1. I am
grateful to the Social Security Association of India for inviting me to speak
on the issue of Pension Reforms in India. This gives me an opportunity to
show-case an important reform being undertaken in India and to inter-act with a
very knowledgeable audience.
Let me begin
by sharing with you, in brief, the background under which the NPS was
introduced and then take you through the current status of implementation of
the NPS architecture.
2. India has
nearly eighty million elderly people, which is one eighth of world’s elderly
population. This segment of population is growing at a rate of 3.8% per annum
as against a rate of growth of 1.8% for the overall population.
Vast
majorities of this population is not covered by any formal old age income
scheme and are dependent on their earnings and transfer from their children or
other family members. These informal systems of old age income support are
imperfect and are becoming increasingly strained.
3. Poverty
and unemployment may have acted as deterrents to provide a tax financed state
pension arrangement for each and every citizen attaining old age. Therefore, in
the organised sector (excluding the Government servants) a pension policy has
been adopted based on financing through employer and employee participation.
This has, however, denied the vast majority of
the workforce in the unorganized sector access to formal channels of old age
economic support.
4. As all of
you already know, a comprehensive pension system has 3basic pillars.
Pillar
I covers every
citizen of the country through a standardized, state-run pension system, which
offers basic coverage and is primarily focused on reducing poverty.
Pillar
II is mandatory
occupational pension system where employee and employer contribute towards
their pension.
Pillar
III is a
voluntary, private funded system, including individual savings plans,
insurance, etc.
Let us now
see where India is placed vis-à-vis this internationally accepted principle of
providing income security after retirement.
Pillar I i.e. State-financed pension has very
limited coverage in our country- it covers indigent persons above 65 years
through the NSAP for poor and elderly and persons employed by the Government
through the traditional PAYG scheme or the defined benefit scheme.
Pillar II covers workers in the organised
sector through a DC-cum-DB scheme.
Pillar
III i.e. purely
voluntary schemes is present in a very restrictive form through PPF superannuation schemes and personal pension plans through annuity providers.
5. Pension
Policy in India has primarily and traditionally been based on financing through
employer and employee participation. As a result, the coverage has been
restricted to the organized sector and a vast majority of the workforce in the
unorganized sector has been denied access to formal channels of old age
financial support.
Only about
12 per cent of the working population in India is covered by some form of
retirement benefit scheme. Besides the problem of limited coverage, the
existing mandatory and voluntary private pension system is characterized by
limitations like fragmented regulatory framework, lack of individual choice and
portability and lack of uniform standards.
High incidence of administrative cost and low
real rate of returns characterize the existing system, which has become
unsustainable.
6.
Non-sustainability of the existing pension system is accentuated by the sharp
increase in financial burden on the Government and the other employers on
account of pension liabilities.
While the
total pension liability on account of the Central Government employees has
increased at a compound annual growth rate of more than 21% during the 1990s,
the comparable rate for the State Government was 27% per annum.
7. As all of
you would know, Civil Servants’ Pension (CSP) is a traditional defined benefit
scheme which runs on the basis of pay-as-you-go system, for employees of
Central Government who were
recruited up to 31st December, 2003 and
employees of State Governments recruited up to the effective date mentioned in
notifications issued by those governments. CSP is an unfunded scheme and there
has been no attempt at building up pension assets through contribution or any
other provision.
8. CSP
scheme is indexed to wages and inflation. A modified one rank one-wage
principle applies to it wherein all retired employees of a certain rank get the
same pension. Pension payments are revised periodically to reflect the growth
in wages and consumer price index. Growth in pension benefits in old age is
typically higher than inflation.
9. The main
problem under CSP is that of fiscal stress. CSP was designed at a time when
going by the pattern of life expectancy most of the employees who retired at
the age of 60 were expected to live up to the age of 68 or so.
The value of
the annuity embedded in the CSP has gone up due to elongation of mortality in
the recent years. The mortality characteristics of Government employees, who
belong to the higher income group than the average, are more or less in line
with the OECD populations.
The fiscal
stress at the sub-national level has been more acute. Some of the State
governments have not made timely payment of pension benefits. One State
government chose to cut benefits by reversing recent increases in the pension
benefits due to hikes in the wages of existing employees.
10. For the
organized sector employees, excluding the Government employees, the basic
structure of pension and other retirement benefits has been outlined in the EPF
& MP Act, 1952.
The
provisions of this Act are applicable to all defined establishments, employing
more than 20 workers and cover about 40 million employees in the organized
sector. This Act remained virtually unquestioned and there were virtually no
changes in the contribution, administration and benefits being provided under
this Act for almost four decades.
First major
change occurred in 1995, with the conversion of part of defined contribution
EPF Scheme to a defined benefit scheme in the form of Employees’ Pension
Scheme. This change in the EPF & MP Act, 1952 marked an important break
from the existing policy of the Employees Provident Fund Organization in two
ways:
(a) With
this amendment, the concept of a mandated annuity to the employees of private
sector was introduced for the first time.
(b) It added
a new pension liability (since the scheme is not fully funded) to the existing
liability with regard to the civil servants of Central and State Governments.
11. The EPF
& MP Act, 1952 is administered by the Employees Provident Fund Organization
(EPFO). At present, EPFO administers the following two old age income schemes,
which are mandatory for all employees in the organized sector, earning a
monthly salary of less than Rs.6,500/:-
(a) The Employees
Provident Fund (EPF);
(b) The Employees
Pension Scheme (EPS).
12. All the
functions/ processes of EPF and EPS are handled by the EPFO, except fund
management, which has been outsourced to one external agency (State Bank of
India).
However,
some establishments, which are under the purview of EPFO are allowed to manage
their own funds. EPFO treats them as exempted funds. These exempted funds are, however,
required to follow the same investment pattern as being followed by EPFO and
are required to match the returns of the EPFO.
13. The
Employees Provident Fund (EPF) Scheme is an individual account defined
contribution scheme wherein both the employee and employer contribute to the
fund at the rate of 12% of the employee’s pay.
There are a
number of provisions under the scheme for pre-mature withdrawal of
accumulation. This pre-mature withdrawal provision is frequently used by the
members of the scheme which leads to small balances at the time of their
superannuation.
Because of
low balance in individual account of the members’, old age income benefit is
negligible. The EPFO scheme enjoys an ‘EEE’ tax structure which constitutes a
major tax based subsidy.
14. The Employees’
Pension Scheme (EPS) is a defined benefit scheme, based on a contribution rate
of 8.33% from the employee to which government makes an additional contribution
of 1.16%.
EPS was introduced in 1995, and is applicable to the workers who
entered into employment after 1995. In case of death of a member the scheme
provides for a pension to the spouse for his/her remaining life.
15. There
are other voluntary pension schemes available for general public but these
schemes cover a very small segment of the total population. Life Insurance
Companies and Mutual funds are offering these plans.
These are
essentially defined contribution schemes. Personal Pension Plans and Group
Pension Products offered by the life insurers are being supervised by the
Insurance Regulatory and Development Authority (IRDA). Schemes offered by the
Mutual Funds are regulated/supervised by the Security Exchange Board of India
(SEBI).
Tax benefits
up to a specific amount are being offered to investors buying these pension
plans. Total coverage under these pension plans is about 1.6 million.
16. The
other popular scheme is Public Provident Fund (PPF) which is also a defined
contribution scheme. Government is managing this scheme. A fixed rate of return
is offered under the scheme.
In addition, tax benefits are being offered for
making investment in the Public Provident Fund account. Coverage under the Public
Provident Fund is about 3.5 million.
Pension
Market in India
17. The
existing system of pensions which leaves more than 88 percent of Indian
workforce uncovered is unlikely to act as a social security umbrella for the
ageing Indians. Even for those that the system covers, the defined benefit is
strictly not guaranteed as most DB schemes are either wholly unfunded or
under-funded schemes.
Improvement
in healthcare facilities leading to increase in life expectancy, evolution of
nuclear family systems and rising expectations due to increase in per capita
income, education etc. are some of the factors likely to compound the problem
in future.
The new pension
system, based on defined contribution and funded liability is a significant
step in the direction of addressing this problem. Spread of NPS is seen by many
as the direction in which the pension reforms need to move to find a viable and
sustainable solution to the problem of old-age income.
Security
18. In 2001,
Government of India appointed a group of experts to study the various aspects
of extending an organized system of pension to the unorganised sector. The
group submitted its report in October 2001.
According to
this report, the pension market (which includes pensions, provident funds and
other small savings i.e. NSC, NSS) would grow to about Rs.4064 billion by 2025.
The growth would largely be due to normal growth of economy in terms of growth
in income and population and does not consider the significant increase in
coverage that would arise because of reforms in the insurance and pension
sectors. A more conservative estimate is that the pension market will be worth
about Rs.1808 billion by 2025.
The
New Pension System
19. During
the last seven years, from 2000 to 2007, a marked shift in pension policy in
India was witnessed which culminated in introduction of a new pension system. A
High level Expert Group (HLEG) and the Old Age Social and Income Security
(OASIS) Project commissioned by the Government were the two initial milestones
on the road to pension reforms for the Government employees and the unorganized
sector respectively.
These
efforts culminated in setting up of the Pension Fund Regulatory and Development
Authority (October 2003), introduction of a New Pension System (December 2003),
and introduction of the PFRDA Bill in Parliament (March 2005).
20. HLEG
suggested a new hybrid scheme that combines contributions from employees and
the Union Government on matching basis, on the one hand, while committing to
the employees a defined benefit as pension.
The objective
of the Government was to design a scheme for new entrants in Central Government
service where the contribution is defined, where no extra infrastructure is
sought to be created in Government and which is capable of serving other groups
like State Government employees, middle class self-employed people and even
those in the lower income bracket amongst the unorganized sector subsequently.
21. OASIS
report recommended a scheme based on Individual Retirement Accounts to be
opened anywhere in India. It was envisaged that Banks, Post Offices etc., could
serve as “Points of Presence” (POPs) where the accounts could be opened or
contributions deposited.
Their
electronic inter connectivity will ensure “portability” as the worker moves from
one place/employment to another. There will be a depository for centralized record
keeping, fund managers to manage the funds and annuity providers to provide the
benefit after the age of 60.
22. The New
Pension System (NPS) which has its origin in the two reports mentioned above,
was made operational through a notification dated 22nd December, 2003. It has
been made mandatory for new recruits in the Central Government (except Armed
Forces) from 1st January 2004.
It marks a
shift from the defined benefit to a defined contribution regime. It is based on
the principles of defining upfront the liability of Government, giving choice
to subscribers, facilitating portability of labour force and ensuring transparency
and fair-play in the industry.
About 100,000 Central Government employees
(excluding employees of autonomous organisations) are already covered under the
new pension system and contribute 10 percent of their salary and dearness
allowance towards pension with a matching contribution from the government.
Nineteen
States have also notified and implemented a defined contribution pension system
for new employees.Many other State Governments have made significant strides in
this direction. NPS will also be available to all individuals in the
unorganized sector on a voluntary basis.
23. Under
the NPS, for all subscribers, at the time of retirement there will be
compulsory annuitisation of at least 40 percent of the accumulated pension
wealth and the balance will be paid as a lump sum.
There will
be multiple pension fund managers licensed by PFRDA and the choice would be
with the individual subscriber to decide which fund manager to go with.
There would
be four broad categories of pension schemes offering investment options with
varying ratio of equity and fixed income instruments. The choice of a scheme
would rest with the subscriber.
Full transparency
and disclosure of information regarding investments will have to be provided by
the intermediaries. Portability will be provided to the participants along with
the option to transfer accumulations from one fund manager to another.
24. To bring
the new pension system within a statutory regulatory jurisdiction, an ordinance
was promulgated on 29 December 2004 setting up a statutory Pension Fund
Regulatory and Development Authority. Subsequently, a Bill was introduced in
the Parliament to replace the ordinance.
The Bill
provides for establishing a statutory Authority to promote old age income
security by establishing, developing and regulating pension funds and
protecting the interest of subscribers to schemes of pension funds. Once the
Act comes into force the Authority shall regulate all intermediaries under the
new pension system including pension funds, central record keeper, points of
presence, etc.
It will
approve the terms and condition of the scheme, lay down norms for the
management of the corpus of the pension funds including investment guidelines
under such schemes.
The Bill
envisages that the pension supervisor will provide robust regulatory umbrella
essential to sustain member confidence and to protect the interests of the
participants and to develop the pension system by inculcating saving habits for
long term.
The Bill
also provides adequate safeguards to take care of the subscribers to the NPS
and stringent penalties for contravention of the provisions of the proposed Act
and the Rules and Regulations framed there under.
25. In
accordance with Parliamentary conventions in India, on introduction in the
Lower House the Bill was referred to the Parliamentary Standing Committee on
Finance. The Committee, having considered the evidence and clarifications
placed before it, opined that “...the reform process in the pension sector
involving the setting up of the PFRDA as a Statutory regulatory body for
managing the NPS is an urgent necessity mainly on account of burgeoning fiscal
stress of pension payments on the Central and State revenues and the need to
provide a viable alternative to the populace at large to save for old age income
security”.
The Committee approved the PFRDA Bill for
enactment subject to certain modifications, which are under consideration of
the Ministry of Finance, Government of India.
26. The Bill
is yet to be taken up for further consideration by Parliament. Meanwhile, in
view of one of the recommendations of the Standing Committee that the initial
or broad contours of the regulations governing the implementation of the NPS
under the infrastructure of PFRDA be framed and put in public domain, PFRDA has
prepared the broad contours of Regulations on registration of intermediaries
and put them in public domain for comments of stakeholders.
27. The NPS
has been mainly designed to fill the gap of old age income security to the
unorganised sector. The scheme is envisaged to be a voluntary one for this
segment of the population.
Given a high
savings rate of 35% of GDP, Indian workers are encouraged in respect of their capability
to contribute towards a self-financed old age income security scheme. In this
framework, the New Pension System will provide them with the opportunity to fulfill
their needs of old age income support in the most productive way.
Further, the
system will also be capable of providing a delivery mechanism for the other
segments of population viz. Pillar-I (population vide mandatory pension system)
and Pillar-II (mandatory occupational pension system).
The low cost
structure of the architecture will enable Governments to utilize this
infrastructure to deliver any scheme of old age income support to any segment
of the population in the most efficient manner.
28. While
the introduction of the New Pension System for new recruits of the Central
Government/ State Governments is a positive step in the direction of reforming
the pension sector in India, the road ahead has many challenges.
29. The
level of financial literacy and preponderance of rural aged make the task
daunting. Sex ratio of the workforce and economic status of women pose special
problems in the design of pension systems.
Designing an
effective, efficient and accessible system, which caters to the requirement of
a heterogeneous work force, nearly 88 percent of which is not covered by any
pension or old age security scheme, is the immediate priority of those concerned
with pension reform process in India. The challenges of translating the design
into reality will arise thereafter and will take a while to overcome.
30. The new
pension scheme is an attempt to move away from the defined benefit pension
plans to defined contribution based schemes. But, this change would be
applicable only to the new entrants. The problem of financing the pension
liability of those already under unfunded or partially funded schemes is like
to cause fiscal stress for the next two or three decades.
Some parametric
changes will, therefore, become necessary for effective and efficient discharge
of this liability. Thus, apart from spread of the new pension scheme,
introduction of parametric changes in the existing defined benefit mandatory
pension systems is equally necessary for reducing the fiscal stress.
Attempts to
estimate the future pension liability arising out of the existing unfunded
pension plans are at a nascent stage in India. Recently, some private
researchers have tried to undertake a limited exercise in respect of the
defined civil service pension scheme.
One such
study puts the implicit pension debt liability of the Central and State
Governments arising out of three components of civil servants pensions at
Rs.20034 billion or 64.51per cent of GDP.
While the
methodology and/or the results can be questioned, the magnitude of the problem
that this estimate suggests cannot be ignored. The enormity of the problem
becomes even more apparent when this liability is compared with the explicit
internal public debt of Government of India, which is 84.86% of GDP (2004-05).
31.
Empirical evidence collected through a nation-wide survey suggests that India
is in transition from old age support systems based on the family to a new
reality where for the generation of workers now aged 40, the balance between
family support and self-support in retirement is likely to fall heavily in the
latter direction.
It is,
therefore, essential that policymakers correctly anticipate the course of the
transition so that adequate counter measures are in place at the appropriate
time. The survey also indicates that without guidance, encouragement and
support, most Indian workers will not save sufficiently for their old age and
the capacity of the State and the labour market to face the challenges is
likely to become even more limited than is the case now.
Recognizing
the fact that pension reforms are an urgent social priority, policymakers in
India are working hard to evolve suitable pension systems.
32. A major
challenge of the New Pension System is to provide the individual subscriber
with an adequate retirement income.
Public
sector pension schemes involve ‘policy risk’ inasmuch as the Government of the day
may not be able to accommodate required pension outlays leading to delays in
pension payments or defaults in some cases.
On the other
hand, private pension schemes are less subject to this ‘policy risk’ because Governments
are less prone to confiscate private property. However, DC funds do involve
‘market risk’ during the accumulations phase when contributions and returns on
investment build up in the fund. The risk is that the pension funds’
performance may be insufficient to give reasonable retirement income to the
pension subscribers.
Our draft
Regulations has addressed this issue by providing prudential investment rules
and ensuring that Pension Fund Managers diversify their portfolios. Also, these
Regulations aim to promote competition by requiring standardized reporting and
disclosure.
33. One
issue which needs attention for making the new pension scheme equitable is the
tax treatment. Pension savings in general and the NPS in particular is a very
long term saving instrument having a time horizon of 30- 35 years.
Therefore,
the treatment of this instrument from a tax perspective, if not the most
preferential, should at least be at par with other medium or short term
financial instruments.
This is especially important at the nascent stage of the
new pension system development. In this context, example of Public Provident
Fund (PPF) and other such instruments are worth mentioning.
PPF having a
life cycle of 15 years is under an EEE (exempt exempt- exempt) tax regime and
is not taxed at any point whereas NPS being a 30-35 years instrument is taxed
at exit.
Therefore, subscribers to NPS are at a disadvantage compared to the
PPF especially when seen in the context that NPS is a mandatory scheme whereas
PPF is a voluntary scheme.
The
Government employees appointed before 1.1.2004 participate in the GPF scheme
which is again an EEE tax regime whereas NPS is subject to EET regime and the withdrawable
tier-II account of NPS (a substitute to GPF) is envisaged to get no
preferential tax treatment.
Further, a common ceiling for contributions of both
the employees and Government under the Income Tax Act, 1961 may be a
disadvantage for the subscribers of NPS.
Accordingly,
a need is felt to treat all long term savings instruments equitably and provide
the same tax treatment to NPS as being given to PPF and other similar schemes.
The tax treatment merits a review so as to take care of the distortions across
financial instruments and giving right fiscal incentives for the development of
the pension sector.
Current
status
34. Pending
passage of the PFRDA Bill and establishment of full architecture of the new
pension system (NPS), the contributions received under NPS are being kept in
the Public Account of the Government concerned.
While a
fixed return of 8% per annum is given by the Union Government on total pension
contributions, (both employee as well as the matching contribution by the
Government), the actual return would have been in the range of 14-29% per annum
if the proposed investment options were given to employees. Delay in the
passage of the PFRDA Bill has thus resulted in lost opportunities to Government
employees.
35. In order
to address the issue of investment of pension contributions under the NPS
through a mechanism of consensus, a Conference of Chief Ministers’ on Pension
reform was held on 22nd January 2007, which was chaired by the Prime Minister.
All the
State Governments, except West Bengal, Tripura and Kerala, were in favour of
the proposal to adopt the guidelines applicable to the non-Government provident
fund prescribed by Ministry of Finance for investing the accumulations under
NPS till the Bill is passed by Parliament.
36.
Consequent upon the consensus arrived at the Chief Ministers’ Conference;
Government has authorized PFRDA to appoint a Central Record-Keeping Agency
(CRA) and three Fund Managers from the Public Sector to manage the accumulated
funds of Central Government employees. The services of the CRA and the Fund
Managers have also been offered to the State Governments to manage the funds of
their employees.
37. PFRDA
has identified National Securities Depository Limited (NSDL) as the CRA and is
in the process of finalizing a contract with it. Three sponsors of Pension Fund
Managers have also been appointed; they are SBI, LIC, UTI- AMC.
All the
three sponsors have incorporated Pension Fund as separate entities and
registered as new companies under the Companies Act, 1956. The selection
process for the Trustee Bank and Custodian are also in the final phase of
completion.
An NPS Trust
has also been registered which will be the registered owner of assets under the
NPS. Thus, all the intermediaries under the NPS have been identified and the system
is now ready to be rolled out by 1st June 2008.
As regards
the cost structure of the NPS, the fund management charges are to be in the
range of 3-5 basis points ( 0.03%-0.05%) of assets under management. The record
keeping costs are low compared to the low volume at present.
This cost
will decline further once the volume increases under the system. The total cost
of the NPS is estimated to be around 1% of the total assets under management
(AUM) in the initial years and expected to decline to less than 0.5% of AUM
within few years of its operation.
38. Till the
PFDRA Bill is passed, there will be two investment options:
(i) As per
investment guidelines issued by the Ministry of Finance for non government provident
funds (wherein up to 5% can be invested in equity and up to another 10% in
equity-linked mutual funds, remaining 85% in debt instruments) and
(ii) In
government securities exclusively.
39. At
conclusion, I would like to emphasise that pension reforms which have been set
into motion in the last five years need to be taken forward immediately if
India wishes to take advantage of the edge that its demographics offer over
similarly placed economies.
Average age of Indians in 2005 was about 26
years with 31% of Indians being younger than 15 years, and nearly 64% of
Indians in the working population.
Thus, the time for undertaking the reforms
in the pension sector could not be more appropriate, but the need of the hour
is to push the reforms further without delay in terms of offering this system
to the unorganised sector workers.
The
demographic advantage is not going to last forever because India’s elderly are
growing at a much higher rate than the total population, as a consequence of
which the current dependency ratio of 15 is likely to shoot to 40 in the next
four decades (dependency ratio here defined as the number of persons over age
60 years to number of persons between age 20-59 years).
The
implications of demographic dynamics for pension planning in India become more
evident when one takes into account the fact that average life expectancy at
age 60, which is currently 17 years, is likely to rise to more than 20 years in
the next three decades and that the population over 60 years of age will
approach 200 million in 2030.
However, India is still at an early stage of
the demographic transition. This is the right time, therefore, to roll out the
NPS to all segments of workers. The New Pension System is designed to use the
21st century Information Technology so as to achieve portability, competition
and coverage.
In contrast
to the traditional approach of mandating participation and contributions from
the workers for old age income support coupled with tax incentives and
guaranteed returns, the voluntary nature of the NPS for unorganised sector is
expected to succeed.
However,
poor financial literacy and the attitude of the households towards financial
savings, risk and retirement planning, pose a challenge to achieving optimum
coverage of NPS.
Creating awareness about these reforms and gaining the
confidence of the people to encourage them to be a part of this movement is the
single most important challenge faced by policymakers today.
Thank you.
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