Indonesia needs pension system reform

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.