As the Maltese government stalls on a commitment to introduce second and third pillars, George Coats points out that the island nation had an occupational system some years ago

Despite a reform of Malta’s state PAYG pension system in 2006, there is a growing groundswell of feeling that more fundamental changes to the whole pensions arena are needed. But while the impact of the economic showdown on Malta’s economic growth will add to the pressure on the system, it is also heightening a reluctance to change anything.

Writing in the Malta Independent newspaper in April, local commentator Alfred Mifsud noted that were the government a commercial organisation it would unquestionably be bankrupt. “We always knew that our pay-as-you-go pension system is a huge burden on future governments who will find it progressively harder to maintain,” he wrote. “If Malta were a commercial company the auditors would insist on showing a liability in its balance sheet reflecting the current value of such future obligations using best estimates regarding longevity, inflation, economic growth and making a subjective judgement on the rate with which to discount future obligations to their present value.”

He added that the theoretical liability that was calculated by a Eurostat/ECB project team estimated the liability at €14.3bn, or 264.2% of the GDP. But while “no commercial company could survive and remain financially stable if it had to recognise in its books a pension liability equivalent to 264% of its internal value-added”, the government is no commercial company. “It has no obligation to include such liability in its financial statements although Eurostat and the ECB seem minded to include it in a revised version of the national accounts of EU countries to distinguish those who, like us, are fully exposed to such obligations from others who have full or partial funding mechanism in place”.

The 2006 parametric reform, which included the gradual raising of the pension age to 65 for both men and women from 61 for men and 60 for women between 2014 and 2023, had the effect of reducing the island state’s pension liabilities by 7%, or €1.6bn, according to the local National Statistics Office (NSO). The reform also extended the contribution period from 30 to 40 years and included changes to the calculation of pensionable income, basing it on an average of 10 years’ earnings instead of three. As a result, some €1.5bn would be saved by the state on pensions, and pension entitlements would drop by 12.2%.

However, the NSO calculation, which was released in April, was based on figures prevailing in 2006 and, announcing them, NSO statistician Clyde Caruana said the sustainability of the pension system was directly linked to the GDP and if GDP growth was not adequate the government would have to make further adjustments to sustain pension schemes.

“Almost four years have passed since the 2006 pension reform and 2005 was a very good year, so I would not be surprised if even the parametric reforms need some fine tuning to meet today’s circumstances,” notes John Cassar White, a retired prominent banker and now a lecturer in business studies at the Malta College of Arts, Science and Technology (MCAST), who continues to commentate on current affairs. “The economic growth projections may need to be revised.”

The EU agrees. In its 2009 Ageing Report, also published in April, the European Commission noted that Malta had only made “limited progress” in reforming its pension system. It estimated Malta’s average annual potential GDP growth between 2007 and 2050 at between 0.4% and 0.6% compared with an EU average of 1.8%, due to unfavourable projected labour market developments. It added that the working age population would decline from the current 69.9% of the total population to 54.9% by 2060 and the over-65s would increase from today’s 13.8% to 32.4%, lifting Malta’s total economic dependency ratio to 199% - one of the EU’s highest levels.

“The reform of the Maltese pensions system has been the subject of extensive public debate over a number of years,” notes Bernard Attard, a senior manager in the tax and legal services unit of PricewaterhouseCoopers Malta, in a recent paper. “The main aim of such a reform is the restructuring of the pensions system so as to make it both adequate and sustainable for the future.”

To this end the 2006 reform law also foresaw the establishment of a mandatory second pillar and a voluntary third pillar, and the following year the IMF urged the Maltese government not to delay plans for the introduction of second pillar pensions, citing concerns over the sustainability of the social security system.

But it has not yet been implemented, the government having said it did not think the economic situation was conducive to the introduction of mandatory second pillar contributions from workers and employers. However, the social policy ministry is required to review the pension reform recommendations by the end of 2010 and last year social policy minister John Dalli indicated that the government was committed to implementing all pension reforms within this legislature, which ends in 2013, if not before. “In the context of the present economic scenario, I believe that we should be in a position to conclude the consultation process with all constituted parties and implement the second tier of the pension system within three years,” Dalli said.

But since Dalli‘s comments no more has been heard from the government on a second pillar.

“The economic downturn is a good argument to put difficult decisions on hold,” says Cassar White. “But the breakthrough made some years ago to tackle the national pensions issue needs to be followed up with further action. Once the economic situation improves, we will need to implement the reform’s tougher recommendations by making additional contributions mandatory for the building of a pensions pot for everyone who works. Extending the retirement age to 65 was unpopular, but relatively easy. The difficult part is implementing the other changes. Of course the time is not right now because no one wants to increase the cost of labour when competitiveness is being threatened by the world economic slump. But in a year, or maybe a little longer than that, we should bring this back on the agenda.”

However, for Malta the introduction of an occupational pension system would be a return to past practice. An earlier version was killed off in the 1970s when a reform of the state system decreed that the replacement rate of the PAYG pension should amount two-thirds of a salary up to a specified ceiling. The resulting increase in contributions to the state system effectively ended the occupational system as employers and employees were unable to pay both sets of contributions and the private system was anyway seen as unnecessary, given a generous state pension. As a result, the schemes were closed.

“I think the rule was that if you qualified for a private pension then you would not get the state pension,” recalls Cassar White. “And obviously that kills private pensions because everyone was contributing to the state pension and nobody wanted to lose the entitlement to it.”

However, the ceiling failed to keep pace with wage growth and inflation. “By today’s standards it is very low,” says Cassar White. “The maximum pension today is about €11,000 a year and the average wage is around €20,000.”

But any revision might take some time to implement. The two-thirds pension reform was enacted by a government formed by the now opposition Labour Party. The affiliated trade union movement remains largely opposed to changes to the current system, although it appears to agree that the present system is unsustainable. Its perception is that a requirement that workers contribute to a funded system would reduce their take-home pay.