The Pensions Working Group has concluded that reforming the system is a must in order to ensure that the adequacy of pensions in the future will not be undermined and also because changing demographics are putting pressure on the present system's sustainability.

Here is an executive summary of the group's report launched yesterday together with the budget for 2005:

The pensions system, unless reformed, will be challenged to provide adequate benefits for future generations in a sustainable manner. A review of the demographic structure of the Maltese Islands shows that by 2050 the population will fall, the cohort aged 60 and above will increase exponentially in relation to other age groups and life expectancy of the same cohort will also increase. On the other hand live births have been decreasing steadily since the post-war period.

The current Pay As You Go pension system is directly tied to a nation's demographic structure. The Pay As You Go pension system is premised on the principle that today's workers will pay for today's pensioners, particularly so in Malta's case given that the two-thirds pension introduced in 1979 is yet to mature and that tomorrow's workers will pay for the pensions of today's workers.

The mathematics of the Pay As You Go pensions system, as has been noted with increasing concern overseas, unravels when the main variable in the equation, that is the labour stock, is clearly seen as being unable to perform as predicted.

The challenge is also compounded by the fact that a perception exists in Malta that the provision of a pension is solely the state's responsibility. This perception has induced individual behaviour to take comfort in the fact that the payment of one's individual social security contribution will suffice to render an adequate pension in the future. To a large extent the concept of "self-help" through saving for retirement has not taken root in Malta.

In the course of preparing the report, the studies commissioned by successive governments were reviewed: the Camilleri Report (March 1998), the Watson Wyatt Report (August 1998), the Galdes National Commission for Welfare Reform (June 2001), the Schembri National Commission for Welfare Reform (October 2003) Reports and the World Bank Report (March 2004). All are consistent in their conclusions. The current pensions system is not sustainable. Benefits will not be adequate. And the principle of "self-help" must be inculcated to induce people to save to secure a decent standard of living upon retirement.

A decision made today to refrain from reforming the pensions system in order to safeguard a decent standard of living for future pensioners will only mean a postponement of the decisions that need to be made. The longer the postponement the more restricted will the policy options be, the harder the impact of the decisions that would be taken and, most certainly, a less adequate benefit secured.

Furthermore, the financial sustainability of the pensions system will be impaired, affecting both recent pensioners and future generations as the demographic replacement ratio will not allow for the sufficient collection of contributions to meet the benefits promised to individuals under the current pensions system.

A policy of no reform is, therefore, not an option that can be seriously considered. A policy of radical changes should also, if so possible, be avoided. Despite the challenges that must be faced there is the leeway today to introduce measures incrementally thereby smoothening their resultant impact on individuals, employers and the economy as a whole. This, however, can only be successfully attained if the proposed changes for reform are taken within the context of a holistically designed pensions system.

It is, however, pertinent to underline that the changes proposed in the report, should they be accepted, should not be considered as immutable. The pensions system must be managed in an ongoing manner - with structured period reviews undertaken to allow for the implementation of parametrical changes as and when appropriate.

The following are the salient recommendations proposed by the working group directed to attain a pensions system that strives to secure a pension that is both adequate and secure for future generations.

Current pensioners

Current pensioners and individuals who will retire prior to the implementation of the proposed changes will not be affected by the recommendations proposed.

Retirement age

The retirement age should be increased to 65 years of age for both men and women. Implementation of this measure will initiate on January 1, 2007. To smoothen the impact of this change it is proposed that this measure is introduced in a scaled manner.

First Pillar pension

The minimum pension guarantee should be annually adjusted to assure its value against inflation erosion. This recommendation should be implemented as from January 1, 2007.

The contribution period for the accumulation of the two-thirds First Pillar pension should be increased from 30 years to 40 years. This recommendation should be implemented as from January 1, 2007. To smoothen the impact of this change it is proposed that this measure is introduced in a scaled manner.

The base line for the calculation of the two-thirds First Pillar pension should be changed from the best consecutive three years in the last 10 years for employees and from the average of the last 10 years' net income for self-employed persons to the average of the 40-year contributions accumulation history for both employees and self-employed. This recommendation should be implemented as from January 1, 2007. To smoothen the impact of this change it is proposed that this measure is introduced in a scaled manner.

A strong compliance regime is put into place in order to safeguard honest and hard working persons as well as to deter abuse, fraud and misuse. Action should be taken with immediate effect.

The two-thirds First Pillar pension is annually built up for all pensioners on an annual uniform basis. The annual uniform basis to be applied should be the retail price index. This recommendation should be implemented as from January 1, 2007.

A person may continue to opt to work beyond the new statutory retirement age whilst enjoying the two-thirds First Pillar (and Second Pillar) pension with no capping on income earned subject to the payment of the First Pillar contribution. This measure will come into effect in tandem with the recommendations proposed on the retirement age.

The current invalidity pensions scheme should be reviewed with a view to tighten the eligibility criteria as well as to adopt the principle of "rehabilitation or alternative work before pension".

The ceiling of the First Pillar's maximum pensionable income should be the current maximum pensionable income adjusted yearly to reflect inflation. This recommendation should be implemented as from January 1, 2007.

The Class I and Class II contributions should remain unchanged.

Part of the social security contribution should finance health services. This should be determined as early as possible in 2005.

A ring-fenced account for contribution benefits and pensions with appropriate transparent governance should be established. This recommendation should be implemented as from January 1, 2007.

Non-contributory benefits should be financed through the Consolidated Fund. This recommendation should be implemented as from January 1, 2007.

A policy instrument that takes into account parental responsibilities in relation to child bearing and child raising periods by providing for the phased crediting of the individual's contributions as well as the payment of voluntary contributions under established conditions should be introduced. This policy measure should be determined in 2006 and introduced as at January 1, 2007.

A policy instrument that removes those elements in the pension system that encourage periods of inactivity within the informal economy when people need to be attracted to participate in the labour market should be introduced. This policy measure should be determined in 2006 and introduced as at January 1, 2007.

A policy instrument that accounts for "credits" for the undertaking of unpaid periods of training, re-skilling and continuous development should be introduced. This policy measure should be determined in 2006 and introduced as at January 1, 2007.

Second Pillar pensions scheme

The new pensions system should include a Second Pillar pensions scheme to increase one's pension income to enhance one's standard of living.

The Second Pillar pensions scheme should apply to both employees and the self-employed.

Measures to provide for financial protection to Second Pillar pensions scheme contributors and pensioners against fraud, misuse, insolvency, etc must be introduced and should be designed in a manner that places the least burden on the stakeholders.

The annual contributions into a Second Pillar pensions scheme should be tax-free. A maximum tax, established at a fixed percentage rate should be paid upon the maturity of the scheme.

The Second Pillar pensions scheme should be mandatory. Nevertheless, it should be introduced in a transitional manner with the Second Pillar pensions scheme first introduced on a voluntary basis as from January 1, 2006.

The Malta Financial Services Authority and the government should work with private sector financial firms to encourage them to introduce a scheme that will allow owners of life endowment and similar policies to convert such policies into the Second Pillar pensions scheme. Action should be initiated in 2006 and once agreement is reached a caveat should be set to allow owners of such policies who take up this option to post date subscription to January 1, 2006.

The determination of the parameters of the proposed mandatory Second Pillar pensions scheme should be taken on the basis of intensive actuarial studies that the government should commission through the MFSA. The government should commission this study through MFSA in tandem with the consultation process.

Indications through the modelling carried out are that a mandatory Second Pillar pensions scheme should be in place by 2010. The government should take all necessary action to establish the appropriate mechanisms to enable the introduction of the mandatory Second Pillar pensions scheme by 2010. Nevertheless, the government should in 2009 undertake an assessment to determine whether the prevailing conditions at that point in time are such that necessitate the mandatory introduction of this Pillar by 2010.

Third Pillar pensions scheme

The new pensions system should also provide for a Third Pillar pensions scheme which shall be a voluntary option directed to complement pensions income which should be introduced as of January 1, 2006.

The annual contribution to the Third Pillar pensions scheme should be non-taxed up to a capped limit. The income derived on the maturity of the scheme should be subject to income tax based on the individual's PAYE rate.

Regulation of the Second and Third Pillar pensions schemes

The regulation of the Second and Third Pillar pensions schemes should be entrusted to the MFSA operating under the Special Funds (Regulation) Act 2002. Such authority should be provided to the MFSA with immediate effect so that the necessary work for the introduction of a voluntary Second Pillar and a Third Pillar pensions scheme is completed in 2005.

Entry of private sector insurance firms into the Second Pillar pensions schemes provision must be subject to strict entry and performance criteria that must be met at all times by the said firms.

The Second Pillar pensions scheme contributions paid by the employer must be strictly separated from the said employer; with the pension fund established as an autonomous "ring-fenced" asset.

The Second Pillar pensions scheme should be managed on the prudent-person principle together with (a) the inclusion of specified limitations to determine the diversification parameters of the investment portfolio and (b) restrictions to limit the private sector insurance firm managing the portfolio to invest in its own assets or subsidiaries.

Periodic review of the pensions system

The new pensions structure once introduced cannot be considered to be etched in stone - immutable to review and change. The pensions structure must be continuously under review so that parameterisation, calibration and changes are undertaken incrementally and in an evolutionary manner.

The first periodic structured review of the pensions system should be carried out in 2009.