George M. Mangion | Wednesday, 08 July 2009

Pension promises

Not a popular subject to treat during the start of the silly season, when attitudes are slowly starting to tone down and are possibly more focused on the summer holiday routine. Others ponder on the architectural merits of the recent unveiling of Piano‘s vision on how best to reconstruct Valletta’s city gate and the erect a new Parliament featuring a space age design (this jars in a Baroque environment). One cannot tackle the subject of pensions without analyzing the economic environment that is prevalent in such turbulent times. Many consider pensions and their sustainability during the current meltdown of global economies as the last problem on the list of troubled finance ministers. True our pensions reforms which commenced a decade ago had generated a universal awareness that the sustainability of the pension fund is closely linked to the pay as you go system. This means that the fund does not exist and today’s workers contribute for today’s pensioners. Of course there is now a general awareness that the demographics are not to our advantage as the birth rate is slowing down while pensioners live longer partly due to better health services. This has been described as a bomb with a short fuse ready to explode in the next twenty to thirty years but politicians tend to smooth over the bitter reforms necessary to plug the massive deficiency, bearing in mind that we are not exactly brimming with surpluses. The EU has given the government up to the end of next year to narrow the financial deficit to acceptable levels. The Central Bank of Malta reiterated in its first quarterly review for the year on the high inflation rate. This has a double pincer effect on pensioners since their investment rates have dropped while inflation means higher product prices and fuel bills.
The opposition is predicting an austerity budget on the books for 2010 since it is not politically viable to tax more but some trimming is essential. By comparison in Ireland, once the Celtic Tiger among the Eurozone, is facing dire times but still the government has found it more difficult to cut the earnings of its own employees. Data issued last month showed Ireland among the EU’s 27 member states was one of the first to go into recession. Still the drop in economic growth was more severe and called for drastic measures. The Irish Cabinet in February imposed a pension levy on public sector workers and froze their pay to help reduce a budget deficit that could rise to 12 per cent of GDP this year. The introduction of the pension levy sparked unusually large protests of 100,000 people in Dublin, but analysts say the depth of the recession will limit the unions’ ability to strike to resist wage cuts. Naturally our minister of finance‘s armoury to cut expenditure is rather limited unless one reverts to introducing a four day week in the general service - something which may ruffle a lot of feathers. In Britain things are not so rosy for pensioners as one reads about Stephen Green’s speech as Group chairman of HSBC when addressing the subject. He said: “A perfect storm is confronting pensions planning, created by an ageing population, falling pension funds values, a drop in state and employer contributions and an economic downturn which is forcing people to make tough financial choices.” Does this sound familiar to us? I think so. In a document titled ‘It’s Time To Prepare’ the Bank has identified a ‘preparedness gap’ in people’s pensions planning across the world with nearly nine out of 10 people not feeling fully prepared for their retirement. This included a survey styled ‘The Future of Retirement‘, which questioned 15,000 people in 15 countries, making it the largest study of its kind in the world. The not so surprising conclusion shows how only 13 per cent of respondents feel fully prepared for their retirement. The rest, eighty-six per cent do not know what income they will receive in retirement with only a quarter (27 per cent) feel they fully understand their long-term finances. England boasts of the three pillar system, which means that apart from the State pensions there are two other pillars resting on privately funded pension schemes. The sad news is that UK pension sector has received a significant blow with a suggestion by leading actuaries in the UK that their life expectancy figures could be fatally flawed. The current system is based upon a model created in 1999 which suggested that the rate of increased life expectancy at that time would not continue into the future. However, there is a suggestion that the trend of constantly increasing life expectancy experienced prior to 1999 has continued with potentially disastrous consequences. Longevity is an expensive yet pleasant improvement in the quality of life as far as pensions go.
The longer the life expectancy of pensioners the more expensive pension funding will become which will either lead to increased contributions or smaller payouts. The picture shown by actuaries of private pension groups is also not so heart warming.
According to financial adviser Aon Consulting, the combined deficit of the biggest 200 private sector final salary schemes is a staggering £73 billion. Back to Malta, the bitter truth is that we either face reality and take action to reform our pensions system now or else condemn thousands of present and future pensioners to a life of poverty and deprivation. Many people will also be surprised to learn that the reform which took over a decade to be concluded left the ceiling of the two thirds pension untouched and due to higher inflation this continues to fall in real terms. PKF had in fact organised a national ‘Pensions reform: one day conference in 2003 attracting comments from speakers of top unions, employers, insurers and senior politicians from both sides of the House. This culminated in creating some pressure on the incumbent party to speed up its ongoing reform which was concluded in 2006. Sadly the 2006 reforms were not deep enough and the second pillar was left to be optional so as not to unduly burden employers. It practically left the ceiling unchanged for pensioners retiring within five years but recommended a gradual increase in retiring age over the a span of years. A look at the demographics show that there are 35,346 males over 60 and 44,729 females over 60. This seems quite a substantial proportion which will not benefit from any advantages recommended out of the recent reform. Certainly any top-up in pensions has to mirror the strength of the economy and this is not firing on all cylinders at the moment. As can be expected our denial by party apologists that recession is not welcome here has now buckled under the weight of hard evidence that the economic engine is sputtering (two punctures). The EU report quotes some bleak forecasts. GDP growth for Malta for the period 2007 to 2050 is forecast to be 1.4 per cent per annum against the EU average of 1.8 per cent because of what the report calls “less favourable demographic prospects”. In the same period the working population in Malta is estimated to go down from the current 70 per cent to 55 per cent in 2060. With less workers tilling the fields there will be less contributions to make up for our unfunded pension pot. One solution is more generous incentives and more enforcement for all grown-up ladies who work to pay NI contributions but this is utopian as it depends on the availability of suitable jobs.
Promises about pension reforms are wide off the mark now more so in light of tough economic times. Regrettably there are no palliatives which our politicians can resort to knowing that a potential time-bomb could go off over the next decade or two. We just have to grin and bear it.

George Mangion
Partner at PKF – an audit and business advisory firm



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08 July 2009


Malta Today


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