Impact Story

Indonesia: Strategic Advice on Pension Reform

In August 2004, the Indonesian government requested FIRST to provide technical assistance to help it devise a strategy that could ultimately provide retirement income to its citizens: The National Social Security System.

The project was aimed at all segments of the population. For the poorest, and those less capable of saving for their retirement, the goal was to provide a safety net from public funding (tax revenues) that would be on a 'pay as you go' basis. 'Pay as you go' means that no specific funds are set aside by government that can be invested and managed by an asset manager – pensions paid under this system do not derive from any specific or ear-marked funds but come out of general government expenditure. With a rapidly ageing population, the future tax burden for honouring a 'pay as you go' scheme can be very substantial (not necessarily the case in Indonesia). Other options included a funded pension for public sector workers (including civil service and military) whereby pensions were specifically paid out of the accumulated and separately managed funds (providing these funds were kept at adequate levels to meet future pension liabilities there should be no increasing impact on the country’s future taxation requirements). Finally, the establishment of a regime to support and encourage (fiscal incentives, for example) the development of privately funded pension funds where employees and often employers both contributed.

One of the vital preparatory steps for developing the strategy was to build a financial modelling software that could 'play' with all the important variables that could impact on the future cost and coverage of potential pension scheme solutions. These variables would include an analysis of Indonesia’s demographics: mortality; age trends; income levels; employment and so on. Modelling could also input variables such as: retirement age; pension formulae for defined benefit schemes where pensions are related to employment salary levels rather than any share in an accumulated fund; and, annuity assumptions for defined contribution schemes where pensions are related to an individual pensioners share in an accumulated fund.

Lessons Learned:

One of the challenges for the future, once the strategy started to be implemented, was to build capacity for the Indonesian Government to be able to continually work with the modelling software: the models needed regular updating as macro-economic and social circumstances changed.

The task of implementation of a pension reform strategy is immense: it requires coordination among many arms of Government and many consultations with stakeholders for a consensus to build behind any specific proposals. The topic is complex and financial ramifications need to be carefully explained to a very wide audience. Broad scale reform as envisaged by Indonesia is also very expensive, and so considerable donor support is likely to be needed to facilitate implementation.

Reports:

The power-point presentations derived from this project provide an excellent approach and methodology for addressing pension reform issues and therefore, ought to be of interest to many countries considering embarking on a similar path.