The future of the government pension expenses: Projecting the cost of the public servant’s pension scheme in Sri Lanka

Abstract

Population ageing is projected to increase the pressure on old-age security systems, particularly on non-contributory pension systems, which are fully funded by the government. In Sri Lanka, a country where the population is ageing rapidly, the Public Servant’s Pension Scheme is funded entirely by the government and has accounted for about 10% of government expenditure over the last 5 years. Many studies have highlighted the fact that the existing system is inadequate to provide income security for the elderly given its low coverage while the sustainability of the scheme is also at stake given its non-contributory nature and the feature of transferring pension payments to widows or dependents upon the demise of the pensioner. This study aims to project the cost of the Public Servant’s Pension Scheme (PSPS) in Sri Lanka to predict the extent of pension burden of the government in future and propose policy recommendations to improve the sustainability of the pension system. This study adopted the method developed by Rannan-Eliya et al (1998) with appropriate assumptions about the future number of pensioners, future public sector wage increases, GDP growth and inflation. The model’s parameters are calibrated using the latest information on the age structure of the existing pensioners, wages, government employment and pension payouts, and validated using observed pension costs for the 2016-2020 period. The projection is carried out for the period under consideration is 2021-2026. The results suggest that as the total number of pensioners continues to increase, total PSPS expenditure will continue to rise steadily over the next few years. If the government continues to adjust pensions with each adjustment to government wages, pension spending is expected to increase by 25% over the next 6 years. The paper then considers several simulations by adjusting the extent of wage indexation, retirement age, and the payment of gratuity. The results suggest that the burden on the government can be reduced by an average of 10% and 12% if wage indexation is reduced by a quarter and a half respectively. Moreover, the pension burden can be reduced by 11% and 25% on average if the government increases the minimum retirement age to 60 or 63, respectively. Finally, the temporary elimination of gratuity payments, in addition to being a politically infeasible option, also does not appear to be a fiscally significant change, leading only to an average of 4.8% cost reduction in the next 6 years. While reforms such as shifting to a defined contribution scheme will be needed to ensure the sustainability of this scheme in the long run, reducing wage indexation and raising the minimum retirement age are important short-term policy recommendations to reduce the burden of the PSPS.