An Assessment Of Reform Options For The Public Service Pension Fund In Uganda earners remain exposed to investment risk, variations in the interest rate have much less impact on benefits compared to the pure DC option.

For higher income groups, the pure DC system may look more attractive than the hybrid scheme, but only under the optimistic scenario with respect to the interest rate earned on individual accounts. If the real rate of return on assets sustains at 5% throughout their career, the two top income groups can get from 100% to 113% of the average wage, whereas under the hybrid reform option their expected benefits are by 5-10 percentage points lower. On the contrary, under the less optimistic scenario these groups will be better off in the hybrid scheme: 78%-88% in the hybrid versus 63%-73% in the pure DC scheme.

Another indicator that can be used to compare the pure DC reform option with the hybrid reform option is the Internal Rate of Return (IRR). In a contributory system workers are supposed to pay contributions, in which case their participation in the pension system can be considered as an investment. Hence, the IRR can be used as a comprehensive measure of the level of benefits that an individual would obtain relative to what he/she would pay into the system in the form of contributions.<sup>42</sup> This indicator takes into account individual’s overall wage and contribution history, retirement age and expected number of years in retirement, initial benefit and its post-retirement indexation. Table 22 summarizes projected IRRs by gender and income group.

**<u>Table 22: Projected Internal Rates of Return</u>**

||**_low_**||**_avera_**|**_Income ca_**<br>**_ge_**|**_tegory_**<br>**_hig_**|**_h_**|**_steep c_**|**_areer_**|
|---|---|---|---|---|---|---|---|---|
|**Reformoption**|_men_|_women_|_men_|_women_|_men_|_women_|_men_|_women_|
|**_Pure DC-5 %_**|7.3%|7.1%|7.5%|7.3%|7.8%|7.6%|7.7%|7.7%|
|**_Pure DC-3 %_**|5.0%|4.7%|5.3%|5.0%|5.6%|5.4%|5.5%|5.5%|
|**_Hybrid-5 %_**|8.9%|8.9%|7.8%|7.8%|7.7%|7.6%|7.7%|7.8%|
|**_Hybrid-3 %_**|8.9%|8.9%|7.5%|7.6%|6.8%|6.8%|6.8%|6.9%|

**Source:** WB calculations

Under the more optimistic interest rate scenario (5% real), high income groups may expect about the same rate of return by participating in either of the two schemes. For average wage earners hybrid scheme seems to be slightly more attractive, and for the low income group the IRR in the hybrid scheme exceeds what they may expect from a pure DC scheme by 22-26%. Under the less optimistic interest rate (3% real), all income groups benefit from participation in the hybrid scheme: the lower the income, the higher the IRR in the hybrid relative to the pure DC scheme.

Overall, the hybrid scheme reduces the investment risk for all contributors: the lower the income, the lower is the investment risk under the two-pillar compared to the pure DC option. Thus, more income security for system participants can be achieved through risk diversification in the hybrid reform option. In addition, it provides higher benefits for the lifetime poor relative to what they may get from the monopillar DC scheme. While in the latter the rate of returns are very similar across all income groups as well as across

> 42 Obviously, the IRR cannot be calculated for the baseline scenario as under the status quo, the system is non-contributory.

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