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Contents

Objective ................................ ................................ ................................ ................................ ........... 3

Introduction ................................ ................................ ................................ ................................ ...... 4

Initial conditions ................................ ................................ ................................ ................................ 6

Present conditions ................................ ................................ ................................ ........................... 10

Reforms that are needed ................................ ................................ ................................ ................. 14

Conclusion ................................ ................................ ................................ ................................ ....... 17

References................................ ................................ ................................ ................................ ....... 19


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Objective

To discuss about the existing pension sector in India and list out possible reforms for the same


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Introduction

An economy, apart from everything else, is a highly fluid transmission mechanism.

Sometimes the smallest of changes have the most complex trickle-down effects. A typical

example of how seemingly minor policy changes can jumpstart the economy can be

illustrated by examining the effects of a reform in the pension system.

India treaded on the path of Liberalization in the early 1990s under Dr. P. V. Narsimha Rao

government and the then Union Finance Minister Dr Manmohan Singh, prior to which Indias

monetary position was in a precarious situation. Before the process of reform began in 1991,

the government attempted to close the Indian economy to the outside world. The Indian

currency, the rupee, was inconvertible and high tariffs and import licensing prevented foreign

goods reaching the market. India also operated a system of central planning for the economy,in which firms required licenses to invest and develop. The labyrinthine bureaucracy often

led to absurd restrictions up to 80 agencies had to be satisfied before a firm could be

granted a licence to produce and the state would decide what was produced, how much, at

what price and what sources of capital were used. The government also prevented firms from

laying off workers or closing factories. Liberalisation led to the dismantling of the licensing

system which was built over the previous four decades. Thus in order to facilitate

liberalisation and to establish a positive rapport with World Bank, Banking and Financial

sector reforms were initiated along with many trade reforms. Private sector Banks including

foreign Banks were encouraged to operate in India. The impact of these reforms may be

gauged from the fact that total foreign investment in India grew from a minuscule US $132

million in 1991-92 to $5.3 billion in 1995-96. Like all the other sectors, pension sector also

got affected. This paper tries to present specifically the reforms in the Pension sector and

major issues related with it.

The OASIS Report first brought out the possibility of pension reform in India. The OASIS

reports about the various data regarding pension sector, its schemes etc. In December 1997, anancial sector policy conference was to take place in Goa the result of whose discussions

resulted in a Project OASIS being initiated by the Ministry of Welfare in July 1998. OASIS

was an acronym for Old Age Social and Income Security. The quest of the project was to

nd implementable policy directions through which the great mass of Indias uncovered

sector could be assisted by a formal pension system, and thus reduce the burden coming upon


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government systems such as the NOAP, which (in any case) were pitifully small when

compared with the scale of expenditure required for a decent existence in old age.

Thus a reform in the pension system tackles the primary problem of the financial sector in a

dual manner. On the one hand introduction of private pension fund managers will ensure thelarge-scale mobilisation of savings. This would increase the rate of savings, which would

lead to a higher rate of capital accumulation, crucial for a developing country like India. It

has been proved statistically that private managers are in a position to earn greater returns

from their sources. So in effect privatising the pension system would place a large pool of

fund in the hands of efficient managers, specialising in this form of activity.

But that answers only half the question. At this point it may be sensible to ask, so where

would these funds be diverted in the absence of adequate channels? This is where the overall

commitment comes into the picture. Admittedly pension reform is only a small part of a

larger programme of allowing private initiative in the economy. The pension reforms largely

determine the source of funds for aged (>60years of age), though there are other minute

sources of funds as follows

Sources of income for Indians over age 60, 2001

Source: Bank staff calculations ., Challenge of Pension Reforms in India, 2002


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Initial conditions

The broad facts about Indian pensions are well known. There are three main components:

1. The Employee Provident Fund Organisation (EPFO) - which is mandatory for private rmswith over 20 employees. This is a blend of a dened contribution (DC) system called the

Employee Provident Fund (EPF), and a dened benet (DB) system called the Employee

Pension Scheme (EPS).

In detail

There are two major programs which are run by the EPFO: they are the Employee Provident

Fund, based on legislation enacted in 1952, and the Employee Pension Scheme (EPS), based

on legislation enacted in 1995. They are mandatory for establishments with more than twenty

employees. Most of Indias labour force is in establishments with less than twenty

employees. The fraction of the labour force in these programs has steadily risen from 1% of

the labour force in 1953 to 5% in 1995. The contribution rates for the two programs are

summarised in the following Table.

Sources of contributions into EPF and EPS

All contributions are expressed as percent of basic wage. Over recent decades, the labour

market has steadily reduced the size of basic wage expressed as a fraction of the total wage.

Hence, these values overstate the true contribution rates as percent of the overall wage bill.

The values shown pertain to the rules that apply for 172 industries. There are ve industries

where slighly different rules apply.

Source: Issues in Pension System Reform in India, Aug 2000, Ajay Shah, IGIDR


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The EPF is a DC program; the participant receives a lump-sum upon retirement. The EPS is a

DB program. It yields a benet rate of 50% of the terminal wage, for individuals who have

contributed for above ten years. The EPFO outsources fund management to a single fund

manager. The rules under which this fund manager operates under are highly restrictive. The

following table shows the required asset allocation.

Regulation of investments for EPF

Source: Issues in Pension System Reform in India, Aug 2000, Ajay Shah IGIDR

2. The civil servants pension - which applies for employees of the government. This is an

unfunded DB scheme.

3. The uncovered sector, which makes up 87% of the workforce. The rst and foremost goal

of pension reforms, is to increase the size of the covered sector. India is at a unique moment

in the demographic transition, where large numbers of young people are coming into the

labour force. If these individuals can be placed into a modern pension system, they will be

able to accumulate pension assets for their old age, and India would then be able to avoid the

crises associated with an ageing population that have been seen in myriad other countries.

But in addition, there were structural problems with the EPFO and with the civil servants

pension which needed to be addressed. The EPS is supposed to be based on contributions and

assets, but is actually underfunded. The expenditure on the civil servants pension was

growing at double digit rates, and a recent paper found that the implied pension debt of the

GOI on account of civil servants alone is probably above 64% of GDP.

Thus, the EPFO and the civil servants pension, both imposed insuperable costs upon the

exchequer. In addition, owing to awed policies in many respects, EPFO typically leaves


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participants without signicant income in old age. In other words, participation in EPFO for

an entire lifetime generally fails to leave a retired person with income security.

The above pensions schemes were considerably changed, during the dawn of Atal Bihari

Vajpayee in 1998 from which the Indian pension saga begun. The policy thinking on perhapsthe most important second generation economic reform for India originated in a tiny, and

perhaps unlikely part of the Government the Ministry of Welfare (which was later renamed

Ministry of Social Justice and Empowerment, abbreviated as MoSJE). The diversified and

vast workforce structure asks for more effective pension reforms.

Workforce structure by employment status (million)

Source: CMIE basic statistics for Indian economy (1993)

One of the many responsibilites of this ministry was the care and welfare of destitute old.

Given the breakdown of intra-family support structures such as the joint family

(cohabitation across generations), income in old age was rapidly becoming a major problem

for the Ministry of Welfare. A program named the National Old Age Pension (NOAP)

Scheme, which paid a tiny means-tested pension of Rs.200 (US$4) per month to a destitute


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person above age 65 had been setup. However, this scheme is plagued by administrative

diculties in means-testing and ineective delivery.

While Indias elderly population had been growing, the ratio of elderly to the overall

population of aged persons had been rising at much faster pace.

Age structure of Indian Population

Source: Indian Pension System: Problems and Prognosis(2001), Ranadev Goswami, IIM B

Data for the 1991 census, which was released in 1995-96, induced considerable concern for

the then Minister of State for Welfare, Maneka Gandhi, when it estimated that the population

of persons over age 60 was at roughly 70 million. Demographic projections also suggested

that life expectancy was rising rapidly, and that a person at age 60 in 1998 could be expected

to live for another 15 years. Projections showed that India would have an elderly population

of 113 million by 2016 and 179 million persons by 2026.

After some years of trying to tackle this situation through traditional approaches, the then

Joint Secretary of Welfare had started thinking out of the box, and had started noticing that in

other countries, the backbone of handling this problem lay in a system of pension funds with


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The linkages of pension system with fiscal and tax policy, labour markets, health and

insurance sectors, and financial markets in general reflect the multi-dimensional character of

pension reform. The pension reform process can therefore be painstaking and long drawn,

with potential to jeopardize or slacken the pace of the overall reform procedure. Hence, in

recent times, the limited initiative to restructure the pension system is marked by a lack of

sustained commitment or application of prudence. With the exception of partial conversion of

some of the provident funds into pension schemes, most of these reforms are practicallyminor adjustments of the current system. Incidentally, such minor adjustments are most

frequent in case of provident funds. From time to time, provident funds have been subjected

to changes in eligibility criteria, contribution and benefit structures or revision in investment

norms.

By the early eighties, there was a growing perception about the limitations of a pure

provident fund arrangement among the organized private sector workers. In 1986, labor

bodies formally approached the Central Board of Trustees (CBT) of the Employees

Provident Fund (EPF) scheme for partial conversion of the scheme in favor of a pension

arrangement. Following some further persuasion, the CBT appointed a committee with the

mandate to restructure the EPF scheme in 1990.

While the committee was developing the framework for a new pension scheme within the

EPF, in a related development in November 1993, the government introduced pension


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schemes for nationalized banks and insurance employees. There has been a long-standing

demand for pension benefits from labor bodies representing these institutions. That the

government acceded to the demand in 1993 is significant as it coincided with the banking

sector reform - giving rise to some speculation that the move was to appease the agitating

employees. The two schemes, known as the Bank Employees Pension Scheme (BEPS) and

the Insurance Employees Pension Scheme (IEPS) were created by diverting the accumulated

employers contribution to the provident funds. The schemes are financed by the employers

contribution to the provident fund contribution, which is equivalent to 10 percent of the basic

wage. Separate pension trusts were created to administer pension schemes for each

institution.

The benefit structure of these schemes replicated the existing pension schemes for the

government employees offering defined-benefit pension on superannuation, death or

disability. The main superannuation pension provides a replacement income of 50 percent of

the final earnings. The pension is indexed to inflation. Participation is mandatory for the new

workers but optional for the existing workers. Meanwhile, the recommendations of the

expert committee on EPF were out for public scrutiny. In a stark contrast to the smooth

transition of provident funds into pension schemes for bank and insurance employees, the

draft legislation for EPF stirred a hornets nest among the workers. The controversy

surrounding the draft bill soon snowballed into an intense debate, both inside and outside the

Parliament. Consequently, the government made some concessions and the original draftlegislation was amended. Most of these labor bargains were aimed at retaining the provident

fund nature of the scheme like liberal withdrawal facilities, commutation provisions, etc.

Even then, it failed to mollify every labor group. Finally, in August 1996, the Parliament,

amidst some opposition, approved the legislation creating the new pension scheme with

retrospective effect from November 1995. The new scheme, known as the Employees

Pension Scheme (EPS), is essentially a defined-benefit program providing earnings related

pension on superannuation, disability or death. Thus, EPF members are now eligible for two

benefit streams on superannuation a lump sum EPF accumulation upon retirement and a

monthly pension from the EPS. The EPS program has replaced the erstwhile Family Pension

Scheme (FPS). The balance amount of about Rs. 90,000 million in the FPS was transferred to

the EPS as the initial corpus. It is financed by diverting 8.33 percent of employers monthly

contribution from the EPF and government's contribution of 1.17 percent of the workers

monthly wages. However, participation to the EPS program is voluntary for the existing


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Different retirement benefits carry different pension schemes

Source: Indian Pension System: Problems and Prognosis, Ranadev Goswami, IIM B


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workers, but mandatory for the new workers whose monthly pensionable earnings do not

exceed Rs. 5000.

The debate surrounding the EPS however continued unabated with many trade unions filing

litigations against the scheme. Aggrieved workers alleged that the pension from the EPS was

substantially inferior compared to the public pension schemes and that the return from the

scheme was even lower than the provident fund arrangement it replaced. The ceiling on the

benefit level and absence of indexation further depressed the return from EPS. Chatterjee

(1996), the principal actuary behind the EPS program, however observed that index linking

of pension is not feasible in case of EPS since there is a high level of pooling of private

employers.

In a parallel initiative to the OASIS, the Ministry of Labor also set up a taskforce to examine

various social security schemes. The report of the committee (Wadhawan Committee),

submitted in May 2000, has called for replacement of the existing social security schemes

with a single integrated comprehensive scheme. The committee recommended the unification

of the Employees Provident Fund (EPFO), Employees State Insurance (ESIC) and the

Employees Pension Scheme (EPS) under the administration of a single agency.

Reforms that are needed

The deficiencies of the current pension system in India are as follows:

y low coveragey under performance of Provident Fund schemesy investment restrictionsy administrative difficultiesy underdeveloped private annuity markety Increase in the informal workforce is further widening the skew ness in the existing

structure of pensions, which in turn introduces distortions into the labour market.

y The differences in pensions between public and private sector employees as comparedto the public sector are wide.


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There is an urgent need to:

y Reduce government burden: In India the number of elderly (persons aged 60 andabove) is expected to increase by 107%, to 113.0 million by 2016.

yInvolve unorganised sector: Barely 34 million (or less than 11%) of the estimatedworking population in India is eligible to participate in formal provisions meant to

provide old age income security. Therefore, almost 90% of Indias workforce is not

eligible to participate in any scheme that enables them to save for economic security

during their old age.

y At present the pension Social Security system is based on employer and employeecontributions, which largely excludes the unorganised sector.

Pension savings accounts represent real and visible property rightsthey are the primarysources of security for retirement. A clear definition of property rights is a reaffirmation of

the rights of people to their accretions.

The reform in the Pension system and the adoption of a system based on funded defined-

contribution Individual Retirement Accounts will have a multi-pronged advantageous effect

on the Indian Economy.

y The governments burden of administering pensions will certainly decrease.y With the entry of private Pension fund managers, pension assets will be invested

wisely thus providing a larger amount to individuals at the time of retirement.

y Pensions, as an issue will be de-politicised and will become more of an economicissue.

y The development of the pension sector will create a symbiotic relationship with theInsurance sector.

y The element of forced saving inbuilt into the system of mandatory contributions willgo a long way in increasing the rate of savings of the household sector which

constitutes the largest part of savers in India. The effective mobilisation of these will

go a long way to aid capital formation and economic growth.


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Changes to the investment rules and increased competition are a necessary but not sufcient

condition for raising long run returns and improving service. The second requirement is good

regulation and supervision. The current system places few demands on the supervisor.

Portfolios are highly restricted and the main task of the EPFO is to ensure that the employers

in the exempt funds actually make the required contributions. In this context, the relatively

light supervision of exempt funds would not be adequate.

In the reformed system described here, supervision will become more complicated. Valuation

will have to be checked frequently, reporting standards will be higher and a series of

safeguards will have to be monitored, including compliance with the new portfolio limits.

Currently, the EPFO functions as both administrator and supervisor. It manages the

individual accounts and investments of three-quarters of EPF members while at the same

time supervising the employers that run exempt funds. The new system will not only require

more resources, but also a staff with a different set of skills from that currently available at

the EPFO.

Systemic reform illustration

Source: Pension Reforms in India(2002) , Robert Palacious


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Many of the issues facing the regulator of the reformed EPF will require experience and

training in nance and insurance. They will need to work very closely with the securities

market regulator and the new insurance regulator. And they will have to be paid comparable

salaries. All of this argues for the separation of private pension supervision from the other

functions of the EPFO.

This model assumes a new pensions regulator, a new set of participants in the asset

accumulation process and an annuity stage that would also have multiple providers. Most

importantly perhaps, it is a system wherein workers in small or large rms, self-employed

individuals and public and private sector workers can participate in a seamless system with a

unied infrastructure of recordkeeping, regulation and supervision. Larger employers that

currently fall into the category of exempt funds would contract directly with one of the

licensed asset managers (LAMs). These dened contribution accounts would be tracked by

the EPFO and would be completely portable from one employer to another. The change

would affect roughly one quarter of the employees covered by the EPFO today and a

signicantly higher share of total system assets.

Conclusion

Indian pension system is passing through a crisis of confidence. The economic, demographic

and labor market trends of the current system are moving in troublesome directions. The

problems that the system is confronting now are quite well known:

Demographic aging: The age structure of the population is changing drastically with

increasing life expectancy and declining birth rates. The result of such demographic transition

will be a larger proportion of older people.

Changing social mores: Collapse of joint family system coupled with pressures of

urbanization and migration are also leading to deterioration in traditional means of support

for the elderly.

Skewed coverage: Existing schemes predominantly cover the organized workers leaving

the bulk of the workforce with little access to any formal system of old age income security.

The coverage is further diminishing due to stronger growth in unorganized employment.


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References

Agarwala R. and Sharma R.K. (1999) Indias Pension System Reform: Challenges and

Opportunities

Does Not india Need a Default Option in the New pension system by H. Sadhak ,

Economic and Political Weekly , Nov 09.

Sinha Tapen, Privatization of insurance market in India: from British Raj to Monopoly Raj to

Swaraj, CRIS Discussion Paper series.

Bank staff calculations, Challenge of Pension Reforms in India, 2002

Pension Reforms in India (2002) , Robert Palacious

Indian Pension System: Problems and Prognosis, Ranadev Goswami, IIM B

Issues in Pension System Reform in India, Aug 2000, Ajay Shah, IGIDR

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