What ails NPS?: A 2012 article

What ails the New Pension Scheme?*

MG Warrier

It is imperative that the government addresses all issues related to the New Pension Scheme to ensure a post retirement lifestyle commensurate with what the employees are used to during their active service.

Before discussing the merits of the New Pension Scheme (NPS), let us take a bird’s eye view of NPS** for central government employees and being gradually introduced by public sector organisations, including banks.

The central government employees who were in service as on 31 December 2003 have a Defined Benefit Pension Scheme. According to a 2008 estimate, the net present value of the pension liabilities of central government now being met on a Pay-As-You-Go basis was Rs3,35,628 crore (6^th Pay Commission Report, 2008). Considering this staggering liability which grows proportionately along with the rise in inflation and periodical revisions in the government pay structure, a proposal to introduce a restructured defined contribution pension system —NPS—was mooted for new entrants to central government service. The NPS was introduced from 1 January 2004, for new entrants to central government service replacing the existing system. Thus the NPS was born.

The scheme was compulsorily thrust upon the central government employees. NPS, somewhat similar to retirement benefit schemes offered by mutual funds, has also been thrown open for subscription to the public two years back, with some incentives from the Government of India. A salient feature which distinguishes it from mutual fund schemes is the attraction offered by the finance ministry that all subscribers registered in FY2010-11 will be eligible for getting a contribution of Rs1,000 per year from the government for four years beginning the same year. Not much research is needed to find that this is simply a back-door borrowing by government, as the matching contribution and the subscriptions will remain with NPS Trust for an unspecified period of time with no liability whatsoever to provide any return!

The Defined Contribution-based NPS has replaced the Defined Benefit-based Pension Scheme, and has been made compulsory for central government staff joining service from 1 January 2004.

Before the introduction of the New Pension Scheme, following the budget announcement of 2003-04 the major pension benefit schemes in operation, in addition to the Defined Benefit-based Pension Scheme, which were available for government and public sector employees, were:

• Government Pension Scheme administered by central and state governments, financed through budgetary provisions.

• General Provident Fund out of employees’ contributions which was open to government employees.

• Employees Provident Fund Scheme for employees in firms with 20 or more employees as well as the Employees Pension Scheme, both envisaging contributions by employee and employer.

• Public Provident Fund maintained with State Bank of India, select post offices and other designated banks. This was open to all individuals.

• Annuity schemes marketed by insurance companies including LIC.

The salient features of the NPS are:

• The system would be mandatory for all new recruits to the central government service from 1 January 2004 (except the armed forces in the first stage). The monthly contribution would be 10% of the salary and dearness allowance (DA) to be paid by the employee and matched by the central government. The contributions and investment returns would be deposited in the so called Tier-I account, which cannot be withdrawn.

• Individuals can normally exit at or after age 60 for Tier-I. Upon exit, an individual will be required to invest 40% of the pension to purchase an annuity from an IRDA (Insurance Regulatory and Development Authority)-regulated life insurance company. In case of government employees, annuity should provide for pension for the lifetime of the employee and his dependents, which includes parents and spouse, at the time of retirement as well as receive a lump sum of the remaining pension wealth.

• The central government has paid 8% per annum interest on the balances credited to Tier-I accounts.

• Individuals may also have a voluntary Tier-II account, which can be withdrawn (either part or whole), as an option. This option is given as General Provident Fund (GPF) will be withdrawn for new recruits in Central Government service. These assets would be managed through the same procedure as the Tier-I account. This account does not constitute pension investment and would attract no special tax treatment.

• The beneficiaries of NPS will have the option to leave the pension system prior to age of retirement, in which case, the mandatory annuitisation would be 80% of the pension wealth.

• The NPS envisaged a central record keeping agency and several pension fund managers to offer three categories of schemes to government servants, namely, options A, B and C based on the ratio of investment in fixed income instruments and equities.

• The existing provisions of Defined Benefit Pension Scheme and General Provident Fund would not be available to those who join government service on or after 1 January 2004.

*An independent PFRDA (Pension Fund Regulatory and Development Authority) will regulate and develop the pension (investment) market.
The PFRDA, observing that the NPS has not achieved any significant progress in the private sector, unveiled fresh guidelines for implementation of the scheme. Once again, PFRDA, instead of going deep into the underlying reasons for non-acceptance of the scheme by the masses, reduced the problem as one of ‘marketing’ and made the terms for fund managers more attractive.

Before this, Nagendra Bhatnagar, CEO, NPS Trust had given some interesting information: “NPS Trust now manages assets worth Rs17,000 crore, up from Rs8,585 crore a year ago—an impressive 100% growth. The Scheme’s corpus from informal workers rose 144% to Rs251.67 crore in fiscal 2011-12”.
 

In May this year, PFRDA chairman, Yogesh Agarwal too had taken a similar view and observed that marketing and distribution issues are the biggest challenges. He recalled that the scheme started with the government sector and was extended to the non-government sector without actually carrying out some basic due diligence. The fact that in the government sector it’s a mandatory scheme but in the private sector, it has to be sold like any other financial product was forgotten. To address marketing and distribution issues, he felt, you have to address incentives. According to him the new fee structure for pension fund managers (PFMs) would be a game changer. He said that there is no interest in marketing NPS and added that PFRDA had started addressing these issues and the incentive structure, for points of presence, had been revised. Perhaps the new guidelines toe the same argument.
 

Going out of its way, the finance ministry prescribed targets for rural and urban branches of public sector banks to generate 150 and 50 subscriptions respectively under NPS (Swavalamban accounts). Bankers have already started explaining their view on the poor market acceptance of the scheme. Further pressure from the finance ministry that the number of Swavalamban accounts opened should be taken into account during annual performance appraisal of bank employees, who have been assigned the responsibility of marketing the scheme, is reminiscent of the marketing of “public debt” by some state governments in olden days by pressurising revenue officials to link such sale with their relationship with the public.
 

In reality, the NPS has genetic structural and technical issues which are responsible for its tardy progress. Calling the scheme’s challenges as “marketing and distribution issues” as Mr Agarwal put it, is over-simplifying the real problem and will further delay evolving a rational approach to taking timely corrective measures to make the product “user-friendly” on par with several financial products already in the market which offer similar benefits.
 

In the above background, it is quite natural that there is hardly any response from the private sector. The collection of less than Rs200 crore in fiscal 2011-12 is nothing to rejoice, considering the deployment of thousands of public sector bank branches as points of presence and the amount of pressure put on bank staff.
 

 It is unfortunate that without resolving the problems of acceptable returns, adequacy of the product as a substitute for a time-tested social security instrument (Defined Benefit Pension Scheme) and acceptance at the beneficiary level, the Centre is trying to impose the NPS on states (which have a stake in the coalition at the Centre) and autonomous institutions like RBI and PSUs, including public sector banks.
 

The central government employees covered by the NPS are two-way losers. One, the huge costs savings for the government in pension payout by the switch over to the defined contribution pension system from the defined benefit pension system is a direct charge on the overall remuneration package this category of employees are entitled to. Two, they do not have a window to air their grievances in this respect because the loss is not immediately felt and the full impact of the change will be felt only after 30 years or so when those who joined the service in January 2004 start retiring. It is also true that the anticipated savings in pension expenditure will also start accruing to government only by then. A time tested social security arrangement available to a section of employees has thus disappeared without any alternative system in place. When one refers to social security arrangement, one has in mind all the pension benefits, including family pension. While in the private sector and profit making public sector undertakings employees have an opportunity to bargain and settle remuneration based on their skill and market realities, government employees and those employed in quasi-government and statutory bodies are a helpless lot whose bargaining power is stifled in the name of “public interest”. It is in this context that they deserve a special treatment in respect of social security arrangements.
 

The conscious exclusion of the category of employees covered by the NPS from the Sixth Pay Commission’s purview while referring pension benefits for the Commission’s review made it unnecessary for the Commission to even examine the impact of the change in the pension eligibility in the overall  remuneration package of this category of employees. It is another matter that, because the introduction of NPS was at a time the Indian equities market was performing fairly well, there was a general feeling that pension funds are going to bring attractive returns. The 8% return given by government on pension funds so far, speaks volumes in this regard.
 

Till two years back, there was no thought in the minds of authorities on the arrangements for payment of compensation/family pension to the survivors of central government employees who died in harness. When several such cases came up, as an afterthought, in 2009, the Centre made some interim arrangements in this regard and decided to make provisional payment of family pension to such survivors under Rule 54 of the Central Civil Services (Pension) Rules, 1972. Such payments were subject to an undertaking to be furnished by the pensioner to refund or adjust the provisional payments... out of the final entitlements as sanctioned by the government at a future date. Such uncertainty and imposition of future liability is unheard of in the case of pension payment.
 

When the government is still in two minds about investing funds with the Employees Provident Fund Organization (EPFO) in stock market due to the volatility in the equity market, the timing of introduction of NPS and allowing the entire funds under the scheme to be invested in stocks raises doubts about external pressures on government.
 

The stated objective of reducing the huge burden from Defined Benefit Pension Scheme by introduction of Defined Contribution Pension Scheme is not convincing as the financial burden is unlikely to come down in the near future.
 

It will be imperative for the government to address issues like family pension, reasonable return on pension funds and review the adequacy of the present 10% contribution from government and employees to ensure a post retirement lifestyle commensurate with what the employees are used to. It does not require much calculation to observe that, in its existing form, the NPS will land the employees in a very disadvantageous position, by the time they retire, compared to their predecessors who enjoy Defined Benefit Pension Scheme, as the government’s own estimates show a much larger outgo than the 10% contribution envisaged under NPS, for meeting the pension liabilities under the previous scheme.
 

From the employees’ side, a conscious effort to understand the scenario and factor in these concerns in their savings habits and also in future bargains of salary structure will be necessary.
 

 (Mr Warrier is a former general manager of the Reserve Bank of India)

*Article published @moneylife.in on July 27, 2012. Another version appears in the 2014 book “Banking, Reforms & Corruption: Development Issues in 21^st Century India” by M G Warrier

**Now National Pension System