NEW PENSION SCHEME -DOES NOT MEET THE BASIC REQUIRMENT OF A PENSION

 New Pension Scheme: Does not meet the basic requirement of a pension



Mythili Bhusnurmath Monday November 16, 2009

Last Monday, the Invest India Economic Foundation, the New-Delhi-based think-tank that has done yeoman’s work for pension reform in the country, held its annual conference. In the nine years since the first conference was held, we’ve come a long way. The New Pension Scheme (NPS) has been in existence for little over five years and fears of a large, and growing, hole in government finances have abated somewhat.





The pension bill is still huge. But beginning January 2004, all entrants are part of the NPS, so the problem will become progressively more manageable. Had the past trend of 21% compounded annual rate of growth continued, in about a decade from now, close to 50% of government’s budget would have been spent on salaries and pensions , an unsustainable scenario. So, as far as containing the pension bill is concerned, the NPS has delivered.





But pension reform was never meant to be only about reducing the government’s burden. It was also meant to extend the coverage of a formal pension scheme to the vast majority outside the privileged class of government employees. And for them, the NPS opened a new option; especially after it was opened to the non-government (albeit organised ) sector as well earlier this year.







In a country where close to 85% of the working population has no formal pension scheme and changing cultural norms combined with job insecurity have made old-age security a critical issue, it was expected there would be a rush to join the NPS. But surprise , surprise! Six months later, the NPS has only 3,000 voluntary subscribers (contribution is mandatory for civil servants). Why?







The usual answers range from lack of awareness to inertia to poor marketing, to competition from other products. Most speakers at the conference seemed to echo this view — virtually none was willing to concede that there is a basic flaw in how the NPS has been positioned.







Consider. Any good pension system is based on three pillars: a universal Pillar 1 that is a flat, subsistence pension, a Pillar 2 that is earnings-related , and a Pillar 3 that consists of voluntary retirement savings. In India, the National Old Age Pension Scheme — the traditional tax-funded pillar 1 — covers only those below the poverty line and is a paltry Rs 400 per month. Consequently, any pension scheme must have two attributes: certainty and survival benefit.







The NPS, unfortunately, does not offer either . The weighted average return of about 14% claimed by the NPS last year may flatter vis-à-vis 8.5% offered by its rival, the Employees Provident Fund (EPF), but it flatters to deceive. For one, there is a tax disadvantage as the corpus is taxed at maturity (NPS is subject to the EET — exempt, exempt, taxed — regime). But more important, as the experience with 401K schemes in the US has shown, NPS is subject to market volatility. Even if over the long term, equity does give you a higher return than debt — try asking the Japanese that though! — what happens if you retire when the market has tanked?







This is where schemes run by the Employees Provident Fund Organisation (EPFO) have an advantage. The EPF offers a fixed rate of return and the EPS (Employees’ Pension Scheme) offers survival benefit. With NPS, if a subscriber dies before retirement, the family gets only the accumulated corpus; with EPS, the wife is entitled to 50% of the pension amount with minor children (a maximum of two) entitled to another 25%.







In the rarefied atmosphere of a five-star hotel where such conferences are usually held, few, perhaps, grasped the significance of these two distinctions. But in the real world where we are talking of income levels of less than Rs 5,000 a month — assuming a per-capita income of $1,000 per annum — these are critical enough to make NPS inferior to a scheme like the EPFO’s to the vast majority of the population.







This is not to say that there is nothing wrong with the EPFO. Beginning with its shoddy house-keeping , high administrative costs and, of course, rampant corruption, the EPFO needs to do a great deal to set its house in order. Computerisation should help as should a concerted attempt to rid the organisation of corrupt elements, if necessary by outsourcing settlement of claims.







There is also a case for linking the rate of interest to the market, pruning withdrawal facilities and, possibly, the benefits as well keeping in mind the long-term sustainability of the schemes. Unfortunately, in the high decibel attack on the EPFO and the equally vociferous push by those interested in pushing more funds into the stock market, these issues are often lost sight of.







True, we are a heterogeneous society. So, there may be a case for selling differentiated products to different sections of the population . But there is an even more pressing case to be transparent about what we are selling. For the non-government sector, NPS is at best a third pillar with EPFO schemes being the second pillar. Junking the latter for the former will be a big mistake. Let both flowers bloom!



SOURCE;ET