No place for dogma in pension reform

By David Spiteri Gingell

The chair of the National Pensioners’ Association (NPA) (Interview, 13 December) is quoted as saying “we should either introduce a second pillar pension along European lines, or nothing…”.

This statement manifestly undelines why complex pension reform is herculean to achieve when ideology substitutes reason.

According to the NPA, Malta should introduce a mandatory second pension (2P) the EU way or no way. And what, may I ask, is the EU way? Is it the Dutch 2P where there is no statutory obligation to participate and consists of occupational pension plans agreed between employers and trade unions? Is it perhaps, the Danish 2P which is a funded occupational pension scheme not mandated by law, as employers contribute voluntarily to a pension fund through industry-wide agreements among the social partners?

Perchance, is it the Swedish 2P based on the mandatory ‘Premium Pension Plan’ that is a funded individual account complementing the Notional Defined Contribution pension system where beneficiaries contribute an additional 2.5%, to the total of 18.5% pension contribution?

Possibly, is it the recently 2P introduced in the UK where employers automatically enrol employees into a pension plan, provide a minimum contribution and where employees can opt out after automatic enrolment? Or is the European line the Hungarian model where in 2001 it rendered the system voluntary and subsequently forced mandatory 2P members to hand savings to the state. Alternatively, is it the more recent Czech model where the voluntary 2P pension system closes down as at January 2016?

The core issue is that the state pension is not designed to provide a replacement rate in retirement that equals income earned in employment. Persons, however, today live longer and healthier than those a generation ago. A 66-year-old pensioner today is the 55-year-old person of a generation ago: having paid off the mortgage and educated the kids they want to enjoy their time together – do what they could not do when raising a family.

The problem is that this is a lifestyle expectation that a maximum pension in most EU states including Malta is unlikely to meet if a person planned his retirement lifestyle based on the state pension alone. A post-retirement lifestyle that equals that enjoyed by the average 55-year-old today is unlikely to happen on an annual maximum pension of €11,894.67 (€228.74 weekly).

The reforms in Malta since 2004 sought to achieve four significant impacts. One. It sought to break from collapse the pension income of future generations (born on and after 1962) in relation to the average wage – in 2004 projected to drop to 18% by 2050 of the average wage. A person who is 50 today (born 1965) and retires at 65 years could be eligible to a maximum pension of €18,430 (estimated). Although in real terms this is higher than the maximum pension enjoyed by current pensioners, in terms of the average pension replacement rate this is still nine percentage points lower than the 54% enjoyed today.

Second. The other primary focus of reform was that of guaranteeing that the minimum pension of future pensioners does not fall below the poverty line. This ‘guarantee’ is achieved by linking the pension income to the EU 60% median income at-risk-of-poverty benchmark.

Mr Azzopardi criticises this benchmark. All of the reform groups since 2004 were uncomfortable with this benchmark. It accounts only for benefits that have an € value assigned to them. The benchmark ignores free medicine, free hospital care, free long-term care, free community care and other free benefits as these are offered in kind.

This fails to present a true picture. Yet this is the EU yardstick against which Malta’s performance is gauged. The reforms guaranteeing pensioners against poverty were directed towards ‘future generations’ – persons placed under more onerous pension rules than pensioners today. Current pensioners lobbied that this right should also be extended to them.

Reforms are not money pits. Fiscal prudency in pension reform design is paramount to the well-being of all generations – vide Greece and other EU countries where pension rights are rolled back as countries lived beyond their means. In this context, the 2013 Group’s primary focus was the strengthening of the pension system against old age poverty by extending the principle of the guaranteed national minimum pension to current pensioners.

The government adopted the longer-term approach and implemented the first step in the 2016 budget – other phases to follow in future budgets.

Third. Malta’s system is characterised by a household in receipt of one pension.

This is a cultural legacy and the pension system is gender-discriminate. Our system is based on an uninterrupted contributory history (40 years for persons born on and after 1962). This favours the male spouse as traditionally female spouses did not work or exited the market to raise a family.

A key plank of the 2004 reform was the building of a supporting framework that allows mothers to remain in employment. The success here is evident: female participation increased from 32% in 2004 to 50% in 2015. Concurrently, credits were introduced for child rearing and human capital (more women graduate from tertiary education than males) to enable women to fill gaps in their contributory history and hence qualify for a pension in their own right and receive a higher pension income. This means that future households will no longer depend on a single pension but on two – one to each spouse. The adequacy level enjoyed by future households when compared to today will improve significantly.

The fourth relates to addressing the gap between income earned in employment and the quality of life sought in retirement. The discussion is befuddled by technical jargon used: second pension, mandatory, compulsion, etc. The result is an ideological platform – second pension or nothing; EU model or nothing; second pension equals adequacy, etc. This is unfortunate for the core of the issue is simple: to what extent should one assume responsibility for bridging the gap between income earned in employment with the quality of life sought in retirement?

All reforms to date underlined that the objective of the pension system remains unchanged: avoiding old age poverty. Increasing contributions from 10% to, say, 18.5%, contribution paid on income and on all income earned to position the system to return an income in retirement closer to work income was never on the agenda for reform. In the absence of significant changes to contributions paid by the employer, government and an employee the state pension income will never breach this gap.

The solution, therefore, rests with saving for retirement – deferring consumption today so as to allow for greater purchasing power in retirement. Research shows that people are myopic in planning and do not think long-term – they are unlikely to save for retirement when young. It is on this basis that the 2004 PWG (which I chaired) proposed a 2P pension. Increases in contribution would not necessarily result in an individual’s improved inadequacy given Malta’s Defined Benefit Pay-As-You-Go system such increased contributions would not go to an individual’s personal account as none exists. Increases in contributions alone are more likely to strengthen the sustainability rather than the adequacy aspect of the pension conundrum.

The recommendations by the 2004 and 2010 Groups generated debate and controversy. This resulted in the current ideological hardening on saving for retirement. The debate is etched in stone – immutable like the Ten Commandments. This is regrettable for it has muscled out consideration of other alternatives.

The 2013 Group is criticised by the UHM and the Opposition for ignoring a mandatory 2P framework. What the UHM, Opposition and others fail to realise is that the Group proposed alternative realistic ways of how savings for retirement can be introduced – alternatives based on approaches adopted within and outside of the EU resulting in pronounced results with little controversy.

The first alternative relates to incentivising organisations to introduce voluntary 2P schemes. Such incentives reduce the cost impact on employers, rendering their support more likely. It provides trade unions with the opportunity to place pension schemes for discussion when negotiating collective agreements.

The second alternative is rendering pension savings on ‘soft’ and not ‘mandatory’ compulsion – compelling a person to enter a scheme with the flexibility to exit it. Such pension schemes are also known ‘mandatory opt-in / voluntary opt-out’.

Yes. The 2013 Group underlines the ‘New Zealand’ scheme as a potential model (and the EU UK based ‘NEST’ scheme). Experience shows that both schemes are meeting the objectives they were designed for: nudging people to save early to build a ‘retirement nest egg’ that allows them to enjoy in retirement the quality of life they plan for.

Surely this is our objective too. ‘Soft compulsion’ works and the 2013 Group proposes that the design of a ‘soft compulsion’ scheme should constitute a core part of the 2020 strategic review.

The Group was criticised on why it focuses on 2020 and not the immediate. The Group’s raison d’etre is not to create markets for financial institutions. There is little doubt that once introduced, providers will target 18 year olds entrants on the labour market. Truth is that Malta significantly lags behind others with regard to financial literacy. The danger exists that persons who do not opt out (in New Zealand 75% do not) are likely to invest in savings instruments they do not understand.

This is morally unacceptable. It is, therefore, of importance that between now and 2020 Malta undertakes sustained, focused retirement income and financial education programmes directed to inculcate financial literacy as a life skill. A Commission on Retirement Income and Financial Literacy will be launched in January 2016.

No. Pension reform is not a matter of European lines or nothing. It should not be driven by dogma. Reasonable and realistic solutions should not be discarded solely because they do not fit the ideological discourse.

David Spiteri Gingell is former chair of the 2004, 2010 pension reform groups and a member of the 2013 group