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Three tiers to pensions

 By Blanche Gatt, The Malta Business Weekly Online


May 8, 2003


Pensions reform is beginning to seem a bit like most New Year Resolutions... lots of talk and determination, but very little actual action. The National Welfare Reform Commission, set up in 1999 and now led by its second chairman, is expected to produce a report very shortly, but as the years roll by and the problem becomes ever more pressing, it is clear that the time has come for determined action to be taken at last.

Mario C. Grech, chairman of the Middle Sea Group, has followed this issue closely over the years. Ten years ago, in April 1993, the Middle Sea Group held a seminar on welfare gap problems, entitled ‘The Demographic Time Bomb’, and seven years later, in November 2000, he produced a paper on ‘Options in Pension Schemes’ for Malta that was presented at the EMCS Conference.

Now, in 2003, in the wake of remarks by the Minister of Finance indicating that reform is imminent, I went to speak to Mario a few days ago to find out what he believes should be done on this issue.

The demographic timebomb has long loomed on the horizon,” he said as we sat down to talk. “We noted this as far back as 1993, when we held a seminar on the subject... but as it was sufficiently far away, government was able to procrastinate rather than confront the problem. Sufficiently far away in 1993, because the real effect of the demographic timebomb will start being felt sometime between 2010 and 2025 and beyond. This is when the baby boomer generation will begin to retire, and we will have over 100,000 people above pensionable age, as opposed to approximately 60,000 people we have today.”

Warnings about the consequences of allowing this situation to remain unaddressed have been issued regularly from various sources; the current pay-as-you-go system, already under tremendous pressure, will be unable to support the number of pensioners drawing from it, as this number increases while the number of contributors decreases.

“But this is not the only thing we are talking about,” said Mario. “We are actually talking about two things... sustainability and adequacy. Already we have a situation where existing pensioners are raising complaints about the inadequacy of the level of current pension benefits. If you are retiring today at the maximum level, you get Lm4,700... what can you do with that amount in 2010, 2015 or 2020?”

Hence sustainability and adequacy are fundamental issues. Mario believes the key to solving the problems lies in generation of real economic growth.

“There is no question whatsoever as far as pensions are concerned that the bottom line is we have to create wealth, as otherwise it will not be possible to sustain even, let alone improve, pensions. This is irrespective of whether pensions are government funded or privately funded or a combination of both... economic development is a must in either scenario. Of course, both government and opposition should get together and get things moving as this is an important issue with long term consequences, but the punto di partenza should be economic growth. Taking a macro-holistic approach, we need to create more economic growth thereby increasing the working population including greater participation of women in the equation.”

Economic growth, more jobs, more people earning and contributing... all positive and desirable, but would that mean government could stop looking at welfare reform?

“All interested parties, including government, opposition, the social partners, all have to get round a table and recognise the problem. In essence this is a question of management... the standard of living of each person has to be managed over the new longev-ity of life. Each individual has to manage his wealth, and if one lives beyond one’s means today, there will be higher dependency when one is retired. Of course, we are talking about the mass of people here, not the small percentage of people who can cater and care for themselves.”

Mario’s insistence that all interested parties get around a table and come up with decisions makes sense of course, but what about the Welfare Reform Commission, I asked? Isn’t that what they are supposed to be doing?

“Well, to get consensus in this matter is not easy,” he replied. “The important thing is that the people who are responsible and have a duty to do something continue discussing... then the time will come when government has to decide. That is actually why I was never in favour of government asking the opposition to be part of this Commission. I feel that the Commission should report to Parliament. They should agree consensually that there is a problem and then look at the report that the Commission produces and move along from there. Ultimately, it is government’s (by government one means present and future) responsibility to make the appropriate decisions, but this is a long-term issue and therefore the opposition should also consider seriously its participation to give an opportunity for continuity.”

What does Mario think the solution to the pensions issue should be, I asked?

“I feel that the most acceptable of the available frameworks, as in other countries, is likely to be based on a three-tier concept. The first tier is the basic state pension operating on the lines of the current scheme with the introduction of the required changes, which would provide a basic pension safety net. A second tier operated as an additional funded optional occupational scheme supplements this. The third tier allows for an optional enhanced retirement scheme involving savings and investment vehicles.”

The third tier, private pension plans, already exist of course, and a number of Maltese are interested in these plans. However, for the vast majority of people, the State pension is what they are counting on for their retirement and this area needs to be addressed seriously through appropriate reform.

“My view is that if the State pension is modified to ensure that it is financially self-sufficient then there is a strong case in Malta for a second tier optional occupational pension. The main features of a reformed pensions system might be: the attainment of a revised and sustainable first tier national pension based on the fundamental principles of solidarity and redistribution; the (re)introduction of a second tier and tax incentivised ‘funded occupational pension’ even if optional initially, and collective agreements could be used as a medium for optional introduction. This would entail a number of changes, I believe, including the optional entry approach, collective negotiation, the removal of the N.I. Act disincentive, a defined contribution basis and a defined benefit. The third tier would be made up of personal retirement enhancement plans, through life savings and investment planning on which there already appears to be an awareness.

“If such a system is envisaged then there would be considerable attractions in the second tier funded optional occupational pension being on a defined contribution basis supported by employers and employees. Difficult decisions will be required in relation to when, and the extent to which, contributions to the second tier should be made on a compulsory basis – there is a case which suggests that without compulsion some sections of society will not save sufficient amounts to provide meaningful pensions.”

The idea of occupational pensions, introduced gradually and initially optional, within a three tier structure similar to Mario’s has been introduced successfully in a number of European countries, including the UK and several Scandinavian countries. Here in Malta too, the idea has been discussed at length...

“That’s why I am positive about this issue,” said Mario. “It is obvious that most people believe occupational pensions would be a workable solution, but now they have to accept it and agree on how to implement it. This is a very serious matter... we are talking about the standard of living of people.”

But should government relinquish its responsibility for pensions, I asked? “No, I believe government should always be there,” replied Mario.

“And today, looking at the collapse of capital markets over the last two years is a lesson. there are lots of pension funds invested in these capital markets. That is why government has a political and social duty that will continue, and whatever solution is chosen, I believe there always has to be the appropriate statutory and regulatory framework on which the way forward should be based to ensure protection to the consumer (pensioners). The main interested parties including Parliament, employers, employees, unions and pensioners’ associations need to discuss, decide and eventually have implemented through the appropriate structures, the necessary reforms.”

Years of discussion have left a lot of people feeling disillusioned with the lack of progress. I asked Mario whether the situation was one of doom and gloom?

“No, I don’t think so. But it is time to stop playing politics,” he replied. “And I don’t mean only the politicians... I mean everyone involved has to start using common sense and be realistic about the situation. Notwithstanding the complexity of this issue, some countries have registered significant progress and therefore I cannot see a reason why we should not do the same. After all, we will not be re-inventing the wheel.

“Of course there are some very sensitive decisions to be made, namely, pensionable age, what will happen to current pensioners and those close to pensionable age, and who are these people and where is the cutoff. But these decisions do have to be made, and I will be very disappointed if no progress has been made by the end of this legislature. It is the duty of our leaders to lead and take decisions.”

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