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Business News/ Opinion / Online-views/  Pension lessons from the West

Pension lessons from the West

We took a big leap forward by designing NPS

Shyamal Banerjee/MintPremium
Shyamal Banerjee/Mint

Trieste, a calm and quaint port city in Italy, houses nearly as many pensioners as workers. Architecture aside, the fast-growing population of pensioners makes this city an apt microcosm of the country and of the developed world at large.

Fittingly, this city was host to the 28th conference of young leaders organized by the Council for the United States and Italy to discuss the new demographics. Fifty young leaders, this reporter included, from different countries, majority from the US and Italy, and from different walks of life wrapped their heads around the challenges that a greying population poses to the developed world and how the relative younger population of the developing world could help.

An ageing population not only adds to the financial burden of the government as dependency increases, but also threatens the social fabric of a nation. For instance in the US, a fellow young leader and a sociologist pointed out, that the “non-white" will overtake the “white" population in the coming decades. This is driving many policy decisions, painful immigration laws being an example. It wasn’t surprising then, where discussions around relaxing immigration laws took place, small meaningful steps such as making women-friendly workplaces were discussed with equal enthusiasm.

But this column will stay with one aspect of the changing demographics: The impact of greying population on the pension system across the world. Most developed nations that offer defined benefits to their retired population are forced to evaluate their methods. A defined benefit pension system, in which the government pays an assured pension depending upon the number of working years and last drawn salary of the pensioner, ironically, takes away from the working population in the form of taxes and other contributions to pay its retired population.

So this system, which usually does not ride on the back of assets but is funded through taxes, is no longer sustainable for many developed countries with shrinking working population and growing ageing population. Italy is a good example of this. Italy’s pension benefit has been one of the most generous benefits in the world. In a 2012 report by The Geneva Association, an international insurance think tank, a table sourced from OECD indicates that in 2009 the pensioners in Italy could potentially enjoy up to 90% of their final salaries as pension. Of this, about 78% was funded through a defined benefit scheme.

The report further states that about 70% of the retired population depends on the government for pension security which costs about 15% of the country’s gross domestic product. So one of the key reforms, to save Italy from a financial meltdown, enacted by the technocratic government of Mario Monti was to write off this cost. It changed its pension system from defined benefit to defined contribution and increased the retirement age. A defined contribution calculates pension based on the amount you contribute and returns the fund earns. Since this government was brought in to save the country that was on the brink of a financial collapse it didn’t have to depend upon the vote bank and could afford to risk such radical reforms.

For Italians who have enjoyed not only a generous pension regime but also cushioned jobs this will take some time getting used to. But the harsh reality for many nations that throw in generous pension benefits is they will have to cut back on such excesses and invest more in the working population. The US has a thriving private pension system that’s based on defined contribution. Japan has also reduced its pension benefits. But it’s not easy for developed nations that are also greying to snap fingers and usher in reforms. A large percentage of the greying population means a larger dependency on the government for pension benefits.

Richard Jackson, senior fellow, Center for Strategic and International Studies summarizes brilliantly in the report the most pressing problem for many governments. “The challenge for most developed countries is how to reduce the rising burden that existing retirement systems threaten to place on the young without at the same time undermining the security they now provide to the old."

Compared with the developed and ageing economies, developing and younger economies such as India have a visible advantage: not only do the pensioners comprise a small percentage, single digit in case of India, pension as a concept eludes a large chunk of the population. To the government the advantages are twofold: not only can it learn from the experience of developed economies but also write the rules fearlessly and condition the masses.

India started off on the right track. In 2000, Old Age Security and Income Security project report pitched for a National Pension System (NPS) based on defined contribution for about 87% of the Indian workforce that do not enjoy any form of pension benefits. The government decided to move its employees, who were enjoying defined benefit to the NPS which caused much heartburn and delay. In 2009, NPS saw the light of the day through an executive order. But the PFRDA Bill that will give regulatory teeth to the pension regulator is still stuck. A section of lawmakers is opposed to foreign direct investment and wants guaranteed return.

So far, we have got everything right, we are staring with pension reforms at the right time and are ensuring that pension benefits don’t cause a strain on state finance but we are beginning to dodder. PFRDA Bill is yet to be passed and the pension regulator, who works through an executive order, is bringing in cosmetic changes to increase the penetration of the NPS that will do more harm than good in the long term. We took a big leap forward by designing NPS and the next big stride for us is to create awareness. Having more pension fund managers or allowing them to market NPS will not increase the footprint the way it should. Investing in creating awareness will.

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Published: 24 Oct 2012, 07:39 PM IST
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