Reforming Indonesia's Pension System
Indonesia's nascent capital markets stand to benefit significantly from a thriving pension industry. Now is the time to reform the pension system, while it has a vibrant economy, rapidly rising income, and a young and growing work force. The three main reforms suggested by Leechor are to:
Reconsider the role of mandatory defined contribution (Jamsostek) plan. Long-standing public distrust of Jamsostek tends to undermine the government's credibility, and terminating the program would probably win popular support. Without Jamsostek, many firms might operate employer sponsored plans. One argument for reforming it is that it could be a powerful instrument for resource mobilization. One option is to maintain mandatory participation but abolish the current monopoly on administrative and investment services and open them to competition from accredited banks, insurance companies, and pension service companies. Another option is allow firms already operating approved plans to drop Jamsostek contributions, but require other firms to make them, choosing their own administrative services.
Make employer sponsored pensions more attractive and affordable. With compliance in the Jamsostek plan so low, the only realistic option for most workers (apart from private savings and relying on family support) is the employer sponsored pension. Few companies now operate approved pensions, covering only 10 percent of the formal work force. Certain measures might encourage private firms to adopt plans providing secured and portable pensions:
- Simplifying and expediting registration and approval processes, raising the retirement age from 55 to 60, and not taxing pension plans directly.
- Limiting political interference in investment decisions by adopting an exposure limit on pension funds' investments in firms with concentrated ownership (especially state banks and public enterprises).
- Permitting pension funds to invest abroad (initially, with certain limits).
- Using term annuities or phased withdrawals instead of life annuities.
- Adopting an adequate government vesting policy as a model for the private sector.
Contain the fiscal burden of the civil service pension plans. Options Leechor discusses: improving investment results; setting limits on administrative expenses; providing the same vesting and portability of benefits required of private pensions (to facilitate labor mobility between private and public sectors); rationalizing benefits; raising the retirement age; and considering partial funding of benefit obligations.
This paper - a product of the Country Operations Division, Country Department III, East Asia and Pacific - is part of a larger effort in the department to understand and monitor financial sector development in Indonesia. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Genet Telahun, room MC9444, telephone 2024582407, fax 2025221675, Internet address gtelahun@worldbank.org. (42 pages)
The full report is available on the World Bank FTP server
