The Pensions Working Group 2010 was tasked by government to consult with constituted bodies, stakeholders and the public on the Strategic Review report on the Adequacy, Sustainability and Social Solidarity of the Pension System which it had presented to the Minister for Pensions and which was tabled in the House of Representatives on 14 December 2010.

In the build-up to the report, the Group had invited the World Bank to assist it in producing the baseline model on the PROST tool for the carrying out of its projections on the future behaviour of the pension system. The Group was mandated to assess and analyse such feedback and to submit a final report to the government for its consideration.

The consultation process was launched on 15 March 2011 at the Malta Council for Social and Economic Development and was concluded in late summer of that year. The feedback arising from the consultation process necessitated the Group to carry out further modelling of the future performance of the pension system under different scenarios.

The salient feedback and critique from the consultation process related to issues such as the undertaking of sensitivity assessments to simulate different assumption scenarios; the linking of the retirement age to a longevity index; the introduction of a mandatory second pension particularly to its timing and its impact on the economy; the competitiveness of Malta’s industry and enterprise and the disposable impact on consumers; the need to achieve a full active participation rate in the labour market as a solution to demographic challenges; the at-risk-of-poverty of pensioners; and claims with regard to anomalies in the pension system affecting current pensioners.

The Group listened and assessed the feedback presented and, where it believed it was necessary, amended the recommendations it presented in the Strategic Review or amplified on the rationale of why it chose to maintain a proposed policy approach.

The recommendations that the Group propose are based across four tiers of policy considerations. The first tier is directed towards the further strengthening of the First Pension, which is and should continue to remain the backbone of Malta’s pension system. The reforms embarked upon in 2007 were, indeed, directed towards this important pension pillar. The reforms of 2007 managed to break a downward spiral that would have resulted in an Average Pension Replacement Rate (APRR) – that is the average value of the pension income in proportion to the average wage of a 17-year-old today who retires at 65 years of age in 2060 of 18 per cent APRR, compared to the 55 per cent APRR that is received by a pensioner today. Additionally, this significantly reduced APRR of 18 per cent would be at an approximate deficit of four per cent of the pension system to GDP.

The 2007 reforms result in a projected APRR of 45 per cent for the person who will retire in 2060 − with a slightly higher deficit of 5.8 per cent of the pension system to GDP. Thus, the 2007 reforms put the brakes on what was, prior to the implementation of the said reforms, an accelerated degeneration of the APRR and thus prevented the pension system from collapse.

Nonetheless, these projections show that the parametric changes to the PAYG pension carried out in 2007 did not go far enough to secure the appropriate level of adequacy and the sustainability of the pension system − in part, because the reports of the then Pensions Working Group in 2004 and 2005 proposed policy measures that went beyond the parametric changes to the First Pension scheme, which the government, at the time, did not embrace.

Malta’s First Pension system faces structural issues that stem from inherent limitations of the pension system itself. The PAYG pension system is intrinsically tied with Malta’s demographic base as well as with the labour active participation base.

The PAYG pension system is based on a solidarity concept, in that the pension contributions paid by a person in employment today, such as you and I, do not go towards financing our pension. Rather, the contributions we pay are directed towards the financing of our parents’ pensions. Our pension will be paid through the contributions of future workers that are yet to enter into the labour market.

The PAYG system has worked well in the past because the ratio between people in employment and people in retirement maintained the necessary equilibrium. The PAYG system, however, breaks down once this equilibrium is distorted.

Malta’s population trends over the past 30 years show that the fertility rate has decreased and that the longevity rate has increased. What this means is that, over time, fewer people are born while people in retirement live longer. The impact of such a fundamental change to the population dynamics is that there will be far fewer people active in the market to finance the pensions of an increasingly larger number of retired people who are living longer. Between 2012 and 2060, Malta’s longevity rate is projected to increase by six years. The ratio of people in employment vis-à-vis those in retirement is expected to change from 1:4 in 2010 to 1:1.5 in 2060.

The positive impact of the 2007 reforms on the PAYG system is, over time, neutralised. Projections show that the PAYG system will kick off into an accelerated deficit of the pension system to the GDP from 0 per cent to 5.8 per cent (approximately) when the demographic tipping point occurs − in around 2035.

In part, increasing the active participation rate as well as reversing the negative trends in Malta’s population can offset the negative impact of the changes in the demographic population dynamics. The question, and ensuing debate, is the extent to which such changes can occur and the degree of the positive impacts of such changes in containing the pension problem discussed.

During the consultation process, a number of stakeholders stressed that Malta’s solution to the pension system’s structural demographic deficit lies in the mobilisation, through aggressive policies, of an optimal active labour participation. Sensitivity modelling projections carried out by the Group, however, show that not even the most optimistic labour active participation market rates possible − such as those of Sweden − will, on their own, result in an adequate and sustainable PAYG pension system.

The Group agrees with the stakeholders consulted that more can and needs to be done to strengthen the demographic as well as the labour participation base respectively. The Group recommends that the government should adopt a holistic approach that weaves together a series of policy measures to strengthen the demographic and active participation base of the First Pension by embracing fertility increase, female participation, elderly participation, disabled people participation, population increases through immigration and residency measures, etc.

Nevertheless, it is of the considered opinion that such a pro-active policy approach alone will not suffice to strengthen the First Pension.

This means that further policy measures need to be considered to secure an adequate and sustainable pension system for future generations. The second tier of policy measures considers further steps that can be introduced to strengthen the inherent framework of the PAYG pension itself. As stated, the 2007 reforms in this regard were far-reaching and comprehensive. There is, indeed, limited room for manoeuvre. One potential measure that the Group discussed is to link the retirement age to a longevity index to compensate for any further increases in the longevity rate of Malta’s population.

Alternatively, a different pension system should be identified for the First Pension and introduced to replace the system. A First Pension system that comes closest to the removal of a statutory pension retirement age as a fundamental parameter to the sustainability of the pension system is the Notional Defined Contribution (NDC) PAYG pension system.

The NDC PAYG pension system minimises the role of the ‘normal retirement age’ and permits a more flexible choice between consumption (working longer) and leisure (retiring earlier) by rewarding the former through an increased pension return and penalising the latter through a reduced pension return below the pension value as set at the official retirement age.

While recognising that a transition to a NDC PAYG based pension system constitutes a major structural reform, and one that should not be entered into lightly, the Group recommends that the government should mobilise the necessary expertise to carry out an assessment on whether a transition to a NDC PAYG pension system is a viable alternative for Malta, given that most international institutions share a rather positive assessment on the future financial sustainability of such a pension system.

The third tier of policy recommendations considered is whether the First Pension should be complemented by a Second Pension mechanism. The Group argues that a First Pension should provide an adequate and sustainable income in retirement to allow retired people to live in dignity. The fact remains, however, that an adequate pension income will not replace the level of income enjoyed when a person was in employment. The purpose of a Second Pension, therefore, would be to breach the gap between an adequate pension income in retirement and the income, and hence the quality of life, earned in employment.

The Group recommends that the government consider introducing a mandatory Second Pension system whereby contributions paid (and not tax, as some assert) are directed into a person’s individual pension account that will subsequently finance a ‘second’ pension. The Group stresses that the adoption of this recommendation is conditional to the presence of a strong governance framework that minimises the market risk to those who enrol in a mandatory Second Pension.

The Group agrees that the introduction of a mandatory Second Pension will have an impact on the local economy and on the disposable income of households. It therefore recommends that, given the national importance of such a decision and the challenges that its implementation creates for all stakeholders, is for the government to lead a process of national discussion that results in a bi-partisan and civil society agreement on the important modalities that surround the introduction, setting up and implementation of a mandatory Second Pension.

The fourth and final tier of policy considerations is directed towards the introduction of a Third Pension framework that will allow individuals to voluntarily save to increase the income available to them in retirement. The Group argues that a cleverly designed Third Pension should allow investors to migrate seamlessly into a mandatory Second Pension, as and when this is introduced. Additionally, the Group argues that a Third Pension should be complemented by an attractive fiscal incentive regime that is aimed at both attracting people to invest in a Third Pension and to embracing those who have already invested in traditional insurance and financial instruments to roll-over, on maturity, the surrender value of such instruments into a Third Pension. It should be noted that, according to the financial services sector, the total maturity value of such instruments between 2012 and 2020 approximates over €400 million.

The Group recognises that there are different policy options and solutions to a complex policy domain such as the continued reform of a pension system than those it has ultimately selected and presented. There is no doubt that there are those who will present alternative rationale and views on the extent and degree of the pension issue and the solutions that are to be adopted.

Indeed, the Group believes it is important – even imperative – that, in the process leading up to the taking of the necessary decisions on such a sensitive and strategic policy domain as pensions, an open, public and honest debate takes place so that Malta makes the right decisions.

David Spiteri Gingell is the chairman of the Pensions Working Group