Social Security Reform in Indonesia: A Critical Analysis

Transcription

1 Social Security Reform in Indonesia: A Critical Analysis Alex Arifianto The SMERU Research Institute 1 Jakarta, Indonesia Abstract The Indonesian national social security program is currently undergoing a major overhaul designed to make the existing system works better for the beneficiaries and to extend social security coverage to more workers, both in the formal and informal sector. The government has proposed a plan to convert the current Jamsostek social security scheme, based on a provident fund system, into a compulsory social insurance system. The feasibility of this plan is critically analyzed in this paper. From this analyses, we can conclude that there are several serious flaws in the government proposal as outlined in the proposed legislation, such as: worsening Indonesia s labor market and investment climate, negatively impacted the state budget, is of little help for current poor elderly Indonesians, and does not provide room for the private sector to provide social security benefits to Indonesians. Crosscountry evidence shows that publicly provided social security scheme is no longer a viable model for workers today and instead, privately provided social security scheme is better suited for their retirement needs. Given the many problems facing the Indonesian social security system today, Indonesia should seriously consider adopting a social security scheme based on the widely used three-pillar approach to replace the current publicly-provided scheme. Keywords: social security, pension, old-age vulnerability, Indonesia. 1 The author would like to thank Dr. Sudarno Sumarto, Dr. Asep Suryahadi, and Bambang Sulaksono for their suggestions and comments and Daniel Perwira for his research assistance. The views expressed are solely those of the author and should not be attributed to the SMERU Research Institute, its management, or its funders. 1

2 I. INTRODUCTION The problem of aging and old-age vulnerability is increasingly viewed as a social problem for Indonesia, due to the fact that the country s life expectancy has increased dramatically within the last three decades, from 45 in 1970 to 66 in This is attributed to the rise in economic development in Indonesia, which also improves the living standards and the quality of life of most Indonesians. Consequently, more and more Indonesians survive into the old age and this trend will continue in the forseable future. It has been estimated that the Indonesian population aged 65 years and older will rise dramatically during the next few decades, from 9.3 million in 2000 to 46.9 million in 2050 (Edwards 2003). This number is equivalent to about 20% of the Indonesian population in the year 2050 (US Census Bureau 2004). At the same time, Indonesians aged 55 years of older will increase from about 10% of the population in the year 2000 to about 30% of all Indonesians by the year (US Census Bureau 2004). More people surviving into the old age also means that they will have to spend more to maintain their health and living standards. As a result, financing the health and retirement needs of elderly Indonesians would become more of a burden to Indonesian families (and taxpayers) by the year Along with the issue of aging, the issue of old-age poverty has also arise as a social problem for the country. In 2002, the poverty rate of Indonesians is estimated to be around 18.2% by the Indonesian Statistics Agency (BPS). In addition to this, it is also estimated that up to 30% of Indonesians are vulnerable from falling into poverty in the event an economic shock such as another economic crisis, a natural disaster, or a conflict, occurs in the areas where they lived (Sumarto and Suryahadi 2001). Specifically among the elderly (those ages 65 and older), it is estimated that about 16,5% of them are living below the poverty line, of which 9,5% are considered to be chronically poor and 7% are considered to be transient poor (ADB 2004: 31). One of the reasons why they are vulnerable from falling below the poverty line is becase most of them have inadequate earnings and savings, since most of them do not have any pension coverage. Only about 10% of all Indonesians (both workers and their spouses) have some form of pension coverage (ILO 2003). They tend to rely exclusively on assistance from their family members and/or their close friends. It has 2 Statistics from UNDP (2003). 2

3 been recognized that as costs of living in Indonesia continues to increase, it would become more difficult for families to adequately support aging family members, as has been shown by several studies (for instance, see Marianti 2002). Even those who receive some form of pension income are still vulnerable from poverty, given that most pension plans in Indonesia pay out their benefits in a lump sum instead of paying them on a monthly basis. At the same time, publicly funded pension plans are still mostly protect retired civil servants and their families and only a small fraction of private sector workers received any social security coverage (financed through the Jamsostek scheme), which only provides minimal benefits for its recipients. Because of its small amount of benefits and limited coverage, the Jamsostek scheme has not been successful in preventing many poor retirees during the 1997/98 economic crisis. Because of these shortcomings and because of the increasing realization that as more Indonesians are aging and will require some kind of income supports from the government as they age, the government is currently proposing a new social security scheme that includes a proposed pension benefits for all Indonesians. However, the costs and benefits of the proposed new social security scheme, along with its possible impacts on current poor elderly is not known at this time. This paper will try to perform such analysis. First, the paper will review current public social security programs and describe their shortcomings. Then, it would then describe the proposed new social security scheme that was recently drafted by the government, and analyze it by measuring its possible costs and benefits and its implications on elderly Indonesians. Finally, it will conclude with several policy recommendations on how to improve the proposed social security scheme so that it would be able to achieve its goals of protecting all elderly Indonesians from poverty. II. CURRENT PUBLIC PENSION PROGRAMS IN INDONESIA There are several public pension programs that were sponsored and administered by the government at this time. The two largest programs are the 3

4 Jamsostek program for private sector workers in the formal sector and the Taspen program for current and retired civil servants and their families The Jamsostek Program for Private Sector Workers The Jamsostek program is a social security program for workers in the formal private sector. It consists of the following programs: (1) workers injury benefits; (2) death benefits; (3) retirement benefits; and (4) health care benefits. The premium for workers injury, death, and health care benefits are paid entirely by employers, while the retirement benefit premiums are shared by both employers and workers. Workers injury, death, and retirement benefits are invested in a provident fund managed entirely by a state-owned company, PT Jamsostek, while the health care benefits could be contracted out to a private provider if it could be shown that the benefits would be either similar or surpass the benefits provided by PT Jamsostek (ILO 2003: 93). Table 1. Contributions/Premiums of the Jamsostek Program (% of wages) Program Employers Workers Total Workers Incident Benefits 0,24 1,74-0,24 1,74 Program (JKK) (5 classes) Death Benefits Program (JK) 0,3-0,3 Retirement Benefits Program (JHT) 3,7 2 5,7 Health Care Benefits Program (JPK) Total 7,24 11,74 2 9,24 13,74 Source: PT Jamsostek (2001) Table 1 shows the specific social security premiums that have to be paid by both employers and workers. It is showed that each employers and workers have to 3 In addition to these two schemes, there is also the Asabri pension scheme for members of the armed forces and their families. However, since little public information is available about this scheme, it is not reviewed in this paper. 4

5 make a contribution in the amount of 9,24 to 13,24% out of total wages paid to their workers. This amount equals to about one month of workers annual salary 4. However, many thought that the Jamsostek scheme has not been successful in preventing those who were afflicted by the Indonesian economic crisis from falling below the poverty line. This is because in many ways, it provides inadequate benefits for workers. First, it does not cover informal sector workers, self-employed individuals, and formal sector workers who are employed by small businesses (with 10 employees or less). This means that the vast majority of Indonesian workers (80% of the total workforce) are not covered by this scheme. In addition, it is also estimated that only about half of employers required by the Indonesian Social Security Law to make contributions to the scheme are making contributions (ILO: 63). Thus, the number of workers that are actually covered by the Jamsostek program is abysmally low. Additionally, the actual benefits received by those who make contributions to Jamsostek are very low. A World Bank study done by Leechor (1996) estimates that the total amount of pension received by a Jamsostek recipient at retirement is only valued at about 7% of their final basic salary after 35 years of active work, while another study conducted by the International Labor Organization (ILO) found that the average value of a Jamsostek pension is only amounted to 5,5 months of their basic salary or 8,5 months of the current minimum wage (UMR) (ILO 2003: 90). It is concluded that these workers would earn a better rate of return to their investment if they put their retirement savings into a bank account rather than putting it into the Jamsostek scheme. Finally, critics have argued that the management of the Jamsostek fund has not been open and transparent. For instance, it has been found that PT Jamsostek as the sole provider of publicly funded retirement benefits in Indonesia has failed to provide financial statements and regular progress reports that could be accessed by workers participating in the scheme and the general public (Leechor: 39). After looking at these factors, it is no wonder that most Indonesian employers and employees have little faith in the scheme to provide social protection for them. The fact that only about half of all employers who are required to participate in the Jamsostek scheme by the Indonesian Social Security Law are making contributions to 4 Add the requirement for employers to pay one-month wages for the Idul Fitri holiday benefits, then employers are required to pay additional wages in the amount of two-month wagers per year. 5

6 the scheme shows how weak is the confidence of employers and employees in the scheme that they chose not to make any contribution into it and instead chose to provide these benefits through the private sector. 2. The Taspen Program for Civil Servants The Taspen (Social Insurance and Retirement Savings for Civil Servants) scheme was created in 1963 to provide retirement benefits, death benefits, and retirement savings by providing both lump sum and monthly pension for participants or their heirs. It is hoped that this benefit could be used as an economic resource for members after their retirement. Members of the Taspen scheme are all civil servants. Members of the armed forces and the police corps are covered under a separate pension scheme called Asabri (Social Insurance for Armed Forces Members) and they are not eligible to receive Taspen benefits. The civil servants retirement benefits managed by PT Taspen consist of an old-age savings scheme and a pension scheme. The amount of monthly pension benefits for members is 2,5% of their basic salary times the number of years they served on the civil service. This scheme is funded mostly through the central government budget (APBN), and from members contribution in the amount of 4,75% of their monthly basic salary. The total number of Indonesian civil servants is currently estimated at four million people. Their total contribution makes up about 8% of the overall cost of funding PT Taspen s programs. PT Taspen contributes about 22,5% of the overall funding costs, dereived from its enormous assets and investment income from members contribution. The rest of the costs (69,5%) are paid for by the government budget (ILO 2003). However, given the recent increase in civil servants salaries and pension benefits, it is estimated that the Taspen scheme would not be sustainable in the long run. Leechor (1996) has predicted that the funds available to pay the full pension benefits of all civil servants would start accuring deficits starting in 2006 and without changes in contribution rates, it might become insolvent by the year This condition is made worse by the existing laws that currently restrict the government to prefund the Taspen scheme far in advance, thus worsened Taspen s fiscal conditions. It is estimated that to fully fund the Taspen pension scheme, an additional funding of 3,25% from civil servants basic salaries is required and in 2020, the total costs that have to be paid by the government to fund the Taspen pension 6

7 scheme would be about 66% of central government s routine budget. This is an amount that could seriously impacted the government s fiscal conditions (Leechor, 1996: 29-30). Compared to the Jamsostek scheme, Taspen s pension fund produces more benefits to its member, because its replacement rate for members is estimated at 100% of members final salaries after 35 years in the civil service, a rate that is much better than Jamsostek, which only replaces about 11% of its members final salaries after 35 years of work (Leechor, 1996: 24). This generous pension benefit was created because the official salaries of the Indonesian civil servants are very low. However, this difference in pension benefits is very large that there is a perception made in some corners that the government generously takes care of its employees when they retired, while at the same time, it does not pay the same attention on the welfare of the general public. III. THE PROPOSED INDONESIAN SOCIAL SECURITY REFORM a. The Indonesian Social Security Reform Draft Bill (Jamsosnas) According to the Indonesian government, the proposed National Social Security System (Jamsosnas) would be run based on the following principles 5 : - Mutual assistance (gotong royong): wealthier participants will assist those who are less well-off, those with low risks will help those with high risks, and those who are healthier will help those who are sicker; - Compulsory membership: all Indonesian residents, in stages, are required to participate in the Jamsosnas scheme; - Trust fund: the funds collected from participants are managed by to the National Social Security Provider Agencies in a trust fund to be used optimally for the welfare of all participants; - Not-for-profit: the management of this trust fund is not for profit motive, but instead is used to meet the needs of all participants; - Openness, risk averseness, accountability, efficiency, and effectiveness: these management principles would be carried out and would become the basis of the management of the National Social Security program; 5 GOI (2004): Explanatory Clauses of the National Social Security Bill, p

8 - Portability: participants will continue as members of the national social security scheme regardless of their income and employment status and will continue to receive benefits regardless of their income and family status, as long as they fulfill the eligibility criteria for receiving these benefits. The scheme proposed by the government is very comprehensive, consisting of retirement benefits, health care benefits, death benefits, and workers disability benefits 6. Unlike Jamsostek, which only covers private formal sector workers, Jamsosnas will cover all Indonesian citizens, regardless whether they are formal workers, informal workers, or self-employed. Table 2. Estimated Contributions/Premiums of the Jamsosnas Program (% of wages) Program Workers Incident Benefits Program (JKK) Death Benefits Program (JK) Retirement Benefits Program (JHT) Total Jamsostek Contribution Rates 0,24 1,74 (5 classes) Total Known Jamsosnas Contribution Rates 0,3 Unknown (Paid in full by employers) 5,7 Unknown (50-50 contribution for public pension and old-age savings schemes) Total Jamsosnas Contribution Rates (Estimated) 0,24 1,75 0,24 1,75 0, (6% for public pension and 4.75% for oldage savings) Health Care Benefits Program (JPK) Total 9,24 13,74 6,24-7,75 17,29 18,80 Source: Author s calculation While not all the contribution rates for the different Jamsosnas schemes are known at this time, we could estimate the rates for Jamsosnas pension and death 6 The GOI also plans to create an unemployment insurance scheme. However, it has not been included in the current draft of the Jamsosnas bill 8

9 benefit programs from current rates of the Jamsostek schemes, with the assumption that that they would not be much different from the existing contribution rates. The retirement benefits program is estimated to have 10,75% of payroll contribution rate (6% for the public pension program and 4,75% for the old-age savings program (the current contribution rate of Taspen scheme s members), both would be shared equally (50-50) by employers and workers). Finally, the death benefit program is estimated to be the same as the Jamsosnas death benefit scheme (currently 0,3% of payroll). From these figures, we could estimate the total cost of the Jamsosnas program to be between 17,29% to 18,80% of formal workers payroll (see table 2 above). b. Institutional Information A National Social Security Board will be set up to oversee the program. It will consist of 15 members, which consists of five representatives from central government ministries and agencies (Ministries of Health, Manpower, Social Affairs, Social Welfare, and Finance), five from employer s associations (Apindo, Kadin, etc.), and five from labor unions. The members will be appointed for a term of three years, which could be renewed for another three years (GOI 2003: 16-17, GOI 2004). The National Social Security Provider Agencies will administer the daily management of the Social Security fund. Responsibilities of these agencies are: to enforce workers compliance to make contributions to the national social security fund, to issue social security identification numbers, and to manage the national social security fund, based on the authority given to the National Social Security Fund Board. The management of these agencies will be appointed by the government through the shareholders meeting. (GOI 2004: section 49). The National Social Security Agencies would consist of the different social security agencies below: PT Jamsostek (manages the public pension of private formal sector employees), PT Askes (manages public employees health insurance), PT Taspen (manages public employees pension program) and PT Asabri (manages the armed forces pension program). These institutions will continue to operate their respective programs, without causing any losses to the existing participants in their schemes. Their legal status would continue as for-profit state-owned enterprises 9

10 (Persero) 7. However, they will receive a special status as Special Perseros (Persero Khusus), in which these companies are obliged to run the National Social Security programs on a not-for-profit basis and their social security revenues would not be subjected to income tax payments (GOI 2004: sections 40 & 41). In addition to the four existing social security companies, a new company would be created to handle the coverage of informal sector workers and recipients of government s social assistance schemes (GOI 2004: section 78). c. Description of the Public Pension Programs Specifically, public pension in Indonesia will comprise of two components: the public pension program and the old-age savings program. Each of these programs will be further discussed below. 1. The old-age pension program. The old-age pension program is a long-term program to which participants pay regular contributions to provide for an additional income to offset a reduction or income loss in the event of retirement. It is a defined benefit social insurance program 8, presumably would operate as a partially funded pay-as-you-go scheme 9. As stipulated by the draft law, for the next fifteen years or so, it would only accumulate social security contributions, but would not pay any pension benefits to retirees (GOI 2004: section 34). 7 The original draft of the National Social Security Bill envisions these agencies to be converted into a single social insurance agency, which would have a legal status as a non-profit entity. However, this proposal was dropped in the later version of the draft. 8 Defined benefit scheme is a retirement plan in which workers are guaranteed a benefit upon retirement, usually based on years of service, age, and final or lifetime earnings. The funding of the plan s liabilities (promised benefits) and the risks associated with the scheme become the responsibility of the employer/government. The opposite of this scheme is the defined contribution scheme, which is a retirement plan in which only the contribution rates and bases of benefits calculations are determined in advance (not the benefit level). The benefit is a direct product of the contributions paid to the investment accounts, plus return of investments from these accounts. The risks, though not the control, of this pension scheme rest with the workers (ILO 2003: xxii, Weller: 3-4) 9 A pay-as-you-go system is a social security system in which no funds are set aside in advance and benefits for current retirees plus administrative costs are paid from current workers contribution (ILO 2003: xxii). A partially funded pay-as-you-go scheme means that the system is partially financed in advance to create a reserve fund for future use by retirees and currently it pays out no contribution to them. After the system matures, it would start paying out pension obligation to retirees and then it could return as a full pay-as-you-go scheme. 10

11 This old-age pension scheme has similar features with the publicly-run pension programs established in most developed countries in Western Europe and North America and to the monthly pension program run by PT Taspen for retired civil servants and their widows/widowers. This program is further divided into four components: old age pensions, disability pensions, widow/widower pensions, and children pension, (GOI 2004: section 34). The defined benefit of the old age pension would normally be a percentage of the average income for the previous year. The fixed minimum pension under the proposed plan is calculated as 70% of the minimum wage. The same benefit level also applies to the disability pension program. Widows/widowers of workers and children of the workers will receive a minimum pension between 40% to 60% of the local minimum wage (GOI 2003: 59-60). Widows/widows of workers will continue to receive pension benefits until they died, have remarried, or start working full-time. Children of workers will continue to receive pension benefits until they have married, start working full-time, or have reached 23 years of age, whichever comes first (GOI 2004: section 34). According to the draft of the academic paper, the contribution level for the pension program will be set differently between formal sector workers and informal sector workers. Formal sector workers contribution subsidizing part of informal sector workers pension. The paper stipulates that the contribution of formal sector workers would be shared with their employees on a basis. Employers are responsible to collect the workers contribution and submitting them to the National Social Security Provider Agency. Informal workers and the self-employed would pay their contribution at a flat-rate amount to be determined later. The government plans to cover the pension of those who are too poor to make a contribution into scheme through subsidies from the state budget (GOI 2003: 22, GOI 2004: section 7, subsection 5). The retirement age is currently set at the age of 55, and a worker who has contributed into the scheme for at least fifteen years will be entitled to receive full pension benefits from the program. These workers, or their survivors if the workers died before reaching retirement age, will receive monthly pension payments. Workers that retired before reaching the fifteen years contribution requirement above, they would be entitled to receive the accumulated amount of their pension contribution, 11

12 plus its investment returns, in a lump sum. However, they would not be eligible to receive a monthly pension (GOI 2003: 56; GOI 2004: section 34). 2. The old-age savings program The old age savings program is a long-term program in which participants are entitled to receive benefits before reaching the retirement age and, in the event of the death of a participant, his or her spouse, children, or official heirs are entitled to receive benefits. It is carried out in the form of a compulsory savings program. Thus, it is similar to the compulsory savings program run by PT Taspen for retired civil servants and their widows/widowers. In other words, it is a fully-funded, defined contribution pension program similar to the mandatory individual retirement account schemes in countries that have adopted a secondary pension pillar as recommended by the World Bank, with one important exception: according to the draft bill, this pension scheme will be run by a public social security agency instead of by private investment companies. The benefits of this pension plan is given as a lump-sum cash payment when the workers have died, suffered from a permanent disability, or has entered retirement age. If the workers have died or are suffering from a permanent disability, their survivors (spouses and children under the age of 23) would receive the benefits. The total amount of program benefits received by members is the entire amount of their contribution accumulated over the years, plus the investment returns of their contribution. Workers could start withdrawing their money from this account at the earliest five years before they reached retirement age. They could even use a portion of the money saved in these accounts as a loan after they have make a contribution for a given period of time, which would be detailed in a future government regulation (GOI 2004: section 30). Each member must pay a contribution into this savings program either as a percentage of their income (formal workers) or a flat-rate amount (informal and selfemployed workers). The contribution of formal workers will be split equally (50-50) between themselves and their employers. The National Social Security Provider Agency will be required to provide an annual report to each worker on the total amount of contribution they have accumulated over the years and the investment returns from the investment of this contribution. Exactly how the government plans to 12

13 invest the fund collected by this scheme will be stipulated in a future government regulation (GOI 2004: section 31). IV. ANALYSIS OF THE PROPOSED INDONESIAN SOCIAL SECURITY REFORM BILL a. General Analysis Based from the results of our analysis on the current National Social Security Reform draft bill (dated January 16, 2004), we can make the following observations about the bill. First, there has been no known actuarial calculations that serve as the sound basis of determining the contribution level and the real benefits of this scheme, nor has there been any reliable economic analyses on the short and long-term impacts of this scheme on the labor market, on Indonesia s business competitiveness, and on the Indonesian economy in general. In the absence of such analyses, the impacts of this scheme on the economy would remain questionable and the adequacy of the proposed contribution rate in paying actual program benefits would remain in doubt. The National Social Security Program (consists of public pension, national health insurance, work injury, and death benefit schemes) would also create significant financial burden for employers and workers, since they are expected to contribute between 18% to 20% of workers wages into these schemes, which would be a 5% to 7% increase from the current Jamsostek contribution rate. Thus, the Jamsosnas scheme could create a substantial burden for formal employers and workers and could make the Indonesia s business climate even less competitive, since it creates substantial new labor costs for companies. As a result, there would be significant incentives for employers to shift the cost of these contributions through lower take-home pay and benefits for workers and reducing the number of workers they employed, which means that in practice, the total cost of paying for these schemes is solely beard by workers. This could reduce the income of low-middle income workers who rely on this salary. According to the Jamsosnas academic paper, the contribution of the formal sector workers would be set at a much higher rate than informal sector workers and the selfemployed, since it is assumed that the payroll tax paid by the former group would subsidize the social security benefits of the latter groups. However, this crosssubsidization scheme is not clearly defined and explained by the draft bill. Thus, the 13

14 new social security scheme would become less attractive for these workers and their incentives to evade from it could be substantial (e.g., by switching to the informal sector, where the payroll tax rates would be much lower than the ones charged to formal sector workers). It is also questionable on whether one-third of Indonesian workers who work in the formal sector could fully subsidize the coverage of informal sector workers, which consist of two-thirds of Indonesian workers. In practice, experience from other developing countries show that similar social security programs only cover a small proportion of the workforce. For instance, the Philippines has had a social security program for 45 years. While about 72% of the workforce are members of the pension program, only 28% of these workers actually paid their compulsory contributions (Capulong 2004). In addition, past experiences that attempts to collect social security contributions from informal sector workers, both in Indonesia and in other developing countries 10, have showed that it is very difficult, if not impossible, to do so. This is because many informal workers are very mobile both in their workplaces, in the type of jobs they undertake, and in the place they live. Thus, trying to find a particular informal worker from one month to another to collect their social security contributions could become an almost futile exercise. In the end, many informal workers are not covered by any social security schemes, either because they could not be found by the tax collectors, or because they failed to claim the social security benefits they entitled to, even though they have made some contributions into the scheme. As a result, informal sector workers continued to be excluded from the publicly sponsored social security scheme, even though many argued that they would be the ones that would need social security protection the most. The program could also run into significant managerial and governance issues. Even though the National Social Security Board will consist of representatives of the government, employers association, and workers, most of the board members would come from government ministries and agencies. Additionally, the proposal does not address the possibility of collusion during the selection process of board members, so the government could appoint representatives from the private sector and workers 10 In 2002/03, PT Jamsostek conducted a pilot project that attempts to collect Jamsostek contributions from informal sector workers. However, due to the many difficulties it found in collecting contributions from them, it has now postponed this project. 14

15 representatives that are friendly to the interests of government bureaucrats. As a result, board members representing employers and workers might not be necessarily work for the interest of these groups. The program will continue to be administered by several state-owned enterprises, which is established as for-profit corporations with obligations to give contributions to the government s budget. Experiences of current social security schemes administered by for-profit state enterprises show that they have failed to provide adequate benefits to beneficiaries because of the low number of people it covers, its low benefits and investment returns, and poor governance. This contradicts the aim of the national social security system that should have been administered on a not-for-profit basis. It is doubtful that the new social security scheme would differ than previous government programs if it is continued to be administered by the same state-owned enterprise without any fundamental changes. Finally, the government s proposal disregards the role of competition in providing social security benefits for Indonesians, since according to the bill, social security provision would become the sole responsible of the government, in spite of the fact that most formal sector workers already have adequate health and retirement benefits from their employers. The government alone will continue to make decisions on how the fund is managed, invested, and distributed among beneficiaries, while workers themselves are not allowed to participate in the decision-making of the trust fund, even though the social security fund is actually their own money and most Indonesians workers place little confidence in the publicly run social security schemes. Yet the bill continues to entrust the government as the sole manager of workers' social security funds. Evidences from other countries (most notably in Latin America and Eastern Europe) show that entrusting the operation of the national social security system to same party that also regulates it (i.e., the government) simply would not work. The government-run social security programs in these countries are always prone to empty promises of generous benefits made by the government to workers that are not financially sustainable for the government to accomplish and continued corruption and abuse of social security funds by officials. This shows that it is not a good idea for the government to both regulate and operate the national social security scheme at the same time. A separation between these functions is needed in order to have a truly functional social security system that would work for workers. 15

16 b. Analysis of the Proposed Public Pension Scheme 1. The old-age pension scheme The proposed Indonesian old-age pension scheme is designed as a social insurance system, operating as a partially funded pay-as-you-go defined benefit program. It is a compulsory, universal insurance program for all Indonesian residents, regardless of their nationality and working status. As a compulsory insurance program, the scheme avoids the problem of adverse selection 11, since no one could opt out from it to choose alternative pension plans. However, it could suffer from the moral hazard problem 12, in which workers might cut their savings because they believe they will receive guaranteed pension benefits when they retire. Thus, workers overall welfare could be made worse with public social security since they have little private savings to supplement their income from the public pension scheme. The defined benefit system adopted by the scheme would place significant financial risks to employers and the government, because they might have to be responsible to make additional contributions into the scheme in the case that it runs into serious financial shortfalls 13. In the Indonesian case, the probability of the program to run into deficits is significant, because the pension benefits offered by the program is very generous, with a minimum benefit of 70% of the local minimum wage. Since many Indonesian workers, especially those who work in the informal sector, have earnings below the local minimum wage, many of them will receive this guaranteed benefit. Due to the substantial amount of this liability, the possibility of serious financial problems to occur in this pension scheme in the future is quite high. In addition, the fact that the benefits of the old-age pension scheme seem to be determined from the minimum wage level could create additional demands from 11 Adverse selection is a situation in which only persons who feel the need to be protected from a given risk (e.g., loss of earnings due to a given disease or death) through insurance scheme are willing to purchase this insurance, while those who do not feel this need would not purchase it. In other words, only those who are determined to be risky by insurance companies are willing to purchase the insurance, thus negate the purpose of insurance, which tries to spread this risk to all members, whether they have it or not. 12 Moral hazard is a situation in which individuals are more willing to pursue riskier activities because of their participation a given insurance scheme (e.g., health, life, and retirement insurance). 13 Section 42 of the Jamsosnas Bill states that the government could perform extra-ordinary measures to maintain the financial solvency of the NSSPA, for instance, by bailing out NSSPA if they become financially insolvent and near bankruptcy. 16

17 workers and labor unions for the government and employers to increase the minimum wage, so that workers could earn higher pension benefits. If the government gives in to such pressures, it would incur additional pension liabilities in the future, something that could further endanger the government s fiscal positions and sustainability in the future, when the time comes for the government to start paying out workers pension benefits. In 2003 and 2004, the UMR increased between 10-15% on average. If this trend continues we would expect pension benefits and therefore costs to rise between 10-15%, whereas inflation is around 6-7% per annum. In addition, the government s plan to subsidize the coverage of low-income persons is also questionable. According to the draft law, Indonesians whose income fall below the local minimum wage (UMR) will be considered as "low-income" persons and therefore are eligible to receive government subsidy to help cover their Jamsosnas contribution. However, there are a substantial number of Indonesians who have the income below the UMR rate, especially those who work in the informal sector or has no permanent employment. If there were too many Indonesians who are eligible to receive this subsidy, the government has to commit significant resources to pay for this subsidy. Consequently, this could put significant financial strain to the government budget. It is not clear on whether the government plans to pay for this subsidy through the general revenues or through other channels such surpluses generated from the investment of the National Social Security Trust Fund. Also not clear is on how the government would allocate this subsidy to the recipients (direct payments to beneficiaries, payments to health providers, etc). If this issue is not addressed, it could become another factor that could make the long-term sustainability of the national social security program in doubt. Additionally, the proposal seems to fail to take into account that the Indonesian population is aging rapidly. It is estimated that Indonesians aged 55 years of older will increase from about 10% of the population in the year 2000 (about 23 million) to about 30% of all Indonesians by the year 2050 (about 100 million) (US Census Bureau 2004). At the same time, the Indonesian population aged 65 years and older will rise dramatically during this period, from 10 million in 2000 (4,5% of the population) to 60.5 million in 2050 (18% of the population) (US Census Bureau 2004). Thus, the elderly would become more of a burden to Indonesian families (and taxpayers) by the year

18 The combination of a relatively young minimum age (55 years), low amount of minimum working years to qualify for pension (15 years) and a rapidly aging population that lives longer, is a recipe for disaster for any public pension program and it seems that this proposed scheme would suffer from such fate and become financially unsustainable. Later attempts to correct the problem such as raising contribution amount and cutting pension benefits are only temporary fixes that only make the program less attractive to participants. Eventually, the pension scheme could suffer from a default, which would place significant financial liabilities to the government and employers and significant loss of retirement income for workers. Experiences from other developing countries such as the Philippines show that the liabilities of social security pension funds could be substantial. In Philippines, the number of new retirees eligible for pension benefits has more than doubled in the 1990s. This has caused the funds accumulated in the country s social security trust fund to decline significantly, so that it is now predicted that the fund would be completely depleted for paying retirees pensions by the year 2015 (i.e., insolvent). If this occurs, the Philippines social security system would run into significant financial problems the hidden public pension debt is estimated to be about US$21 billion (200 trillion Rupiahs) (Capulong 2004). We could see that if the same situation occurs in Indonesia, which has a population about three times larger than the Philippines, the Indonesian government (and eventually, Indonesian citizens), would be obliged to pay a substantial number of new debts that could be up to four times larger than the debt incurred by the Philippines social security system (around US$ 63 billion or about 598 trillion Rupiahs). Since Indonesia has a large amount of public debt today (estimated at US$136 billion or about 1,292 trillion Rupiahs) as of March 2004 (The Jakarta Post, June 7, 2004), this country could not afford to have a new 598 trillion Rupiahs debt on top of the existing ones Finally, it is estimated that the impact of the proposed Jamsosnas old age pension scheme on current Indonesian elderly population would be minimal. Since the system is a partially funded pay-as-you-go scheme, unless they pay a contribution into the Jamsosnas scheme, current elderly retirees would not benefit at all from it. This is despite the fact that it is the currently poor retirees that would need the benefits of the Jamsosnas old age pension scheme the most; they would not have the financial resources to contribute into the Jamsosnas scheme. 18

19 Elderly persons who will retire between the time the Jamsosnas pension scheme takes into effect and the time when the it will start paying out contributions (about fifteen years after its establishment, according to the draft law) also would not benefit from the Jamsosnas pension scheme. As stipulated by the draft law (GOI 2004: section 34, subsection (5)), they would not be eligible to receive a pension. They would only receive the money accumulated in their old-age savings accounts (contribution plus investment earnings) 14. However, in general, only those who will retire fifteen years after the Jamsosnas pension scheme has been in place and has made regular contributions into the scheme would receive Jamsosnas pension benefits. Thus, unlike what has been claimed by the proponents of the Jamsosnas bill, the Jamsosnas pension scheme would not be very helpful for current retirees who do not have the resources to make a contribution into the scheme. However, this group of elderly is still vulnerable from old-age poverty, if not more so compared with future retirees that participated in the Jamsosnas pension scheme. Consequently, the government might have to establish a separate pension or income support scheme for this poor elderly. b. The old-age savings scheme Since the proposed old age savings scheme is similar in many ways with the current Jamsostek provident fund scheme (both are fully funded, defined contribution schemes fully paid from workers contributions), we can draw from the experiences faced by the Jamsostek scheme as possible problems that would occur in the new old age savings scheme. As stipulated in section II, the Jamsostek scheme suffers from low participation rate, low compliance rate, low investment returns, low amount of benefits offered, and poor governance. These have significantly reduced the real value of the Jamsostek scheme as a possible old age income source for its participants. Thus, many participants do not regard Jamsostek as a reliable source for their post retirement income. 14 The only exception from this requirement is when the worker dies before reaching the retirement age or has contributed into the Jamsosnas pension scheme for fifteen years. In this case, their heirs (surviving spouse and children) would continue to receive their pension benefits until they died or have started working full-time (or for the children, when they reached 23 years of age) (GOI 2004: section 34, subsection (4) and (7)). 19

20 One lesson we could draw from the Jamsostek s experiences is that without significant reform in financial and managerial governance of the current old age savings program, it is unlikely that the new old age savings scheme would significantly improve its performance, investment return, and benefits that it could offer to program participants. This would make the proposed old age savings scheme unattractive to them and like Jamsostek today; participants would not regard it as a potential source of their old age income and would continue relying on private voluntary savings schemes as a more reliable source for their retirement income. V. CONCLUSION AND POLICY RECOMMENDATIONS a. General Conclusions Indonesia is at a crucial stage in its attempt to extend social security coverage to Indonesian workers and to reform its current social security scheme so that it would work better for the workers inside the system. The current social security system is not sustainable and has not been successful to provide adequate benefits to the workers covered by it, thanks to a relatively low rate of workers participation in the scheme, low rate of returns of the national social security fund, and poor management of the scheme. Therefore, many parties acknowledged that a fundamental overhaul of the system is badly needed. The current Indonesian social security reform proposal as stated in the draft of the National Social Security Reform Bill could create a disincentive for Indonesian workers to save, does not treat all workers equally, set up a benefit level that is too generous and could endanger the fiscal sustainability of the government. In practice, it is also done very little to help current poor elderly Indonesians that were publicly claimed to benefit from this new scheme. The program also does not take into account the rapid aging of Indonesians in the near future, which could put additional fiscal strain to the government, and ignores the potential for poor governance and management. All of these would jeopardize the retirement prospect of Indonesian workers and could force them to live below the poverty line after they have retired. In most countries of the world, publicly financed social security scheme is no longer viewed as an ideal system to finance workers social protection. Many of these countries have pursued other alternatives to achieve universal social security coverage for their citizens and at the same time maintain competition and choice in the provision of social security programs. Social security financing and provision should 20

21 no longer be regarded as a government monopoly. There are many cases in which private involvement in social security provision could positively improve service delivery, promote competition and innovation that would improve social security provision and in the end, improve health and retirement outcomes of program s members. Many developed and developing countries have introduced reforms to overcome the financial problems inherent in the defined benefit pension scheme. Recent reforms adopted in many other countries are built around three pillars that provide old age pensions and health insurance 15. We feel that Indonesia could learn from these international experiences with pension reforms. The three-pillar strategy is based on the following principles: 9The first pillar is a public pillar that provides a social safety net this resembles existing public pension plans such as Jamsostek but it is smaller and focuses on redistribution, providing a social safety net for he old, particularly the old whose lifetime income was low 9The second pillar is a fully privately managed funded pillar that handles peoples mandatory retirement schemes and insurance it links benefits to contributions as in a defined contribution plan. Under a defined contribution plan, the worker s pension is linked to his/her contributions plus the return on investment. This program is fiscally sustainable in the long run as benefits are tied to worker s contributions and therefore avoids pension costs in the state budget. 9The third is a voluntary pillar for people who want more consumption in old age strategy. The three-pillar approach allows private sector participation to diversify risk. Workers and employers have the option to choose a social security program that is suitable for their own needs and needs. The government can design a mandatory social security program but it is not necessary for the government to run the program as a monopoly. The program can be run by the private sector or some combination of state, private sector, and not-for-profit sector (NGO). However, experiences show that the program would earn better returns for its participants if it is run by the private sector. The three-pillar option includes both public and private sector management. 15 For further details on the three-pillar system, please see World Bank (1994). 21