The third challenge to pension schemes, but also to social security schemes more generally, consists in the extension of coverage. Some countries are considering the extension of formal social security benefits to the informal sector. This extension, however, is feasible neither from a financial nor from an administrative point of view. Although the poor in the informal sector are probably more affected by social insecurity than the majority of formal sector workers, their protection will require informal approaches to social security. Therefore, all pension policy considerations should take into account the extent to which a system effectively can reach the groups it seeks to protect.

# **_What_** _type of scheme should be adopted ?_

There are two main types of scheme6 from which to choose: (i) under a defined contribution scheme, the contributions paid by or on behalf of the worker are maintained in an individual account as under the provident fund system. The income from the investment accumulates with the contributions to form a lump-sum which at retirement is converted to an annuity. The contribution rate is usually fixed but because the final balance and the annuity depends on financial markets there is some uncertainty as to the final level of the pension benefit.<sup>7</sup> (ii) under the defined benefit system, a promise is made that the member will receive a pension of a prescribed amount on retirement either as a flat rate benefit or proportional to earnings. The benefit is known in advance but there is some uncertainty as to the cost in contributions of ensuring that this promise is kept.<sup>8</sup> In Zambia, a defined contribution system cannot by itself be expected to produce an adequate pension for those with low life-time earnings or for those who have broken periods of employment. If a minimum benefit level is to be achieved, the system would have to be complemented by a government backed minimum pension guarantee. The investment performance of the ZNPF raises doubts whether a fully funded public scheme could be administered in the best interests of its members.<sup>9</sup> The volatility of the financial markets has had a negative effect on annuities and those insurance companies which have been operating pension schemes for employers have tended to move away from defined-contribution 'money-purchase' schemes in favor of defined benefit ones.

A pay-as-you-go financed defined contribution scheme would avoid these problems but it would require fairly sophisticated management techniques and be subject to a considerable amount of government intervention in the setting of the notional interest rate and the annuity factor. Given the 6For a complete overview of contractual savings institutions, see Vittas and Skully, 1991.

7Most of these schemes are fully funded but recently some countries have introduced pay-as-you-go defined contribution schemes. Under this approach, notional accounts are kept for each member by creating a direct link between contributions and benefits and crediting notional interest - determined by the government and usually linked to the growth of covered wages - to the accounts. At retirement, workers use their individual accoun **t** o "buy" an annuity from the pension system which depends on life expectancy at retirement.

8 World Bank 1994 9As demonstrated by Chile and other Latin American countries, these risks can be greatly reduced through the introduction of a competitive privately managed defined contribution scheme. Due to the underdevelopment of the financial sector and the lack of regulatory and supervisory capacities in Zambia, however, the Chilean model is not considered applicable in Zambia.

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