Some call it a Ponzi scheme as it assumes that when you and I reach our retirement age, there will be sufficient persons working that can finance our pensions. Demographics, unlike active labour optimisation, is a dicey thing. When we started the reforms in 2004, the old age dependency ratio was estimated to fall from one retiree for every four workers to one retiree for every two workers. We used the United Nations demography data at the time to maintain the same baseline in comparing the reform measures we would propose with the dire “no reform” scenario projected by the World Bank. In essence, the projections showed that with the fertility rate below 1.8, Maltese were a dying population, with, if memory serves me right, the Maltese indigenous population falling below 390,000. At the time, we had just entered the EU and it was next to impossible to obtain work permits for third country nationals or employers acting on their behalf.

We focused on achieving an optimised labour force, sometimes called the “fourth pillar” or flanking policies. Working with other government stakeholders we proposed measures relating to increasing female participation through family-friendly measures and before and after school education. We removed the cap on pension income if retirees earned more than their pension rendering it unattractive for them to remain in the labour market. We proposed measures for targeted TCNs immigration for sectors requiring specialised and highly skilled employees in the here and now to take root and grow. We reformed the invalidity pension process – an open-door exit pathway if there was one. We also recommended that illegal immigrants should be allowed to be productive until their cases were settled one way or the other, and in doing so, providing them with dignity.

Some of the reforms resulted in rapid transformations. Females were only 30% active in the labour market in 2004. By 2018, 14 short years, they were over 60%, particularly the 35-year-old cohort, above the EU average. Some never saw the light of day, like fast routing TCNs, even though advanced manufacturing and services industries required highly skilled competencies.

Be that as it may, there are limitations to the extent that we can optimise human capital as a country. Thus, in a scenario where Malta’s demography is “dying”, the balance between pension adequacy and % deficit to GDP will always remain a conundrum.

In the 2010 strategic review, we applied the latest Europop 2009. These are population statistics drawn up by Eurostat, based on a common framework methodology and assumptions across the member states: the size-fits-all beloved principle of the European Union and the European Commission. With a decreasing fertility rate and minimal immigration assumed by Eurostat, the projections showed that the Maltese population would decrease in 2060. I believe the projections showed that Malta’s population would be less than 390,000 and with over 30%, 65 years and over.

Now we come to the 2015 strategic review. Suddenly, Eurostat, having changed its assumptions for I believe Europop 2013 particularly relating to migration – for all member states – showed that Malta’s population would not actually be dying out but would grow and significantly so to 475,000. A larger population results in more revenue earned from contributions, so the figures balancing adequacy and the % deficit to GDP started to look significantly better.

And it gets better. As stated in the 2020 SR published report and I quote: “Europop 2019 demographic projections [Europop 2019], produced by Eurostat [and] Europop 2019 projects that in 2100, the population in Malta will stand at 689,359 individuals. A significant increase in the population is projected to take place between 2020 and 2070, after which it stabilises. In 2070, the population is projected to be 706,915 … Malta’s population is expected to increase by 199,964 [on actual reported population by the National Statistics Office) or 39.4% between 2020 and 2070.”.

The Adequacy Retirement Replacement Rate – the yardstick on which pension adequacy is measured – will, for future pensioners retiring in 2070, be 55% with a percentage deficit to GDP of -3%. These projections assume that none of the reform considerations presented in the 2020 SR will be implemented. By far, they are the best-projected results achieved to date.

Minister Caruana raised a furore earlier this year when he was quoted as saying that forecasts based on the current model require that Malta’s population increases to 800,000 by 2040. Projections of the pension system, in the absence of no sustainability reforms, to achieve an APRR of marginally above 54%, which was planned by the 2004 reform group as the minimum goal to achieve for future pensions by 2050, will be based on the SR 2020 (assuming that the government takes up none of the considerations presented) will happen 20 years later than the cohort of future pensioners retiring in 2050 and a demographic base of 700,000.

The joker in this pack is demographics.

The post Demographic dynamics: the unpredictable element in the pension reform first appeared on The Malta Business Weekly.

Individually, the characteristics of different populations and income cohorts present different challenges. For example, the financial capability of vulnerable persons demands greater attention to their ability to manage their income and debt. On the other hand, young adults are conditioned by behavioural heuristics: pensions are for the future while addressing today’s life cycle challenges: getting married, raising a family, buying a home, etc.

The 2010 Strategic Review (SR) on the pension system mandated placed financial capability as a fundamental pillar for pension reform. Indeed, a specific chapter titled Establishing a Framework for Financial Literacy, formed part of the SR report prepared by the Pensions Working Group. The government, late in its administration in mid-2012, acting on the recommendation of the 2010 SR, set up a Commission on Financial Literacy and Retirement Income – setting out for it two short-term goals: (a) carrying out a national survey on financial literacy in Malta to be based on the OECD/International Gateway for Financial Education survey instrument, and (b) to design a national strategy on financial literacy and retirement income – both to be completed by December 2012. Neither task was completed and the Commission was not reconstituted following a change in administration following the March 2013 elections. Regrettably, this Commission did not survive the change in administration in 2013.

The 2015 SR, in a section of its report titled Inculcating a culture of literacy concerning financial savings and investments and retirement income in its final report underlined that the “Pension Strategy Group (PSG) agree[d] with the direction proposed by the 2010 PWG in the setting up of a leading structure that would result in the articulation of a financial and retirement income strategy and which would coordinate its implementation … [that] a Commission for Financial Literacy and Retirement Income” is set-up.

The responsible minister at the time and the chair of the PSG tasked me to draw up a national strategy for financial capability. A draft was published for public consultation in early 2016 and the post-consultation strategy was approved in 2017. I was tasked to implement this strategy. One of the immediate tasks I undertook was the carrying out of the OECD/INFE survey instrument. My objective for Malta participating in this survey was to understand the level of financial capability in Malta and what gaps exist, thus allowing us to determine how these are to be addressed and to establish a baseline against which Malta could evaluate its performance over time in addressing financial capability. The report Financial Literacy in Malta: A Study on the awareness, knowledge, skill, attitude and behaviour necessary to make sound decisions was made public in late 2018. This report has a wealth of data I have long concluded which remains untapped. Among some of the important observations that emerge from this research are the following:

• 1 in 3 adults (29% – 292 respondents) do not take any initiative to track their household finances;
• The overwhelming majority of Maltese persons prefer saving money in savings / deposit accounts: 77.4% for the population cohort 20-29 years and 80% and over from the 30 years and over age cohort, with an average of 84.3%;
• Investing in bonds is highest with the 60-69 and 70-79 population age cohorts at 35.6% and 32.6%  – averaging 10.7% for the 30-39 age cohort and lower;
• Preference in investing in stocks and shares is 17.3% and less for the 40-49 and lower population cohort, relatively high at 30% and 39.7% at the 60-69 and 70-79 age cohorts, respectively;
• Buying in cryptocurrencies at 2.9%, 5.9% and 3.5% for the 18-19, 20-29 and 30-39 age cohorts but insignificant for the other population cohort;
• Among the 60-69 and 70-70 age cohorts use of a banking app or other e-tools to manage money and keep track of outgoings stated at 9.6% and 5.2%, respectively, averaging 36.6% across the other age cohorts, the highest being the 20-29 age cohort at 50.3%;
• 45.2% stated that they do not have a retirement plan and 11.1% stated that they are “not at all confident” or “not confident” in having done a good job of making a financial retirement plan;
• 54.1% are looking at funding their retirement from savings;
• 44.8% depending primarily on the state pension; and
• 14.9% have a private pension plan

The above is only a small insight into the observations from this research. I understand that Ġemma has tacked into the next OECD/INFE survey cycle. I await the publication of the findings of the findings of this research. Comparing the results of this new research with the 2018 OECD/INFE Malta results will present an interesting analysis of behavioural changes within and across different population cohorts and nationally in terms of ensuring that Maltese citizens are financially capable.

The post Financial capability in Malta: Unearthing the facts first appeared on The Malta Business Weekly.

It is pertinent to apply this discussion to our context.  Are we, the late baby boomers and Generation X, poorer than our parents?  Will our children, Gen Z, be poorer than us?  Will my generation’s retirement period be cushioned by the wealth we inherit from our parents?  Will we inherit any wealth from our parents, given that as they live longer yet frailer lives, they use, as they rightly should, their wealth to receive the level of care and support they require?

Discussions on quality of life in retirement have always centred on how this will be financed through pension income against wealth accrued over a lifetime.  The exception is property.  We know from the Census (the last one published was 2011) that (a) over 76.4% of persons in Malta own (freehold and ground rent) their home; and (b) on average, 75% of these homes were in good state of repairs.  We know from the Central Bank of Malta’s assessment of household wealth (2023) that real assets – property mainly – constituted 89.4 of a household’s wealth – with the median value of the main residence standing at €300,000.  The 2011 Census also showed that 13.3% of the housing stock available at the time, that is, 22,404 units, were for household occasional use – either as seasonal homes or purchase for rental – with a median value of €180,000 (CBM:2023).  It is this understanding that pension reforms since 2004 have all called for the introduction of home equity release schemes in Malta:  to allow retirees to access wealth accumulated in such property as income during retirement.

Pre-COVID-19, MFSA issued a regulatory framework to launch equity-release financial products locally.  To the best of my knowledge, financial services operators have launched no equity scheme products – which does not surprise me as the regulatory framework is unnecessarily complex.  Nevertheless, we know that informal and unregulated equity release has been happening since private providers in the elderly care home industry started operating in the 1990s.  Many elderly couples exchange their homes for lifetime residency in such privately operated residency.

What is less known is the extent of wealth bequeathed from one generation to the next and how this may influence the recipient’s outlook on their retirement – which should influence the positioning of pension reform measures.  Pension reform working groups sought to study this matter but faced data limitations. 

The afore mentions CBM study on household wealth is the fourth of its kind.  The third such study in the series (CBM:2019), whilst referring that the survey instrument applied for the study collects information on intergenerational transfers, the report itself did not present its findings.  The last report (CBM:2023), however, does.  It shows that:

• 2020 approximately 25% of households claimed to receive a gift or inheritance.
• 82% received one gift throughout their lifetime.
• Most gifts were in cash – 48%; property – 45%; land – 5%; and valuables – 1%.
• 6.8% of households that owned a house in 2020 reported that they inherited their main residence.
• 7.7% of households received some form of financial support specifically to purchase their main residence.

The findings of the CBM research show that households benefit from intergenerational transfers throughout their lifecycle through gifts and not necessarily through inheritance only.

Future strategic pension reviews should delve deeply into intergenerational wealth transfer.  I hypothesise that the average person of my generation is likely to have their financial wealth somewhat increased as they are likely to inherit assets – property or cash primarily – from their parents.  This inheritance, together with our accrued financial wealth, will provide us with a better quality of life.  I posit, however, that this is unlikely to be the case between mine and future generations.  If my hypothesis is correct, this means that Malta will follow similar trends elsewhere, where future generations will be poorer than current generations.  In terms of pension reform measures, the issues of pension adequacy become more acute as the gap between income generated during employment and pension gap will not be bridged, at least partly, through inheritance.

The post Inheritance erosion: Will shrinking legacies impoverish future generations? first appeared on The Malta Business Weekly.

Over the past decade, much has been done concerning instilling financial capability core knowledge and skills domains. I was privileged to lead an inter-ministerial group of experts to draw up Malta’s first national (2017 to 2021) and second (2022-2025) financial capability strategies. Ġemma was set up in 2017 to implement the first national strategy and has undertaken a comprehensive financial capability programme across different population cohorts using different media, including gamification. The National Curriculum Framework 2012 established financial literacy as one of the key cross-curricular themes and learning outcomes were established in the curriculum for various subjects in the junior and senior secondary education cycles. Non-government organisations, like the JA Malta Foundation, have also promulgated extensive financial capability education programmes. The Malta Stock Exchange routinely holds education sessions on investments. These are just a few examples of various financial capability programmes underway.

Though much has been achieved, we are still way behind other countries such as New Zealand, the UK, Australia, Canada or the US regarding a financially capable, savvy population. I believe there are two reasons why we have not yet managed to up the tempo to a level that allows us to instil financial capability as part of the fabric of our society.

First, while many financial capabilities activities are underway, these do not come together cohesively. Too often, these are disparate initiatives where the glue between them is missing. This prevents Malta from having a highly connected, networked and intertwined approach towards instilling financial capability. The old and new national financial capability strategies (2022-2025) strongly underlined that achieving a financially capable savvy citizen is a national collaborative sustained effort. Vertical strategic partnerships, while important, on their own do not suffice. Sure, and it is given that the government has a critical and leading role in achieving such an objective. It is also a societal obligation generally – lack of financial capability, for example, is strongly correlated with poverty – and the financial services sector specifically.

When I drew up the 2022-2025 national financial capability strategy, I argued and recommended in the strategy that a National Council on Financial Capability be created to bring together all stakeholders. Looking back, I do not believe this would suffice. I believe a public-private partnership should be established, which would act as a national centre of excellence for inculcating financial capability as a core life skill for Maltese citizens.

Second. Setting up a national public-private partnership mandated to achieve a financially capable, savvy Maltese citizen requires financing. This brings me to the financial services sector specifically. When I sought to implement the 2017-2021 national financial capability strategy, one of my major disappointments was how few financial institutions sought to support Ġemma’s programmes. Many a time, where supported, the financial support provided was paltry. I believe that financial service providers have both a social and moral obligation to ensure that people who invest in financial products, which constitute a complex landscape to navigate, are financially literate and capable in terms of:

• What the financial products they offer mean, how they will impact them and the related risks and returns;
• Ensuring their clients know their rights and how to respond to them when issues arise; and
• Embracing the principles of integrity, fair conduct, respect and transparency by improving their client’s financial capability to reach better-informed financial decisions that fit their circumstances.

A financially capable, savvy Maltese citizen is likely to invest more than less in financial products – for retirement or investment. And a financially capable, savvy Maltese citizen is more likely to make better-informed decisions, thus resulting in, say, lower incidents of misselling scandals and thus increased trust in the financial services system. The result is a “win-win” situation for all. Given the millions of profits they generate yearly, I posit that the financial services industry should take a far more active and aggressive role in financing programmes and initiatives directed to ensure that Maltese citizens become financially capable.

In the absence of this, I argue that the government should place a levy on all financial service providers as a percentage of profitability, fees to corporate services providers, and so on to finance a national financial capability fund governed by the proposed public-private financial capability centre of excellence. And the government would demonstrate its commitment to attaining a financially capable, savvy Maltese citizen by matching the funds generated from the levy placed on local financial service providers.

The post Achieving a financially capable, savvy Maltese citizen first appeared on The Malta Business Weekly.

The PAYG is not designed to provide a pension income close to income earned in employment concerning persons with an employment package over the maximum pensionable income (MPI) – the threshold on which the 2/3rds pensions are calculated. For persons born in and after 1962, the MPI is €26,831. Assuming that one meets all the parametric criteria, the maximum pension a person is entitled to is €17,887. What the above means is that for a person whose salary was €30,000 before retirement, on retirement if they are dependent solely on the state pension, their income will fall to a potential maximum of €17,887, which can be less if a person has gaps in their 40-year contribution accumulation period or did not pay the maximum contribution on 10 years over the 40 years. This means at midnight of a person reaching their retirement date; their income falls to 60% (6% less of the social contract of the 2/3rds social security contribution) of what they earned while in employment. This impact on income during retirement widens the higher the salary compared to the MPI.

Bridging the gap between income earned during employment and the state pension is a matter of self-responsibilisation. To incentivise persons to plan for retirement, the government introduced voluntary private pensions (VPP) and voluntary occupational retirement pensions to be offered by employers to their employees. The incentive relating to VPPs are a tax credit of a maximum of €750 on a maximum contribution of €3,000 annually and a tax-free lump sum of 30% of the accumulated nest egg through the VPP. This monetary incentive is designed to overcome behavioural heuristics of myopia and inertia when planning for retirement.

All of the above assumes that one has a clear understanding of what their state pension income shall be so that a person can take the right steps to bridge the gap, partially or fully, between the pension income and income earned during employment and thus embark on retirement planning including investing in a VPP. Yet, is this case?

Ġemma, the government’s financial capability education platform, in March 2021, surveyed persons born in or after 1962. The survey aimed to identify the extent of their knowledge of how the state pension system works and their ability to make informed decisions regarding their retirement generally and the state pension specifically. The results of this survey attracted no attention. This is unfortunate. The results of this population cohort’s knowledge of how the state pension works and thus how it relates specifically to them, is disquieting. The following are some of the results of the survey (https://gemma.gov.mt/wp-content/uploads/2021/06/Final-110621-GEMMA-Survey-on-Pensions.pdf):

• 37% of males and 45% of females stated that they are not knowledgeable about the amount of social security they pay;
• Only 37% of males and 26% of females answered correctly that they pay a 10% contribution if employed;
• 61% of the respondents could not indicate the maximum pension income on which the 2/3rds pension income is calculated;
• None of the respondents was able to indicate that the MPI in their regard and that their pension income would increase on an indexation formula of 70% wage inflation: 30% retail inflation;
• 17% of the respondents only answered correctly concerning the number of social security contributions they will pay in a given year;
• Only 9% answered correctly to the question concerning the minimum number of contributions to be paid to qualify for a contributory pension;
• 37% of the respondents answered that they are unaware of how their pension income will be effected if they only paid 25 out of the 40 contributions accumulation period;
• Only 49% of the respondents stated their statutory retirement age is 65 years;
• 59% said they do not know how their state pension will be calculated;
• 86% said they do not know what a “crediting of a contribution” means concerning their pension;
• 82% stated they are unaware of a credit entitlement for child-rearing; and
• Only 12% stated that they know that they could benefit a credit entitlement for higher and further education.

This research strongly suggests that a significant proportion of persons born in or after 1962 are basing their retirement planning, if at all, on the wrong understanding of how the pension system works concerning them and the state pension income they are likely to receive. What this research unequivocally shows is that sustained financial capability education is imperative for persons to achieve their goals for a desired quality of life during retirement.

The post Retirement roulette: The perils of inadequate knowledge in planning first appeared on The Malta Business Weekly.

The recommendation made in 2004 for a mandatory second pension was not received well, neither by the government at the time, nor the Opposition, and constituted bodies representing employers and employees, among others. And the terms of reference assigned to the pension strategy group by the new government in 2013 specifically excluded the group from presenting recommendations to it on a mandatory second pension. The Musu strategic review, in late 2013, issued an interim report on the setting up of a voluntary personal private pension (PPP) and a voluntary occupational retirement pension (VORPS). The recommendations of this interim report were consistent with those of a task force specifically set by the Ministry of Finance to draw up a regulatory framework for PPPs and VORPS. By late 2015 the first local PPP products were on the market while VORPS followed in 2017 or thereabouts.

The PPP and VORPS framework sought to nudge uptake by incentivising through tax credits – whether for individuals to invest in PPPs or for employers to introduce VORPS for their staff. Experiences in other jurisdictions show that PPP and VORPS uptake is not pervasive. As a reform measure on its own, voluntary incentivised PPP and VORPS do not provide a solution to the adequacy conundrum. The Musu strategic review recognised this and emphasised that should these voluntary pensions “not have delivered as planned… [a future review should] strategically assess the introduction of Mandatory Opt-In Voluntary Opt-Out framework”. The mandatory opt-in voluntary opt-out framework is today referred to as Automatic Enrolment.

Regrettably but foreseen, the PPP and VORPS frameworks have not gained traction. During the 2021 tax base, PPP membership was 13,672, and VORPS 1,685. The number of persons in 2021, aged 46 years and over, enrolled in a PPP constituted 38% and those in VORPS 29% of the respective total cohorts. This suggests that these are substitute savings, which already form part of a person’s saving portfolio but are transferred from one product or instrument to another. In this case, these substitute savings are potentially the result of people shifting their savings from no and minimal-interest savings and deposit accounts to voluntary pension schemes to benefit from the fiscal incentive. The number of persons aged 19-29 who are the “new” savers and who will, over 40 years, accumulate a significant retirement egg nest investing in the PPP and VORPS in 2021 stood at 9.1% and 12.3% respectively.

I have long concluded that in a polity, where the political and social climate for a mandatory second pension does not exist, the most appropriate solution to address the adequacy issue is the introduction of Automatic Enrolment. AE is a creative solution designed to turn behavioural heuristics, in particular inertia, on their head, for under a purely voluntary scheme, inertia affects a person in a way that inhibits them from enrolling. Even if a person believes that becoming a member of a voluntary workplace pension is important to them, they may keep taking action as more immediate and pressing matters require their immediate attention. Under a voluntary workplace pension based on AE, inertia inhibits the person from opting out of the PS once enrolled. The same inertia that propels a person to procrastinate enrolling in a voluntary pension scheme now restrains the person from opting out once enrolled. AE schemes, such as those introduced in New Zealand (Kiwi Saver) and the United Kingdom (Workplace pension), successfully meet their objectives of engaging and retaining individuals to save for their retirement over time.

When my involvement in the pensions strategy group following the presentation of the 2020 strategic review terminated, I worked with the Chamber of Commerce and the General Workers Union to establish a framework for AE that they would jointly be prepared to present to the government. In March 2022, both the Chamber of Commerce and the GWU jointly presented to the government a framework based on the following principles:

• As is the case today, employers are nudged to contribute on behalf of their employees based on a fiscal incentive (that is, no mandatory contribution) and through collective bargaining;
• Employees earning below a certain income are excluded from opt-in on employment so that no negative pressures are placed on their disposal income, though they will maintain their right to opt-in should they wish;
• Each employee will have the right to opt out or suspend their contribution;
• The contribution that an employee will pay, which will continue to be subject to a fiscal incentive, will be the annual minimum requested by the pension provider selected by the employer or that selected by the employee;
• The only obligation to be placed on the employer is that of presenting information on retirement on the engagement of an employee, enrolling an employee in the pension provider selected by it or that chosen by an employee, managing the monthly contribution payment deducted from the employee’s wage and transferring this contribution to the selected pension scheme provider; and
• The pension scheme is introduced incrementally over five years, initially targeting large employers and rolling it out to micro and small enterprises.

The government has two major players at its side in implementing a fundamental pension reform that will go a long way to address the adequacy conundrum. It should grasp this opportunity.

The post Pension reforms: The case for automatic enrolment first appeared on The Malta Business Weekly.

First. What should the goals of reform be? These were easy to identify at their essence: to avert the collapse of the pension system by rendering it solvent and sustainable and by providing an adequate pension to future generations. As mentioned in previous articles, pension adequacy for future generations was expected to collapse to 16% by 2050 with the PAYG bankrupt.

Second. How would the reforms be implemented? Were they to be implemented and introduced within a short period (vide the reforms in France) or were they to be phased and introduced incrementally, enabling them to be absorbed smoothly without major social shocks? If the latter, how would the reforms be phased in terms of their impacts on retirees, people nearing retirement and future generations?

Third. Which population cohort among those already in the labour market would be defined as “future” generations?

To a large extent, the responses to these questions were intertwined and required compromises and trade-offs.

The reformers determined that future generations would receive pension adequacy equal to that enjoyed by retirees and persons who would be retiring by 2020 – and in doing so, ensuring that the system can sustain such adequacy in terms of a pension deficit as a percentage of the GDP. This was the minimum objective that the reformers sought to balance adequacy and sustainability for future generations. Adequacy is technically defined by the average pension replacement rate (APPR), the relationship between the average pension income and the average wage. For retirees and persons retiring between 2004 and 2020, this was projected to be 54%. To achieve this 54% adequacy rate reforms, measures were directed towards boosting adequacy while securing sustainability. Two countervailing forces are working against each other.

The reforms towards sustainability consisted of tough changes to the architecture of the PAYG: an increase in the retirement age from 61 to 65 years, increases in contribution accumulation from 30 to 40 years and changing the pension income calculation formula to the best 10 out of 40 years, among others. On the adequacy side, the most important reform was the need to ensure that both the maximum pension threshold on which the 2/3^rd pension is calculated and the pension income are both annually adjusted so that pension income, and hence adequacy, increase over time. It is pertinent to remember that between 1979 and 2004, the maximum pension threshold, which in 1979 was pegged to the President’s salary, increased only once from €13,980 to €15,720 while wages generally and the President’s salary respectively increased many times over.

The solution in this regard was to graft onto the PAYG an indexation mechanism. There are three main options: pegged to retail inflation, pegged to wage inflation and a hybrid. In the modelling carried out, an indexation mechanism pegged to retail inflation alone boosted the adequacy rate for future pensioners to 35% – below the World Bank minimum adequacy level of 40% and far less than the 54% minimum stated objective we had set. An indexation mechanism pegged to wage inflation alone rendered the system unsustainable. The modelling showed a sustainable indexation mechanism would be a hybrid of 70% wage and 30% retail inflation. However, the problem with this indexation is that pension adequacy only boosted the APPR to 45%. This would render future generations 9% poorer than their counterparts retiring by 2020. The problem facing the reformers was that the minimum stated adequacy goal for future pensioners would not be achieved with parametric changes to the PAYG alone. The question, therefore, was: how to bridge this 9% gap between future generations and current pensioners?

The solution opted for at the time was that the 9% gap would be bridged through a mandatory second pension. This decision, one could say, positioned what the reformers would define as “future generations”, how the reforms would be phased and how different cohorts of persons would be impacted. Determining who should be exempted from the negative aspects of the reform (the parametric changes but also contributing to a mandatory second pension) was the easiest of all. We believed there should be no changes to the social contract of persons close to retirement. The line was drawn at 55 years of age from when the government implements, if at all, the recommendations proposed. Indeed concerning this cohort of persons, two positive measures were introduced: a mechanism to have the maximum pension increased annually by retail inflation and removing the cap on pension income if they continued to be active in employment post-retirement.

The definition of who would be defined as a future generation stemmed from two considerations. The first was how long it would take a person to accumulate a fund to bridge the 9% adequacy gap. The second was to ensure a sufficient buffer for an accumulated fund to recover in a financial shock. The period identified was 20 years – through employees and employers each paying a contribution rate of 4% that is reached over 10 years. This meant that given that we recommended that the statutory retirement age for future generations would be increased to 65 years, then future generations of persons would be those who would be 45 years and younger when the reforms were introduced: that is, all of the negative parametric changes to the PAYG, a 4% annual contribution to a second mandatory pension and an indexation mechanism of 70% wage inflation: 30% retail inflation. We further proposed that the reform would impact in-betweens, that is persons aged between 46 to 54 years depending on how close they were to these two poles: less so if closer to 55 and more so if closer to 55 years.

We presented the recommendations to the government in 2005. The government enacted the reforms in 2007 and the demarcation line of what constituted a future generation was set: 20 years from 2007 being people born on and after 1962. The problem, however, is that the government cherry-picked the reforms. Faced with harsh criticism from all and sundry, the government immediately made it clear that it would not embrace a mandatory second pension. In doing so, the government made the worst of two worlds: future generations would still be significantly poorer compared to their counterparts retiring in 2020 and difficult to explain to those born in 1961 why the 70% wage inflation: 30% retail inflation indexation was also not applied to them.

The post How decisions taken in 2007 continue to shape the pension reform narrative first appeared on The Malta Business Weekly.

Data at the time showed that blue-collar workers had a short life expectancy of three years compared to white-collared workers.

The reformers proposed that there should be a conditional exit pathway:  that a person had to work up to 61 years of age (the previous retirement age), had to meet their full contribution accumulation history (in the case of a person born on and after 1962 this is 40 years), and would have their actual pension reduced by 7% for every year they retire early.  The idea was that a person would not enjoy a full pension if they opted for an early exit pathway, receiving a reduced pension whilst still being able to work.  At 65 years, that person would then enjoy the full retirement pension.

The government did not fully implement this recommendation.  There was a concern that such an early exit pathway would dilute the impact of the new retirement age.  For this purpose, whilst maintaining the concept of an early exit pathway from the labour market, it set the condition that early exit would exclude a person from actively participating in the labour market.

In December 2021, I teamed up with the Chamber of Commerce and the General Workers’ Union to assist them in putting a joint statement on pension reform to present to political parties before the 2022 elections.  One of the measures we presented was to replace this “all-or-nothing” condition relating to persons who opt for an early exit with a flexible retirement framework.

The reasons we based our rationale for change are various.  The current mechanism prevents employers from legally retraining or recruiting from a pool of skilled senior citizens immediately available in the labour market.  In an economy where full employment dominates, employers have to import labour – at a high cost:  relocation, culterisation, training, and ramp up to productivity, to mention a few.  Data by the Central Bank of Malta shows that 50% of imported labour leaves Malta within the first 12 months of coming here and a further 20% by the second year – requiring a further cycle of labour importation. 

The concern expressed when the initially early exit pathway was mooted nearly 20 years ago that this would be used as a means of opting out of the labour market has not been realised.  The 2020 Pension Strategic Review document states “that 80% of persons who were born in 1951 remained in full-time employment after they reached age 61, nearly three-quarters of the cohort born in 1957 was still working after that age … the pension age rises have boosted the labour supply significantly, leading to thousands of workers staying longer in economic activity.  Moreover, this has tended to be in sectors heavily affected by ageing.  It also indicates that concerns about certain workforce groups being less able to work beyond the early exit age have not materialised.  Manual workers have had a faster increase in their post-61 employment rates, possibly contributing to less inequality in retirement income provision.”  In short, the culture of continuing to work past 61 years has taken root.

Furthermore, people opt for an early exit pathway, not necessarily for leisure.  People may have to exit early for personal health reasons, to provide informal care to their loved ones, or to provide care for their grandchildren as their children and spouses work.  People who wish to work despite being banned because of triggering early retirement choices will find a way to do so.  They will engineer employment in the shadow economy resulting in revenue leakage to the government from direct and indirect taxation and social security contributions. 

Finally, this policy contradicts EU and government policies on active ageing.  I suspect that many people who have opted for the early exit pathway would be willing to continue to be actively engaged in the labour market if they had the opportunity to do this on a flexitime basis.

The forthcoming 2025 Strategic Review should take a strong look at the recommendation presented by the General Workers’ Union and the Chamber of Commerce that a flexi-retirement framework replaces the current all-or-nothing policy instrument concerning early retirement.  A flexi-retirement framework can be designed in different ways. 

One potential model would be to set a minimum number of hours that must be worked, a lower pro-rated pension income when retiring before the person’s statutory retirement age, and so on.

The post Introducing a Framework for flexible retirement first appeared on The Malta Business Weekly.

The pension journey since 2004 has been one of twists, turns, stops and detours. Many a recommendation, when first presented, was at first not politically taken on board and implemented. Of the 2004 reforms presented to it, the PN administration focused primarily on parametric changes to the system’s architecture. For example, the PN administration completely ignored the recommendations to introduce a framework for incentivised pensions. Today we take these for granted but they did not exist in 2004, dismantled by Mintoff when introducing the 1979 National Insurance reforms. Indeed, I have strong, vivid memories of imploring the PN government that introducing a third pillar framework was a no-brainer. Recently ploughing through various hard disks, I came across numerous memoranda I harried the government with arguing the importance of establishing a critical sustainable mass to drive financial capability education and strategic pension reform. It was only towards the end of the PN in government when a Commission for financial literacy (June 2012) and a Pension Strategy Unit (November 2012), were respectively set up.

Although the reform journey between 2004 and 2020 has not been a straight line, paradoxically enough, when a studied tale shall be told of this journey, one will find a path of reform more than partially sustained by a continuum. This reform continuum directly results in the innovative strategic review trigger I discussed in my previous blog. As those involved in the reform moved from one strategic review to the next, we picked up, improved and re-drawn measures not politically considered when first presented. Thus, for example, the Musu ably driven strategy group set up in 2013 presented recommendations for introducing third pillar pensions, which were politically accepted by the new administration, with the first local products appearing in the market by late 2015 (over 10 years after my colleagues and I had militated for their introduction).

Recently there was a spate of articles discussing our pension system’s health. Undoubtedly, much more could have been achieved, and there are several key reforms which, if introduced, would have resulted in a system that provides better adequacy, equity, intra-generational solidity and a stronger sustainable position than it is today. Be that as it may, when I look back at 20 years of pension reform, I tend to see a glass half full rather than half empty, which is not my normal default position. Perhaps, this stems from the fact that of all who have been involved in pension reforms over the past 20 years, I have been (until September 2021) the only constant.

On the positive side of the balance sheet, much has been achieved. Flanking policies, partially triggered through the reform, were designed, accepted and introduced to optimise active labour market participation. In 2004 less than 30% of females were active; at the time of the 2020 review, over 60%. In 2004, a handful of retirees were actively engaged in the labour market as they were disincentivised due to a cap placed on their pension income if in employment. Today thousands of retirees continue to work, enjoying their full pension and income from employment. In 2004 over 8,000 persons were designated as invalid. Tightening what defined invalidity halved this. Migrant policy flipped from one in 2004, making it impossible to import skilled labour irrespective of the local human capital supply. While fertility has fallen drastically in Malta, (1.1) carefully designed policy instruments have optimised labour market participation, buffering the otherwise damaging impact of the collapse of our fertility rate.

The top-up incentive mechanism, introduced following the 2015 strategic review, allowing persons to increase their maximum pensionable income by up to 23%, has been a resounding success. Research shows that 80% of persons worked up to their “new” statutory retirement age and even up to 65, including those working in tough and hazardous jobs. A series of reforms have been introduced to counter the inherent gender discrimination of the PAYG system – from child-rearing credits as a means of compensating for enforced breaks in careers and hence allowing for higher pensions to a widow receiving the full 6/6^th vested successor right, previously set at 5/6^ths.

The voluntary occupational and personal pension saving instruments are now introduced, with people incentivised to save specifically for their retirement by a tax credit of a maximum of €750 annually on the contribution paid and a 30% tax-free lump sum on its de-accumulation. Financial capability measures are being strengthened and taking root – whether these are led by Ġemma, set up at the Ministry for Social Policy in 2017 to implement Malta’s first national strategy of retirement and financial literacy, or NGO and private foundations.

The positives I present here are not exhaustive. They are meant to show that over 20 years much has been done to strengthen the pension system. I do not doubt that today’s pension system is at its strongest regarding adequacy, solidarity and sustainability since the National Insurance system was introduced in 1979. Have we reached the pension Shangri-la? Of course not. Is there still much reform to be carried out within the system itself and its determinants? Unquestionably so. With the new 2025 pension review now looming close, I will, in future blogs, discuss reforms which I believe are significant to the further strengthening of the pension system.

The post Pension Reform: Of twists, turns, stops and… continuity first appeared on The Malta Business Weekly.

Projections carried out in 2004 for up to 2050, tenuous as 50-year projections are, showed that by 2040 Malta’s system would be teetering towards collapse – even though most of the baby boomer generation would have crossed the rainbow. By 2050 it was projected that the system would be bankrupt and the pension income of future generations would be next to worthless (receiving an average pension replacement rate (the technical term applied, which measures the relationship between average pension income and the average wage) of less than 20%). One must remember that the 1979 social security system established a social contract that defined a person’s pension income as two-thirds of the Maximum Pensionable Income.

By the mid-1990s, nearly 20 years after the system was introduced, the fundamentals on which it was based were falling apart. The fertility rate fell from over 2.5 in 1979 to 1.5. Longevity increased from 67 for males and 75 for females to 75 and 82, respectively. Loopholes to exit the pension system exploited – with over 8,000 persons on Invalid Pensions. Labour market policies designed with quasi intent to disincentivise persons from entering or remaining active in the labour force – whether retirees, females or migrants.

It was only in 1997 that the government, the Sant administration, took the first steps to study the health check of our pension system. The Reno Camilleri report and a Watson Wyatt study clearly showed that the system, unless reforms were introduced, would face serious challenges regarding its sustainability and adequacy. Gonzi picked up the ball immediately following the PN’s re-election in 1998. The Galdes Commission was set up, which reached the same conclusions as the studies under Sant, though not necessarily in tandem with reform measures to be adopted.

Dalli, in late 2003 commissioned the World Bank to carry out, yet again, another study. The World Bank report landed on Gonzi’s desk weeks after winning the PN party leadership and becoming prime minister. The report was such that it could not be ignored. The report was stark, blunt and to the point: reform now or future generations will have no pension system to speak of by 2040.

When tasked by Gonzi to lead the pension reforms in 2004, I kept asking myself why the pension system was allowed to march confidently, like the Titanic, towards an impending catastrophe. Apart from the reports I mentioned, no policy measures were introduced to shore up the pension system in the immediate and medium term, let alone to safeguard it for future generations.

I always contended, and continue to do so today, that pension income inadequacy for the baby boomer generation directly results from such policy inaction. When the pension was introduced in 1979, the Maximum Pension Income on which the 2/3 pension is calculated was based on the salary of the President of Malta – €13,980. By 2004, the MPI increased once only, in 1987, by €1,165 to €15,145: a measly increase of €48.5 annually. During that period, the average wage experienced considerable growth, and inflation eroded purchasing power.

Why was this allowed to happen? The argument is often made that the five-year electoral horizons drive politicians – and thus reforms, the impacts of which are seen in the long-term and which invariable involve some degree of pain on the voting public are avoided. The tougher the policy issue, the further they are kicked down the road. Yet such deliberate inaction invariably comes back to haunt governments and policy-makers – vide the drydocks, shipbuilding, Airmalta, Enemalta and so on. If anything, decisions deferred require tougher, harder policy actions providing politicians little room for manoeuvring. At that point, corrective actions may demand big bang solutions resulting in social and economic convulsions.

My colleagues and I on the Pension Working Group (2004) were adamant that our solutions for reform had to have an in-built corrective mechanism that secures policy action over defined intervals. I, for one, have a complete aversion to proposing reform today based on assumptions that look 50 years into the future. The environment we live in changes dynamically and in ways few predict – the financial crisis of 2008, the Covid-19 pandemic and Russia’s invasion of Ukraine – all having significant economic and social impacts on us.

The solution we came up with was embedding a trigger in the Social Security Act that mandates that politicians review the pension system regarding its sustainability, solidarity and adequacy on a pre-defined basis. The trigger introduced demands a five-year review – sufficient to assess the performance and health of the pension system, calibrate for changing circumstances, question the assumptions previously taken and measure the impacts of reforms made or for those left on the wayside.

It is a policy innovation which I believe has, in the main, served us well. Since incorporated into law, three reviews were triggered: 2010, 2015 and 2020. A fourth has to take place by the end of 2025. Furthermore, public scrutiny is assured, given that the review’s conclusions are tabled at the House of Representatives. Important reform measures have been introduced following each review, increasing the adequacy and sustainability of the pension system.  Pensions as a policy issue continue to remain high on the national agenda.

It is a legal innovation, which, if it continues to be applied by politicians and senior administrators in the spirit for which it was designed, Malta should be in a position to avert a pensionocalypse.

The post Averting pensionocalypse first appeared on The Malta Business Weekly.