Necessary changes to an unsustainable system
FISCAL pressures and demographic trends (increasing life expectancy and ageing society) in Malaysia have increased the urgency of reforming our pension system for enhancing fiscal and economic sustainability.

It is also to mitigate possible adverse economic impacts arising from a pension deficit when revenue, contribution and return on investment are insufficient to cover rising pension liabilities.

Civil service pension reforms formed part of the overall fiscal consolidation, focusing on the expenditure side, which includes subsidies rationalisation, plugging leakages and better management of public expenditure along with the revenue enhancement.

The government offers the defined-benefit pension programme for eligible civil personnel who meet the requirements. In general, each retiree will receive two types of payment.

The first is a monthly pension payment according to the employee’s final salary and years of service, and is limited to a pension of three-fifths (60%) of the last basic salary (after 30 years or 360 months of the recognised service period) and the second, is the one-off gratuity upon retirement in appreciation of their services to the government.

Currently, public employee pension is funded by the state and federal government’s annual contribution to the Retirement Fund (Inc) or KWAP, which was established on March 1, 2007 under the Retirement Fund Act 2007 (Act 662) to manage retirement savings of civil servants.

It is estimated that 32,000 new retirees every year, and currently we have 971,000 retirees.

As of end-July 2023, KWAP had RM184.5bil of assets under its management from the RM200bil target to be achieved in 2025.

The KWAP pension fund needs a longer period of at least 25 to 30 years before it becomes fully vested when the fund contributed by the federal government is fully accessible by the pensioner.

The budget spending on retirement charges had increased from an average of RM1.5bil per year in 1976-1999 to RM19.4bil per year in 2010-2019 and further to RM32.0bil in 2020-2024.

Accordingly, retirement charges have accounted for an average of 10.7% of total operating expenditure compared to an average of 5.5% in 1976-1999.

The relatively large size of pension in government budget is expected to increase to RM46.0bil in 2030 and will further increase to RM120bil in 2050.

With a large size of pension spending, along with other high committed expenses (emoluments of RM95.6bil or 31.5% of total operating expenditure in Budget 2024, RM49.8bil or 16.4% for debt service charges, and RM52.8bil or 17.4% for subsidies and social assistance), fiscal adjustment plans are necessary to reduce the fiscal deficit and contain the bloated debt.

In this regard, credible civil service reforms are needed to improve the quality and value of public services-based performance and productivity-linked salary system.

The review of Public Service Remuneration System, including a new civil service hiring policy, should include a review of pension sustainability, rightsizing civil servants and accelerating digital government.

A path to public pension reform entails the transition to a defined contribution plan via the Employee Provident Fund for new hires as it eliminates the potential risk to underfund long-term pension liabilities.

However, in reforming the public pension system, we have to ensure a continued interest to pursue a career in the public service.

Civil service pension reforms possibilities

The appropriate level of pension spending and design of the pension system are ultimately to reduce the fiscal burden; improve labour market efficiency; assist in the capital market development; generate higher public and private savings as well as reduce burden on future generations.

There is a need to reform public sector pension scheme to make it financially sustainable. As the pension is a statutory expenditure, it has the first claim over future government revenue.

Regardless of the future performance of tax revenue and the government’s financial capacity to bear the pension expenditure of civil servants, their pension benefits to them will continue. This raises the risk of inter-generational equity.

The revenues must be sufficient to cover the liabilities and to ensure financial sustainability in the long run.

The ability to finance future expenditures will depend on the fund contribution, the return on investment on the management of assets, and the pension promises to the current and future retirees.

When a pension deficit occurs, it will result in a pension debt that the government needs to finance through its revenue or by raising taxes.

Given rising fiscal cost and increasing number of retirees as well as new recruits, public policy must adapt to improve the sustainability of pension system.

Studies have shown that overly generous public pensions not only burden government budget spending as the number of retirees increases, but affect the saving behaviour of individuals, who will be less inclined to save on their own for retirement needs.

Less generous public pensions can induce people to save more for their mainly self-funded retirement.

Some governments have addressed underfunded pensions with a wave of pension reforms that seek to limit benefits for current employees and alter the benefit structure for future employees.

Pension reforms can avoid the need for even deeper cuts in pro-growth public investment spending such as for the healthcare, education, food security and elderly community services.

There are a number of ways to reform public pensions system: raising the statutory retirement age, review the period of service to qualify for pensionable status, review the size of pension benefits and payouts by reducing their generosity, changing the accrual rate (the rate at which pension benefits build as member service is completed in a defined-benefit plan), and move from defined-benefit to defined-contribution as adopted in the private sector.

Many countries have enacted significant pension reforms in recent years to contain the growth in the number of pensioners, given the fiscal funding challenges brought about by the ongoing demographic transition.

These include changing key parameters of the pension system, such as increasing the statutory retirement age and tightening eligibility rules.

For example, the recent reform proposal in France aims to raise the full-pension retirement age to 64; the reform adopted in Brazil in October 2019 increases retirement ages to 65 for men and 62 for women from 56 and 53, respectively.

In some countries, such as Cyprus, Denmark, the Netherlands, and Portugal, the statutory retirement age is legislated to increase in line with rising life expectancy.

Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
Economy
FISCAL pressures and demographic trends (increasing life expectancy and ageing society) in Malaysia have increased the urgency of reforming our pension system for enhancing fiscal and economic sustainability.