Addressing the Challenges for Asset-backed Pensions in Indonesia

The Indonesian pension system faces numerous challenges to providing adequate retirement benefits for its population. While the introduction of the mandatory asset-backed pension schemes for private-sector workers in 2015 was a significant step towards improving access to pension schemes for the Indonesian population, many categories of workers remain underserved and have fewer opportunities to save for their retirement. The rules relating to benefit accruals and the withdrawals of retirement savings occasionally fail to incentivise saving or provide adequate benefits in retirement. Additionally, occupational pension plans are being closed, and vehicles to protect retirees from longevity risk are not widely available. Furthermore, even when saving for retirement is mandatory, compliance is low.

In addition to addressing the challenges leading to retirement savings protection gaps, the Indonesian pension system needs to ensure the design of the system itself is conducive to achieving its objectives. Key challenges relate to investment, sustainability, and complementarity. First, pension fund investments remain overly conservative and strategies are not appropriate to achieve optimal outcomes for members at retirement. Second, the parameters relating to the financing of defined benefit plans are inadequate to ensure their long-term solvency and sustainability. Finally, the different components of the system sometimes lack clear and complementary objectives.

To address these challenges, Indonesia should first ensure that the rules of the pension system allow individuals to accumulate adequate retirement savings. Rules for different types of workers should be more aligned in terms of contribution limits and the accrual of benefits to avoid hindering the ability of certain groups to accumulate retirement benefits. Accrual formulas should also ensure continued incentives to contribute to encourage compliance and participation in the pension schemes. Retirement ages for mandatory schemes should align to encourage workers to contribute for longer. The payout options available and their taxation should encourage individuals to take their retirement savings as regular income in retirement.

The regulatory framework should also promote the availability of options to accumulate retirement savings and provide an income in retirement. Additional measures could reduce the costs of opening and administering a plan to counter the trend to close voluntary occupational schemes. Allowing providers to offer non-guaranteed lifetime income options could promote the availability of payout vehicles offering longevity protection by limiting risk exposure to providers. A public annuity provider could also be considered to ensure the supply of lifetime income vehicles.

The authorities should also take steps to improve the uptake and use of retirement savings schemes by the population. Contributions to mandatory schemes could be better enforced by leveraging the position of the tax authority. Government-provided matching contributions could also encourage participation, in particular for low-income groups who may have a lower capacity to save.

The investment strategies of pension schemes should be more diversified and in line with the goal of financing retirement. Certain investment restrictions, such as minimum requirements for investment in government bonds and limits on foreign investment, should be relaxed. The expanded use of default lifecycle investment strategies could help to increase investment risk exposure at younger ages and increase overall investment returns in the long run. Investment performance should be measured with appropriate metrics and benchmarks that are in line with the long-term investment horizon of pension funds to promote accountability for investment results. Rules should eliminate the possibility to finance severance benefits with occupational pension funds, as this presents a conflict of interest with the objective that pension funds should have to finance the retirement benefits of employees. Finally, policy makers should strengthen requirements around investment expertise in the governance framework.

The regulatory framework also needs to strengthen the sustainability of defined benefit pension funds. For public mandatory schemes, contributions need to increase to better align with the expected benefit payments. Voluntary occupational plans should be subject to clear requirements for the valuation of their liabilities and funding calculations that better reflect their actual solvency position and ensure adequate funding levels.

Finally, schemes’ design should align with clear objectives that aim to ensure complementarity of the different components of the system. Currently, the severance pay system lacks a clear objective, and it is not designed in a way that actually benefits those it intends to help, so should be replaced by increased employer contributions to the mandatory defined contribution scheme for private sector workers. Early withdrawals from the mandatory defined contribution scheme for private sector workers should only be allowed for exceptional individual circumstances to avoid savings being depleted before retirement. Finally, the objective of the new mandatory pension programme that increases contributions for higher-income employees needs clarification to ensure the alignment of its design with that objective.

The policy options included in this report, which draw on OECD guidelines and international good practices, could help the Indonesian pension system to address some of the challenges it faces and improve retirement outcomes for the population.