Welfare and health reform is potentially a hot potato for politicians to handle as a major overhaul of the existing system must be carried out. The World Bank presented its latest report entitled “The Maltese Pensions System, An Analysis Of The Current System And Options For Reform”, which the government forwarded to MCESD for discussion and evaluation alongside other proposals prepared by the Welfare Reform Committee. The World Bank report notes inter alia that the current pension system “suffers from both issues of fiscal non-sustainability and low pensions in the long run”. It makes a number of interesting proposals that include raising the retirement age to 68 by 2072 and basing the pension on lifetime earnings, rather than the best three of the last 10 years for employees and the average of the last 10 years for the self-employed. The report notes that the way the pension system was set up in Malta included a number of disincentives for people to keep paying their contributions after 30 years; it seemed that many were claiming invalidity to get their full pension early. This is because the pension system allows individuals to accumulate a two-thirds pension after 30 years. The average length of service in Malta is 30 years and workers who start contributing at the age of 20 can have a full pension by time they are 50. As there is no additional pension accrual during the last eight years of contribution, people claim invalidity. Invalidity rates in Malta rise dramatically from about four per cent after the age of 50, to over 10 per cent by the age of 56 and close to 16 per cent by the age of 59. Another suggestion is to add a “funded pillar” by taking an additional contribution of about two per cent, from both employees and employers, and to gradually raise this amount to five per cent by 2020. Annual wage increases will be more than sufficient so the take home pay will not be affected and pensioners would be able to receive a pension from both the pay-as-you go system as well as the funded pillar. The pension fund would be centrally managed and offer two portfolios, one with fixed income securities and one composed of shares. No doubt the insurance

Surely the gap exists and it is no surprise that pensioners may well ask if this a problem shared with other countries in Europe. Let us see how they addressed it.

Sweden carried out a fundamental restructuring of its pension system. The architects of the Swedish pension reform claim it is a solution to demographic financial and political pressures on old-age security. The most important decision was taken 10 years ago when it adopted a number of guidelines for pension reform. The influential policy was drafted and implemented in 1994/1998, which proved that even mature statutory pensions systems could be improved as a result of political compromise and goodwill among stakeholders. Due to structural setbacks, implementation of the actual legislation was delayed by four years and in 2001 the first benefits generated under the new system were paid out. Not unlike Malta, the old-age pension part of the Swedish system was under-financed and it was clear, in view of the increased demographic pressure – projections of which could easily be made – that the existing problems would be further aggravated.

The golden rule is that all contributions are “accumulated” and attributed a rate of return equal to the growth in average annual pensionable income of all insured persons. The 1994/1998 reforms thus introduced a new logic for determining benefit size. The amount in contributions going to the “notional account” was set at a level assumed to be high enough to cover the earned entitlements in the old system. This has manifestly improved the sustainability of the Swedish welfare system for the foreseeable future.

Let us now view what progress in pension reform was achieved in other European countries. Reform in the UK, widely seen as highly innovative, has almost certainly changed the future path of pensions policy-making. The financial pressures from future contribution rates were mild compared to those in other systems. France by contrast faces the most serious pressures from future commitments, even after the 1993 reforms, but the changes to the institutional structure might constitute a shift to a new path in pension policy-making. In Germany, reform of pension arrangements without institutional shifts appear to have tackled the strong commitment to the occupational structuring of welfare. In Italy, the government instability has delayed reforms repeatedly and it is unclear whether future governments will continue to implement current provisions designed to resolve the problem of rising pension costs.

As a general comment, over the last two decades pension systems across Europe have had to confront a series of common challenges each having different effects according to system and country.

The first challenge, commonly termed the “pension time bomb” is demographics, or population ageing in the most developed countries. In most European countries, pension schemes are (pay as you go) PAYG, whereby current contributions are not capitalised but used to pay current benefits and are particularly susceptible to changes in the number of retirees. Data from the OECD reveal a particularly worrying situation and future trends for Continental Europe (OECD 2000). These data show a dramatic increase in the ratio of elderly people over 65 to the working population. There is a predicted dependency ratio for 2030 of 49 per cent in Germany, 48 per cent in Italy and 39 per cent in France. The second factor contributing to financial instability is the degree of maturity of pension schemes in that the share of resources transferred to the retired population is a function of beneficiary and contributor rates (the ratio of beneficiaries and contributors to the total population). If these ratios are still growing, and they are expected to grow in the future, then the system is still in a process of maturation. The third dimension of the pension problem derives from the transformation of labour markets and from employment and unemployment rates. High unemployment rates are part of a vicious circle that are difficult to understand in terms of causal mechanisms and subsequent effects. Thus, these factors are both pressures on the sustainability of current pension programmes and possible consequences of their impact on the economic competitiveness of EU countries.

Imagine saving diligently all your working life only to find you have to struggle to live on less than a third of your final salary. Depressing figures from recent press announcements revealed that this is the likely future facing today’s young savers. For the typical young worker aged 35 retiring in 2033 the figures are even gloomier.

Working women’s plight is even worse. Their combined impact of lost earnings and pension contributions because they took career breaks to have children, plus lower salaries on returning to work, means their pension is likely to be low as inflation will eat into the present capping system based on the 2/3 scheme. Perhaps we have to bite the bullet and, as suggested by the World Bank report, raise the retirement age to 68 by 2072 while basing the pension on lifetime earnings rather than the best three of the last 10 years for employees and the average of the last 10 years for the self-employed. Notwithstanding the public’s indifference to find a workable solution given our record of State finances, we now have a golden political opportunity for reform. The reform spearheaded by the Prime Minister Dr Gonzi, did not come a moment too soon. It came hot on the heels of the realization that due to demographic and other changes, State revenue will in the near future only pay 27 per cent of welfare expenditures, compared to 92 per cent today. If we further postpone our long awaited reform, pundits say that workers in the near future will be dancing their way to financial Armageddon following the implosion of the pension time bomb.

George M. Mangion is a partner in PKFMALTA, an audit and business advisory firm.