71378 Policy Note on SJSN PROGRAM AND POLICY IMPLICATIONS Issue 2, July 2012 Design and Financing of SJSN Employment Benefits The Government of Indonesia (“government� or “GOI�) Articles 30, 36, 40 and 44 of the SJSN Law define who is a will implement a new National Social Security System participant in the four SJSN employment programs. There (Sistem Jaminan Sosial Nasional or SJSN) over the course are slight differences in the definition of participants among of the next four years that will radically change the social the programs that should be noted. protection paradigm. The legal bases for these changes are the SJSN Law No. 40/2004 and the Law No. 24/2011 on Similarly, Articles 34, 38, 42 and 46 of this law state how Social Security Administrative Bodies (referred as Badan contributions are determined for each of the four programs. Penyelenggara Jaminan Sosial or BPJS law). Again, the wording varies by program and employment group. Different rules apply to contributions for salaried The new social protection program will cover all Indonesians, workers, workers who do not receive a salary and the poor. including formal and informal sector workers, for five However, a common theme applies to all four programs. benefits – health, pension, old-age savings, death benefits Salaried workers make contributions as a percent of payroll and worker accident and provide the same benefits for while non-salaried workers pay a flat amount in rupiah. all. The BPJS Law mandates the establishment of BPJS Kesehatan and BPJS Ketenagakerjaan, by transforming The table below summarizes both the participation and current administrators, PT Askes and PT Jamsostek, from contribution rules for the four SJSN employment programs. state owned enterprises to public legal entities. Program Participant Salaried No salary PBI* SJSN Law Work- Person who Percent of Pay Not Accident has paid salary, fully nominal mentioned contributions paid by amount BPJS Law employer Old-Age Those who Percent Pay Not Savings have paid of salary. nominal mentioned BPJS Kesehatan BPJS Ketenagakerjaan contributions Employer and amount employee share cost Old-Age Work Death Health Pension Pension Employee Percent Not Not Savings Accident Bene�ts who has paid of salary. mentioned mentioned contributions Employer and employee This policy note will focus on the key issues that should share cost be considered in the design and financing of the SJSN Death Person who Percent of Pay Not employment programs (pension, old-age savings, work- Benefit has paid salary, fully nominal mentioned accident and death benefits), with particular emphasis on contributions paid by amount the two retirement programs – the pension and old-age employer savings programs. *PBI: Penerima Bantuan Iuran (recipient of contribution assistance) Legal framework. The SJSN law identifies the types of From this table, it is clear that the basic structure of social security programs, but offers only minimal guidance contributions is similar for all four programs, but the regarding the level of benefits. Similarly, the law states the cost sharing arrangements vary by program. Employers basis for calculating contributions for salaried and non- and salaried workers share contributions for the old age salaried workers and the poor, but it does not state the savings and pension programs. However, the employer required contribution rate. These fundamental issues are left pays the full cost of the death benefit and worker accident to regulations. programs. BAPPENAS Perhaps surprisingly, it also appear that non-salaried workers Design and contribution rates should not be separately do not participate in the pension plan, and the government determined. The primary reason many social security does not appear to be required to pay contributions for systems become underfunded or insolvent is that the poor for the SJSN employment programs. It would be benefits and contributions are determined separately. interesting to understand why these differences exist. Non- Design and cost are related and contribution rates must salaried workers are in need of lifetime income after leaving be directly related to both design and cost. For any social the labor force just as much as salaried workers. Although security program, the contributions that are collected must measuring actual income might be difficult for non-salaried be sufficient to pay for all future promised benefits and cover workers, proxies for income could be used to simplify the plan’s administrative expenses. administration and provide non-salaried workers with this important benefit. It also appears that the government is For any given program design, there will be one expected not obligated to pay for the poor for any of the employment cost calculation showing the expected benefit payments programs. This means the poor will not benefit from any of and administrative expenses in each future year for the these important social protection programs. program. However, for a given set of costs, there are numerous possible contribution paradigms. Design determines cost. A fundamental principle of social security program design is that the design determines At one extreme, the contribution rate could be set so it is the cost of the program. In this context, cost means the exactly sufficient to cover benefits and administrative costs expected amount of benefits to be paid by the program each year. On this basis, contribution rates usually increase each year. A program with higher benefits will cost more. each year. This if often referred to as pay-as-you-go funding. While this may seem fundamental and obvious, cost is often On the other end of the spectrum, contribution rates could be confused with contributions. Often policymakers believe that determined so they are expected to remain level for extended two programs with the same required contributions cost the periods of time. This is often referred to as target funding or same or that the contribution rate is the cost of the program. full funding. And there are many options in between. What is important is complete transparency about the current Contribution level of contributions and the expected future level of contributions to fully finance expected costs. Whenever the government of Indonesia considers a design option for any of the SJSN employment programs, it is important for the government to calculate the cost of the program at the same time and to make sure the contribution Bene�t rates that are established are sufficient to ensure the solvency of the fund over an extended period of time. The For example, in Thailand, the initial contribution rate for the level required contribution rate over a 75-year period is a formal sector pension program was set at 6% despite the common international standard for comparing the cost of fact that the true long-term cost of the plan was estimated different pension program designs. at 11.6%. Looking at the program in the short-term only, it appears that even the 6% rate is excessive. Under Thailand’s program, like Indonesia’s SJSN pension, participants must Design options should be supported by contribute for 15 years to be entitled to a pension. Since the cost analysis of the options. program started in 1999, no one is yet eligible for a pension A 75-year cost projection is a common and contributions are much higher than necessary. In the international standard for comparing meantime, in 2006, Thailand increased their benefit formula but left the contribution rate unchanged at 6%. But now the the cost of different program designs. true cost of the plan is about 18% and the plan will run into financial difficulties starting in the mid-2020’s. The program design process. There are two fundamental This same misconception occurs in many countries. An ways to think about designing the SJSN employment argument will be made that a larger benefit doesn’t cost programs. The first method – the social policy perspective more because the initial required contribution rate is the – is to determine the desired level of benefits and then same. This ignores the fact that the contribution rate will calculate the costs and required contribution rates. This ultimately have to be increased if the benefit is higher, appears to be the primary thought process of policymakers or else the benefits will ultimately have to be reduced in at the moment. The goal is to assure that no one receives order to keep the cost the same. This distinction between smaller benefits under SJSN than they are receiving today cost and financing is a fundamental factor to keep in mind and that Indonesia complies with all established international during design discussions if Indonesia is to avoid repeating norms for benefit levels. This is an admirable goal, but the the mistakes of others. risk is that the required contribution rate will be too high 2 The World Bank for employers, labor and the government to afford. The Indonesian policymakers will have a difficult time resisting temptation is then to leave the benefits unchanged and set the urge to provide rich benefits while setting an initial the contribution rate at a lower level and hope for favorable contribution rate that is too low. Workers and employers experience. This is a common pathway to insolvency. will support such an arrangement because they get high benefits while paying for low benefits. The government will be happy because the budget expense is kept down. However, in just a few years, the programs will become badly underfunded. Method 2: Method 1: Design Cost Payroll contributions and the labor market. It is Social Policy Methods A ordability important to understand that social insurance programs Perspective Perspective —programs that are financed by payroll taxes on employers and workers—raise serious labor market, labor relations and macroeconomic issues. Employers and workers will both be required to pay contributions to each of the four SJSN employment programs (and the For example, if the SJSN employment programs are based SJSN health program). These contributions will be a percent on the civil service health and pension program benefits of covered payroll. If benefit programs are too rich, then the and the Jamsostek old age savings program, death benefit contribution rates could be high enough to create some program and work accident program, the total required serious problems. contribution rate on a fully funded basis could exceed 25% of payroll, and the cost of severance pay would be in addition • High payroll contribution rates discourage hiring of new to this amount. This contribution rate is highly unlikely to be workers and encourage employers to substitute capital acceptable to workers, employers and the government. for labor The second method is to start by determining the amount • High payroll contribution rates directly reduce workers’ that employers, labor and the government are willing to take-home pay. Workers may then pressure employers to contribute and then work backward to determine the increase their pay by enough to compensate affordable level of benefits. This is also an admirable approach, but it may result in proposed benefits that are too • High payroll contribution rates reduce employer profits low to be meaningful and to meet the fundamental goals of and put pressure on employers to raise the price of their the SJSN law and the country’s social policy. products In practice, it is best to use a combination of both methods to • If Indonesian payroll contribution rates are higher than produce optimal results. The goal is to find a combination in other countries in the region, then it could negatively of benefits and contributions that are both meaningful impact the regional and global competitiveness of and affordable even in the face of adverse experience. Indonesian goods and services Governments have a tendency to make overly optimistic assumptions about the country’s future demographic and • Labor costs are a significant determinant of foreign macroeconomic circumstances when determining affordable direct investment. High payroll contribution rates may benefits. When actual experience fails to meet these lofty discourage foreign investment in Indonesia expectations, the programs become underfunded. Proper practice is to use conservative assumptions to be sure • Rich benefit programs may crowd out private pension the programs are financially sustainable even in the event programs, occupational pension funds and private of adverse circumstances. This is often referred to as the insurance products. “robustness� of the pension program. While workers may appreciate receiving high benefits from Another reason social security programs tend to become the SJSN employment programs, they will not like the underfunded is that they create a natural conflict of interest higher payroll contribution rates needed to finance them. for politicians and policymakers. The programs will be in Consequently, the government should be cautious about the place for many years and decisions about benefits that level of benefits and contributions due to their implications are made today may have minimal impact on costs in for the labor market and macro economy. the near-term but a significant effect in the long-term. Consequently, it is tempting for politicians and government Indonesian policymakers need to be realistic about the true policy makers to increase benefits today, knowing that the cost of its social security programs and the affordable level impact on costs over the time they are likely to be in office will of benefits. If programs are properly priced, employers and be minimal, and then leave the long-term financial problems workers will be forced to make a choice between paying they create to a future generation of leaders. higher contributions or receiving smaller benefits. Policy Note on SJSN | Issue 2 | July 2012 3 Integration of the Pension and Old Age Savings living following retirement while keeping the old age savings Programs. The SJSN Law will create a traditional World plan contribution small. The proper balance depends on Bank multi-pillar pension program for Indonesia. Pillar 1 will the government’s goals and objectives for the combined be the SJSN pension program, a mandatory, contributory programs and the affordable level of payroll contributions. defined benefit plan, while Pillar 2 of the pension program will be the old age savings program, a mandatory, contributory How the World Bank can support the Government. defined contribution pension program. This has become The World Bank will work together with various government a very common design for national pension schemes offices/agencies and other development partners to meet throughout the world, and particularly in Eastern Europe and the government’s technical and financial needs for the some parts of Latin America. implementation of BPJS Ketenagakerjaan. The government should think about these as two The Bank has strengths in many areas relevant to the components or pillars of a single retirement income system implementation of BPJS Ketenagakerjaan. We have global, rather than as two separate programs. The pension program regional and local expertise in pension and old age savings provides guaranteed lifetime monthly income (longevity plan design, computer modeling, actuarial analysis, and insurance) while the old age savings fund provides liquidity pension program administration. at retirement by paying benefits as a lump sum. Our prior work with the government on SJSN actuarial The two programs complement each other well because modeling and training, and on passage of the BPJS law will they have very different risk characteristics and treat also allow us to add value to the implementation process. vulnerable groups very differently. Under the pension Moreover, our PROST (Pension Reform Simulation Toolkit) program, longevity and investment risk are primarily born by model is recognized internationally as a valuable tool for the pension fund while these risks are with workers under fiscal analysis of pension programs such as the SJSN the old age savings program. The pension program also pension and old age savings programs. provides better protection for women and vulnerable groups than the old age savings program. This Policy Note was produced as part of the World Bank inputs to the Government of Indonesia on the Women live longer than men and the pension program guarantees payments for life. Therefore, women tend to implementation of SJSN (Sistem Jaminan Sosial get greater benefits relative to contributions than men. The Nasional, National Social Security System). This note pension program also contains survivor benefits for spouses was prepared by the Poverty–Social Protection unit of the and children in the event of death of the wage earner World Bank Office Jakarta and written by Mitchell Wiener before or after retirement. Pension programs can also be (Senior Social Protection Specialist, EASHS) and Iene designed to allow benefits to accumulate for women who Muliati (Consultant, Social Protection Specialist, EASHS). are temporarily out of the work force to raise children, for Funding for this note was made available by the Australian those who are disabled and for those who are temporarily Agency for International Development (AusAID). unemployed or underemployed. Significant input for this note was provided by partners from the Government of Indonesia, particularly Rahma By contrast, the old age savings program simply pays a Iryanti (Director for Manpower and Employment lump sum at retirement based on contributions actually Opportunities Development) from Badan Perencanaan made and investment income earned. This is problematic for women since contributions are rarely made for women dan Pembangunan Nasional (Bappenas), the National who are temporarily out of the labor force. Women also live Development Planning Agency. longer than men, so they will have to spread their retirement The findings, interpretations, and conclusions expressed savings over a longer period of time. There are also no post- herein do not necessarily reflect the views of the retirement death benefits under the old age savings program Board of Executive Directors of the World Bank or the and disability and survivor benefits prior to retirement are Governments they represent. equal to the accumulated account balance. This benefit can be highly inadequate, especially for those who die or For any questions regarding this note, please contact become disabled at a young age. Mitchell Wiener (mwiener@worldbank.org) or Iene Muliati (imuliati@worldbank.org). The government will need to decide the relative balance THE WORLD BANK OFFICE JAKARTA of these two programs. At one extreme, the government Indonesia Stock Exchange Building Tower II/12th Floor could provide a flat defined benefit pension that is just Jl. Jend. Sudirman Kav. 52-53 sufficient to prevent poverty and have a large contribution Jakarta 12190, Indonesia to the old age savings program. At the other end of the Tel: (6221) 5299-3000 spectrum, the government could focus on assuring the pension program provides guaranteed lifetime pay-related Fax: (6221) 5299-3111 benefits that allow workers to maintain their standard of 4 The World Bank