This chapter discusses the various measures that the Indonesian authorities have taken to address the challenges relating to retirement savings described and proposes additional measures that they could consider to improve retirement outcomes, drawing on OECD guidelines and international good practices.
Addressing the Challenges for Asset-backed Pensions in Indonesia
Abstract
Indonesia could consider numerous measures to close protection gaps and address the challenges it faces relating to investment, sustainability and the harmonisation and complementarity of the pension system. This chapter discusses the various measures that the Indonesian authorities have taken to address the challenges relating to retirement savings described and proposes additional measures that they could consider to improve retirement outcomes, drawing on OECD guidelines and international good practices.
The introduction of the mandatory pension schemes for private sector workers in 2015 was a significant step towards improving access to pension schemes for the Indonesian population. Nevertheless, workers who are not employed in large or medium sized enterprises remain underserved, as they generally do not contribute to the BPJS-JP scheme and informal workers have lower contribution rates to the BPJS-JHT scheme.
The Indonesian authorities have taken several measures to increase contributions and replacement rates, but these are primarily focused on those who already contribute more to the system because of their employment status or salary. Voluntary schemes are primarily offered in large and medium sized companies, whose employees are also mandated to contribute to the BPJS-JP scheme. The government is also introducing a new mandatory pension programme, but this will be targeted at those with higher earnings so will not improve the situation for middle- to lower-income workers, who generally have fewer opportunities to access and contribute to a retirement savings scheme.
The normal retirement age is not harmonised across the mandatory publicly-provided pension schemes for private sector workers. While the retirement age for the BPJS-JP scheme is gradually increasing to age 65, that for the BPJS-JHT scheme remains 56. As such, individuals tend to retire at the earliest possible age, at 56. Replacement rates from the yet-to-mature publicly-provided schemes are currently low, and they will not be able to finance a retirement of over 20 years with so few years of contributions.
However, the government has already taken measures to harmonise the retirement ages for voluntary occupational pension plans. The minimum pension age that voluntary schemes can offer is now five years before the normal retirement age of 55. This should increase the retirement savings accumulated in voluntary schemes.
The government has also taken steps to introduce more flexibility in how people receive payouts from voluntary pension plans. Since 2023, periodic payouts from both DB and DC plans can be paid over a minimum of ten years rather than for life, and there are additional limits around how lump sums can be taken. While full lump-sums are not always allowed for voluntary plans, lump-sums tend to be taxed more favourably than annuities.
Nevertheless, the BPJS-JHT scheme continues to pay out only lump-sums, and drawdowns or annuities from this plan are not available.
The Indonesian authorities could consider several measures to improve the rules of the system to deliver better retirement outcomes. Some potential options to improve access to retirement savings schemes would be to align the contribution rates across different types of workers, harmonise the schemes between public and private sector workers, and to reformulate the cap on benefits from the BPJS-JP scheme. Publicly-provided schemes could encourage later retirement by harmonising the retirement ages. The rules around the payout options available could be more coherent with the intended role of the different components of the pension system by limiting payout options for the BPJS-JHT scheme before retirement and remaining neutral with respect to the taxation of the different payout options.
2.1.1. Align contribution rates across different types of workers
Private sector workers who are not required to contribute to the BPJS-JP scheme miss out on benefits coming from the additional 3% contribution made to the scheme for employees of medium and large enterprises. In addition, this population is not likely to have access to an occupational pension plan. Furthermore, informal workers are only allowed to contribute 2% to the BPJS-JHT scheme, whereas formal employees benefit from an additional contribution of 3.7% from their employer. The only option for those wishing to save more for their retirement is to save in a personal plan offered by a financial institution, which is likely to incur higher fees.
The OECD recommends aligning contribution rates across all types of workers (OECD, 2019[1]). Most OECD countries do not differentiate contribution caps by type of worker for asset-backed pension plans. Nevertheless, eight OECD countries have higher contribution caps for salaried employees, because the additional employer contribution increases the overall cap for the employees.1 Some countries actually allow higher contributions from the self-employed into certain types of plans, as is the case in Belgium, France, Japan, and Switzerland (OECD, 2019[2]).
As such, the allowed contributions to the pension schemes should align across different types of workers. Workers who cannot contribute to the BPJS-JP scheme or have lower contribution rates to the BPJS-JHT scheme should still be able to contribute that additional amount to the BPJS-JHT scheme, even if those contributions would not be mandatory.
2.1.2. Harmonise the mandatory pension schemes for public and private sector workers
Most OECD countries have taken steps to harmonise the pension schemes for public and private sector workers. The majority have plans that are fully integrated, with no differentiation between the plans of public or private sector workers. A few countries do have a separate scheme for public sector workers, but which offers very similar benefits as for private sector workers. Ten countries provide an additional top-up for public sector workers in addition to the plans that also cover private sector workers. Only four OECD countries have schemes for public sector workers that are entirely separate from those for private sector workers (Belgium, France, Germany, and Korea). Indeed, since the 1990s, 11 OECD countries have reformed the civil service pension schemes to be more aligned with the schemes covering the general population (OECD, 2016[3]).2
Indonesia should move towards aligning the mandatory pension schemes for public and private sector workers. The design of the schemes is already similar, with a base DB plan and a DC component as a top-up. However, the benefit accrual and contribution levels differ. Better alignment and integration can present numerous benefits, such as improved equity, transparency, labour mobility, portability, and administrative costs (OECD, 2016[3]).
2.1.3. Reformulate the cap on benefits from the BPJS-JP scheme
The cap on benefits from the BPJS-JP scheme could result in declining replacement rates from the scheme over time that could eventually result in a disconnect between the contributions that workers make and the benefits they receive. If the cap on benefits declines significantly compared to wage growth, workers may have to continue contributing to the scheme without gaining any additional entitlement for their pension. This could harm the population’s trust and confidence in the system, and lead to increased incentives for workers to become informal or leave the labour market earlier than they would have otherwise planned to do.
The experience in Finland provides an example of how the imposition of a maximum benefit can lead to perverse incentives regarding labour market participation at older ages. Before the 2005 reform abolished the cap, earnings-related pension benefits in Finland were capped at 60% of an individual’s highest wage in their career, meaning that many did not benefit from continuing to work at older ages after having reached their maximum benefit. This contributed to a very early effective retirement age of around 57.5 leading up to the reform. Figure 2.1 shows that the removal of the cap, along with other measures to encourage longer working lives such as limiting the ability of people to take an unemployment or disability pension as a pathway to retirement, led to a significant increase in the effective retirement age in the years following the reform (Börsch-Supan, 2005[4]).
Source: Finnish Center for Pensions (2024[5]), Effective Retirement Age, https://tilastot.etk.fi/pxweb/en/ETK/ETK__130elakkeellesiirtymisika/esiirtymisika01.px/chart/chartViewLine/.
Rather than formulating the benefit cap as an absolute value in total, the cap could instead reflect a maximum value of annual accrual of benefits. This would mean that contributors would accrue benefits at a rate of 1% of salary per year, with a cap on the salary. This formulation would allow all contributors to continue accruing benefits with each additional contribution, while maintaining the redistributive features of the scheme.
2.1.4. Align the retirement ages for publicly-provided pension schemes
The BPJS-JP and BPJS-JHT should align their retirement ages to avoid the incentives to retire earlier and withdraw all assets from the JHT scheme. The average normal retirement age across the OECD in 2020 was 64.4, which increases to 66.3 when accounting for future planned increases (Figure 2.2). The only OECD country having a normal retirement age less than age 60 today is Türkiye, which plans to increase the age from 52 to 65 for new entrants to the labour market.
Source: OECD (2023[6]), Pensions at a Glance 2023: OECD and G20 Indicators, https://www.oecd.org/en/publications/pensions-at-a-glance-2023_678055dd-en.html.
2.1.5. Align the payout options available for the BPJS-JHT scheme with the objective to finance retirement
The OECD Recommendation for the Good Design of Defined Contribution Pension Plans states that the design of DC pension plans should be coherent with their long-term purpose and role in the pension system, and that pension systems should ensure protection against longevity risk in retirement (OECD, 2022[7]). The legal mandate of the BPJS is to administer basic pension benefits for the Indonesian population. The BPJS-JHT scheme is mandatory for many workers, and the only contributory pension scheme that most workers have access to. As such, it is likely that savings in the plan with be primarily used to finance an individual’s essential spending in retirement. Payouts with guaranteed lifetime income are best suited for meeting essential spending needs because they ensure that the individual will have a certain level of income for life, as illustrated in Figure 2.3. Nevertheless, restrictions around payout options also need allow for some flexibility for circumstances where this option may not be the most suitable, such as when the individual is in poor health or if they have not saved enough to obtain a meaningful level of lifetime income (OECD, 2024[8]).
Source: OECD (2024[8]), OECD Pensions Outlook 2024: Improving Asset-backed Pensions for Better Retirement Outcomes and More Resilient Pension Systems, https://www.oecd.org/en/publications/oecd-pensions-outlook-2024_51510909-en.html.
Nevertheless, coherence in design also involves coherence between the design of the accumulation and payout phases. Limiting the options that individuals have to use their savings can also have a detrimental effect on participation in the plan when doing so is voluntary. As such, the main payout option from the BPJS-JHT scheme for those with mandatory participation should be a lifetime income, allowing for exceptions for those with low balances or in poor health. However, additional flexibility could be allowed for those participating in the scheme on a voluntary basis.
2.1.6. Make taxation neutral between lump sums and annuities
The tax treatment of payout options should accommodate, not disincentivise, options providing a regular income. In Indonesia lump sums are taxed favourably in comparison to options providing an income. The objective of the pension system is to encourage individuals to save enough for their retirement. Those who manage to save enough to be able to opt for an annuity should not then be at a relative financial disadvantage because they take a regular income in retirement.
The pension system in Indonesia faces some challenges with respect to the options available for voluntary pension plans in both the accumulation of retirement savings and in their payout. The number of employer-provided occupational pension plans has been dramatically declining, particularly for DB plans, many of which have either been closed completely or converted to a DC plan. One important driver of this trend has been the introduction of mandatory contributions to the publicly managed schemes, which compete with the resources available to employers to finance an occupational pension plan. For the payout of retirement savings from DC plans, there are currently no options available for people to purchase a lifetime income product when they arrive at retirement.
The Indonesian authorities have taken several measures to limit the unfavourable trends relating to the availability of voluntary pension plans. In an effort to promote competition and efficiency, recent legislation has allowed asset managers to manage pension funds in addition to insurance companies and banks. Legislation also allows employers to convert their pension plans from a DB plan to a DC plan, which could mitigate the number of plan closures by reducing the risks borne by the employers. Employer contributions to pension plans are already tax-deductible, reducing the overall cost for them to contribute to the plans. At retirement, pension savers are now also allowed to opt for a fixed term annuity, rather than being required to purchase a lifetime annuity, to ensure that retirees have a sustainable income option available to them at retirement.
Additional policy options to promote the availability of occupational pension plans and lifetime income options include reducing the cost for employers to establish and manage a plan, allowing for alternative designs of lifetime income products, and considering the establishment of a centralised public annuity provider to ensure supply.
2.2.1. Take measures to reduce the costs of opening and administering a plan for employers
While the offer of an occupational pension plan can present numerous benefits for an employer, the cost of providing a plan can deter many employers from establishing one. Pension benefits add to an employee’s remuneration, and therefore can be useful to recruit and retain good employees, ultimately reducing an employer’s cost to recruit and train new staff. However, the cost and complexity of setting up a plan are common reasons that prevent employers – particularly smaller employers – to set up a plan (OECD, 2022[9]).
Governments can take various measures to reduce the costs to employers of establishing a pension plan. One way is to provide financial support to employers to set up a new pension plan. In the United States, for example, the government provides a tax credit for smaller employers who set up a plan, and in the United Kingdom providers using the publicly-established pension fund NEST do not have to pay any set-up costs. Another way is to establish a centralised clearinghouse to administer the contributions of employers to a third-party pension provider, thereby reducing the administrative costs of running the plan for employers. Such bodies can be set up within a public institution, which is the approach taken for example in Lithuania, New Zealand, and Mexico. In other countries, such as in Chile and Colombia, the pension providers themselves have taken the initiative to set-up a clearinghouse. Australia has set up a clearinghouse specifically available to small employers (OECD, 2022[9]).
2.2.2. Allow non-guaranteed lifetime income options
Non-guaranteed lifetime income options provide longevity protection to retirees while limiting the risk exposure to providers, which could help to promote the availability of lifetime income options for pensioners. These types of products pool the longevity risk of participants and provide regular income payments, but unlike regular lifetime annuities, the level of the income is adjusted up or down depending on the actual investment and longevity experience of the plan. As such, it is the participants of the plan who collectively bear the investment and systemic longevity risks, while still being protected from the idiosyncratic longevity risk of living longer than the average life expectancy. In addition, as payments are not guaranteed, banks and asset managers could offer such products, not only life insurance companies (OECD, 2022[10]).
2.2.3. Consider establishing a public annuity provider
Public annuity providers provide lifetime income payments for publicly provided pension plans, or to ensure the supply of lifetime income products when the private sector is unwilling to do so at a competitive price. Several countries with asset-backed mandatory or quasi-mandatory pension schemes, such as Denmark, Lithuania and Sweden rely on publicly established institutions to provide the lifetime income payments to members in retirement. Other countries, such as Croatia and Singapore, have public annuity providers that operate alongside private providers to promote competition in the market, thereby ensuring the availability of cost-efficient products.
Public annuity providers should have robust regulatory and risk management frameworks in place to manage risk exposures and ensure that they will have sufficient capital to make the lifetime payments to their members. If such requirements are not in place, the government will effectively act as the backstop of the provider in case of any solvency problems, which would unfairly shift the cost and risk of providing lifetime income products to the taxpayers. Strong governance frameworks should include internal controls to ensure the entity is complying with regulatory requirements and that the risk management framework is effective.
In Indonesia, the BPJS could provide lifetime income payments for members of the JHT scheme, thereby managing a coherent lifetime pension scheme for both the accumulation and decumulation of retirement savings. For voluntary occupational DC plans, the BPJS could provide lifetime annuities, or alternatively a separate and independent institution could be established to carry out this mandate. Regardless, the governance structure in place would need to ensure the independence of decision making and operations to avoid any potential conflicts of interest with government priorities.
Indonesia faces a huge challenge relating to the coverage of pension schemes, primarily relating to a lack of participation. There is a large percentage of non-compliance even when participation is mandatory, and voluntary participation in the publicly provided JHT scheme is low. In addition, voluntary pension plans cover only a small percentage of the workforce. Nevertheless, there is likely to be some additional capacity to save for average earning workers, though saving more may be more challenging for those with lower incomes.
Policy options to encourage higher rates of participation and uptake of plans include better enforcement of mandatory participation through the tax authority and providing matching contributions to participants.
2.3.1. Enforce mandates through the tax authority
To combat the low level of compliance with mandatory contributions to pension schemes, Indonesia could rely on the tax authority to enforce those mandates. Several countries have relied on this approach to ensure that workers contribute the required amounts to the funded pension schemes. In Iceland and Israel, the tax authority checks that workers have made their required contributions when individuals submit their income declarations and follows up with the workers who fail to comply. Other countries take specific measures to enforce mandatory contributions for the self-employed, which can be harder to impose. For example, in Chile, tax is withheld each year from the self-employed to fulfil their contribution obligations for the following year.
2.3.2. Provide matching contributions
Many jurisdictions use government-provided matching contributions to promote retirement savings and to help low-income people in particular to build up retirement savings even though they may have a lower capacity to save. Matching contributions are additional contributions that the government or employer makes for every contribution the individual makes, often calculated as a proportion of the individual’s contribution and normally subject to a maximum amount. Matching contributions can also specifically target lower income groups. For example, the Australian government provides a matching contribution for voluntary contributions made by those having an income below a certain threshold. In Chile, the government provides matching contributions for younger employees between the ages of 18 and 25 who make less than 150% of the minimum wage for their first 24 months of contributions, to increase savings for those who are most likely to benefit it. In Colombia, the government provides a matching contribution at the point of retirement rather than at the time of contributing to increase the amount of savings members have available at retirement (OECD, 2024[8]).
While some improvements have been made, the existing rules and limits relating to investment tend to lead to investment strategies that are overly conservative and lack diversification. Legislation passed in 2023 addressed one of these problems for the BPJS plans by allowing them to sell their assets at a loss, thereby eliminating the ‘cut loss’ problem. However, the positive effects of this measure may take some time to materialise as asset managers adjust their investment approach. Authorities also made it mandatory for voluntary defined contribution plans to offer a lifecycle investment strategy. However, lifecycle funds are only mandatory as an option for employee contributions, and all investments are still subject to a minimum investment in government bonds of 30%. Additionally, pension funds are prevented from investing abroad, and local opportunities for long-term investment and other vehicles or instruments appropriate for retirement remain limited.
In addition, plan sponsors and investment managers lack incentives to implement investment strategies that are more appropriate for the goal of financing retirement. The BPJS is not required to report their investment performance, which impedes the measurement and assessment of their investment approach. For voluntary pensions, occupational plans are primarily used to fund employers’ severance liabilities, creating an incentive to minimise the risk of loss of capital to ensure they can pay the severance liabilities when they are due rather than to maximise long-term investment returns. The authorities have taken some measures to address this issue. Recent legislation reduced the severance benefits that employees are entitled to, and will require that employers send contributions to fund the liabilities for lower-income employees to the JHT scheme. However, employers will still be able to use occupational pension funds to finance their liability to employees earning over the threshold.
Finally, there is a lack of investment knowledge in the governance and oversight of pension funds which further limits their ability to implement and oversee appropriate strategies. For the BPJS and voluntary plans, not all members of the governing bodies are required to have any technical knowledge of pensions.
Policy options to promote diversified investment strategies that are appropriate for the goal of financing retirement include removing minimum requirements to invest in government bonds, relaxing restrictions around foreign investment, making lifecycle investment funds the default strategies, developing performance benchmarks and metrics, removing the possibility to finance severance benefits through pension funds, and strengthening the investment expertise of the governing bodies.
2.4.1. Remove the minimum requirement for voluntary pension plans to invest in government bonds
The OECD’s Core Principles of Private Pension Regulation recommend against having minimum investment limits in place for any given category of investment, and more generally any limit that could impede adequate diversification (OECD, 2016[11]). Having a minimum required investment of 30% in Indonesian government bonds presents significant concentration risk, which could threaten the solvency of pension funds in the case of default. In addition, having a minimum limit in government bonds can prevent investment managers from investing in higher levels of equity, even when such a strategy could be in the best interests of members investing over a long-term horizon for their retirement.
2.4.2. Gradually relax restrictions around foreign investment
The restriction on investing abroad imposes significant limitations on pension funds to implement a well-diversified investment strategy. In the OECD, investments abroad make up a significant portion of pension funds’ investment. In 2023, OECD countries had on average 46% of pension assets invested abroad (OECD, 2024[12]).3 In jurisdictions where restrictions on foreign investment have been relaxed, pension funds have often followed suit by increasing their investments abroad, demonstrating an appetite for international diversification. This is evident in Peru, where the foreign investment by pension funds has increased along with the regular increase in the foreign investment limits since the early 2000s (Figure 2.4). Similarly, in Chile restrictions on foreign investment were gradually relaxed from 2006 to 2013, with foreign investment by pension funds correspondingly increasing from 32% to 42% over that period. South Africa has also gradually increased the allowed foreign investment since 2006, driving the increase in pension fund investment abroad from 4% in 2006 to 20% in 2019. Indirect restrictions on foreign investment can also impede diversified investment. For example, limits on foreign currency exposures and derivative investment in Croatia have presented an obstacle for pension funds to invest abroad. However, following the adoption of the Euro at the beginning of 2023, it became easier for them to invest elsewhere in Europe, and foreign investment by pension funds increased from 21.6% in 2022 to 27.6% in 2023 (OECD, 2024[13]).
Source: OECD, (2019[14]), OECD Reviews of Pension Systems, https://www.oecd.org/en/publications/oecd-reviews-of-pension-systems-peru_e80b4071-en.html.
2.4.3. Expand the use of lifecycle investment strategies for DC plans to increase investment risk exposure at younger ages
While voluntary pension plans must offer lifecycle investment strategies as an option for employee contributions, this is not the default strategy and employer contributions do not follow this approach.
The OECD Recommendation for the Good Design of Defined Contribution Pension Plans highlights that lifecycle investment strategies that take on more investment risk at younger ages and gradually reduce the risk exposure as individuals approach retirement can be appropriate default strategies for pension fund investment (OECD, 2022[7]). These strategies allow for the possibility for members to earn higher returns early in their working life when they still have the time to recover from negative shocks to the market, while mitigating the risk that they will experience large shocks just before retirement that could be significantly detrimental to the amount of retirement income they would be able to finance.
Conservative investment strategies can be extremely detrimental to retirement savers, as they will lose out on the potential upside of investing in higher growth assets over the long term. Reforms to the default investment strategy in the Slovak Republic illustrate the magnitude of such choices. In 2013, the government transferred around 90% of pension savers to pension funds investing in fixed income. As a result, the level of investment earnings savers missed out on is estimated to be between 2 and 8 billion euros (Ódor and Povala, 2020[15]). Savers investing in an equity index would have accumulated more than twice the amount of assets by 2023, and even those investing in a slightly higher level of risk of a mixed equity and bond fund would have accumulated over 20% more.
OECD calculations illustrate the benefits of investing in more diversified investment strategies, including lifecycle strategies, compared to solely investing in domestic fixed income. The coloured bars in Figure 2.5 show the total additional accumulated asset with a diversified equity portfolio, a diversified 60/40 portfolio in bonds/equities, a life-cycle investment strategy reducing the equity exposure 10 years before retirement, and the life-cycle investment strategy reducing the equity exposure 20 years before retirement, compared to a domestic fixed income portfolio. In all cases, the vast majority of cohorts across all countries shown would have been significantly better off investing in a strategy other than domestic fixed income (OECD, 2024[8]).
Note: FI means fixed income.
Source: OECD (2024[8]), OECD Pensions Outlook 2024: Improving Asset-backed Pensions for Better Retirement Outcomes and More Resilient Pension Systems, https://www.oecd.org/en/publications/oecd-pensions-outlook-2024_51510909-en.html.
Lifecycle investment strategies could be the default investment strategy for individuals contributing to voluntary pension plans. They could also potentially be implemented for participants in the BPJS-JHT.
2.4.4. Develop performance benchmarks and metrics appropriate for a long-term investment horizon
Performance measurement and assessment should improve across the entire pension system in Indonesia to better align the metrics and benchmarks with the investment horizon and objective of the pension funds. The BPJS does not currently report accurate investment return calculations by which performance can be assessed. Voluntary pension funds report annualised investment returns, however benchmarks to compare the investment performance of funds do not seem to be used.
The measurement and assessment of the investment performance of pension funds needs to be consistent with their long-term investment horizon and objective to finance retirement. The OECD Core Principles of Private Pension Regulation further specify that that performance benchmarks need to reflect the risk level of the strategy and be clear and objective (OECD, 2016[11]).
Ideally, the measure of investment performance of pension funds should consider a period longer than one year to dampen the volatility and provide a more accurate picture of long-term returns. When reporting and comparing the investment returns of pension plans, the OECD’s Pension Markets In Focus reports not only the returns over the last year, but also the average returns over the last 5, 10, 15, and 20 years where data is available (OECD, 2023[16]).
Performance benchmarks used to assess the investment performance of pension funds should also be reflective of the asset allocation and strategy chosen. Such benchmarks can be constructed based on a weighted average of benchmark returns for different asset classes, typically referencing passive indices. Performance can also be compared to the benchmark for different time horizons to help identify whether the selected investment strategy is underperforming compared to the market average. In Australia, for example, the regulator has developed a heatmap that assesses the investment performance of pension funds over three-, five- and eight-year horizons using multiple benchmarking methods in order to provide different perspectives regarding their investment performance. One benchmark is a simple reference portfolio of passive, low-cost and liquid investments in order to assess the added value of the investment strategy selected by the pension funds. Another benchmark reflects the fund’s strategic asset allocation to assess their implementation of the investment strategy (APRA, 2022[17]).
2.4.5. Eliminate the possibility to finance severance benefits with occupational pension funds
The use of occupational pension funds to finance the severance liabilities of employers presents a conflict of interest with the objective that pension funds should have to finance the retirement benefits of employees. Rather than striving to achieve long-term investment returns in line with the objective to finance retirement, the objective of the fund becomes to preserve capital to be paid out when an employee leaves the organisation. This has resulted in investment portfolios weighted towards cash and deposits.
The severance benefit programme is distinct from the voluntary occupational pension programme, and the two programmes should not be combined into the same financing vehicle. Any pre-funded severance liability programme should be established as a fund separate from the occupational pension plan.
2.4.6. Increase requirements around investment expertise in the governance framework
The governing bodies of pension funds do not necessarily have the investment expertise needed to inform strategic investment decisions or supervise the implementation of the investment policy. The only member of the governing body of the BPJS required to have pensions expertise is the independent expert. For voluntary pension funds, only the management board is required to have technical knowledge, while there are no requirements for the supervisory board to have technical knowledge of pensions or investment.
There are three main approaches to increase the investment expertise in the governance framework. The first is to increase the knowledge requirements for the members of the governing body. The second is to impose educational requirements for the members of the governing body to provide them the opportunity to increase and maintain their knowledge. The third is to establish expert committees to advise the governing body on the decisions they need to make.
Governing body members are often held to minimum standards with respect to qualifications or expertise. Such requirements can refer generally to professional or management experience or require more specific knowledge of certain topics such as investment. Occasionally, as is the case in Australia and Estonia, regulators require that the governing body members formally demonstrate their technical capabilities before being allowed to become a member of a board.
Another option is to impose educational requirements on board members to ensure that they have the opportunity to acquire any knowledge they may be lacking. Ireland, for example, requires that trustees receive training within the first six months of their appointment, and continue to receive regular training at least every two years after that. In the Netherlands, members of governing bodies are required to take regular courses on the investment and governance of pensions to make sure they maintain the relevant knowledge. Several jurisdictions are also making efforts to increase the accessibility of training. For example, the regulator in the United Kingdom offers e-learning courses for trustees to follow online.
Another approach to address a lack of expertise is to establish expert committees to advise the governing body. Investment is a common focus of such committees. The committees are normally made up of at least one member of the governing body along with the experts, and are occasionally mandated, as is the case in Israel. Such committees could be particularly useful to establish for the Board of the BPJS. The supervisory board of voluntary pension funds can already have advisory committees on certain topics, one of which is risk monitoring. This committee could include a focus on investment risk, and the requirement to establish such a committee could be expanded to smaller funds.
Measures should be taken to ensure the sustainability of both the BPJS-JP DB scheme and the DPPK DB schemes in the long term. Contributions to the BPJS-JP scheme are not adequate to provide the promised benefits in the long-term. DPPK DB pension schemes are allowed too much flexibility in how they value their liabilities and funding levels, which impedes a proper assessment of their solvency risk and puts members at an increased risk of losing their benefits.
Several measures could be considered to strengthen the sustainability of defined benefit pension funds. The parameters of these plans need to adapt to ensure that the contributions made to the schemes are sufficient to finance the promised benefits. To further protect members from the risk of insolvency of voluntary occupational DB plans, authorities could consider introducing a pension guarantee fund, though this would need to account for the potential downsides of doing so.
2.5.1. Increase contributions to the BPJS-JP DB scheme to ensure sustainability
Contributions to the BPJS-JP scheme are currently 3% of salary, which is largely insufficient to finance the annual accrued benefit of 1% of salary. Without increases in the contributions or downward adjustments to benefits, the scheme will rapidly become a PAYG scheme with benefits financed by the contributions of current workers rather than by the invested contributions made by the members over their lifetime. While Indonesia is currently a relatively young country with an old-age dependency ratio of around 10%, this ratio has been following a regular upward trend since the 1950s.4 This ratio can only be expected to increase further with decreasing fertility and increasing life expectancy. Fertility rates in Indonesia are currently around replacement, with 2.17 births per women in 2021, down from over 5 births per women in the 1960s (Roser, 2024[18]). As with other countries experiencing rapidly increasing old-age dependency ratios, PAYG pension schemes eventually will come under financing pressure, particularly if contributions are not representative of the cost of financing benefits, and future generations of workers will unfairly be forced to bear the consequences. Indeed, the productive share of the population is projected to decline after 2030 (OECD, 2024[19]). The BPJS-JP scheme is still young, and Indonesia still has the opportunity to ensure its long-term financial sustainability by setting contributions at a level that is actuarially fair, which will also promote intergenerational equity for the participants of the plan.
2.5.2. Strengthen requirements around the assumptions used to value liabilities and calculate funding for voluntary occupational DB plans
The valuation of liabilities and calculation of funding positions of defined benefit plans need to reflect the actual financial obligations that the plans will have to pay to their members to ensure sufficient contributions to the plan and protect their long-term solvency. Currently, there are no requirements around the discount rate and mortality rate assumptions used to value pension liabilities. Actuaries can set the discount rates used to value DPPK DB plans at a level above the expected investment return on assets, implying that the calculated funding ratios would then overestimate the funding position of the plans. In addition, funding ratios can reflect the contributions receivable that have not been paid into the plan, adding to the uncertainty that assets will be sufficient to finance future liabilities. Plans are given the flexibility to choose their preferred valuation methodology, increasing the lack of comparability of funding positions across plans.
Regulatory requirements should establish the basic requirements for the assumptions and methodology used for the valuation of pension liabilities to ensure their adequacy and a certain level of comparability across schemes. It is common for there to be legislative requirements around such calculations (Ellis, Kivisaari and Stańko, 2015[20]). Requirements usually establish a minimum standard for the assumptions and calculations related to plan funding.
The assumptions and methodology appropriate to calculate liabilities and funding ratios should link to the objective of the calculation. If the objective is to assess the current level of funding of the plan, valuation using the risk-free rate under the solvency termination methodology is the most transparent and comparable assumption to use, and allows a clear picture of whether the current assets are sufficient to finance the future expected benefit obligations (OECD, 2020[21]). Nevertheless, valuation based on a going concern perspective using a discount rate based on the expected return of assets may be more useful for strategic decision making relating to issues such as the investment strategy and the contribution rates. Having multiple calculations provides a more complete perspective of the funding situation of the plan. Canada, for example, requires DB pension funds to assess their funding levels using different methodologies to have different views on the funding status of each plan (OECD, 2020[21]).
There should be a requirement for the mortality assumptions to reflect realistic expectations. The current level of mortality should be reflective of the mortality experience of the plan members, and assumptions should account for future expected improvement. Jurisdictions take varied approaches to establishing the requirements around mortality assumptions. Some jurisdictions, such as Chile, require providers to use the mortality tables prescribed by the regulators. Others, such as Denmark, require that providers justify any deviation of assumptions from the table developed by the supervisor. Canada requires that providers use the tables developed by the actuarial association, while in the United Kingdom those tables are recommended but not required (Mosher, 2023[22]). Regardless, pension funds should be able to demonstrate the appropriateness of the mortality assumptions to justify the appropriateness of their use.
2.5.3. Prioritise ensuring adequate funding levels of occupational DB plans before considering the introduction of a pension protection fund
Members of voluntary occupational DB plans have little protection in the case of insolvency of the plan sponsor. The risk of default is increased by the lack of investment diversification and the overstatement of funding ratios. One option the Indonesian authorities have discussed to increase the protection of members’ benefits from DB plans would be to introduce a pension protection fund. Nevertheless, such a measure could lead to negative unintended consequences.
Pension protection funds guarantee the payment of at least a portion of the pension benefits promised by DB plans. These funds effectively act as an insurance for plan members against the insolvency of the plan sponsor. The funds can either take over the management and responsibility of the plan, insure the plan via the purchase of an external annuity, or inject funds to make up any deficit. The first two options are the interventions that protection funds most commonly rely upon.
Normally, plan sponsors must pay a premium to the fund for the insurance offered. Insurance premiums should reflect the underlying probability that the insurance will be triggered, which is driven by the underlying risks. There are three key risks that drive the probability that the protection fund will be triggered. The first is sponsor strength. If the sponsor is in a weak financial position, they are more likely to face insolvency. The second is the underfunding of the plan. The larger the plan deficit, the more likely the sponsor will default on its obligations to the plan. The third is the investment strategy taken. The riskier the investment strategy, the more likely it is that the plan will face large losses that it may not be able to recover from in time to meet its payment obligations. Nevertheless, premiums do not often fully reflect the underlying risk that the fund will be triggered, which creates a disconnect between the finances available to the protection fund and its potential liability, increasing the risk that it will not be able to fulfil its role as a guarantor of benefits.
Table 2.1 summarises some examples of pension protection funds that exist in the OECD. It includes the intervention they take in the case that the fund is triggered, as well as the basis for the premium. Most premiums are higher for underfunded plans, but only one fund also accounts for sponsor strength and no fund also accounts for the investment strategy the plan employs.
Source: Broeders and Chen (2013[23]), Pension Benefit Security: A Comparison of Solvency Requirements, a Pension Guarantee Fund, and Sponsor Support https://www.jstor.org/stable/24548150.
The challenge with enforcing risk-based premiums for protection funds is that sponsors having a higher risk of defaulting on their pension obligations are also the least likely to be able to afford higher premiums. Requiring higher premiums could in turn increase their risk of default, which could also present higher systemic risk for the protection fund as sponsor defaults tend to be pro-cyclical, being more likely in difficult markets. In addition, risk-based premiums would increase the cost of the protection fund for most firms, rendering it unaffordable and acting as a disincentive from offering a pension plan at all.
Given the current trend to close voluntary DB occupational plans, the introduction of a pension protection fund requiring additional premiums from sponsors would likely accelerate these trends. As such, the introduction of risk-based premiums would therefore be even more difficult, and the government would likely have to act as the backstop of such fund if it was unable to cover the defaulted obligations of sponsors.
Therefore, the initial focus to improve the protection of benefits of members of occupational DB plans should be to shore up the funding of these plans. Once the market is more stable, authorities could consider whether the introduction of a protection fund would be feasible and beneficial overall.
A key priority of the government is to further harmonise the pension system to ensure the complementarity of the different components. The institutional framework for the management of social benefits has been streamlined into two institutions managing employment and health-related benefits. Other measures have aimed to improve the efficiency of voluntary pension plans and facilitating members’ transition to retirement. Retirement ages are now also standardised across voluntary pension funds to promote the use of benefits from the plans to finance retirement. Nevertheless, there is no clear objective regarding the severance pay system, which is not benefiting those that it should. The BPJS-JHT fails in its objective to improve financial security in retirement because assets are largely withdrawn well before retirement. A new measure to increase mandatory savings for higher-income workers aims to improve replacement rates in retirement, but will concern only a minority of workers and is not targeted at those who are at higher risk of inadequate benefits.
Policy measures should ensure that each component of the system has a clear objective that it aims to fulfil within the overall objective of the pension system, and that the design of each component is conducive to achieving that goal.
2.6.1. Replace the severance pay system with increased employer contributions to the BPJS-JHT
The severance pay system lacks a clear objective, and it is not designed in a way that actually benefits those it intends to help. While the programme pays benefits at retirement, it is not designed to complement the other pension programmes in a targeted manner. Even though it is mandatory, employer compliance is low and only employees of the largest companies actually benefit. Additionally, the benefits paid only reflect the length of employment at the last employer, and not the employee’s full career. Those who receive benefits are therefore often not those who are most in need of them, and there is little relationship between the benefits that the individual will receive in their retirement and their employment over their lifetime.
Retirement benefits linked to employment should reflect the entire career of the individual. The proposal of the authorities to require funding of severance liabilities in the JHT scheme could improve this link, so long as the contributions are made to an account that the individual is able to keep when they change jobs. However, this design lacks any distinction from requiring employer contributions to the BPJS-JHT scheme and eliminating the severance plans.
An alternative would simply be to replace the severance programme with increased employer contributions to the BPJS-JHT scheme. In addition to retirement benefits, as currently designed the JHT also pays benefits if the member dies or has a disability, so the provision of these benefits from the severance scheme could also be replaced by the JHT scheme.
2.6.2. Forbid early withdrawals form the BPJS-JHT scheme except for exceptional individual circumstances
The OECD Recommendation for the Good Design of Defined Contribution Pension Plans recommends that “any early access to retirement savings should be a measure of last resort and based on individuals’ specific hardship circumstances” (OECD, 2022[7]). Currently, savings in the BPJS-JHT scheme are very easy to withdraw, as savers can withdraw all their savings when they change jobs if they have contributed at least five years. The government tried to introduce a law limiting withdrawals to 10% of savings contingent on having contributed at least ten years, but following protests the law was never passed.
The ability for individuals to fully withdraw their savings from the JHT scheme undermines its purpose to complement the BPJS-JP scheme in improving the adequacy of financing for retirement. Rather than serving to improve financial outcomes in retirement, it is being used for everyday purposes when changing jobs. In recognition of these two distinct uses and objectives, the government is considering splitting the JHT accounts into one that can be used in case of exceptional needs, such as unemployment or health issues, and one that must be reserved for retirement.
The limited use of retirement savings to aid individuals in exceptional individual circumstances is in line with the OECD Recommendation, and it may not be necessary to add complexity by splitting the account into two as long as the conditions to withdraw from the account remain limited to individual circumstances that may lead to hardship. Additionally, limiting the amount that can be withdrawn rather than allowing withdrawals of the whole account could ensure that at least a portion of the savings will go towards its intended purpose. Limiting early withdrawals from the JHT would also remove this impediment for the pension funds to implement investment strategies more focused on the long term.
2.6.3. Clarify the objective of the new mandatory pension programme and ensure the alignment of its design with that objective
Law 4/2023 introduced a new mandatory pension programme for those earning more than IDR 10 million as part of the government’s efforts to meet its overarching objective to achieve replacement rates of 40% by 2033. Nevertheless, this programme will only impact the retirement savings of around 5% of the working population.
The objective of this additional programme is not clear, particularly as it is more likely to impact the population that would already have access to an occupational pension plan, or in other words those who are better off and working in medium to large size companies. These groups already have the highest expected replacement rates, so they are less likely to be at risk of having insufficient financial resources in retirement.
Having additional mandatory pension contributions for higher earners, particularly when those contributions are intended to finance individual retirement savings and not part of a scheme involving some redistribution across income levels, can be useful if they have lower replacement rates. One example of a country who takes this approach with asset-backed pensions is in Sweden, where high earners are required to make higher contributions to the quasi-mandatory occupational pension plans. However, the public pension benefits in Sweden are rather progressive, meaning that low-income workers receive higher replacement rates. The rationale for higher contributions for high earners to the occupational pension plans is therefore to avoid that high-income earners have much lower replacement rates than low-income earners.
The objective to equalise replacement rates across income groups is not a clearly stated objective of this new pension programme, although the benefits from the mandatory schemes in Indonesia are also somewhat progressive due to the benefit cap imposed. However, many low-income workers are excluded from the BPJS-JP scheme, so additional contributions for the highest earners could be expected to exacerbate financial inequalities in retirement.
Another consideration for implementing a mandatory pension programme based on a salary threshold are the incentives for employers or employees to be above or below that threshold. For example, employees earning around the threshold may prefer to negotiate a lower salary for other additional benefits to avoid the extra contribution. If employers are expected to contribute, they may try to avoid offering salaries above the threshold, reducing overall pay to employees.
Ensure that the rules of the pension system allow individuals to accumulate adequate retirement savings
Align contribution limits across different types of workers. Employees of small and micro enterprises and informal workers have lower contribution ceilings for the publicly managed pension schemes than employees of medium and large enterprises.
Harmonise the mandatory pension schemes for public and private sector workers. While the design of the schemes is similar, with a base defined benefit plan and an additional defined contribution component, the benefit accrual and contribution levels differ and public sector workers benefit from higher expected replacement rates.
Reformulate the cap on benefits from the BPJS-JP scheme. The current cap may result in declining replacement rates from the scheme over time which could eventually result in workers having to continue contributing to the scheme without accruing additional benefits.
Align the retirement ages for publicly provided pension schemes. The retirement age for the mandatory defined contribution plan for private sector workers is 56 while the retirement age for the mandatory defined benefit plan is gradually increasing to 65. Most workers therefore retire at age 56.
Align the payout options from the mandatory defined contribution schemes with the objective to finance retirement. Savings can currently only be taken as a lump sum and not as an income in retirement.
Make taxation neutral between lump sums and annuities. Lump sums are currently taxed more favourably than options providing an income.
Promote availability of options to accumulate retirement savings and provide retirement income available
Take additional measures to reduce the costs of opening and administering a plan to encourage employers to offer them. There is currently a trend to close occupational pension plans despite existing measures to improve their attractiveness to employers.
Allow non-guaranteed lifetime income options for payout. This could help to overcome the lack of availability of lifetime income solutions by reducing the risk exposure to providers.
Consider a public annuity provider. This can be a solution to ensure the supply of lifetime income products where private provision is lacking.
Improve the uptake and use of retirement savings schemes needs
The tax authority could play a role in enforcing compliance with contributing to mandatory schemes. Currently only 38% of formal workers participate in a mandatory retirement savings scheme.
Promote matching contributions to encourage participation. These can help low-income people in particular to build up retirement savings even though they may have a lower capacity to save.
Encourage diversified investment strategies that are appropriate for the goal of financing retirement
Remove the minimum requirement for voluntary pension plans to invest in government bonds. The plans must currently invest at least 30% of their assets in Indonesian government bonds.
Gradually relax restrictions around foreign investment. Pension funds are not currently able to invest abroad, limiting their investment opportunities.
Expand the use of default lifecycle investment strategies for defined contribution plans to increase investment risk exposure at younger ages. While pension funds must offer these strategies as an option for contributions from employees, this is not the default option and they are not in use for employer or mandatory contributions.
Develop performance benchmarks and metrics appropriate for a long-term investment horizon. The BPJS does not currently report accurate investment return calculations by which performance can be assessed, and voluntary pension funds lack benchmarks to assess their investment performance.
Eliminate the possibility to finance severance benefits through occupational pension funds. The use of occupational funds to finance the severance liabilities of employers presents a conflict of interest with the objective that pension funds should have to finance the retirement benefits of employees.
Strengthen requirements around investment expertise in the governance framework The governing bodies of pension funds do not necessarily have the investment expertise needed to inform strategic investment decisions or supervise the implementation of the investment policy.
Strengthen the sustainability of defined benefit pension funds
Increase contributions to the BPJS-JP scheme to ensure sustainability. Without increases in the contributions or downward adjustments to benefits, the scheme will rapidly become a PAYG scheme with benefits financed by the contributions of current workers rather than by the invested contributions made by the members over their lifetime.
Strengthen requirements around the assumptions used to value liabilities and calculate funding for voluntary occupational defined benefit plans. Currently, there are no requirements around the discount rate and mortality rate assumptions used to value pension liabilities.
Prioritise ensuring adequate funding levels of occupational defined benefit plans before considering the introduction of a pension protection fund. The introduction of a protection fund to guarantee occupational pension promises in the case of sponsor default would require additional premiums from sponsors and would likely accelerate trends to close occupational plans. The initial focus to improve the protection of benefits of members of occupational defined benefit plans should therefore be to shore up their funding.
Align schemes’ design with clear objectives that aim to ensure complementarity of the different components of the system
Increase employer contributions to the mandatory defined contribution scheme for private sector workers to replace the severance pay system. The severance pay system lacks a clear objective, and it is not designed in a way that actually benefits those it intends to help.
Allow early withdrawals from the mandatory defined contribution scheme for private sector workers only for exceptional individual circumstances. The ability for individuals to fully withdraw their savings from the scheme is not in line with the objective to finance retirement and undermines its purpose to complement the defined benefit scheme in improving the adequacy retirement benefits.
Clarify the objective of the new mandatory pension programme that increases contributions for higher-income employees to ensure the alignment of its design with that objective. The programme is more likely to impact the population that would have access to an occupational pension plan and that already have higher expected replacement rates for retirement.
References
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← 1. Czechia, Finland, Ireland, Israel, Korea, Luxembourg, Norway, Poland.
← 2. Austria, Canada, Greece, Israel, Italy, Japan, Luxembourg, New Zealand, Portugal, Spain, Türkiye.
← 3. Simple average across selected countries where data is available, not weighted by assets invested.
← 4. This means there are 10 individuals over age 64 for every 100 working age people between the ages of 15 and 64.