Pension reform and the financial implications of second pillar pensions : a Toly products case study

Abstract

Until recently, pension systems around the world were based on the funding concept of "pay-as-you-go" where workers pay for the retirement pension of those who are already retired. The system was self-sustainable for as long as the population and workforce were expanding. However, falling fertility rates and increasing life expectancies led to a smaller number of workers supporting an ever increasing number of pensioners. This was the hallmark of the "pensions time bomb". In the light of demographic and fiscal pressures, pension reform became a hot topic on the Maltese agenda, leading to the enactment of Act No XIX of 2006. This Act, although it did not introduce the much expected and anticipated Second Pillar Pension Schemes, established the framework for the eventual introduction of such mandatory Schemes, with Government maintaining that this is an issue of "when" and not "if'. This study thus seeks to predict and analyse the financial implications on a Maltese company of mandatory Second Pillar pensions, using the Final Recommendations presented to Government as a template for the design of such schemes. Data were obtained from Toly Products Ltd, and computations were performed to transform such data into meaningful information, analysed according to the two main designs of Second Pillar Pension Schemes, Defined Benefit Schemes and Defined Contribution Schemes. The conclusions of the study indicate that while both types of schemes have their pros and cons, the costs and risks of Defined Benefit Schemes are mostly borne by the employer. It is hard to justify recommending Defined Benefit Schemes for Maltese companies, even more so when the experience of foreign companies with such schemes is taken into consideration. However, Defined Contribution Schemes shift such risks from the employer to the employee, defeating the concept of wealth creation and high quality pensions. A 'third-way', in the form of Hybrid Schemes, is also examined and found to achieve an equitable risk-sharing balance.