Review of the Maltese Pension System: Understanding the challenge Pensions Strategy Group June 2015

Outline The 2007 Pension Reform and Recent Trends The Demographic Element: Recent developments and projections Understanding the Challenge

The 2007 Pension Reform and Recent Trends

Pension Expenditure on a rising trend over past decade… Source: Eurostat

Yet, the expenditure ratio remains below the EU average…. Source: ESSPROS, Eurostat

Nevertheless, the welfare gap remains substantial…. Source: NSO

Main Elements of the 2007 Reform Main Measures Born before 1 January 1952 1952-1961 Born on and after 1 January 1962 Rise in Pension Age 60\61 years Females\Males Gradual increase from 62-64 years 65 years Pension Formula Best 3 years of last 10 years Best 3 years of last 11-14 years Best 10 years of last 40 years Lengthening of the contribution period 30 years 35 years 40 years Indexation of the Maximum Pensionable Income COLA 70% Wage growth & 30% Inflation Minimum Pension Linked to Minimum Wage Linked to Median Income Pension Indexation Collective agreements & COLA

Observations on the 2007 Reform Besides reversing overall drop in generosity, 2007 reform included measures to help certain groups, such as the introduction of child rearing credit, better survivors’ benefits and the Guaranteed Minimum Pension. The more generous indexation of the maximum pensionable income was to be financed by an increase in spending, an effective increase in contribution revenue and an increase in the pension age to 65. The Maltese pension system was changed in 1979 to be the main income source for pensioners. However due to the indexation of the maximum pensionable income, it was going to become a very low flat rate pension replacing just 18% of the average wage by 2060. To address this, parametric reforms were put in place in 2007 to limit this decline to a replacement rate of 45%, down from 55% now. These included measures intended to help particular groups, such as the introduction of child rearing credit, better survivors’ benefits and the Guaranteed Minimum Pension. The more generous indexation of the maximum pensionable income was to be financed by an increase in spending, an effective increase in contribution revenue and an increase in the pension age to 65.

The Current Situation: Adequacy Between 2005 and 2013, the proportion of the population aged 65+ that was at risk of poverty or social exclusion in Malta fell from 27% to 21%. This is similar to the drop seen in the EU (from 26% to 18%). The bulk of this drop reflected a decline in the relative risk of poverty. The relative median income of the 65+ in Malta stands at 80% against a Euro area average of 92%. The aggregate replacement ratio stands at 46% against 54% in the Euro area. Note that the poverty threshold for Malta grew by 33% since 2005, as against just 19.5% in Germany.

The Current Situation: Sustainability Between 2004 and 2012, spending on old age pensions rose from 8.8% to 9.6% of GDP in Malta. In the EU it rose from 12.2% to 13.3% of GDP. Revenue from social security contributions paid by employees has declined from 3.5% of GDP in 2004 to 2.7% in 2012. In the EU it increased from 5.8% to 6.1%. The employment rate rose from 54% to 61% between 2005 and 2013, while it was stable at 64% in the Euro area. Among older workers in Malta it rose from 31% to 36%; against 41% to 50% in the Euro area. Life expectancy at age 60 in Malta stands at 24 years, as against 19 years life expectancy at 65 in the Euro area. Career duration in Malta averages 32 years, as against 35 years in the Euro area.

The Demographic Element: Recent developments and projections

The Old-Age Dependency Ratio has been on the rise since the 80’s…. Source: Eurostat

Focusing on the economically active population, the ratio for Malta is close to the EU average Source: The 2015 Ageing Report Underlying Assumptions and Projection Methodology;

Demographic Projections The demographic projections are based on the EUROPOP 2013 exercise by Eurostat; Exercise assumes a process of (partial) convergence in the fertility rates across Member States to that of the forerunners over the very long-term. Expected to reach 1.78 for Malta by 2060. Life expectancy at birth is projected to increase by 6.4 years from males and 6.3 years for females over period 2013-2060 Net migration for Malta projected to average around 1,400 over the period 2013-2060.

Total population to reach 476,000 by end of 2060... Source: The 2015 Ageing Report Underlying Assumptions and Projection Methodology; Eurostat

with the number of older dependents expected to continue rising Source: 1960-1970 Central Office of Statistics, Malta; 1980-2060 Eurostat

Share of persons aged 15-64 will become smaller relative to 65+ 2060 Males Females Source: Eurostat

The OADR will exceed the EU average by 2060 Source: The 2015 Ageing Report Underlying Assumptions and Projection Methodology; Eurostat

….with the Effective Support ratio declining from 2.0 to 1.4 by 2060 Source: The 2015 Ageing Report Underlying Assumptions and Projection Methodology; Eurostat

Understanding the challenge

Understanding the Challenge Latest projections suggest an increase in the old age dependency ratio from 25% now to 51% in 2060. Note that the previous projections had 55% in 2060. Main change – migration. Life expectancy at 65 set to rise by 5 years, or 30% for men, and by similar amount for women by 2060. Potential growth to average 1.7% till 2060, against 1.4% in previous projections. Maltese economy no longer assumed to halve its potential growth by 2045. Instead stable growth. Growth rate in subsequent years declines but just to 1.4% in 2060 rather than 0.9%. Participation rate expected to grow from 69% to 80% in 2030. It was previously forecast to be 69% in 2020 rather than now, and would reach 74% by 2050. Moreover larger work force due to migration.

Understanding the Challenge Previous Ageing Report projected a rise in spending on pensions of 5.5% of GDP by 2060. Most of the increase (4.5%) to occur after 2040. Maltese spending to exceed Euro area average by 2055. Euro area spending to rise by 2% by 2040, then stable. At present Malta spends 5.8% of GDP on old-age and early pensions against 9.6% in the Euro area. This reflects low female labour participation. Certain outlays were expected to decline, such as survivors’ pensions down by 1.9% of GDP by 2060. Disability pension spending stable.

Revised Pension Spending Projections The revised demographic and macroeconomic assumptions result in a significant downward revision in the pension spending projections. Up to 2030, there is little difference between the two sets of projections, but thereafter the trend increase in the new baseline is much more muted. On the other hand, while it is true that the increase in spending is now just 3.9 percentage points, instead of 6.3; the system deficit is still expected to be relatively high at 4.8% . This reflects the fact that contribution revenue remains stable in the face of rising spending.

Revised Adequacy Projections The other interesting result from the new projections is that the average pension replacement rate instead of declining by 9.6 percentage points by 2060, as was expected 4 years ago, now is expected to fall to just 50.5%. This unforeseen rise in generosity, which reflects a much faster increase in minimum and maximum pensions (due to larger increases in wages and higher employment rates) would occur at the height of the ageing transition. In fact, like had been projected in 2010, for the next two decades, generosity will decline to well below 50%. It then rises gradually back to 50.5%. So the transition generation is still projected to bear the brunt of the change, being affected by lower generosity in the general scheme and the minimum pension while facing the increase in the pension age.

Understanding the Challenge Elderly poverty rate in Malta is higher than the Euro area. Generosity of public pension set to decline by one eighth for future pensioners. Indications that private saving has declined over time. Currently period spent in receipt of state pensions is high compared to EU, while career lengths (32 as against 35) and contribution rates are smaller. In the future, period in retirement closer to EU if people retire at 65, but contribution period could remain relatively low. The Maltese state faces significant challenges to finance health and long-term care. Increase in these areas nearly as high as pensions. Pension system balance is stable up to around 2040, deteriorating progressively thereafter. Hence the need to revisit the pension parameters for persons born after 1 January 1962 with a view to strengthen financial sustainability whilst safeguarding the adequacy of their pensions.

Thank you