Indonesia needs to reform its pension system

By Stanislav Velinov

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

HONG KONG: While still employed, both employer and employee benefit from tax evasion. This is why, law enforcement is the main prerequisite for the success of the implementation and functioning of the pension system. In addition, it also determines how to distribute the pension insurance burden between the social partners.

The burden on the employee can be compensated by readjustment of the wages and flexible taxation.

The pension insurance burden on the employer in general is bigger and in addition he has to make compensation for medical treatment, clothing, social benefits, additional remuneration for working in harmful environment, etc.

However, the taxation on his revenues may open a legal way for balancing his expenditures on salaries and social security. In some countries, government employees are subject to special rates of pension insurance which are different than the mass, but these countries are an exception.

When speaking about the pension insurance burden, logically we have to think about the volume of the burden or in other words the percentages which the legislation must impose.

In this regard, there are many factors that must be considered starting with the average life expectancy for both sexes, migration, unemployment rate, demographic problems, inflation, interest rates, other politic and economic forecasts on the social sphere, etc.

Once a reliable analysis is ready, the legislators have to determine if they want to adopt a scheme with early retirement and smaller pensions, later retirement and bigger pensions or another alternative. Early retirement and high pension compensation for the mass is in general impossible though politicians often speculate with such statements especially during election campaigns.

However, exceptions can be made for a special category of employees working under harmful conditions and environment.

Why is early retirement and big compensation impossible? Because big compensation means higher contributions which will decrease the collection efficiency and increase tax evasion. Meanwhile it may provoke, lower or unregulated employment. In this line, the political decision, based on the parameters listed plus a number of other sociopolitical indicators should adopt such a system which best suits the national working power.

It should determine the right retirement age (working life) plus volume of contribution made to the pension system.

The political decision has many pros and cons and if we have to group them into two main groups we can see the economic approach on one side demanding higher retirement age in view of the pension funds multiplication and on the other side stands the political approach which provides for early retirement, thus reduction of some compensation (gradually increasing in advanced age) and ensuring new employment opportunities for the younger generations.

Another major point in the pension system reform that must be addressed is the dilemma of making the new system socially acceptable at the cost of financial stability or making it more secure and less profitable. The political decision should represent the best compromise between these standpoints.

What is the situation with the voluntary pension insurance? The voluntary pension insurance, being the third pillar of the system represents people's motivation and initiative to invest in long-term plan. Furthermore, the utilization of such facility indicates the monetary potential of the average employed citizen and his living standard.

In this view, when choosing a voluntary pension fund, there are two approaches. The first one is known as the "collective approach" where the trade union leader or a representative of the collective negotiates conditions and chooses a fund and the second approach is the individual one, where everyone is free to choose a pension fund himself.

The selection of a pension fund is extremely important because a wrong choice may lead to unsatisfactory results or even loss.

Focusing on the most negative scenario, named "loss", the legislators, through the law, impose such regulations that optimally minimize the risk and the ratio of the loss.

However, theoretically, even in the most secured pension system a fund failure is possible and this is why the right choice is very important.

Going back to the old maxim that high profit is commensurate with high risk, the return from our investment is one of the crucial factors but not the only one. The other factors are background, where and how the fund invests, what risks it takes and what strategy it follows.

On the other hand, we are obliged to say that in countries in transition where the mass is not well introduced to investment practices, the possibility for manipulation with negative results is very high.

People are often lured by promises of high returns, compensation insurance and medical packages, lucky draws, etc. but expectations must not exceed reality. As any other investment, it is advisable to choose a reliable asset manager prior to choosing a voluntary pension fund.

Actually the manager is the one who can analyze for its customer the existing market alternatives and point out which is the best one.

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