Simulating pension increase using differential

equations
CJ Castillo
Simulation House

January 2017

In the long run we are all dead.

J. M. Keynes

1 Introduction
Pension increase became an important topic in the 2016 Philippine Presidential
elections with the extreme left using it as a launch pad for their senatorial frontrun-
ner. Politically speaking, it did not matter whether the proposed pension increase
of two-thousand pesos were financially sound or not because it will still make a
good political platform to introduce a candidate. Other candidates jumped into the
bandwagon and endorsed the bill despite warnings by the SSS itself of its adverse
implications in the funds life. The proposal passed both chambers of the Congress
but failed to become a law because President Aquino, whose bureaucratic tendencies
became very handy when he cited results of actuarial evaluations of the impacts of
the increase, vetoed it.
However, pensions in SSS are really low. Mesa-Lago, Viajar, and Castillo (2011)
found that of the existing public pension schemes in the Philippines, SSS gave the
lowest average monthly pension of about 3,000 to 4,000 pesos. With pension ad-
justments not indexed to inflation, this value can easily be eroded by rising prices.
SSS explains that pension level is low is due to the fact that contribution rate in
SSS is also low (in 2011, it was 10.4 percent while contribution rate in GSIS is 20
percent; also, SSS implements salary credit ceiling while GSIS does not have one).
However, this argument quickly falls into pieces if we start looking at other public
pension schemes especially that of the uniformed personnel such as the police, mil-
itary, coast guard, and those from the fire department, and especially the judiciary.

Draft for fun. Use at your own academic risk.

1
These pension schemes are not contributory yet pensioners, especially justices of the
Supreme Court, enjoy high levels of pension.
The pension problem is twofold: on one hand, pensions must be raised. On the
other, we need to keep the pension system funded and the easiest way to do this
is to match every pension increase with increase in contribution income assuming
that investment income is unreliable1 . The current proposal is to increase contribu-
tion rate but this has been met with opposition from the SSS members and some
politicians who raised a legal fact that any pension increase that requires increase
in contribution rate is to be considered illegal.
Our problem can easily be seen as one that involves trade off. And this is indeed
true at first glance. If there exists another way to fund the SSS, the controversy
surrounding the increase may not have reached an incredible height. But before
any discussion about possible funding schemes for the pension fund, we should be
able to determine first the impact of increase in pension as well as contribution
rate. This paper proposes a model to estimate such impact. A system of ordinary
differential equations is used to model the SSS fund life. The initial value problems
are solved using data from SSS annual reports. We then input pension increase and
rate increase and do simulation to determine their impacts on the SSS fund life. The
rest of the paper is organized as follows: in part 2, we discuss the model and how
the model is solved; in part 3, we discuss the results of the simulation; we conclude
in part 4 and present some possible ways that can mimic the effect of an increase in
contribution revenue of SSS.

2 The model
In this paper, we use ordinary differential equations to simulate the impact of the
proposed pension increase and contribution rate adjustment. We begin by noting
that the change in pension fund f maybe expressed as a sum of incomes and expenses
which are variables that denote flow as opposed to stock. We have the following
equation:
df
= Y (t) X(t) (1)
dt
where Y (t) is total income at time t and X(t) is total expense at time t. Contributory
pension funds that have resorted to financial markets to generate resources have two
major sources of income: first, contribution income; and second, investment income.
Meanwhile, their expenses can be classified easily as either pension payment, P (t)
or administration expense,E(t). Thus, equation (1) may be expressed as:

df
= C(t) + I(t) P (t) E(t) (2)
dt
1
Or the pension system may also improve collection rate.

2
where C, I, P , and E are all functions of time t. To solve equation (2), we need
equivalent expressions for these variables. To simplify the model, we suppose that
investment income I(t) is zero, i.e. the pension scheme does not rely on investment
income.2 We may also assume that administration expenditure is constant across
time. Hence, we only need to determine the expressions for contribution income
C(t) and pension expenditure P (t).
Contributory pension schemes such as the SSS derive income from member con-
tributions, C(t) which is equivalent to the sum of the products of contribution rate
and monthly salary credits of members. Let r R+ be the contribution rate, n
be the number of contributing members, and Si the salary credit of member i,
i {1, 2, . . . , n}. Then, the amount of contribution income is

C(t) = rS1 + rS2 + + rSn

Xn
= rSi
i=1 (3)
Xn
=r Si
i=1

Honestly, we do not have data about the salary credits of each SSS member.
However, we can express (5) into a simpler equation by dividing both sides of (5)
by the number of contributing members n.
n
C(t) rX
= Si
n n
i=1
n
P
Si (4)
i=1
=r
n
= rS

where S is the average monthly salary credit. We multiply both sides of (4) by n to
obtain another expression for the total contribution income

C(t)
n = nrS
n (5)
= nrS

We take the total derivative of (5) with respect to t.

dC dr dn dS
= nS + rS + nr (6)
dt dt dt dt
2
This maybe considered a conservative assumption. However, this assumption will be useful
especially if we want to isolate the effect of adjustments in contribution rate and pension amount.

3
 We use (5) to express (6) as
 
dC dr 1 dn 1 dS 1
=C + + (7)
dt r dt n dt S dt

Notice that in (7), the change in contribution income over time is just the product
of contribution income at time t and the sum of the growth rates of contribution
rate, contributing members and average monthly salary credit.

3 Simulation results

4 Conclusion

5 References

6 Appendix: SCILAB Codes