The Economics of Ageing and Pensions

Population ageing and its implications for the sustainability of public programmes and economic prospects has been on the agenda of policy-makers around the world for a considerable period of time. The rising share of older individuals in the total population, is a global fact with important economic and socio-political consequences. From a demographic perspective, population ageing is the result of low fertility rates, continuous gains in life expectancy and migratory trends. Indeed, the United Nations is projecting that by 2050 the number of persons aged 60 and over in the global population is expected to increase from 0.9 billion in 2015 to 2.1 billion in 2050 with Europe being the continent with the highest percentage of older persons.

Population Projections for Malta

Focusing on Malta, the issue of population ageing has been on the policy agenda since the mid-nineties, especially in view of its implications for the sustainability of public pensions. When assessing the magnitude and the expected evolution of the demographic ageing, population projections such as those prepared by Eurostat (ESSPOP2015) can serve as a useful benchmark. Indeed, whilst total population in Malta stood at around 440,400 persons as at 1st January 2017, population projections by Eurostat indicate that total population is expected to reach around 521,000 by 2070. Such development reflects gains in life expectancy, fertility and migration. Indeed, by 2070 life expectancy at birth is projected to advance by 8 years for males and 7.4 years for females, with the gender gap narrowing but still favouring females by around 3.8 years. Meanwhile, total fertility rate is projected to rise from 1.45 in 2015 to around 1.75 in 2070 which is below the replacement rate of 2.1 children per female. It is noteworthy, that a key driver of demographic developments in Malta over recent years was certainly migration. Indeed, net migration is projected to average around 2,250 annually over the period 2015-2070. The projected changes in the composition of the Maltese population are illustrated in Figure 1, which illustrates the shifts in the Population Pyramid.

Population Pyramid

The scale of the ageing challenge facing Malta can be better appreciated by looking at the old-age dependency ratio (OADR). This ratio captures the share of individuals that are likely to be retired (aged 65+) as a proportion of those persons that are likely to be in employment (aged 15-64). Eurostat data shows that Malta’s OADR stood at around 28.6% in 2016, slightly below the EU 28 rate of 29.3%. By 2070, the OADR for Malta is expected to reach 55.9% thus exceeding the EU 28 rate of 51.2%. These developments are indicative that Malta faces a significant ageing challenge when compared to European peers. Conversely, the support ratio – the number of persons of working age that could potentially support persons in retirement – is expected to worsen significantly from around 3.4 persons in 2016 to 1.8 persons by 2070. This picture could actually look more dire when one considers that not all persons of working age are actually in employment, even though not all persons that reach pension age are actually entitled to a pension.

Ageing and the Sustainability of Pensions

It is evident that ageing will result in higher expenditure on public programmes in health, long-term care and pensions. Pensions, especially those based on a Pay as You Go (PAYG) schemes are the main sources of income in retirement for most European countries, including Malta. Indeed, PAYG public pension schemes are facing the multiple challenge of ensuring financial sustainability whilst supporting an adequate income in retirement. Indeed, consumption smoothing and poverty relief are key objectives for any pension system. In this regard, financial sustainability remains paramount in ensuring that any pension scheme delivers upon its promises.

PAYG pension schemes involve the transfer of resources from workers to pensioners, consequently this implies that the declining support ratio owing the demographic ageing is bound to lead to rising expenditure. This has negative consequences on the sustainability of public finances unless matched by rising contributions, capital resources and productivity. At the same time, ageing is also bound to have important effects on the structure of national economies. Indeed, long-term projections by European Commission show that demographic ageing is also likely to result in lower potential GDP growth in light of the effect of ageing on specific components on potential output. This implies that ageing will have a dual adverse impact on the sustainability of public pensions.

Pensions Reform Process in Malta

As stated above, the pension reform process in Malta has been ongoing for a number of years. The first major reform since the introduction of the Two-Thirds Pensions in 1979 took place in 2006 when several parametric changes were introduced. The main changes included increases in the pensionable age, the lengthening in the contributory period, changes in the calculation of pensionable age and the introduction of the Guaranteed National Minimum Pension alongside changes in the indexation of pensionable income and pensions. Projections at the time indicated that in under a no-reform policy scenario, pension adequacy was bound to worsen progressively thus giving rise to pressures from the social perspective. Indeed, the 2006 reform addressed both sustainability and adequacy concerns with the overall outcome being that the trajectory of expenditure was reversed.

The second major reform took place in 2016. The adopted measures carefully balanced adequacy and sustainability concerns, taking also into consideration the needs of present retirees. The main measures addressing adequacy included increases in the minimum pension, improved crediting for child rearing and the introduction of crediting for human capital development and measures addressing specific groups such as pensioners in receipt of service pensions and survivors. In terms of sustainability measures, the contributory period was raised from 40 to 41 years for persons born on and after 1 January 1969 with the proviso that it shall be reviewed every five years to ensure that stable proportion is kept between the contribution period and the time spent in retirement. Furthermore, an incentive mechanism was introduced, focusing on private sector employees, whereby individuals who have fulfilled their contributory requirements can receive permanent increases in their pensions upon retirement provided they defer their pension and continue working beyond the age of 61 years.

Another key plank of Government’s pension policy relates to the diversification of pension income in retirement. In this regard, two key developments were the introduction of tax incentives targeting the take up of third pillar voluntary pension products which covers also certain insurance products. Work is also underway to introduce tax incentives favouring the establishment and take-up of voluntary occupational pension schemes.

Conclusion

This brief article has focused on the implications of ageing for the sustainability of PAYG pensions. Nevertheless, it is evident that independent of the form in which pensions are organised as funded or PAYG, ageing raises important sustainability and adequacy concerns alike. This underscores the importance of economic growth in supporting pension schemes since afterall pensions cannot be analysed in isolation but also in the context of other competing demands for public expenditure (in the case of PAYG schemes) as well as the state of the economy. Indeed, it is notable that policies that focus on raising labour productivity through investment in infrastructure and human capital and raising employment play a key role in supporting growth in output. In the case of Malta, raising employment through raising participation, especially amongst females and older workers, postponing retirement and migration all played a key role in raising employment in recent years. In this regard, the pension reforms, tax measures and other supporting active labour market policies are a step in the right direction in ensuring that the labour market continues to play a key role as supporting pillar to pensions sustainability in Malta.

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