Using dynamic column names in PostgreSQL
RETURN QUERY EXECUTE was introduced with Postgres 8.4.
Your version is just too old and unsupported by now. Upgrade to a more recent version.

Also, dynamic column names in the result are very hard to come by. It's a principle of SQL that it wants to know the return type - including the names - up front.

Returning anonymous records without a column definition list only works for a single record. Else you have to provide a column definition list in the call. Details under his question on SO:
Return multiple fields as a record in PostgreSQL with PL/pgSQL

There are limited ways around this with with polymorphic types. Advanced stuff:
Refactor a PL/pgSQL function to return the output of various SELECT queries

BTW, your function would look like this in modern PL/pgSQL:

CREATE OR REPLACE FUNCTION get_policy_name (
  _id        int,
  _lang      text,
  _def_value text
) RETURNS TABLE (col text) AS
$func$
BEGIN
   RETURN QUERY EXECUTE
   format('SELECT COALESCE(%I, col, $1)
           FROM my_table WHERE id = $2'
         , 'col_' || _lang)
   USING _def_value, _id;
END
$func$ LANGUAGE plpgsql;


Call:

SELECT col AS col_fr FROM get_policy_name (1, 'fr', 'foo');


Here, I am simply using a column alias in the call to achieve what you want. Much easier than dynamic column names ...