India has lessons for UK in PSU pension reforms

The UK can actually learn some lessons from India, at least in one area of financial sector reforms ?the politically sensitive area of pension reforms for govern-ment employees.

Despite heavy political odds, the Indian government has been successful in laying down a system which entails shifting from defined benefits (DB) to a defined contribution (DC) system.

In the former, an employee received a fixed amount (50% of his last drawn salary) as pension after retirement while in the latter, accumulated assets created by contributions of both the employee and the employer are invested over a period of time by the professional fund managers to generate pensions. This is applicable to new civil servants joining after 2004.

Pension expenses in DB schemes are totally funded and create huge budget deficit for the government. But DC schemes are unfunded and beyond certain contribution government has no financial liability on account of pension of its employees.

However, the UK, which otherwise has the most advanced financial system in the world, still follows DB schemes for paying the pension of its employees. ?The entire pension liability for UK government employees is straightway funded from the Budget, thereby burdening the entire public finance and tax payers,? said a top professional of the UK financial market. Though the UK government understood comforts of the DC scheme, it did not have the will power to initiate the process, he added.

Private sector financial market players from the UK, in a meeting with a visiting Indian delegation had appreciated India?s bold moves to shift to DC scheme, which would save a lot of tax-payers? money. The Indian delegation comprised senior officials of the Insurance Regulatory & Development Authority (Irda), Pension Funds Regulatory & Development Authority (PFRDA), Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC).

However, the private sector pension industry in the UK is thriving and is the second largest after the US with assets managed on behalf of domestic clients totaling over $1541 billion at end of 2005.

The sizeable asset base arises from substantial funding of pensions and significant voluntary provisions. Underpinned by the rise in equity markets, returns generated by UK pension funds have picked up in the past four years averaging 14% in 2003, 8% in 2004, 17% in 2005 and estimated 7% in 2006.