Indonesia needs pension system reform

By Stanislav Velinov

This is the first of two articles on Indonesia's pension system.

HONG KONG: As the Indonesian government begins to streamline the use of pension funds in many departments and institutions, it is perhaps the right time to learn a lesson on the use and systems of pension funds in other countries in transition.

A country in need of successful pension system reform would maybe ponder the following issues:

- Public discontent with the existing pension system and forecasts for its inevitable financial catastrophe;

- existence of public and political will for reforms and readiness for implementation of non-standard measures and techniques by the government;

- lack of alternative views for the philosophy of the pension reform and unwillingness for bearing responsibility on the issue by the political opposition;

- in expectation of the creation of something "positive" for the present and future pensioners, there is relatively good public and media support;

- readiness of domestic and foreign donors and international financial institutions to support technically and financially the reform by covering the initial deficit.

Considering the above, proper functioning of the pension system is one of the main indicators of a country's social security and prosperity. The more civilized and advanced a country is, the more civilized and advanced the pension system.

Recently Indonesia, one of the most populous nations in the world, was shaken by a scandal involving mismanagement and misuse of a corporate social welfare and pension fund, namely the Bulog affair.

Instantly the issue was placed on a political pedestal, scrutinized as the next scandal of corruption, collusion and nepotism (KKN). The question: "Is the present pension system good enough?" may have crossed people's minds.

The answer to this question is very complex and is a part of the sociopolitical spectrum in the country. It is not our task to comment on the pluses and minuses of the present pension insurance system, but to see what are the pension reforms undertaken by other countries in transition.

One of the popular pension systems is called the "Tri-pillar" system. The first pillar consists of the public pension system where the social security payments of the employed people support the pensioners.

The second pillar -- the supplementary mandatory pension insurance, is based on a capital principle, which means that the pension compensation is determined by the amount of funds deposited by the employee and his employer(s) in the pension fund during his employment life. The participation in such a fund is mandatory.

The third pillar -- the supplementary voluntary pension insurance, is similar to the second pillar, but the participation in the fund is optional to the employee and his employer.

What is the logical order to be followed and what steps are to be taken by the legislature?

Certainly, the first step is the adoption of a law regulating the activities of the existing funds and providing the basis for adaptation within a more sophisticated tri-pillar system.

The key-issue in such a program is the establishment of a central regulatory body which is to become the core of the whole pension system in the state.

This body should guarantee the security of the pension funds, stimulate people's initiative to participate and contribute and last but not least should create such structures and institutions that will manage the funds professionally.

Taking into consideration the last aspect, the question about the management instantly comes up. Who is the one to manage these funds, how and where will the funds be invested?

Certainly, these issues are regulated also by the law and in some countries the scheme is working in such a way that the pension fund is obliged to invest up to 90 percent of its borrowed funds in specific government bonds and fixed income instruments. Remaining percentages usually cover operational costs and some minor investments.

Balance cash positions and refinancing of the fund members or shareholders are some of the points of strict monitoring by the regulating body and the law is very conservative on such events.

However, the law in the well developed countries gives access of the pension funds to the primary and secondary capital markets where they may invest or raise additional funding for their needs.

The striking issue is the social conflict between employed people and pensioners and which system the legislation will adopt. The reform alternatives are not in abundance and we can identify some of them.

The first one is when pensioners receive fixed budget- subsidized pensions regardless of their pension contributions. The system is not flexible and creates social discontent but enables easier planning and additional funding to budget deficit.

Only presently employed people would be able to benefit from the capital-based compensation when they retire. The second alternative is when the pensions are calculated on the basis of working experience and volume of contributions made.

In this scheme the burden is heavier on presently employed people because they have to compensate those already retired and meanwhile accumulate resources for their own pensions.

Since the process is regulated through the state-budget, the deficit gap will be higher and perhaps compensated by higher mandatory contributions from the public sector.

This gap in the state-budget is to be managed by the executive and legislative branches of the government in such a way that the ratio of the pay-as-you-go system is closer to zero or even positive.

However, there are eventual risks connected with rising unemployment, demographic and politic problems, economic factors, etc.

For this reason, the regulatory body mentioned earlier should not only monitor the strict adherence to the present legislation but also forecast eventual politico-economic risks which may impact the ratio of the pay-as-you-go system.

The dilemma of who should take the main pension insurance burden (employee or employer) remains. Different countries have different solutions to this issue.

The perfect scheme is where the burden is equally divided between the two social partners but in developing countries with low wages and poor law enforcement such a scheme is hardly acceptable.

The reason is that in many countries in transition, the so called "black market" or "economy in shadow" provides employment to, in some case, up to 30 percent of the working force. Additionally, up to 22% of the population benefits from this economy.

The employers, if such eventually exist, remunerate their employees with unregistered funds and in the best case, they declare to the tax authorities a minimum wage compensation thus avoiding tax and social security obligations.

In many countries, minimum wages are tax-exempted but the pension compensation becomes a burden on the budget. Thus, the poor law enforcement leads to budget burden.

The writer is executive director of Tat On Investments Ltd, Hong Kong and a private asset manager.