facilitating privately funded retirement income savings by an ageing workforce (World Bank, 1994).Many countries have opted for various forms of contributory pension scheme where employers and their employees are supposed to pay a certain percentage of the employee’s monthly earnings to a retirement savings accounts from which they would be drawing their pension benefits after retirement. Besides pension funds are now among the most important institutional investment in the world capital markets (Klumpes and Mason, 2000). Nigeria adopted for the contributory pension scheme following her pension’s reform in 2004.

Pension is the amount paid by government or company to an employee after working for some specific period of time, considered too old or ill to work or have reached the statutory age of retirement. It is monthly sum paid to a retired officer until death because the officer has worked with the organization paying the sum (Adam, 2005). Pension is also the method whereby a person pays into pension scheme a proportion of his earnings during his working life. The contributions provide an income (or pension) on retirement that is treated as earned income .This is taxed at the investors’ marginal rate of income tax. On the other hand, gratuity is a lump sum of money payable to a retiring officer who has served for a minimum period of term year (now five years). A greater importance has been given to pension and gratuity by employers because of the belief that if employees’ future needs are guaranteed, their fears ameliorated and properly taken care of, they will be more motivated to contribute positively to organization’s output. Similarly various governments’ organizations as well as labour union have emphasized the need for sound, good and workable pension scheme (Adebayo, 2006).

Globally pension industry had undergone a series of reforms during the last two decades, as it is considered as a catalyst of economic growth and development. These reforms are largely necessitated by the increase in the population ageing and shortcomings of old age support mechanisms. The main objective of the reforms in pension industry is to ensure income security in old age at a least cost manner (Davis 1998), the also targeted some macroeconomic benefits including aiding labour and financial markets developments. The resultants quality labour and efficient capital market are expected to facilitate economic growth and provide adequate resources for the elderly population in the economy without an undue burden on the working population.

In realizing the pension goals, pension industry initially relied upon pay-as-you-go (PAYG) scheme which seems cheap as there are few retirees then; however, costs rise while the population ages and hence the dependency ratio rises faster than the passivity ratio. PAYG is therefore criticised for being vulnerable to the effects of population ageing, this makes PAYG engender economic distortions and unsuitable for retirees situations like early retirements, disability pensions, evasion and disincentive to save (Davis, 1998). On the contrary, the current funded scheme offers better labour market incentives as well as aiding the development of financial markets.

In Nigeria, Pension Reform Act 2004 (PRA) was signed into law together with the Pension Reform Act 2014 and it is in effects. The act which introduced the New Contributory Pension Scheme and covers employees in the both public and private sector. Under the scheme, each employee and employer contribute a minimum of 7.5% of the employee‟s monthly emoluments but in the Military, an officer contributes 2.5% while the employer contributes 12.5%. An employer may elect to contribute on behalf of the employees provided that the total contribution shall not be less than 15% of the monthly emoluments of the employees. The scheme also allows for voluntary contributions to be made by employees (including those exempted by the Act) that could only be taxed at the point of withdrawal where the withdrawal was made before five years from the date the first voluntary contribution was made.

The new pension scheme in Nigeria is fully funded, meaning that the contribution of an employee is deducted monthly from the employee‟s salary while the employer will provide the counter-part contribution for the employee, which will both be transferred to the relevant retirement savings account. Thus, the pension assets are kept aside from the onset to meet future pension liabilities, and that every employee is required by law to open a Retirement Savings Account (RSA) in his name with a Pension Fund Administrator (PFA) of his choice. The act also required and specified that the pension funds assets collected are to be invested in securities and stocks from which the returns accrued to the retirees. According to the pension commission (2016), the pension industry witnessed 1.75% growth in the scheme membership during the first quarter of 2016, from 6,950,503 contributors at the end of the 2015 to 7,071,791 at the end of 2016 first quarter. The expansion in industry membership according to the commission was driven by Retirement Savings Account (RSA) Scheme. RSA scheme had an increase of 121,338 contributors representing 1.76% percent whereas membership of the Closed Pension Fund Administration Scheme (CPFA) declined by 50 representing 0.21% of the total members of the scheme, while the Approved Existing Scheme (AES) membership remained unchanged. Similarly, the total monthly pension contribution made by contributors from both the public and private sectors into their RSAs was N3.55 trillion as at the end of first quarter 2016. This shows an increase of N120.51 billion representing 3.51% over the total contributions as at the end of the 2015. A review of the aggregate total contribution shows that the Public Sector contributed 53.45 percent of the total contributions, while the Private sector contributed the remaining 46.55%.

While there is substantial amounts of pension fund assets in Nigeria, there was strong demand for investigation into how the investments of pension assets affect economic growth and development and capital market in particular. For instance, Henshaw (2012) argues that pension funds investment could provide long term funds for economic and social development of the country. In view of this, there are some challenges in respect of pension funds‟ assets an investment in Nigeria, which is one of this major challenges is the dearth of investment outlets. The commission also linked this challenge to the recapitalization program of the financial sector (banks, insurance companies and stock broking companies), while the Nigerian capital market is still under developed (Pencom, 2008).

For example, Tsado and Gunu (2011) pointed out that top twenty companies in the capital market have more than 70% of the total market capitalization, necessitating a pool of pension funds chasing few quality investments. However, this study is of the view that pension fund investments contribute to the capital market performance, a subject which received little attention from the academia. This therefore constituted the research gap fill by this study.

1.2 Statement of the Problem

Nigeria’s pension reform of 2004 was necessitated by the myriad of problems that plagued the “pay-as-you-go” schemes in the public sector and the varying types of pension schemes that existed within the private sector, which resulted in retirees not getting their benefits. The Pension Reform Act (PRA 2004), the subsequent review and enactment of PRA 2014, introduced the Contributory Pension Scheme (CPS), which made it mandatory for employers and employees in both the public and private sectors to contribute towards employee retirement benefits. The new pension scheme introduced a tripartite system with three key autonomous players: the regulator, the administrator and the custodian to minimize the possibility of misappropriation of pension funds.
In Nigeria, the reform was done because the pension schemes were faced by many problems. This as stated by Mschelia are “the public pension’s pay-as-you-go was un-funded, weak, inefficient, less transparent and cumbersome and the private sector schemes had been characterized by very low compliance ratio largely because they were neither regulated nor supervised”.

It is anticipated that growth will materialize if three key challenges plaguing the scheme are overcome, which are: Benefit Adequacy: Will the Nigerian worker on retirement receive adequate benefits such as to achieve the goals of the pension reforms? Coverage & Compliance: Do all Nigerian workers have access to the CPS and does it cover the most economically vulnerable groups? Have all who are meant to comply under the provisions of the PRA 2014 done so? Financial Sustainability: Can Nigeria fulfill its responsibilities in managing the CPS in the short, medium and long term? Can it fulfill the financial commitments associated with the transition from the previous pay-as-you-go scheme to the new contributory pension scheme? This examines the effect of the various pension reforms on capital formation.

1.3 Objectives of the Study

The aim of this study is to examine the contribution of pension industry investment to capital formation in Nigeria (2007 – 2020). Specifically, the objectives of the study include to;

To determine the relationship between Pension Gross Savings and capital formation in Nigeria
To determine the impact of Return on Investment on capital formation in Nigeria
To determine the impact of Administrative Coston capital formation in Nigeria
To determine the impact of Total Contribution on capital formation in Nigeria

1.4 Research Question

The following research questions are formulated to guide this research:

What is the relationship between Pension Gross Savings and capital formation in Nigeria?
What is the impact of Return on Investment on capital formation in Nigeria?
What is the impact of Administrative Cost on capital formation in Nigeria?
What is the impact of Total Contribution on capital formation in Nigeria?

1.5 Research Hypothesis

HO1: There is no significant influence of pension industry investment on capital formation in Nigeria.
HA1: There is a significant influence of pension industry investment on capital formation in Nigeria.

1.6 Significance of the Study

The research is systematically meant to be practical and educative in the sense that it is going to assist in exposing some of the challenges and prospect in management of pension fund in Nigeriaand its contribution to capital formation in Nigeria. Essentially, this work is a step in a right direction to assist and enlightened the general public and the stakeholders in the pension scheme.

Furthermore, employers of labours and the employees (which include those still in the service and those who have retired from service) the pros and corns of investment in pension fund and the benefits of contributing to the scheme. This research work will equally serve as a guide for those in academic institutions, the regulatory authorities, the government and the banking industry, other areas that needed adjustment in the scheme that will benefit the workers at the old age, so as to actualize the motives of establishing the board, this will add more knowledge to those in the field of research and improve more literature in the field.

Finally the study is aimed at been beneficial to policy makers, corporate and non-corporate organizations in Nigeria on how many invested in the possession fund scheme are been utilized and invested.

1.7 Scope of Study

The study is designed to examine the contribution of pension industry investment to capital formation in Nigeria. The study covers the period from 2002 to 2020. The variables used were Gross capital formation (GCF) which represents the dependent variable, Total Contribution (TC), Return on Investment (ROI),Administrative Cost (AC), and Pension Gross Savings (PS).

1.8 Limitation of the Study

In the course of this study, the researcher encountered some limitations. There was paucity of data relevant to the completion of this work, hence, the researcher had to make use of secondary data sources that were verified and approved for use such as the National Bulleting of Statistics, and the Central Bank of Nigeria. Also, the researcher faced time constraints and had to combine the research with other academic activities and coursework. Also, the study considered four independent variables without considering other proxies that influence capital formation, hence, the result may be different if other variables were to be added.

1.9 Definition of Terms

Pension:

A pension is a retirement fund for an employee paid into by the employer, employee, or both, with the employer usually covering the largest percentage of contributions. When the employee retires, she’s paid in an annuity calculated by the terms of the pension.

Pension Investment:

A pension investment is a pool of money that is to be paid out as a pension when employees retire. Pension funds invest that money to multiply it, which will potentially provide more benefit to the retirees.

Capital Formation:

Capital formation is a term used to describe the net capital accumulation during an accounting period for a particular country. The term refers to additions of capital goods, such as equipment, tools, transportation assets, and electricity.

1.10 Organisation of the Study

This study is organized into five chapters.

Chapter one included the background of the study, research problem, research objectives and questions as well as limitation of the study.
Chapter two contains the literature review.
Chapter three includes the methodology.
Chapter Four contains the results and discussion of key findings of the study.
Chapter Five finally looks at the summary, conclusions, and recommendations based on the findings.

Chapter Five

5.0 Summary, Conclusion and Recommendation

5.1 Summary

This study was conducted to examine the contribution of pension industry investment to capital formation in Nigeria (2007 – 2020). This study showed that

H01: Total contribution does not have significant effect on Gross capital formation in Nigeria.The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of total contribution (TC) is 0.949 which is greater than 0.05 significant level, thereby the null hypothesis is accepted that total contribution (TC) have significant impact on gross capital formation in Nigeria.

H02: Return on investment does not have significant effect on Gross capital formation in Nigeria.The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of return on investment (ROI) is 0.005 which is less than 0.05 significant level and greater than 95% confidence level, thereby the null hypothesis is rejected and the alternate is accepted that return on investment (ROI) have significant impact on gross capital formation in Nigeria.

H03: There is no significant relationship between administrative cost on Gross capital formation in Nigeria.The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of administrative cost(AC) is 0.011 which is less than 0.05 significant level and greater than 95% confidence level, thereby the null hypothesis is rejected and the alternate is accepted that administrative cost (AC) have significant impact on gross capital formation in Nigeria.

H04: Pension savings does not have significant impact on Gross capital formation in Nigeria. The ordinary least square (OLS) result in table 4.2.2 connote that the p-value t-stat of pension savings(PS) is 0.000 which is less than 0.05 significant level and greater than 95% confidence level, thereby the null hypothesis is rejected and the alternate is accepted that pension savings(PS) have significant impact on gross capital formation in Nigeria.

5.2 Conclusion

Based on the Summary of Findings, the following are the conclusion: The Ordinary Least Square (OLS) test conclude that total contribution has negative relationship on capital formation and also does not have significant impact on capital formation in Nigeria. Return on investment, administrative cost and pension savings are positively related to capital formation in Nigeria and also have significant impact. Therefore the study conclude that pension reform have significant effect on capital formation in Nigeria.

5.3 Recommendation

Based on the findings of this study, the following are recommended;

There is however need for improving the total contribution made so far with effective legal backing and increased government responsibility to pension managers. Pension rules and regulations should not be too flexible so as to enable employees fulfill their own part of the contribution.
Diversification of pension funds into alternative asset classes should continue to be encouraged so as to ensure much higher return on the investment and avenues should continue to be created for protection of invested funds and to maximize returns.
Although, administrative cost has significant impact, the study further recommend that government should still continue to reduce spending on departmental management.
Government should continue to encourage pension savings in a bid to aid more capital development.

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