Existing pension schemes in India are limited in their coverage and poor in their design.
First, there is a pension scheme for civil servants and employees of autonomous bodies such as universities which is fully funded by the government. Second, there is the EPFO, which is mandatory for the organised sector, which offers a provident fund and a pension scheme. A small scheme is also run by the EPFO for unorganised workers. Finally, about 50 odd insurance companies and mutual funds offer over 700 financial products to all citizens though only 1 percent of the population buys such products.
Civil Servants Pensions:
In the traditional civil servants pension employees of the government are entitled to a generous pension - roughly half their last salary - until they die. There is no process of putting money aside to cope with these future pension liabilities. The government plans to pay pension in the future out of tax revenues in the future. The outgo on account of the civil servants pension has grown dramatically. Just the States pension outgo went up from Rs.5107 crore in 1993-94 to Rs.30396 crore in 2002-03.
Estimates of government pension liabilities show that existing GOI pension promises to central and state employees adds up to nearly Rs 1.7 trillion . The total explicit stock of government debt already stands at 84 percent of GDP. When another 55 percent of GDP, the implicit pension debt is added, it is a frightening 140 percent of GDP. This is clearly unsustainable.
The Employees Provident Fund Organisation has very limited coverage because it covers only the organised sector. The Indian Retirement, Earnings and Savings (IRES) database, a survey of 41,000 earners from across the country, recently released by PFRDA and ORG-ACNielsen shows that barely 4 percent of the country's workers have EPF accounts.
Also, only those with a monthly income of upto Rs 6500, working in the organised sector, are covered by the EPF through mandate of law. In 2004 93 percent of the total 3.94 crore members had balances below Rs.50,000 and 85.39 percent of the total members had balances below Rs. 20,000. The average balance in the category below Rs. 20000 was Rs. 2,938. The objective of the EPFO scheme was to encourage build up savings for old age. Yet, the data shows that this is not what is happening. The bulk of the members withdraw their monies while in employment. Second, members are choosing to take final settlements when changing jobs rather than building up for retirerment. 90 percent of the cases of final settlement are of those who are resigning from their jobs. Only 10 percent cases are superannuation cases.
EPS is a "defined benefit" scheme run by EPFO and guaranteed by the government. This means that the employee is guaranteed a certain pension - regardless of whether there is enough money to pay for it or not. EPS is mandatory for employees earning less than Rs.6500 a month in all establishments covered by EPFO (roughly speaking, companies with more than 20 workers).
EPS can work if on retirement date, the assets in hand for a person are enough to pay for the flow of pensions that must ensue. At every point of time the value of the pension liabilities can be measured by adding up the promises. The value of the assets can be measured by summing up the securities in hand and the expected future contributions. The two sides - the sum of assets and sum of promises must match.
But the arithmetic does not tally. The contributions are small, and the promised pension is big. Since the freedom of EPFO to do any "asset mangament" is limited as its hands and feet are tied in terms of portfolio management, higher returns cannot be obtained by better fund management. In addition, defined benefit schemes have a constraint where investments can only be in fixed-return government bonds since the promises are fixed. The latest actuarial report for the "Employees Pension Scheme" (EPS), shows an unfunded gap of Rs. 22,000 crore.
Pension Policies offered by insurance companies and mutual funds:
Today, if someone has an LIC policy and an ICICI Prudential Policy, and if she is unsatisfied with the returns or service offered by one or the other, it is extremely cumbersome for her to shift service providers. Through paper work, hassle, and financial loss involved, she is practically locked into the schemes for life. In some cases, the penalty involved in moving money from one insurance company to another is upto 50 percent of the charges in the first 3 years.
In summary, effectively 93 percent of the work force (including the self employed) does not have access to a pension scheme.
The government has set up a New Pension System for civil servants that will be open to all. That should certainly wake up everybody's interest because the bureaucrats usually get the best for themselves. What is different about the new system?
The new pension system will be based on defined contributions, and will use the existing network of bank branches and post offices etc. to collect contributions and interact with participants, allowing transfer of the benefits in case of change of employment, and offer a basket of pension choices.
It will have centralised record keeping and accounting (CRA) infrastructure, and several competing pension fund managers (PFMs), each of whom will offer three styles of schemes viz. option A, B and C with different risk and return characteristics. The participating entities will give out easily understood information about past performance, so that the individual will able to make informed choices about which scheme to choose.
An independent pension fund regulatory and development authority (PFRDA) will regulate and develop the pension market. PFRDA will develop its own funding stream based on user charges.
While it is important that there is competition in the market, it is also important to remember that the complexity and financial sophistication of schemes makes it very difficult for comparisions to be made. A straight-forward and standardised set of options will be available under the NPS. Transaction costs will be low and there will be all India access. Costs of moving from one fund to another will be minimal to increase competetion.
In short, NPS is the civil servants making sure that finance wizards do not manage to cheat them or charge high service charges. Piggy backing on the babus, the aam aadmi can rest assured that he will be getting the best deal available.
Ila PatnaikIla Patnaik