08 March 2006

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Business Today

Pension reform: a cautious approach

It’s been 10 years in the making and finally we have a blueprint of what government intends doing about pensions. The reform announced last week is an important first step but by no means exhaustive and enough. Minister for Social Solidarity Dolores Cristina defends the proposed changes saying they will ensure pensioners enjoy a decent standard of living. She disagrees with the argument that the reforms do not adequately address sustainability, arguing that the main challenge “will always remain adequacy.”
Cristina says the introduction of mandatory private pensions is necessary but requires deeper analysis because it would put additional financial burdens on employers and employees. “Government is cognisant of the fact that both the macro and micro economies are in transition. And yes, this requires sensitivity and caution when introducing additional financial impacts, even if these savings are introduced,” she says.

What is the economic impact of the baby boom generation on pension payments?
Apart from the increasing impact on the labour market as a result of their retirement in terms of valuable experience and skills in all fields, according to the modelling carried out by the Pensions Working Group, it is calculated that the impact of the baby boomers will increase from -2% of GDP (in 2011) to -3% of GDP by 2015. It will reach -4% of GDP by 2020, peaking at approximately -4.8% by 2027. It is estimated that by 2035 it will be -4% of GDP and will go down to -3.5 of GDP by 2047.
For a correct assessment of the situation, one should not consider the baby boomers alone. One has to factor the declining birth rate as well as the current pensions system.
This assessment is mirrored in The Maltese Pensions System: An Analysis of the Current System and Options for Reform (World Bank, March 2004) which states:
‘Currently if the working age population is assumed to be all those above age 15 and retirees above the retirement age, there should be 3.9 workers per old age retiree. At the demographic peak, there will be no more than 1.3 workers per retiree. However, looking at the pensions system, the change is more drastic. Currently, there are about 5.8 workers per 2/3 pensioner, more than the demographics would suggest. This is largely because many of those retiring under the old occupational schemes are receiving only top up pensions and not the full 2/3 pension, a function of the immaturity of the system. In the future, the projections suggest that there will be 1.0 worker per 2/3 pensioner. Furthermore, the system finances more than just 2/3 pensioners. When all the invalids, widows, survivors and top up pensioners are condsidered, there are only 2.6 workers per pension today and in the future there are projected to be only 0.9 workers per pensioner’.

The reform announced last week makes sure pensioners have an adequate income to sustain a decent living but it fails to address the issue of sustainability. With the pension bill set to increase because of demographic reasons and because of the changes announced last week, how is government going to foot the bill?
The pensions reform addresses three fundamental elements. The first is demographics. Given the declining birth rates, the increasing elderly cohorts and the increasing life expectancy, the reform of the statutory retirement age is integral to the pensions reform process.
The second is the first pension (first pillar). We have stated all along that we believe that the first pension is the critical element of our pensions system as it provides for solidarity. It is the main pension pillar, and for this matter its strengthening is undoubtedly of the utmost importance. Critical here is the reform we have announced in the National Minimum Pension as well as in the Maximum Pensions Income ceiling, which will increase from Lm6,750 set in 1981 to Lm9,000 over a number of years. Highly important is the fact that this will increase thereafter, thereby ensuring it is responsive to inflation and other pressures – something that the current system did not allow for as the ceiling has been practically static since 1981.
The third is the introduction of the supplementary pension – the second pension, an issue I will address later.
The reforms will positively impact the sustainability of the pensions systems.
The challenge will always remain adequacy – adequacy in terms of wages earned by people working and ensuring that the pensions income does not fall behind wages earned. This is the main challenge. And it is for this purpose that we are primarily recommending a structured five year review of the pensions system. This will allow the government of the day to apply this review as a control lever and introduce parametric reforms, as opposed to fundamental ones, to maintain the appropriate level of adequacy of pensioners vis-à-vis people in employment.

Increasing the retirement age to 65 was an expected move but on its own it is not enough to ensure sustainability of pensions. Why has government opted to postpone reforms in the second pillar – private pension schemes?
I believe a better understanding of the raison d’etre of the second pillar is essential. If one carefully reads the work of the Pensions Group one will find that the intention always was for the first pension to be directed towards adequacy and the second pension towards an improved standard of living. The second pension’s main objective is not the sustainability of the pensions system but a contribution towards one’s standard of living on retirement.
The introduction of the second pension has two key issues: should it be voluntary or mandatory; and if mandatory, at what contribution? It is pertinent to underline that mandatory implementation would demand a contribution from both the employer and the employee. The Pensions Working Group in its first report had recommended that implementation should initially be voluntary with mandatory implementation looked into by not later than 2009, with introduction in 2010. It is important to take into account exactly what the Pensions Working Group stated in its Final Report:
‘Malta is currently going through a restructuring process within all sectors of the economy. Stable macro-economic policy demands a rationalisation of government expenditure to ensure that government expenditure is directed to increase productivity and capital investment. The private sector, on the other hand, too must introduce micro economic policies to allow it to face the threat of globalisation. A direct consequence of the restructuring process taking place is a slower pace of economic growth until such time [that] the transition is completed.
In this regard, the Group is concerned that the introduction of a mandatory Second Pillar Pensions Scheme today that will demand from employers payment of a new savings contributions into the Second Pillar Pensions Scheme would add additional pressure at a time when micro econmic reform is important.’
The Pensions Working Group, to account for the above, proposed the neutral introduction of the Second Pillar – neutral in the sense that 1% of the 10% currently paid by Class I contributors and the self employed is routed to the Second Pension fund. The actual increase in contributions is, in fact, proposed to occur in 2011 – a 1% increase on both employers and employees.
Nowhere has Government stated that it will not introduce the Second Pillar. The Prime Minister announced that when, not if, the Second Pillar is introduced it will be introduced in a mandatory manner. Yet, Government is cognisant of the fact that both the macro and micro economies are in transition. And yes, this requires sensitivity and caution when additional financial impacts, even if these savings are introduced.
What Government has stated is that it requires further time to determine whether the Second Pillar can be introduced neutrally – neutrally, that is, in not only hiving 1% of the NI contributions to the Second Pillar as proposed by the Group, but how to do so whilst continuing to invest, as is currently done without the vired 1%, in the health system and other social benefits, without reducing such investment.
It is the Government’s determination that this issue will be addressed by the time it will present a pensions reform law to Parliament before the summer recess.

Government announced that the decision to have obligatory private pensions was taken but needs to be postponed. Why wasn’t a voluntary private pension structure proposed to get people into the habit of saving for their retirement?
It is pertinent to emphasise that the key word here is mandatory. In the event that a mandatory implementation of the second pension is not possible immediately, there are no objections to the third pension (third pillar). In fact, the Pensions Working Group, together with the MFSA, the Inland Revenue Department and an international actuarial company are working to study possibilities of incentives for both the Second and Third Pension schemes respectively. These studies should feed into the work being carried out by the Tax Review Commission.
There is one other aspect of the recommendations of the Pensions Working Group that we should not forget about. The Group proposed the introduction of regulated Property Pension Funds – that is the ability for people to transform their locked in capital in their property into pension funds. This too is being studied.

By arguing that the reforms in the second pillar need to be postponed until the economy is in better shape, government is simply using the same arguments made by Alfred Sant, who insists that pension reform can only be tackled after the economy picks up and more women are encouraged to enter the labour market. Why this volte face?
The reform is not in the second pillar, as you mistakenly imply. The reform is a holistic one leading to a new pension system. The only volte face that has surfaced is from the Leader of the Opposition.
The Leader of the Opposition has insisted there is no issue, or if there is an issue this is a future one and should not concern us today. This is morally irresponsible. Macro pensions reform takes time for decisions to cascade. After ten years of discussion and following the publication of Government’s proposals, the leader of the Opposition has requested his Shadow minister to prepare a report!
We have, all along, tackled the issue of pensions by accepting that this is an issue of national importance that requires decisions today. And we have not shied away from such decisions.
You imply that the pensions reform can only take place if a mandatory second pension is introduced. This is not correct. As I stated above, the second pension is only one of the media – it is by no means the only medium. If a mandatory second pension is not introduced immediately, there is always the possibility of having a third pension.

A pertinent issue in all discussions on pension reform is the need to have more people enter the productive labour market. Over recent years it was government’s policy to give early retirement schemes to employees in restructured public entities. Has this policy been discarded?
All forms of exit from the labour market should be discouraged. In terms of invalidity we should seek alternative forms of employment before invalidity pensions. In terms of labour groups of people, such as women and the elderly, we should incentivise and encourage their retention or re-entry into the labour market.
The same applies for exit from the market due to early retirement schemes. Our focus must be to retain people in the labour force – by re-skilling, re-training, applying life long learning, introducing employment pracitices such as job rotation and job sharing, and so forth.
Economic growth and output is strictly related to the labour market and the quality and skills of that labour. It is our imperative that we optimise and maximise this to the best of our ability.

Another important aspect from both a social policy and economic perspective is the need to encourage more women to remain in productive labour. Apart from the one year tax relief introduced in 2005 for women returning to the labour market, what other measures is government contemplating?
Encouraging women to remain, or to return, to productive labour requires an integrated, holistic approach. Women’s working lives pass through more phases than those of men for a variety of reasons.
Without a shadow of doubt, for the younger working woman, accessible and reliable childcare remains a priority. However, childcare alone, no matter how excellent it is, will not bring about the substantial change we need.
Making work pay, introducing more family-friendly measures addressed at both parents, tax reform and the provision of tax and pension incentives (such as credits for child rearing years) all need to move in parallel to lead us to the desired results.
The introduction of family-friendly measures in the public sector has already led to an increase in the number of women staying on in their jobs. Private entrepreneurship that is sensitive to the family responsibilities of its employees retains loyal, trained and valuable personnel.
We still need a culture change in this country. Encouraging women to remain or to return to the workforce is not simply about economics. It goes further and deeper and although there is a tangible and visible change we still have an intrinsic need for a more rapid one.

A common concern for parents is that pre-school child care is unaffordable. Is government considering some form of partial tax relief on child care expenses?
So far, Government’s policy has been mainly directed to ensure quality at child care services. As announced in the Budget Speech Government will be allocating Lm130,000 to support current providers to upgrade their services so as to comply with the standards for childcare facilities which will be phased in over a number of years.
Smartkids childcare facility within ACCESS Complex at Cottonera offers means tested services for families living in the area.
It is a success story that should be replicated in other areas of the country.
All tax incentives are being studied by the Tax Review Commission that will conclude its studies by June.

How many women have utilised the one year tax relief measure as an incentive to get back into productive labour?
Since this is a new measure introduced in 2005, it is not possible to provide data as yet since the relevant tax returns for the basis year 2005 are to be submitted by 30 June, 2006.

Increasing the retirement age to 65 requires a total re-think in employment policy since work places have to cater for an older population which has particular needs. How will this phenomenon be addressed in social policy terms?
Undoubtedly, increasing the retirement age to 65 years of age requires a certain mind-set as well as changes in cultural and employment practices. Yes, many factors require a total rethink of the labour market as well as employment policies and strategies by Government, Unions and employers. Retirement age is only one of these factors.
Many developed countries have made such transitions, successfully, well before us. There is no reason why such a transition will not be successful in Malta. Yes, we have to look elsewhere and study what measures have been applied in such transitions – what has worked, and what has not, what is applicable to our culture and what is not.
Transitions require education, communication and management. Transitions require also partnerships between the stakeholders: employers, employees, trade unions and Government. Government will play a leading role in facilitating and catalysing this transition.
Dolores Cristina was interviewed by Kurt Sansone

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