Pension Reforms in India –The insecurity dimensions.
P. Madhava Rao
Introduction:
It is not known whether the process of liberalization in India encouraged investment wizards from
within the country and from out side to develop the country and generate employment, but has given
the strength and freedom to many to freely comment, lobby and divert the attention of policy makers
from welfare state attitude to individual’s responsibility to sustain himself/ herself in the name of
‘economic efficiency’ and to ‘allow’ the government produce only pure public goods. This ironically
does not consider poverty levels and population growth and employment opportunities in the country,
on the other hand advocates downsizing or ‘right sizing’ to throw the people out of employment, at
the same time telling them that they should save for their future in the name of reforms to Social
Security systems, leaving other non plan expenditure totally ignored or un touched. The committees
like OASIS, Bhattacharya and IRDA etc. set up to suggest strengthening social security systems for
the vulnerable groups, have purposefully exceeded their limits to comment on the sustainability of
Old age and survival benefit schemes currently available in the country and with a simple agenda of
liberating them from state governance and allowing private fund mangers to enjoy the fruit of
managing pension funds. The reports also suffer from many maladies like data insufficiency,
ignorance of economic literacy of the population, poverty levels and wage levels in the informal
economy, volatile financial markets, longevity of pension funds maturity, unstable political economy,
trust that has been built in the publicly managed financial organization, and above all continuity of
financial requirements of retired people. Thus the schemes formulated, advocated and proposed to be
implemented appear to be with full of insecurity dimensions. Although they are said to be Social
Security schemes they predominantly appear neither ‘Social’ nor ‘Secure’. It is in this background
proposed to examine in this paper, the proposed Pension reforms in the country, their scope
limitations and the insecurity dimensions and whether India could opt for such drastic changes in its
current state of poverty and unemployment. The paper also seeks to draw some policy conclusions on
the provision of social security schemes for the targeted population.
The premises:
The story of pension reforms started with commissioning of project OASIS (Old Age Social and
Income Security) during August 1998 by the Ministry of Social Justice and Empowerment,
Government of India, which claimed its stake as a provider of Old- Age security to the population as a
measure of Social Justice. The original mandate and focus of the Project OASIS expert committee
was on the ninety-percent of workers that are not covered by any pension scheme in India, however it
made a ‘paradigm shift’ in advising reforms to civil services pension in India on the premise that the
government finances are under pressure due to an aging civil service grew.1
The work of the
project was given to one Invest India Economic Foundation, Mumbai, a private firm interested in
financial and capital market education in India. The foundation feels that the Ministry of Social
Justice and empowerment realized that the poverty alleviation programs directed at the aged alone
cannot provide a solution to the income and social security problems of our elderly, the problem will
have to be addressed through thrift and self help, where people prepare for old age by savings
accumulating through their decades in the labour force. The role that Government can play in this
enterprise is to create the necessary institutional infrastructure to enable and encourage each citizen to
undertake this task.2
The Schemes:
On the above premises, the expert committee under the Project OASIS suggests an individual
contribution based – non-benefit guaranteed- non return guaranteed – non accumulations guaranteedpension scheme for the unorganised sector, suggested to be managed by private fund managers, where
the contributions of a small amount of Rs.5 to Rs.10 per day per worker flow in to the system. The
worker is expected to contribute continuously from the age of 25 to 60 years at these rates every day
so as to enable him to get the accumulations converted in to an annuity that is expected to give him a
1
2
S.A. Dave, Rethinking pension provisions for India 2003, invest India- Tata McGraw-Hill p.3
Project OASIS report submitted to the Government on January 14 2000
1
monthly pension of Rs.1500. The experts group further proposes to give a choice to a worker to
decide the pattern of the investment. With regards to the paying capacity of a worker in the
unorganised sector, for a scheme designed to alleviate poverty at the old age, the experts take the per
capita income as the base to support Rs.10 per worker a day as contribution as prudent. The expert
group further observes “ we assume a contribution rate of Rs.10 per day from age 25 (Rs.3600 per
year) till age 60, growing at 3 percent per year. Then the terminal wealth proves to range from Rs.0.2
million (100 percent government bonds) to Rs. 0.8 million (significant use of equity index). Hence,
the minimum annuitisation of Rs.200, 000 is reliably attainable under the most conservative
investment strategies as long as Rs. 10 is contributed into the pension account every day from age 25
till age 60; better investment strategies bring down this threshold to Rs.2.50 per day. In the India of
2000 with an approximate average per capita GDP of Rs. 20,000 per person per year (or Rs. 80000
per family of four per year), the universe of potential participants in the pension system, who can
make contributions averaging between Rs.2.50 per day to Rs.10 per day, should be fairly large” 3.
Calculating the contributing capacity of a worker from the unorganized sector based on the per capita
GDP of a nation, and claiming that he would be able to contribute towards an unknown amount of
future benefit to alleviate his poverty is some thing beyond the comprehension of any economist of
the world who has measured and seen the poverty and the wage levels of the informal sector workers
requiring economic support for their old age poverty alleviation.
Having satisfied with the ‘paying capacity’ of an individual for his old-age income security
needs, the committee has come out with an investment package, where again an individual of small
means and who is expected to save less than Rs.10 a day will be given a chance to speculate with his
future by selecting a fund manger and a product of his choice and try his luck. The committee
originally suggested six fund managers to operate in the filed and offer 18 products with three styles. .
(Table-1) However the report does not speak of any explicit or guaranteed benefit or return on the
investments made by the fund manager on the advice of an individual participant.
Table-1
Investment guidelines for three styles
Safe Income
Balanced Income
Government Paper
>50%
>30%
Corporate Bonds
>30%
>30%
Domestic Equity
<10%
<30%
Of which, International Equity <10% <10%
Growth
>25%
>25%
<50%
(Source: Report of Project OASIS, Ministry of Social Justice and Empowerment, 2000)
While investing, of course, the committee suggests that for the first five years, all domestic equity
investments should be implemented using index funds on the NSE-50 or the BSE-100 indices only. In
a plan of old-age income security where benefits are paid after a long gestation, it is not known how
such decisions would help build funds for future payments.
Another committee popularly known as IRDA committee appointed to examine possible Social
Security provisioning for the informal Sector, has come out with its suggestion not on the informal
sector but on the current pension system in India. Professor Ramesh Guta of Indian Institute of
Management Ahmadabad says “According to IRDA, the need for reforms arises from the following
reasons:. Pension: Government and state owned enterprises as employers are finding it difficult to
fund their pensions liabilities and the proposed system will relieve employers from their pension
liabilities. EPFO and employers’ managed funds are return inefficient, service deficient, and not in a
position to meet their liabilities. Private companies, particularly insurance and fund managements, are
waiting in the wings at the prospect of handling investible funds and presumably would offer better
3
Project OASIS report submitted to the Government on January 14 2000
2
old age security to retirees for the contribution they make.” 4 We do not know how far these
observations and suggestion make us think of a pension system for the Unorganised Sector workers,
certainly make one think on the systems in place for the formal sector employees and pressurize the
governments to disturb the current systems, and they did in reality.
The Bhattacharya Committee appointed to look into the pension provisioning for the Government
Employees has suggested:
1. An unfounded defined benefit, pay-as-you-go scheme (PAYG), or a pure defined contribution
scheme is not suitable for government employees; instead a hybrid defined benefit/defined
contribution scheme is recommended (para 10.23). This is a two-tier scheme. In the first tier, there is a
mandatory contribution of 10per cent each by employer and employee. The accumulated funds would
be used to pay pension in annuity form. The second tier is to promote personal savings and there is no
limit for employee’s contribution but employer’s contribution would be matching and limited to 5 per
cent. Accumulated funds can be withdrawn in lump sum or converted into annuity at the time of
retirement. These payments would be tax exempt and portable if an employee changes job before
retirement.
2. Funds collected in the first tier would be deposited in a separate fund and would be invested in both
debt and equity. Some funds can be earmarked for active fund management including for short term
trading for better returns. However, irrespective of fund performance, government would remain
liable for pension to its employees based on predetermined benefit formula. (Para 10.37 and 10.38)
3. Contribution obtained in the second tier will have a separate institutional structure and the
employee would have a choice of funds (income, balanced, and growth) to invest in. Employees may
decide to continue, quit, or swap among funds while in service. Government will not guarantee any
specific rate of return.5
Fortunately this scheme for the informal sector as suggested by OASIS committee has
not been implemented, however the proverbial sword has fallen on the future employees of the
Central Government, Central public Sector undertakings and the like.
Here the Central government has conveniently ignored the observations made by another
committee appointed by it under the Chairmanship of A.M. Sehgl, the then Controller General of
Accounts on 21 October 1999. The committee felt “The WG has included a set of projections of
future pensionary outgoes of the Union Government essentially for the sake of closure of the Report.
It cautions explicitly that the projections are merely an indicative base level and need to be interpreted
with extreme caution in any exercise of fiscal planning.” (Para 10.1 of the Report)
“Projections based on methods that are not actuarial may lead to substantial revisions in estimates of
the government’s pension liabilities if and when the new methods are incorporated.” (Para 10.6 of the
Report)
“Since pensions in the government are a deferred wage component, it has been suggested that the
gravity of the burden of compensation to labour can be better judged by considering the wage and
pension burdens together, as a whole”.(Para 10.3 of the Report)
The Government has ultimately come out with a defined contribution pension system for the
employees joining Government on or after 1st January 2004.
The salient features of the scheme are:
4
Pension reforms in India: Myth, Reality and Policy Choices, Indian Institute of Management, Ahmadabad,
2003
5
Pension reforms in India: Myth, Reality and Policy Choices, Indian Institute of Management, Ahmadabad,
2003
3
a) The system is expected to lessen the burden on the Government from year to year and
envisages a shift from the current unfounded defined benefit pension to a fully funded defined
contribution system, where the pensionary liability of the government can be estimated every
year;
b) The persons joining Government service on or after 1st January 2004 are no longer entitled to
receive a defined pension as was being paid to the Government employees already in service;
c) There will be a defined contribution pension system in place for the newly recruited
Government Employees;
d) The Central Government will contribute at the rate of 10% of the salary towards a pension
scheme for their employees;
e) Government servants will have to deposit a matching contribution from their salary;
f) The system of General Provident Fund has been dispensed with;
g) The Pension Fund Development and Regulatory Authority will identify the Fund Mangers
who will operate the investment system and offer different products;
h) The Government employee has to chose the investment package like- Safe or Balanced or
Growth fund offered by the private fund mangers and advise his investor to invest in that
particular product or a combination of the products;
i) The fund at the end will be converted into annuity that may pay a monthly pension to the
Government employees;
j) Periodical withdrawals are discouraged in the system so as to enable the Government
Employee build enough sum to generate a sizeable amount of monthly annuity after
retirement at the age of sixty.
Although the main intension of the Government has been to lessen the burden of the
Government revenue and arrest un estimated out go to the Pension of the Government employees, it
appears that it has not given a serious thought to the observation made by the Sehegal Committee. The
committee cautioned the Government by saying that pre-funding pension liability from the
Government budget will not reduce the burden on the Government on the other hand it will increase
the government burden during the long transition that is required to shift from an unfounded system to
a funded system to the newly recruited staff of the Government. In the name of transparent estimates
the Government during the transition pays huge amounts towards pension out goes and towards
pension contributions for the newly recruited.
Ignoring all these factors, the Government of India has implemented the new pension schme for the
employees joining on or after 1`st January 2004. in the absence of any Central Registering Agency,
fully functional PFRDA or identification and appointment of fund managers.
The insecurity dimensions:
The system that is being put in place suffers from many insecurity dimensions as the operating
environment for a defined contribution system for the newly employed has not been established so
far. Further the administrative costs of maintenance of individual retirement accounts is enormous as
observed by many international experts; however the Government of India has not considered the
required administrative setup and the administrative costs for that particularly when the fund mangers
from the private sector are being encouraged to operate the system.
The fundamental principles of money changing the hands and expected rents by every one who
changes money from hand to hand has not been seriously discussed in the system. The fund many not
generate any additional income to pay the rents, but have to compromise with the benefit package. It
therefore appears that the craftsmen of the scheme conveniently have not guaranteed any end product
in the benefit package neither have they guaranteed even the principle amount that goes in to the
system.
4
The list of insecurity issues goes like this:
a) The scheme is a mandatory defined contribution scheme where every employee has to
contribute as directed by the Government but has not been guaranteed any thing by the
Government including his/ her principle amount;
b) The fund will not be managed by the Government, but Government directs and makes it
mandatory to invest it through a private fund mangers who does not have any control over the
money neither the Government will take the responsibility in event of the fund performing
badly;
c) The Scheme takes away the current General provident Fund where the Government employee
hither to used to park his savings and use it as and when he wanted for some specific
purposes;
d) The Scheme does not guarantee any family pension; early retirement pension; children
pension; pension on the death of an employee; disability pension or pension on voluntary
retirement. The employee has to wait for the day of retirement to come and then wait for the
annuity to generate his pension amount;
e) The Government Employee can not foresee his post retirement economic support and plan his
life accordingly, on the other hand he has to spend his time on market information if he is
literate enough or depend on any other person who can advise him every month on the
performance of the market so as to enable him to advise his fund manager who can simply
escape from the criticism of being a bad performer in event of the market not performing
well;
f) The decisions are of employees’. The good or the bad performance of the market is totally
left to the Investment Market trends. The Scheme indirectly allows an employee to gamble. It
is wise in case a person is capable of taking a decision and withstands the eventualities that
follow his decisions. Only in the case of large number of rank and file employees with not
much better than a BPL income, the non guaranteed mandatory system may ultimately throw
them into poverty against the very fundamental principles of protective social security
schemes that are designed and delivered to protect the people from falling into contingent
poverty;
g) Multiplicity of agencies in the system make a person run from pillar to post in the evening
years of life for agencies like the Government, the employer, the fund mangers, annuity
providers and the PFDRA etc are the players in the system;
h) The system has huge administrative costs that are ultimately transferred to the beneficiary like
costs on advertisements, costs on licensing, costs on selling the product, cost on maintenance
of individual accounts, costs on benefit delivery, costs on annuity purchase, costs on
investment, costs on regulation, costs on effecting deductions from the salary of an individual,
and costs on deposits etc and series of other costs estimated and not estimated plus profits of
fund mangers who wish to play in the market of non pure public goods. In the current
interests rates regime, the return on investments need not be overemphasized. The fund
manger has too ekes out a living out of this interest.
i) After meeting these costs it is not clear how much of the expected return will be transferred to
the employee.
j) Purchase value of the annuity to provide suitable income in the old age hs neither been
estimated nor quantified at least at the current rates.
Since the pension reforms as suggested by the OASIS report have not been
implemented for the informal sector, and a Scheme of Social Security with government subsidy and
individual contribution are being put in place with a voluntary approach it will be too early to measure
the insecurity dimensions of this scheme.
Conclusions:
5
Pension is an Old-Age income and survivor benefit scheme in the package of Social Safety net or
Social Security provisioning. Social security is said to be the security that is provided by the society
for the people or individual who cannot count on his own. The main objective of any Social Security
scheme is to support vulnerable groups of the Society to live a decent living and not fall in to poverty
trap. Worker who earn above BPL income are not poor. However they will fall into poverty or get
into poverty trap on account of various contingencies of life- like: Old Age which incapacitates one
for work; Sickness by which one may not be able to take up or continue his employment; Disablement
that hampers a persons work life; widowhood that makes a woman a destitute etc. The poverty that
troubles and disturbs a man’s otherwise trouble free journey to his death due to these contingencies is
called contingent poverty. Pension is thus a product to protect a persons falling into poverty during
old age and therefore in the category of protective social security.
The schemes that are designed for protecting people from contingent poverty should be able to
provide them a guaranteed return during the old age. Further the pension is repeatedly considered as a
deferred wage and part of the wages paid to an employee and therefore even after shifting to a defined
contribution system in the name of fiscal transparency, the Government has not shed its responsibility
of supporting a pension system with its contribution. However the approach and the scheme that is
more beneficial to a fund manager than to a contributor should have not been thought of at all.
Alternatively it is wise if the management of the defined contribution pension system is handed over
to the Employees Provident Fund Organisation, (EPFO) which is managing funds of over three crores
workers in about three lakh business houses and has experience and expertise of managing funds for
over 50 years. Further the (EPFO) is on the path of modernization and re invention to offer worldclass services to its members6.
Unless all the risks are properly estimated and a comprehensive administrative machinery is
established that goes into the details of the interests of fund mangers with a view to protecting the
interests of the working class in the long run, the pensions funds transferred to fund mangers with the
hoe that they would show some miracles in scams infested financial market would throw the civil
servants into destitution in the evening years of their life. Then, thirty years or so down the line, we
may not know whether political economy will be ready to bailout the programs.
6
Re-Inventing EPF India, 2000
6