Photo: M. Crozet/ILO

With legislation passed in 2010 that is to be implemented fully by 2012, the Egyptian social security system is engaged in an important process of reform. Despite the significance of the new legislation, implementing the reforms presents a particular set of challenges, and the country’s current uncertain political and economic situation may yet impact the scope, sequencing and timing of the reforms.

Egypt’s social security system covers around 25 million members and is administered by the National Organization for Social Insurance (NOSI) through two separate funds – one covers government workers (civil servants, armed forces, police force, etc.) and the other workers in the public and private enterprises, some self-employed, casual workers and Egyptians working abroad. At present, the country’s social security system, like that of many countries, is confronted by a number of challenges. These challenges stem from external factors as well as the current design of the social security system:

• Increases in life expectancy are contributing to the rising cost of a system that is already deemed expensive in comparison to other countries in the region – a total contribution rate equal to 40 per cent of an employee’s covered salary plus a government contribution of 1 per cent and a guarantee to finance any actuarial deficit. The estimated cost to the government of financing the actuarial deficit alone is expected to reach around 2.5 per cent of GDP by 2027.
• Large sectors of the population have limited or no coverage – the informal sector is currently estimated to be around 40 per cent of the labour force – and benefits for those who are covered are considered inadequate and have failed to keep pace with inflation.
• The design of the defined benefit social insurance system creates a number of adverse incentives. The maximum monthly earnings for contribution purposes are capped at EGP 1,750 for the financial year 2010/2011. Benefits are calculated according to the salary in the five years preceding retirement for workers in the private sector, or the two years preceding retirement for civil servants and public-sector employees. The final salary scheme creates an incentive for workers in the private sector to under-report income and minimise contributions until shortly before retirement when employers start to report higher salaries. This occurs because there is no link in the final salary system between contributions and benefits.

Seeking solutions to the systems’ high costs and inadequate benefits and coverage

In 2005, having recognized these growing financial and other challenges, the Ministry of Finance (MOF) took on the responsibility for the supervision of the social insurance system.

The MOF and the NOSI, working closely with international organizations such as the International Labour Organization, the World Bank and the International Monetary Fund, reviewed the system in the light of other countries’ experiences, and developed a reform proposal that took into account Egypt’s particular socio-economic conditions. The reform proposal included both parametric and systemic reforms.

A vigorous national debate was initiated involving all major stakeholders, such as the trade unions, employers’ federations, the federation of chambers of commerce and major Egyptian political parties. The draft Bill was discussed extensively in the Shura Council and the People’s Assembly before the final approval of the reform proposal. Owing to the comprehensive and innovative nature of the reform, these discussions resulted in significant modifications before the law was passed by the parliament in June 2010.

Developing a new approach and philosophy

The new law (Law No. 135 of 2010), which is scheduled to come into force fully in January 2012, seeks to build a system founded on the principle of reinforcing solidarity. With an emphasis on improved compliance, an aim is to encourage individual savings. The new law looks also to achieve a more equitable distribution of income for individuals who are forced through circumstances that are often beyond their control (e.g. unemployment or military service) to withdraw from the labour market for a period of time. Its provisions aim to overcome the problems and challenges facing the old system by improving benefits, encouraging compliance, reducing costs, and better targeting the government’s contribution towards those on low incomes.

The new system also introduces “individual” accounts and “solidarity” accounts. The system will guarantee a minimum level of benefits for all risks, which will increase as higher levels of contributions are made to the individual accounts, as well as a minimum guaranteed rate of return on the investment of the funds held in individual accounts. The contribution rates and the cost of social insurance for those on low and medium incomes are to be reduced.

New role for the Public Treasury

Under the new system, the financial contribution of the Public Treasury will focus on reducing poverty among pensioners. A basic pension equal to 18 per cent of the net national average wage for all persons older than age 65 who do not have another source of income will be provided. Since 1 July 2010, the Public Treasury is meeting the cost of increasing the value of low pension payments, which has already benefited 48 per cent of all pensioners. These elements aim to reduce poverty among pensioners and their survivors.

The Public Treasury will also guarantee the regular adjustment of pensions in line with the rate of inflation on the condition that the inflation rate is above 8 per cent, and will underwrite any shortfall in the returns on the investment of social insurance funds, which are intended to determine the value of the annuity on retirement.

In addition, the Public Treasury provides incentives for informal-sector workers to join the new system and safeguard individuals’ retirement pension rights in case of death, disability and work injury.

Achieving a more equitable distribution of income

The new law establishes two measures to achieve a more equitable distribution of income. The contribution rate is reduced while the cap on pensionable income is removed so that higher-income earners and their employers will have to pay contributions on the entire salary.

The new contribution rate for insured workers under the new system is 11 per cent of earnings compared with 14 per cent in the current system. Persons earning less than around EGP 3,000 a month will pay lower contributions than under the current system while those earning above that cut-off point will pay more. For example, the contributions for an employee earning EGP 10,000 a month will increase substantially from EGP 218 to EGP 1,100 under the new system, while their employer’s contribution will rise from EGP 437 to EGP 1,950. However, an employee earning EGP 1,000 a month will see a reduction in the monthly social insurance payment from the current EGP 125 to EGP 110 a month, on average. Table 1 details the contribution rates under the current and new systems.

Improving compliance

The NOSI is aiming to develop a link with the national tax authority to ensure that social security contributions will be deducted and taxes paid at the same time and be based on the same amount of reported earnings. In addition, NOSI staff will have legal authority to detect and investigate cases of contribution evasion while the penalties for contribution evasion will increase substantially to EGP 20,000 (USD 3,490) with a custodial sentence of one year in prison. The new pension system based on individual accounts aims to discourage contribution evasion and create a direct link between benefits and contributions whilst maintaining the traditional social insurance principle of solidarity.

Addressing the demographic challenge

To help tackle the current and future financial challenges posed by a high dependency ratio and increasing life expectancy, the retirement age will increase gradually from age 60 to age 65 for all employees over the period 2012 to 2027. The new system determines the value of the old-age pension according to the annuity factor at the time of retirement, which allows for future improvements in life expectancy.

Strengthening social solidarity

The new system introduces two solidarity accounts: one for old-age, disability and survivor benefits, and the other for unemployment benefits. A defined portion of each individual’s contributions will be paid into the solidarity accounts.

The remainder of the individual’s contributions will be deposited in the individual’s two accounts (old-age, disability and survivors; unemployment insurance) from which benefits to that individual will be paid. Once these funds are exhausted, payments may be received from the solidarity accounts, according to the system rules. The total amount of benefits paid to beneficiaries from each solidarity account will be capped at a multiple of the net national average wage.

A Pensioners’ Social Welfare Fund is also to be established to support different activities and services to old-age, disability and other pensioners. For example, it will create welfare places for pensioners (in care homes for the elderly and day care centres), will cover medical services as well as contribute to the cost of major medical surgery undertaken outside of Egypt for pensioners, and provide emergency assistance as required.

The Pensioners’ Social Welfare Fund is financed through pensioners’ flat rate contributions (that vary according to the amount of the pension payment), and 0.15 per cent of the returns on invested funds plus income equal to a third of the value of collected fines. The Public Treasury will also contribute to the Fund.

Encouraging individual savings

It is anticipated that the introduction of individual accounts that links future benefits to the value of contributions made (additional voluntary contributions to enable higher benefits are to be permitted) will encourage workers to save more. The expectation is that these measures will increase the domestic savings rate by 18 per cent, and the professional and productive investment of such funds will help achieve an estimated economic growth rate of more than 7 per cent.

Extending coverage to informal-sector workers

Bringing workers from the informal sector, which represents 40 per cent of the labour force, into the social security system is a major aim of the new system. Under the new system, the government will contribute an amount equivalent to 25 per cent of the contributions made by informal-sector seasonal workers and farmers to provide a positive incentive for such individuals to contribute and, consequently, to help reduce poverty in the event of the worker’s death or disability.

Introducing a new Unemployment Insurance mechanism

Under the new system unemployment benefits will be offered for up to 12 months, according to the number of months of contributions paid prior to unemployment. The minimum contribution period of 12 months allows a 6-month period of benefit payment and each additional contributory year will give the right to an additional month of unemployment benefit. Benefits will be paid from the eighth day of unemployment at a rate of 65 per cent of the insured’s average net wage in the 12 months prior to unemployment, the rate reducing by 3 per cent each month.

Unemployment insurance benefits will be paid from the insured’s unemployment insurance individual account first. In the event that the balance in the individual account is not sufficient, the benefit will be paid from the unemployment solidarity account. Any balance remaining in the unemployment insurance individual account at retirement can be used to increase the value of the retirement pension or can be received as a lump sum.

Ensuring efficient asset management

Under the current system, the social insurance fund, which has a value of about EGP 450 billion (equivalent to more then USD 75 billion), is invested largely in low-yield government instruments. The main aim of the new system is to diversify the portfolio in which the funds are invested.

An investment board of directors, comprising experts from the private and government sectors, is to be appointed when the new law comes into force in January 2012. The board will be responsible for setting up and implementing a strategy for investing around 35 to 45 per cent of the assets of the fund in non-government instruments. The remainder will continue to be directed toward Treasury bills and bonds and other traditional government investments and to pay off the liabilities of the old system.

The new law stipulates that around 40 per cent of the funds received annually from the new system will be invested in a diversified portfolio including private equity, real estate, land and corporate bonds, leading to the possibility of higher returns, but also potentially higher risks. It is expected that the rate of return on investments in the long-term will range from 6 per cent to 10 per cent, with an average of 8 per cent.

Challenges in implementing the new system

Although the reforms underwent extensive discussion and modification before the final provisions were passed, the implementation of the new system nevertheless presents major challenges.
The innovative and extensive nature of the reforms implies developing new procedures and business processes, new operating models, staff training and an appropriate IT system. Staff in the NOSI, government ministries, private and public agencies, and other bodies and institutions, must be trained to use the new system, procedures and software.

Coverage under the current system will continue for any individual that joined the old system before 31 December 2011, and who chooses to stay in the current system or participate in both. Although there will be an option to switch to the new system, it is expected that the current system will continue to operate for around 75 years.

These factors alone create considerable challenges, but it may be further complicated by the uncertain political and economic situation in Egypt that may have an impact on the planned reforms, either in their scope or the timetable for implementation. Whether or not the new envisaged system can be implemented smoothly remains to be seen, but there is no doubt that the objectives of the reform are intended to strengthen social solidarity, ensure the financial sustainability of the system, improve redistribution and provide better social protection for the majority of the population.

Ms Mervat Abd es Salem Sabreen, Senior Economic Researcher, Ministry of Finance, Egypt.
Dr Maait, Deputy Minister of Finance, Egypt.
The authors are grateful to Ms Sara Saleh, Actuarial Analyst, Ministry of Finance, Egypt for support in preparing this article.