Policy Brief Issue 1, April 2012 Reforming The Civil Service Pension and Tabungan Hari Tua (THT) Programs 70789 Background Indonesia’s civil service pension program (CSP) and Proper actuarial valuations must be endowment savings program (Tabungan Hari Tua, THT) carried out diligently and transparently to are stand-alone retirement programs, distinct from estimate and disclose the cost of the CSP retirement income programs covering other segments of the labor force. The CSP program provides civil and THT programs for civil servants. servants with a lifetime annuity following retirement and Reliable data and commonly recognized is fully funded by the government through the annual and accepted methodology and budget. The THT program provides lump-sum benefits assumptions must be used for the actuarial at retirement as well as pre- and post-retirement death valuation of CSP and THT programs. benefits and is supposed to be fully funded by employee contributions. The political and economic environments of Indonesia However, the current programs, which date have changed dramatically since 1969. The Indonesian back to 1969, reflect obsolete objectives and economy has grown and continues to grow rapidly each are inconsistent with current Indonesian year. Indonesia is now a lower-middle income country administrative reforms. Both the CSP and THT with an expanding middle class. As a result, the types programs do provide some financial security to civil of services citizens expect from the government have servants and their dependents throughout their changed. This requires a better educated and more retirement. Over time, internal changes in the civil professional civil service work force. service such as reformed career patterns and remuneration policies, as well as external causes like increases in The CSP and THT programs would benefit from Indonesian longevity mean the programs no longer meet a major overhaul to adapt to current and future important, basic objectives for any retirement scheme, economic and demographic conditions, the new such as fairness, adequacy, affordability, sustainability, environment created by the adoption of National and efficiency. Social Security System (SJSN) Law in October 2004, ongoing bureaucracy and pay reforms in the civil Country Economic & Investment Growth service and the increasing importance of sub-national government. This combination of demographic changes, civil service reforms and the central government’s Public Service Improvement decentralization initiatives pose significant challenges to professionalism, e ectiveness, integrity, service quality the sustainability and effectiveness of the current pension schemes. Many governments are reviewing their benefit Bureaucracy Reform, Pay Reform, Rightsizing programs to control and mitigate risks through reforms of the pension design and delivery systems. Indonesia CSP needs to do the same. and THT Reforms In fact, the Government of Indonesia is currently reviewing and analyzing the design and financing of Adoption of SJSN Law Economic & its CSP and THT programs. But to make informed Demographic Changes decisions, the GOI needs better knowledge of the factors 2 The World Bank driving pension costs and the financial impact of changes Myth about civil service pension (CSP) in system design. In addition, upcoming changes in program… accounting rules will require the GOI to more accurately measure and disclose the accounting expense and CSP program is too expensive and its cost liabilities of its pension programs. needs to be reduced Fact is… Facts about the Current CSP Program CSP program is affordable and fiscally sustainable but it provides highly The current civil service pension program provides inadequate benefits to mid-level and lifetime annuities equal to 2.5% of final base pay for each year of service to a maximum of 75%. Despite senior civil servants when they retire expected increases in expenditures over the next 15 years, the civil service pension program appears to be • Pension benefits are indexed to the Presidential fiscally sustainable and the cost is low by international matrix (wages), rather than to inflation, making the standards. Expenditures as a percent of GDP will program more expensive while constraining policy increase over the next 15 years due to a temporary surge options. Normally, pension benefit increases are tied in retirements but then they will decline and stabilize. to inflation in order to maintain the purchasing power The accrued liability is about 44% of GDP today and of pensions. Pensioners normally to not share in the declines steadily over time due to rapid GDP growth productivity gains of the active workforce. relative to wage increases. The size of the accrued liability should not be of concern since it declines over time and • The pension payable is calculated using final base the annual costs of the program are affordable. pay, which is only a small percent of the total take- home pay received by civil servants, especially Despite the favorable financial outlook, there are a few for mid-level to senior officials. Consequently, the major design and equity issues surrounding the current pension benefits received by mid to high level officials pension program: can be highly inadequate compared to the total compensation they were receiving prior to retirement. • No credit is given for service over 30 years although many civil servants will have more than 30 years of • Final base pay is used to calculate benefits under service at retirement, particularly if retirement ages the current programs rather than average pay are increased in the future. for all years of a worker’s career. Final pay is an Total Expenditures as % of GDP inappropriate basis for calculating benefits because it is not representative of pay over the worker’s entire 1,2% 1,0% career. Today, many civil servants get promoted near 0,8% retirement and pension benefits become based on an 0,6% artificially increased salary. 0,4% 0,2% The CSP program needs to be reformed to create a 0,0% more equitable system. It is possible to restructure the 2010 2020 2030 2040 2050 2060 2070 2080 current program to give higher and more equitable Accrued Liability as % of GDP benefits at the same cost as the current program. Fiscal 50% space can be created by gradually increasing retirement Bene ciaries Actives ages to reflect Indonesians’ increased life expectancy and 40% the fact that civil servants as a group are healthier than 30% the population as a whole, and by indexing pensions 20% to inflation rather than to the increase in civil service 10% wages. These changes alone reduce plan liabilities and 0% expenditures by half. These savings can then be used to move to a plan based on total indexed career average pay 2010 2020 2030 2040 2050 2060 2070 2085 that gives credit for up to 40 years of service. Policy Brief Issue 1, April 2012 3 Facts about Current THT Program The THT program is separate and distinct from the THT Accrued Liability as % of GDP current pension program; however, it involves the 2.5% same participants and competes with it for fiscal space. 2.0% The program provides a lump-sum benefit at retirement 1.5% and both pre and post-retirement death benefits. As fiscal 1.0% resources are limited, the allocation of post-retirement benefits between lump sums and income protection 0.5% during retirement is a strategic decision in terms of 0.0% benefit adequacy, liquidity needs and affordability. 2010 2015 2020 2030 2040 The THT program appears to be a defined contribution THT Accrued Liability Comparison program because it is funded by a 3.25% employee 180 Mio. Post-retirement contribution rate. However, it is in reality a defined 160 death spouse pensioners benefit scheme because benefits at retirement are based 140 on a formula and not on the accumulated employee Post-retirement death old-age 120 contributions. Furthermore, the THT contribution pensioners rate is not based on actuarial calculations of the required 100 Pre-retirement death actives, funding rate. The required contribution rate to fully fund 80 spouses the program is more than double the current 3.25% rate. 60 and children The THT program has been underfunded for many 40 Post-retirement death actives years and the current structure assures that the unfunded 20 Endowment liability will continue to increase each year. The size of liability 0 the unfunded liability is expected to continue increasing actives ABO PBO ABO PBO as a % of GDP for the next 5-10 years. with with no no freeze freeze freeze freeze The THT program shares similar shortcomings to the pension program since the benefits are calculated There is also an issue with undervalued liabilities. The based on final base pay. The 5% to 20% per year basic interest rate and salary increase assumptions currently used to calculate plan liabilities are inconsistent with recent pay increases over the past five years have significantly increased the THT liability, since both endowment and experience and the current macroeconomic environment. post-retirement death benefits are based on basic pay atIn addition, the post-retirement death benefit liability retirement. for current and future retirees is significant and much higher than has been previously reported. About half of The improper funding has already necessitated a benefit total THT liabilities are for endowment benefits and the freeze in 2001 and in recent years the government has other half are for death benefits. been regularly making special contributions from the annual budget to the program even though it is supposed If the GOI decides to use total indexed career average to be fully funded by employee contributions only. pay when calculating CSP benefits, it would be logical and consistent to use the same pay for the THT benefit THT program is not financially stable. as well. However, this would significantly increase THT Its unfunded liabilities are higher than endowment and death benefit liabilities. has been previously reported and will create an ever increasing burden for the The current THT program will never be financially State budget. Therefore, THT program stable as currently designed and is not financially needs to be restructured to maintain sustainable without significant annual government special contributions. Either the benefit should be the sustainability of the program and fixed and contributions actuarially determined or minimize a potential financial impact on the contribution rate should be fixed and the benefit the government budget. should be the accumulated value of the contributions. 4 The World Bank REFORM GOALS Reform Process Support HR policy by linking bene�ts to total career average pay Provide equitable bene�ts to all civil servants at all pay levels Establish bureaucratic framework Provide balance between monthly income and liquidity and a working group Increase retirement ages and link to life expectancy increases Index bene�ts to inflation rather than wages Identify implementation steps and timing Costs within �scal envelope for civil servant total compensation Fiscally sustainable in short and long-term Fairly allocate risks between civil servants and government Design analysis and formulation of reform strategy Equitable among generations of civil servants and taxpayers Funding policy tied to macroeconomic goals Implement international accounting standards Implementation steps Allocate accounting expense to sub-national level Ef�cient and accurate program administration Reformed programs Why Reform is Necessary CSP and THT reform is necessary to support the including, but not limited to, the Vice President’s Office, strategic orientation of Indonesia’s bureaucracy and pay Ministry of Finance (MOF), State Minister for State reforms, assure consistency with overall HR strategy for Apparatus and Bureaucracy Reform (Kemenpan), Civil civil servants, and eventually, assure integration with Service Agency (BKN), and the State Administrative the National Social Security System (SJSN) programs, Institution (LAN). although this will not happen until 2029. The CSP and THT programs should be harmonized with the SJSN Support Provided by the World Bank so programs in a way that allows the objectives set for CSP far….. and THT programs to be achieved in the aggregate by the combination of these programs and the SJSN programs. The World Bank has run capacity building workshops, When defining reform options, the Government must take conducted financial analysis of the potential future into account political economy, technical, administrative, costs and sustainability of the existing CSP and THT legacy and transition issues and reform goals. programs, analyzed a range of reform options and presented the results to various government officials. Who Needs to be Involved The results of our analysis have been documented in an actuarial report and in an executive summary. These It is necessary to have policy dialogue among relevant documents can serve as a basis for discussion of reform government offices and with a working group comprising options. However, senior government officials must take government officials representing key stakeholders, a more active role to move the process forward. This Policy Brief was produced as part of the World Bank inputs to the Government of Indonesia on the Civil Service Pension Reform and is the first in a series of Policy Briefs on civil service pension program reform issue. This brief was prepared by the Poverty–Social Protection unit of the World Bank Office Jakarta and written by Mitchell Wiener (Senior Social Protection Specialist, EASHS) and Iene Muliati (Social Protection Specialist, EASHS). This brief is based on the Executive Summary “Civil Service Retirement Programs for a New Era�, the 2011 Actuarial Consultant Report by Yves Guérard for the World Bank and on various consultations with key representatives from the Government of Indonesia. The authors would like to thank Theo Thomas, Staffan Synnerstorm, Erwin Ariadharma (WB-Jakarta-based Public Sector Management team) and Yves Guérard (Actuarial Consultant) for comment and discussion. Funding for this note was made available by the Delegation of the European Union to Indonesia and Brunei Darussalam, the Kingdom of the Netherlands, the Switzerland Government, and the U.S. Agency for International Development (USAID). The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the Governments they represent. For more information, please contact Mitchell Wiener (mwiener@worldbank.org) or Iene Muliati (imuliati@worldbank.org). THE WORLD BANK OFFICE JAKARTA Indonesia Stock Exchange Building Tower II/12th Floor Jl. Jend. Sudirman Kav. 52-53 Jakarta 12190, Indonesia Tel: (6221) 5299-3000 Fax: (6221) 5299-3111