Do we need a new pension scheme?

DEBATE

The current one caters to only a small portion of the workforce and is financially unsustainable, but the Left parties don't buy this argument.

S P Subhedar
Senior Advisor,
Prudential Corporation Asia, Hong Kong

Globally, it is increasingly being recognised that today's social security systems were devised for yesterday's world and so rethinking about social security is based on what can work.

This has been apparent in UK pensions policy and, most recently, in George Bush's national address on social security reform in the US. Many countries are now acknowledging the need for individuals to take more of a role in providing their retirement income.

Because of ever-increasing longevity, a system of retirement provision based on inter-generational income transfers faces crisis. And, with more people living longer, and working populations reducing, the "new math" is that there are fewer workers supporting each retiree.

This trend is set to continue. One solution is to move to self-financing of old-age income, with the government creating the institutional and financial infrastructure to enable and encourage people to save and invest assets for their own retirement income.

The government's initiative to set up the new pension system and to encourage the development of a structure for privately-managed pensions is a notable example of this.

This indicates real foresight. While India makes up about 16.3 per cent of the world population, its elderly population is only about 12.5 per cent of the world's elderly population.

India's population is currently relatively young but this will change as health and other social initiatives lead to continuous improvement in birth and death rates.

There are currently 70 million people over the age of 60 in India and fewer than 10 per cent of them have their pension; the others have to work or rely on transfers, mainly from their children.

A recent survey commissioned by the Pension Fund Regulatory and Development Authority (PFRDA) and Asian Development Bank revealed that post-retirement dependence on children is 71 per cent in rural areas and 59 per cent in urban areas.

The Old Age Social and Income Security (OASIS) Committee, constituted to examine policy questions connected with old-age income security, enunciated the basic philosophy of pension reforms, namely that "economic security during old age should necessarily result from sustained preparation through life-long contributions" and that "the government should step in only in case of those who do not have sufficient incomes to save for old age".

In its second report, the OASIS recommended the introduction of defined contribution, fully funded, individual retirement account pensions, with the fund management of these entrusted to private fund managers.

The aim of any pension reform initiative is to reduce the unfunded pension liability, reduce the role of the state as pension provider and increase the pension coverage.

The introduction of the new pension system would arrest the increase in the unfunded pension liability of the government employees pension by covering the new government employees joining service from January 1, 2004; reduce the role of the government in supporting the other unsustainable defined benefit pension liability, which would ultimately fall on the government; provide universal access to people, enabling those who do not have access to any vehicle to build up assets for old-age income, and once the new system settles down, the government could have increased resources to consider strengthening the means tested tax-financed pension for those who do not have adequate income to self-finance their old-age income.

While these appear separate components of the system, one has to take a holistic view to see how the seemingly separate components of the system are actually interdependent.

When a change in the pension system is envisaged there are always concerns. The first concern is about the change in pension design of government employees.

This has to be viewed in the context of the unsustainability of the current defined benefit pension. According to the World Bank, for the Central government, the pension bill expressed as a share of GDP doubled between 1995 and 2000.

The World Bank report also indicates that outlays on pensions for government employees are likely to grow faster at the state level where employment more than doubled in 30 years, levelling off only recently, and that the future growth in the pension bill would reflect this.

The move to defined contribution pension for new employees is a step to mitigate this. The transition can be effectively smoothed by efficient fund management and the monitoring of the accumulated pension on a continuous basis.

It is in this context that the proposed pension system is envisaged to offer different funds/risk profiles.

(The views expressed by the author, a former MD of LIC, are personal)

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W R Varada Rajan
Secretary,
CITU

The move to shift to a new defined contribution pension scheme for employees recruited since January 2004 is really continuing the move by the National Democratic Alliance (NDA), and had been opposed by government employees and trade unions even when the NDA was in power.

The NDA religiously followed the prescriptions of the World Bank report titled Averting the Old Age Crisis, the thrust of which was not to tackle the crisis faced by the elderly in their old age but to resolve the "crisis" of the pension payout burden of governments the world over.

The NDA commissioned three reports: the Old Age Social and Income Security (OASIS) Committee report in 1999; Insurance Regulatory Development Authority's (Irda's) report on "pension reforms in the unorganised sector" in 2001; and the Bhattacharya Committee report on the new pension scheme in February 2002.

In February 2000, the Central Board of Trustees under the chairmanship of the then labour minister unanimously held the OASIS report to be "investment-centric and not social security- or social insurance-centric and [containing] a number of recommendations and suggestions which are inconsistent with the ground reality or practical considerations".

It is important to note that both the OASIS and the Irda report had framed their proposals on a "voluntary" tier comprising individual retirement accounts.

Later, however, the NDA regime decided to discontinue the defined benefit pension scheme applicable to government employees and constituted the Bhattacharya Committee.

The report recommended a new pension scheme, but even the Bhattacharya Committee, it is to be noted, did not recommend only a "defined contribution" scheme, which is the case with the new pension scheme.

It recommended a hybrid defined benefit/defined contribution (DB/DC) or mixed scheme. While the UPA's Bill states, "the New Pension Scheme is mandatory for new recruits to the Central government services," it has ominous portents since in the Bhattacharya terms, the NDA included "[exploring] the option of moving existing employees to a contributory system."

Indeed, despite the National Common Minimum Programme committed to the fact "that labour-management relations in our country must be marked by consultations, cooperation and consensus, not confrontation", the present ordinance on the Pension Fund Regulatory and Development Authority (PFRDA) has been resorted to without any consultations with trade unions, in a blatant violation of this commitment.

The move towards setting up of the PFRDA has dangerous implications. It is intended to flag off retrograde moves towards privatisation, which has three main thrust areas.

First, switching over to the "defined contribution" from the "defined benefits" concept; two, shifting to personal and social insurance schemes from social assistance schemes; and three, diverting social security funds from the debt market to equity markets.

This is an erroneous and dangerous move, as the private sector seeks to participate in social security only eyeing the huge corpus of private pension funds that could be generated, which could be diverted to the equity market in the country.

This is also accompanied by two other retrograde moves. One, a change in the tax treatment for contributions to the pension scheme, shifting from the EEE formula, where the monies were exempt from taxation at all three stages of contribution, accruals and withdrawal (of terminal benefits), to the EET formula where terminal benefits will be taxed at the applicable rates in the year of receipt.

Budget 2005-06 has envisioned opening up of the pension sector for foreign direct investment, which means a green signal for foreign corporations to garner the huge pension funds for their speculative hunt for profits.

The present fiscal-related problem cited by the government for the unsustainability of the present "Pay As You Go" pension scheme is of its own making.

The present pension scheme was introduced in the past as a substitute to the then Contributory Provident Fund Scheme, to which the Central government had been making a matching contribution.

It was replaced by the General Provident Fund with only the contribution by the employees and in lieu of its matching contribution, the Central government brought in place the present pension scheme. Even the Fifth Pay Commission had recommended retention of the present pension scheme.

The government, over the past years, merrily used up the funds that were due on the former contributory provident fund scheme and failed to make any provision for an appropriate funding arrangement in place for meeting the pension liability towards its employees.

For this, the employees cannot be penalised as is being resorted to now.