Second pillar on the agenda
Malta's new social policy minister has put pension reform firmly on the agenda, reports Stephanie Testaferrata
Only months into his new post as Malta's social policy minister, John Dalli (pictured left) is wasting no time hammering out the country's pension reforms. "We will implement the pension reform in full during this legislature," he says. "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."
Plans for reform have been in the works for over a decade, although policy only took a significant turn in 2004 when a pensions working group submitted a proposal for wide-scale first second and third-pillar reform.
Two years later, a reform of the PAYG state pension scheme was implemented. This extended the pensions age to 65 years, but people can retire at 61 if they have been making contributions for 40-years.
A pensions income ceiling was established as €21,000 from 1 January 2014. Thereafter it will increase on the basis of a formula that includes wages, representing 70%, and inflation, representing 30%.
The reforms have also established a minimum pensions guarantee that is pegged to 60% of the median income, including the basic wage, overtime, allowances and bonuses.
Although most of the groundwork for occupational and third-pillar reforms has been covered by the pensions working group, with assistance from the consultancy Hewitt, resistance from the unions remains strong. The General Workers' Union (GWU) has made it clear it does not support the proposed reform recommendations, especially a proposal that occupational schemes be mandatory. However, the GWU has not dismissed reform altogether.
Vince Esposito, (pictured right) a pensions expert at the GWU, recalls that Malta had occupational pensions schemes in the past. "In 1979, after the introduction of the two-thirds pension scheme, where the employers and workers had to contribute 8% of their basic wages and government made further contributions, most occupational pension schemes were wound up because the parties could not afford something like 5% or 10% towards the occupational schemes," he says.
"Primarily the GWU maintains that the government should continue to maintain the present system of the two-thirds pension scheme contributed by the social partners and that such pension should be adequate enough for pensioners to enjoy a good standard of living even after they retire from work. The second pillar should be introduced on a voluntary basis."
Esposito recalls that throughout the discussions over the last 15 years, both the employers and the workers made it clear that only a minority could afford to introduce a second pillar scheme. "Presently the situation has worsened in view of globalisation, fuel expenses, high cost of living and taxation," he says. "Instead of wages and conditions of employment getting better, they are regressing. Consequently most workers are unable to contribute towards an employment pension scheme. Now that the National Security contributions have gone up to 10%, workers cannot afford to pay more. However, subsidising the second pillar is from the national security scheme would be detrimental to the two-thirds pension scheme and therefore most unjust to the majority who will not benefit from the second pillar scheme."
According to Esposito, the most important implication of the 2006 reform is the drastic cut in the benefits of future pensioners. Employees will have to work an additional four years and therefore contribute four additional years. Also, their pensionable income will be considered on the average of 10 years' earnings, instead of the present three years which, says Esposito, will mean a smaller pension.
"Such measures will definitely badly affect pensioners with minimum pensions and who are already on the poverty line," he notes. "Regarding taxation on pension contributions, we maintain that contributions should not be taxed, but there should be safeguards against abuses."
However, Dalli appears to be untroubled by the union resistance. Asked whether it is possible to find a peaceful balance between reforming pensions and appeasing union concerns, he said: "I do not think that the projected pensions reforms will encounter problems with the unions."
And the financial services industry is delighted with Dalli's aims. "The target is more than reasonable given the work that has already been done by the pensions working group," says Stuart Fairbairn, pensions consultant for Middlesea Valletta Life and chairman of the pensions expert group at FinanceMalta. "The changes made so far have focused on state provision. Raising the state pension age was inevitable, as was increasing the eligibility conditions for maximum pension. What the reform has failed to do so far is introduce incentives for occupational and private pension provision."
Notwithstanding the reforms to state pensions, Fairbairn believes a state-only pension scheme is not sustainable in the future. "Changes to the social security system, effective in 2007, increased the state pension age for males and females to 65 by 2027," he notes. "Changes were also made to the calculation of pensionable income - the state pension in Malta is earnings related not flat rate - and the contribution period for full entitlement was increased to 40 from 30 years."
Compared with other countries in the EU, Malta's pension ranking is worryingly low. "Aon's 2007 European Pension Barometer places Malta nineteenth out of 25 member states in terms of pensions ranking," says Fairbairn. "The rankings are based on demographics, adequacy of state pension, affordability and sustainability of state pension and private pension provision. The results indicate that major problems still exist despite the first round of reform, which if not addressed, will create serious problems for the pension system. The main risks lie with demographics - an ageing population, low birth rates, low female and older worker participation rates - and a lack of a credible private pension system."
He adds: "The 2004 World Bank Report stated that by 2011 the government's contribution of 10% to social security would be insufficient to cover the pensions deficit. Since the recent changes to the social security system I have not seen an economic impact study on the effects of the changes. However, one has to question whether the increases to the state pension age will have made a major difference, particularly with life expectancy figures typically being underestimated."
However, Fairbairn is optimistic, especially considering the legal framework is already in place for second pillar pensions and the financial services industry is geared up to offer third pillar pensions. "The biggest challenges will be in deciding whether to make schemes mandatory, and if so what contribution levels, how to provide for the self-employed, and how to structure the fiscal incentives. Tax legislation will need to be updated in a number of areas if fiscal incentives are to be workable."
Unusually for a politician with such a challenging mandate, Dalli is a man of few words. Asked whether third-pillar pension schemes with attractive tax breaks would be introduced in the near future, he replied: "As I said, the full pension reform will be implemented."
Under the new Social Security Act, his ministry is required to review pension reform by no later that the end of 2010 (or every five years). If Dalli's three-year target is to be reached, a reformed pension system should be implemented by then.
Some of Malta's leading insurance companies already offer savings' products, but they have not really taken off due to lack of tax incentives. The best solution for third pillar schemes, according to Fairbairn, is that they must be simple to understand and easy to join. "Any tax concessions on contributions and investments help bolster savings but don't necessarily lead to greater participation, although more employers are likely to sponsor schemes if they receive concessions. Fringe benefit tax laws need to be reviewed accordingly.
"Access to schemes should be made compulsory through employers, similar to the stakeholder designation requirements in the UK, at least ensuring every employee has easy access to a savings vehicle for their retirement. Auto-enrolment should also be considered in order to improve participation rates."
In order for reform to take off smoothly and efficiently, Fairbairn emphasises the need for the government to focus on education. "The reform urgently needs to address the financial education of the population by making people aware of what the state is likely to provide for them in the future and what individuals can do in order to improve their security in retirement."