the emerging pension scenario in india

7/29/2019 The Emerging Pension Scenario in India

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A PROJECT ON

THE EMERGING PENSION

SCENARIO IN INDIA

Submitted to

Director General,

Prof. P.V. NARSIMHAM

By:

MS. AYESHA B. GAGRAT

M.M.S. FINANCE

ROLL NO. 15

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS

OF THE MASTER OF MANAGEMENT STUDIES (M.M.S.)

DEGREE COURSE 2003-2005


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UNIVERSITY OF MUMBAI

CERTIFICATE

This is to certify that the project titled The Emerging Pension Scenario In

India, been submitted by Ms. Ayesha B. Gagrat, Roll No. 15, towards partial

fulfillment of the requirements of the Master of Management Studies

(M.M.S.) degree course 2003-2005, has been carried out by her under the

guidance of Prof. P.V. Narsimham at the K.J. Somaiya Institute of

Management Studies and Research, Mumbai 400 077, affiliated to the

University of Mumbai.

The matter presented in this report has not been submitted for any other

purpose in this institute.

Prof. P.V. Narsimham,

Project Guide & Director General,

K.J. Somaiya Institute of Management Studies and Research, Mumbai.

15th of March 2005


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Acknowledgements

I would sincerely like to thank my project guide,

Director General, Prof. P.V. Narsimham, for his

valuable support, guidance and encouragement given

to me during the course of this project.

I am grateful to the library staff of the institute for

their timely co-operation. I also thank the

administrative staff members for providing help at

various stages.

I extend my heartfelt gratitude to my colleagues and

other good wishers who contributed towards the

successful completion of my project work

Dated March 15 2005

Ayesha B. Gagrat


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Old age is the most

unexpected of all things that

happen to man.

- Leon Trotsky


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Preface

Preface

As science and medicine become more advanced, all over the world the population of old

people is growing rapidly. Supporting oneself at that age requires considerable savings

that have been got through good intelligent investment practices through the early years.

In India the joint family concept with the Patriarch as the pivot, traditionally provided

Old Age Security. This was adequate in a agrarian & rural society

But as time passed by industrialization and urbanization undermined the traditional

concept. Today, in India, old age seems to be most unanticipated and unfortunately the

groundwork for meeting the financial demand that old age entails is quite inadequate.

This report studies the pension sector in India along with the various reforms undertaken.

It starts by explaining what pensions are along with their characteristics. It throws light

on the current retirement benefit scenario in India, leading to the deficiencies in this

sector, thus the need for reforms. The recent reforms as well as the challenges ahead have

been highlighted in the report at the end.

Project Report By: Ayesha Gagrat


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Table of Contents

Table Of Contents

1 Executive Summary.. 1

2 Introduction... 4

3 Pension Defined.. 6

3.1 What is Pension 6

3.2 Pension System Characteristics... 6

4 Current Retirement Benefit Scenario & Historical Background. 10

4.1 Current Schemes: For Government and Public Sector Employees. 11

4.2 For the Organised Sector Employees.. 12

4.3 For the Unorganised Sector. 16

4.4 Tax Treatment of Provident Funds, Pension & Regulation of their Funds.. 18

4.5 Latest Investment Guidelines .. 19

5 Need for Pension Reforms.. 21

6 Project O.A.S.I.S. 28

6.1 Introduction... 28

6.2 Goals before the OASIS Committee in framing the New Pension System.. 33

6.3 Features of the Report... 38



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Table of Contents

7 The Indian Pension Reform of 2003.. 46

8 Pension Fund Regulator and Development Authority Ordinance. 56

9 Challenges Ahead 70

10 Conclusion... 73

11 Appendix- A Case Study.... 75

12 References... 86



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Executive Summary

Chapter 1

Executive Summary

In India, retirement benefits consist of three different systems. There is the system of

Provident Fund, Gratuity and Pensions. Pension is a mechanism for saving for the old age

by building a fund during the earning years of individuals, which, if managed properly,

can provide them adequate income in their twilight years.

Everywhere old age is unanticipated but in India the groundwork for it is not enough. The

hangover of the welfare state ideology has resulted in government sponsorship of a

large part of pensions, which are a major part of government expenditure. As of now,

payment of pensions constitutes a large part of the governments expenditure. This is

expected to increase more so in the future as the improvements in health have resulted in

an increased life span of the elderly.

Indias Pension System has a low coverage and there is an under performance of

Provident Fund schemes. Investment restrictions exist along with administrative

difficulties. The private annuity market is underdeveloped and an 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. The Social Security system is based

on employer and employee contributions, which largely excludes the unorganised sector.

Project Report By: Ayesha Gagrat1


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Executive Summary

Also the differences in pensions between public and private sector employees as

compared to the public sector are wide. Thus there is an urgent need to reduce

government burden and involve the unorganised sector as at present the pension.

The reason that led to reforms was that the existing retirement benefit schemes suffered

from various drawbacks. Government worried over the ever-increasing cost of the

inflation linked Defined Benefit scheme, which was on a pay as you go basis. Reforms

were also triggered by estimates of the burgeoning pension liabilities of the Government.

Given Indias demographic forecast, life expectancy is increasing while birth rates are on

the decline, that is the share of population above the age of 60 is growing at a rapid rate.

Thus in the last few years, a number of important developments and studies have led the

Government of India to reexamine the various public programs meant to ensure old age

income security for its workforce and consider reform strategies which include an

increased role for privately managed, defined contribution schemes. The OASIS Report

first brought out the possibility of pension reform in India. The Committee presented its

report in January 2000 recommending a system for private-sector management of pension

funds to generate market-linked returns, based on individual retirement accounts, with

product choices, accessible through points of presence, contributions being flexible.

There would be professional funds management, as well as portability through

centralized record-keeping, central depository and administration.



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Executive Summary

While presenting the Union Budget for 2003-04, the Finance Minister announced the

Governments intent to introduce the above, pension system Also the government

proposed to set up a new agency called the Pension Fund Regulatory and Development

Authority (PFRDA) to supervise and regulate the functioning of this new pension system.

This initiative would enable the government to gradually transit to a fully funded pension

scheme for all its employees over the next few decades. It would also, for the first time,

provide a vehicle for informal sector workers to save for their retirement during their

working lives. This will in turn contribute to greater income security in old age for our

workforce as India enters its demographic transition. By reducing fiscal pressures caused

by unfounded or inadequately funded pensions and by channeling long-term savings

effectively, the new pension system will benefit a much wider population in the decades

to come.



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Introduction

Chapter 2

Introduction

It is surprising how the mathematics of compounding can manifest a relatively small

saving today into a sufficiently large pool of resources tomorrow. A countrys pension

system is an attempt at capturing this mathematical phenomenon into its policy initiatives

to ensure that the contributors to the Gross Domestic Product today are not left wanting

tomorrow. The relevance of an efficient pension system is further accentuated in a

developing economy where the smallest of policy changes can have the most complex

trickle down effect.

A formal old age security system has been neglected in India largely because a major part

of the nations population placed reliance on the next generation as an old age support

mechanism. But with the growing westernisation of the country, nuclear families appear

to be the order of tomorrow. With the age-old joint family system undergoing dilution, it

was about time that India formulated a robust pension system to provide adequate

income, to the aged in their twilight years.

Pension systems should be conceived as long-term financial contracts under which

pensioners contributions today are exchanged for benefits tomorrow. Monetary

payments on or after one has ceased to work, can be made in a number of ways, say lump



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Introduction

sum on retirement or regular series of payments for a certain number of years or lump

sum on death or series of payments to dependents etc. These can be in combination of

two or more or on stand-alone basis. All these benefits are known as Pension or

Retirement benefits or Superannuation benefits and exact nomenclature for the same type

of benefits varies form country to country.

In India, as of now, there is no unique definition of pension. What is commonly

understood by pension is the stream of regular monthly payments made till death,

commencing from retirement.



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Pensions Defined

Chapter 3

Pensions Defined

What Is Pension?

Pension is a mechanism for saving for the old age by building a fund during the earning

years of individuals, which, if efficiently and profitably managed by competent people,

can provide them adequate income in their twilight years. Pension systems should be

conceived as long-term financial contracts under which pensioners contributions today

are exchanged for benefits tomorrow.

A countrys pension system is an attempt at capturing this mathematical phenomenon and

when managed by competent people, can provide them adequate income to support

themselves in the latter years of their lives.

Pension System Characteristics

Pension products either individually or in group are placed in two types : the ones which

define or prescribe benefits which are delivered when due but assets are not created to

deliver the same prior to occurrence of the benefits. Necessary resources are arranged as

and when benefits fall due. In the other, assets are created to generate benefits to be

delivered when due, whether benefits are defined / prescribed in advance or not. The

former pension plans are called Un-funded or Pay-as-you-go (PAYGO) system and the



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Pensions Defined

later is called Funded. In either case, the benefits can be pre-defined in which case the

plan is called Defined Benefits (DB) type and in case where the plan is funded and

benefits are not pre defined or prescribed, the same is called Defined Contribution (DC)

type.

The following matrix explains the relationship.

Type DC DB

Funded

Un-funded

The pension products need to incorporate various characteristics so as to capture varying

circumstances. The following matrix attempts to capture the relationship of plan types

with various characteristics.

Characteristics Pay-as-you-go or Un-funded Funded

Financial System A method of financing

whereby current outlays on

pension benefits are paid out of

current revenues.

The accumulation of

pension reserves that

satisfy 100% of the

present value of all

pension liabilities owed to

current members.

Contributions Non Defined

They are neither fixed nor

Defined

A pension plan in which



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Pensions Defined

uniform. At the beginning,

when there are few pensioners,

the contribution is small but, as

the pension system matures

and the population ages, the

contribution must be raised.

the periodical pension is

prescribed and the benefit

depends on the

contribution plus the

investment return.

Benefits Defined

Benefit is regulated by law/

pension scheme, which

establishes its minimum and

maximum, provides a formula

to calculate the pension

according to the years of

service and amount of income.

Non-Defined / Defined

1. Non-defined : the

insured gets the pension

resulting from his / her

contributions (defined

contribution).

2. Defined : Defined

Benefits Plan where the

present values of all

obligations to date are

funded.

It has to be noted that under the DC scheme, the liability of the provider of the pension

scheme is fixed and has to be provided from year to year. Once the defined contribution

is made for the year, the providers liability ceases. Under a DB scheme, since the

ultimate pension payments are linked to the final salary, the liability is very much



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Pensions Defined

dependant on inflation as also the interest earned by the pension fund. If the DB scheme

is inflation linked, then the liability goes on increasing throughout the retired lifetime of

the pensioner.



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Current Scenario & Historical Background

Chapter 4

Current Retirement Benefit Scenario

& Historical Background

To understand the current Retirement Benefit scene a little historical background would

help. The current scene is substantially employee oriented. Also the Indian Pension

market is ring fenced by legislative provisions including taxation.

It has to be noted that in India, retirement benefits consist of three different systems.

There is the system of Provident Fund where the employee contributes a percentage of

his salary to a fund with a matching contribution from the employer. The accumulated

amount is given to the employee on his retirement. The second system is known as

Gratuity. This is a lumpsum payment by the employer on the employee ceasing to be in

service. The lumpsum will be a product of the final salary, the number of years of service

and the rate of payment of gratuity. The third system is the Pensions, a series of payments

made after retirement from service till the end of life.

The system of Pensions in India is a legacy of the British rule. The Civil Service in our

country have always had the Pension System of retirement benefits. In the corporate



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world, in the early days of independence, this system was hardly in existence. It existed

only in some of the multinationals. The Provident Fund system has been in vogue in India

for a very long time. Some corporates also started giving gratuity over and above the

provident fund. With the two benefits in vogue and later on legislation making these two

benefits mandatory, the Pension system had no chance to grow. However, the first signs

of change did come with the passing of the Payment of Bonus Act, which places a cap on

the payment of bonus. Officers and executives were at the receiving end of this

legislation. To overcome this drawback many corporates started providing pensions as a

third benefit to their officers and executives.

With this background, discussed below is the current retirement system existing in India.

Current Schemes

1. For Government and Public Sector Employees

The Government of India and State Governments administer separate pension programs

for civil employees, defence staff and workers in railways, post, and telecommunications

departments. This is called the Civil Servants Pension Scheme (CSPS). These benefit

programs are typically run on a pay-as-you-go, and are index linked defined-benefit

schemes. The schemes are non-contributory i.e. the workers do not contribute during

their working lives. The entire pension expenditure is charged in the annual revenue

expenditure account of the government. The Government also operates Provident Funds

to which only the employees contribute. The employees are also entitled to gratuity to the

extent of death in service, which is very generous, and also on retirement from service.



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The basic pension payable to an employee with service of 33 years and above is 50% of

10 months average of final salary, with proportionate amount for service less than 33

years. Basic pension attracts Dearness pension, which is revised form time to time in line

with the revision of D.A. of employees in service. There is also provision for

widows/orphans, pension in case of death of employee and disability pension.

Certain Quasi-Government organizations like Reserve Bank of India and Public Sector

Financial Institutions like banks and insurance companies also have inflation linked

defined benefit pension plans and employee contribution to provident funds.

2. For Organised Sector Employees

Employees' Provident Fund (EPF)

The EPF programme, established through the Employees Provident and Miscellaneous

Provisions Act 1952, is a contributory provident fund providing benefits upon retirement,

resignation or death, based on the accumulated contributions plus interest, from

employers and employees. The Act applies to specific industries and establishments,

employing more than 20 employees. The specified contribution is10-12% of salary from

the employee with a matching contribution from the employer.

Subscribers to the EPF have the option to make partial withdrawals for specified

purposes such as house construction, higher education for children, marriage, and

medical expenses associated with illness. Establishments covered by the EPF can either



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have the EPFO manage the provident fund, or can undertake processes to qualify as an

exempt establishment, whereby they manage the provident fund themselves. In general,

exempted establishments are large companies. (Private Provident Funds)

In India since withdrawals are permitted from Provident Funds, it negates the purpose for

which it was originally set up for i.e. as a fund that would cover expenditure during the

lifetime after retirement.

There are similar enactments of Provident Funds applicable to specified vocations like

Seamens Provident Fund Act, Coal Mines Provident Fund Act, etc., which operate more

or less on similar lines as Employees Provident Fund and Miscellaneous Provisions Act.

Employees' Pension Scheme (EPS)

The EPS, established in 1995, provides for the payment of a members pension upon the

members superannuation/retirement, disability, and widow/widower pension, and

children's pension upon the members death. The EPS program has replaced the erstwhile

Family Pension Scheme (FPS). Employers that are not mandated to be covered may

voluntarily apply for coverage. 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 amount of the pension benefit is based on the



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employee's average salary during the final year of employment and the total number of

years of employment. Under the EPS, members must have completed a minimum of ten

years of service and must be atleast 58 years old. However, if an employee has completed

twenty years of service, he/she may obtain an early pension from age 50. Under this

provision, the amount of pension benefit is reduced by 3 per cent for every year falling

short of 58. Exemption from the EPS is allowed, but in this event, the employer will have

to cover the government's contribution.

However, participation to the EPS program was voluntary for the existing workers as on

1995 but mandatory for the new workers whose monthly pensionable earnings did not

exceed Rs. 5000, now Rs. 6500. 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. The debate

surrounding the EPS continues unabated till today, with many trade unions filing

litigations against the scheme.

This programme is funded by utilizing a part of the employers contribution to EPF

(namely 8 1/3% of the salary, with a cap on salary of Rs. 6500) The Government also

contributes 1.16% of the salary, the amount that they were contributing to the erstwhile

Family Pension Scheme. In a way this is defined benefit pension scheme with a defined

contribution. The E.P.F.O, which manages the scheme, gets an actuarial valuation



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conducted form time to time. The latest actuarial report reveals a deficit in the fund of

Rs. 17,000 crores as revealed in the newspapers.

Employees' Deposit Linked Insurance Scheme (EDLI)

The EDLI programme was established in 1976. This programme provides lump sum

benefits upon the death of the member equal to the average balance in the members EPF

account for the 12 months preceding death, up to Rs. 25,000 plus 25 per cent of the

amount in excess of Rs. 25,000 up to a maximum of Rs. 60,000. This programme is

funded by contributions from the employer at the rate of 0.51% of salary.

Payment of Gratuity Act, 1972

In addition to the provident fund, workers in both public and private sectors receive a

second tier of lump sum retirement benefit known as gratuity. It is paid to the workers

who fulfill certain eligibility conditions like a minimum qualifying service period of five

years. It is equivalent to 15 days of final earnings for each years of service-completed

subject to a maximum of Rs. 350,000. The cost of gratuity is entirely borne by the

employer.



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Pensions

For a very small minority of employed population, there are pension schemes also.

MNCs and large Indian industrial houses have designed a voluntary pension scheme for

the benefit of their staff (in most cases management staff). Most of these schemes are

non-contributory.

3. The Unorganised Sector

The Public Provident Fund (PPF) scheme, introduced about three decades ago, is meant

to provide unorganised sector workers with the facility to accumulate savings for old age

income security. Under the scheme, amounts between Rs 100 to Rs 60,000 per annum,

now RS. 70,000 can be deposited into the PPF account. These investments are eligible for

tax rebate under Sec 88 of the Income Tax Act and the interest is fully tax-exempt

under Sec 10.

The scheme has poor coverage because of ineffective marketing and the service delivery

is grossly inadequate. Being largely urban centric, the scheme is used more as a tax

planning vehicle by high-income savers than an old age income security plan.

In an effort to widen the reach of the social safety net for the aged poor, the central

government, in 1995, introduced a more comprehensive old age poverty alleviation

program called the National Old Age Pension (NOAP) under the aegis of the National

Social Assistance Programme (NSAP). The scheme aims to provide monthly pension to



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thirty percent of the poorest elderly. This programme provides benefits for poor people

above the age of 75 years. Under the programme a pension of Rs. 75/- per month is

provided to eligible persons.

Besides the above there are many pension products of insurance companies and mutual

funds, which are essentially, tax centric. Tax benefits are available for investment in such

plans. Sec 10(23AAB) read with 80CCC of the Income Tax Act 1961 and Sec 10(23D)

along with Sec. 88 (2)xiii(c) provide tax relief for such schemes. To name a few schemes:

Jeevan Suraksha of LIC

ICICI Pru Forever Life of ICICI Prudential Life Insurance Co Ltd.

Retirement benefit plan form UTI

Kothari Pioneer Pension Plan from Kothari Mutual Fund

The formal old age income security system in India can thus be classified into three

categories:

The upper tier consists of statutory pension schemes and provident funds for the

organised sector employees.

The middle tier is comprised of voluntary retirement saving schemes for the self-

employed and unorganised sector workers.

The lower tier consists of targeted social assistance schemes and welfare funds for

the poor.



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Tax Treatment of Provident Funds, Pensions & Regulation

of their Funds:

Under the present system, a beneficiary is entitled to a limited relief on the contributions

that he makes to Provident Fund and Superannauation Fund. Contributions made by the

employer are not taxable in the hands of the employee. Interest credited to the account of

the beneficiary is not taxed .On cessation of employment, accumulations from Provident

Funds are completely tax free (subject to a five year vesting).

In case of superannaution funds, the accumulations are permitted to be utilized to pay a

monthly/periodical income, which is taxable as salary. A part of this monthly income is

permitted to be commuted for a tax-free lump sum. The above mentioned position exists

for both the private funds as well as the statutory funds.

Private Pension/ Gratuity/ Provident Funds in order to qualify for tax benefits have to

obtain approval of their scheme form the Income Tax Department. The IT department

when granting recognition to the scheme imposes many conditions. The most important

is the imposition of the pattern of investments, which must be followed by the funds.

There is also a ceiling to the contribution that can be made. One provision for approval of

pension schemes is that on cessation of service, the fund must purchase the annuity from

LIC. This has been one of the factors, which has hampered the growth of Pension

Schemes in India.



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The Government from time to time alters the guidelines on investment. The bias in

investment is more on Government Securities. Recently on revising the guidelines, the

Government has allowed investment in corporate equities for the first time.

Latest Investment Guidelines:

The latest guidelines to be followed from 1 st April 2005 for investment announced by the

government which are to be followed by non-Government, Superannuation Funds and

Gratuity Funds are as given below:

% amt to be

invested

(i) Certain defined Central Government securities and /or units of

such mutual funds which have been set up as dedicated funds for

investment in Government securities regulated by the Securities

and Exchange Board of India

25%

(ii) (a) Government securities as defined by any State Governments

and /or units of such mutual funds which have been set up as

dedicated funds for investment in Government securities

regulated by the Securities and Exchange Board of India and/or

(b) Any other negotiable securities where the principal and interest

is fully guaranteed by the Central Government or specified State

Governments.

15%



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The exposure of a trust to any individual mutual fund, which ahs been set up as a

dedicated fund for investment in Government securities should not be more than 5% of

its portfolio at any point of time.

(iii) (a) Bonds/Securities of Public Financial Institutions, Public Sector

Companies and Public Sector Banks; and/or

(b) Term Deposit Receipts upto 3 years issued by public sector banks

(c) Collateral Borrowing and Lending

25%

(iv)

(v)

(a) To be invested in any of the above three categories as decided

by their Trustees

(b) Shares of companies that have an investment grade debt rating

from at least two credit rating agencies

30%

5%

(vi) The trustees, may invest upto 1/3rd of (iv) above, in private sector

debt instruments and/or in equity-linked schemes of mutual funds

regulated by the Securites and Exchange Board of India.

Any money received on the maturity of earlier investments reduced by obligatory

outgoing has to be invested in accordance with the investment pattern prescribed in the

notification

In case the rating of any of the instruments mentioned above falls below the investment

grade, confirmed by two credit rating agencies, the exit option can be exercised.



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Need for Pension Reform

Chapter 5

Need For Pension Reform

India A Demographic Analysis

Necessity is the mother of invention; this may be true of policy reforms also. The necessity for

pension reforms was triggered by estimates of the burgeoning pension liabilities of the

Government, given Indias demographic forecast. India is in the phase of a rapid

demographic transition. Life expectancy is increasing while birth rates are on the decline.

As per the report submitted by the Old Age social and Income Security Committee (OASIS),

global demographics suggest that the population of the world is ageing with about one-eighth of

the worlds elderly living in India. The share of population above the age of 60 is growing at

a rapid rate. Those who cross the age of 60 are expected to live till or beyond the age of

75. This has not sufficiently dawned in the minds of our people. They tend to be myopic

and are not saving sufficiently for old age, a period of 15 to 17 years beyond the age of

retirement. There is a serious threat that persons who were not below the poverty line,

might sink below the poverty line in their old age, since not enough savings have been

made by them. On the other hand, they have to incur heavy expenditure on health, neglect

of which will only worsen their quality of life. Destitution and ill health could lead to

rampant devastation of life of aged people under such circumstances.



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Populations, worldwide, are ageing. In India, while the total population is expected to rise

by 49% (from 846.2 million in 1991 to 1263.5 million in 2016), the number of aged

(persons aged 60 and above) is expected to increase by 107%, from 54.7 million to 113.0

million, in the corresponding 25 year period. In other words, the share of the aged in the

total population will rise to 8.9% in 2016 (from 6.4% in 1991). Population estimates

further suggest that the number of the aged will rise even more rapidly to 179 million by

2026 - or to 13.3% of the total Indian population of 1331 million.

Today, males and females in India at age 60 are expected to live beyond 75 years of age.

Thus, on an average, an Indian worker must have adequate resources to support himself

for approximately 15 years (and his wife for an even longer duration) after his retirement.

Traditionally, governments and societies provide economic security during old age

through pension provisions. Sound pension systems form a social safety net for reducing

poverty during old age. However, a rise in the number of older persons often causes a

corresponding increase in government expenditure on non-contributory pensions and

health services - since health and pension spending rise together. Higher government

spending on old age security has often been at the cost of expenditure on other important

public goods and services and has increasingly been a serious drain on government



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drawing a monthly salary of 6500 or more have the option to opt out from contributions

to Provident Fund.

Over 28% (13 million) of the salaried employees and approximately 89.2% (280 million)

of the workers (including self-employed and farmers) are not covered by any pension

scheme that enables them to save for economic security during old age. Though the

Public Provident Fund (PPF) was introduced in 1968-69 to provide a facility to self

employed persons to save for old age, it today serves only as a medium term savings

instrument with liberal withdrawal facilities and tax benefits. Thus, the present formal

provisions for old age income security in India cover less than 11% of the estimated

working population.

However, even for these individuals, incomes generally fall below poverty line during old

age despite the high levels of contribution (over 24% - among the highest in the world)

prevailing in India. This is primarily due to low real returns and generous withdrawals.

For instance, in 1996-97, Rs.2047 crores was prematurely withdrawn by 1.20 million

provident fund members to fund marriages, illness, housing and purchase of insurance

policies. In the same period, a total of Rs.3306.15 crores was paid out to 1.32 million

outgoing provident fund members on account of retirement, death or leaving service -

indicating an average lump-sum accumulation of Rs.25,000 per member.

Over the last decade, provident funds in India have earned a return of little over 2.5%

over inflation for their members (as against 11% in Chile). On the other hand, the long-



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run average rate of return on the equity index in India is 18.5%, which has the potential to

revolutionize the wealth accumulation over a worker's lifetime. The average wealth that

is obtained by investing Rs.5 per working day into the equity index, from age 25 to age

60, works out to Rs.36,00,865. Over such a long term horizon, there is a 99% chance that

equities outperform bonds.

While we witness an increase in the number of aged, and insufficient accumulations for

old age, the traditional, informal methods for income security, such as the joint family

system in India, are increasingly unable to cope with the enhanced life span and medical

costs during old age.

There is growing stress in the family system and there is an immediate need for

introduction of formal, contributory pension arrangements, which can supplement

informal systems. This problem is particularly important in India, which will enter its

demographic transition into increasing number of aged persons at lower income levels

than those seen in other countries which have since long introduced systems to cope with

the problems of an ageing population.

India has been among the enlightened nations, which recognised the need for social

security during old age quite early. The Provident Fund Act was introduced way back in

1925 for select public enterprises. We have the Employees Provident Fund and

Miscellaneous Provisions Act (EPFMP) of 1952 which covers 177 industries today. From



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1995, workers covered under the EPFMP Act, 1952 are also covered by the Employees

Pension Scheme. While these have been laudable steps, and are serving the working class

well, their coverage is woefully small, with only 11 percent of the working population in

India covered by them.

There is also the Public Provident Fund (PPF) scheme for self employed and those not

covered by the EPFMP Act. Though good in intention, the PPF has not been well

publicised, and as a consequence, its clientele is basically confined to large cities. It is not

easily accessible either.

The final reason as to why India needs reforms in its pension sector is that formal systems

of retirement income provision suffer from three major weaknesses problems of

funding, problems of investment restrictions and administered rates, and problems of

mismanagement of funds. Each of these problems is present to varying degrees in many

of the pension and provident funds in India. The ultimate impact of these problems will

be to place greater demands for taxpayer-financed bailouts of these funds a solution that

is not sustainable in an already difficult fiscal situation. This point has been illustrated in

the Seamans Provident Fund case attached in the appendix.

Thus to conclude, projections suggest that the number of aged will rise more rapidly to

176 million by 2026; i.e. by 2025, it is anticipated that about 13.3 percent of Indias

population will be above 60 years of age. This in monetary terms would mean that where



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the Government has to provide a lowly amount of Rs 100 per month as pension to the

projected 175 million elderly, it would translate into a whooping annual outflow of over

Rs 210 billion (about USD 4.7 billion). This figure may increase further if the increasing

average life expectancy is factored in the years to come. The proposed pension reforms

suggested to address this change in Indias demographics should be viewed in the context

of the existing pension system in India and its deficiencies.



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Chapter 6

Project O.A.S.I.S.

(Old Age Social And Income Security)

Introduction

The least noticed of the destitute in India are the elderly. Millions of elderly in India are

trapped in misery through a combination of low income and poor health.

The traditional support structure of the family is increasingly unable to cope with the

problem. In a world where the joint family is breaking down, and children are unable to

take care of their parents, millions of elderly face destitution. The emerging demographic

profile and socio-economic scenario of the country indicate that matters will worsen

dramatically in the years to come.

While there is a need to initiate poverty alleviation programs designed to support the

elderly, the gigantic dimensions of the problem defy an easy solution. The steady

elongation of life expectancy and declining birth rates are inexorably taking us towards

an India where there will be such a large number of aged persons, that a poverty

alleviation programme, which aims to pay even a modest subsidy would require a

staggering expenditure much beyond the capacity of the government.

Project Report By:Ayesha Gagrat28


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In this situation, the Government realises that poverty alleviation programmes directed at

the aged alone cannot provide a complete solution to the problem. Faced with such large

numbers, it is apparent that the problem will have to be addressed through thrift and self-

help, where people prepare for old age by savings accumulating through their decades in

the labour force. The role that the Government can play in this enterprise is to create an

institutional infrastructure to enable and encourage each citizen to undertake this task.

Project OASIS, the first comprehensive examination of policy questions connected with

old age income security, took birth in this background. The basic mandate of the Project

is to make concrete recommendations for actions, which the Government of India can

take today, so that every young person can genuinely build up a stock of wealth through

his or her working life, which would serve as a shield against poverty in old age.

It is interesting to note that India already has a high contribution rate to the provident

fund system from amongst salaried employees in large establishments. The challenge

therefore is not so much to ask workers to save more but to convert high saving rates into

old age security.

The inefficiencies of the pension system and Indias precarious pension liability was first

recognised by the Government in 1998. Consequently, the Government commissioned a

national project titled OASIS and nominated an eight member expert committee that

constituted of representatives from the Ministries of Finance, Labour and Social Justice



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chaired by Mr. S.A. Dave to suggest policy changes to the existing pension framework.

Thus the OASIS Project was commissioned as the first comprehensive study of Indias

pension sector by the Ministry of Social Justice and Empowerment, Government of India,

to Invest India Economic Foundation (IIEF) in August 1998. The OASIS Committee

commissioned over 25 research papers and studies to domestic and overseas experts and

conducted several technical consultations to elicit opinions and create policy awareness

and consensus on the core principals of pension system design. During the process, the

OASIS Committee also received inputs from a team of experts from The World Bank.

The final OASIS report was submitted to Indias Prime Minister on January 14, 2000 at

New Delhi.

While the original mandate and focus of the Project OASIS Expert Committees report

was on the ninety-percent of workers that are not covered by any pension scheme in

India, it eventually raised awareness regarding the overall state of the pension system. Its

proposals are now seen as an option to be considered beyond the informal sector.

Specifically, as the pressure on government finances due to an aging civil service grew,

the paradigm shift advocated by the OASIS report gained support.

Part of the awareness that was created by the OASIS Project and other efforts was

recognition of the deficiencies of the existing system that provided strong rationale for

reform. Low coverage, flaws in the benefit formula and indexation procedures that

produce inequities between and within generations, and most notably, the risk that



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promises could not be kept in light of projected pay-as-you-go deficits were found to

undermine the social objectives of the existing system. In fact, it was not clear that those

social objectives had ever been clearly defined and in this way, the OASIS Project helped

raise fundamental questions as to the objectives of the system itself.

Importantly, the OASIS Project brought the debate on pension system design and reform

into the public domain. However, even from the outset, the policy discussion was not

limited to the internal workings of the pension system. The fact that fewer than one in

ten workers are covered by a pension system in a country with high levels of absolute

poverty makes the indirect impact of the pension system on the economy more important

than usual. Such indirect effects could be positive for example, when a pool of long

term savings is created and is effectively channeled into projects that increase economic

growth, or when pension funds contribute to greater liquidity and depth in domestic

capital markets. However, these indirect effects can also be negative, as is the case when

governments use the savings to increase wasteful public consumption or when high

contribution rates add to the incentives for small firms to remain in the informal sector.

In the case of civil service pensions, the program may also begin to crowd out other

social programs as the pension bill eats up a rising share of tax revenues.

As the national dialogue on pension policy progressed, it was also important to recognize

the opportunities and constraints for pension reform created by changes in other parts of

the economy. There were important developments in the financial sector that improved



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the prospects of a funded pension system including the end of the 50 year monopoly of

the Life Insurance Corporation of India and the introduction of modern technology in

Indias securities markets. The growth of the private mutual fund industry, including

partnerships with foreign firms, is especially relevant to the proposed reform.

Meanwhile, the presence of new, voluntary private pension products provided additional

rationale for the creation of a specialized pension regulator. These developments made it

more likely that a defined contribution scheme of the type advocated by OASIS could

succeed.

The Ministry of Social Justice and Empowerment is entrusted with the nodal

responsibility for care of older persons. The Ministry has been increasingly concerned

with the issues of ageing, health and income security during old age as well as its close

links to mental and emotional well-being.

As a culmination of this growing concern, and coincidentally with 1999 being declared

the "International Year of Older Persons", the Ministry commissioned the national

Project titled "OASIS" (an acronym for Old Age Social and Income Security) and

nominated an 8-member Expert Committee to examine policy questions connected with

old age income security in India. The Project OASIS Expert Committee was mandated to

make concrete recommendations for actions that the Government of India can take today,

so that every young worker can build up a stock of wealth through his or her working life,

which would serve as a shield against poverty in their old age.



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The research and recommendations under Project OASIS have a twin focus: that of

further improving existing provisions, and, to devise a new pension provision for

excluded workers who are capable of saving even modest amounts and converting this

saving into an old age income security provision. The Report on reforms to the existing

provisions was submitted to the Ministry of Social Justice and Empowerment

in February 1999.

The objective of this Report is to recommend a pension system which can be used by

individuals spread all over India, which enables them to attain old age security at the

price of modest contribution rates through their working career. It is simple and

convenient to use and has the capability for converting modest contributions into

reasonably large and comfortable sums in an almost risk-free manner for old age security.

Goals before the OASIS Committee in framing the New Pension System

(a) Today, we in India face severe problems in the form of poverty amongst the elderly.

In addition, three powerful forces are at work which ensure that the problem will worsen

in the years to come:

Improvements in health are increasing longevity, which means that more people are

living to ever-longer life spans. Present demographics suggest that a person who survives

to age 60 has, on average, 17 years ahead of him. This number may rise to 25 years in the



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coming decade. This would mean that a person who retires at the age of 60 has to plan to

live for a quarter century without a wage income.

Families are becoming smaller as people have fewer children. Geographical labour

mobility implies that children are increasingly likely to be geographically separated from

their parents. Individual and social values are changing so that the joint family is

increasingly considered unattractive. All these factors are leading to a situation where the

young are increasingly unable or unwilling to have parents living with them.

Improvements in education and health are generating new expectations on the part of the

elderly for the minimal level of consumption that is considered acceptable.

(b) In the face of this problem, it is clear that anti-poverty programs will simply not

suffice in addressing the problem. The sheer number of the elderly is too large, and the

resources with the State are too small, to make anti-poverty programs the central plank in

thinking about the elderly.

International experiences, and common sense, suggest that Government dole is not

sustainable on a significant scale, that economic security during old age should

necessarily result from sustained preparation through lifelong contributions and the

central values that a pension system should emphasise are self-help and thrift.

(c) Hence, the need to establish an institutional infrastructure through which individuals

can prepare for old age while they are in the labour force, i.e. an efficient pension system.



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The role of the pension system is to encourage and enable old age preparation on the part

of a large fraction of individuals presently working in India.

(d) Most individuals in India are outside the organised sector. Thus the concept of a

"regular monthly salary" is alien to most of India, and hence the concept of a "monthly

pension contribution" is equally alien. The large number of workers who are agricultural

labourers or construction workers falls in this category. Unorganised sector workers may

change jobs, opt for spells of self-employment, move from one location to another and

also face temporary unemployment during their working lives. A pension system for

India should thus be flexible and useful to this mass of individuals; not just to the small

fraction of people in India who work in the organised sector, have a "regular monthly

salary", and undergo very little job mobility.

(e) Tax incentives are more or less synonymous with old age income security savings in

India. However, most individuals in India are not taxpayers, hence an exclusive focus on

tax incentives as a vehicle to encourage pension savings is misplaced. Indeed, in a

situation where the rich in India pay taxes while most do not, tax incentives which benefit

the rich may often prove to be regressive, as the revenue forgone may be made good by

some other form of commodity taxation.

(f) From a financial perspective, sound pension planning can be achieved by two factors:

(i) by obtaining continuous, uninterrupted accumulations and (ii) by using sound fund

management to achieve the highest possible rates of return. Once these two ingredients

are in place, the arithmetic of compound interest over multiple decades generates



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remarkable income security from even modest flow of savings. A rupee saved at age 25

turns into Rs 7.68 at the end of 35 years with a real rate of return of 6%. When either of

these two features are absent, old age income security is lost. If the accumulation is

broken by withdrawal, or if low interest rates are obtained through weak fund

management, then a much higher savings rate is required in order to avoid poverty

in old age.

(g) The terminal wealth at age 60 is highly sensitive to the rate of return. An

improvement of one percentage point in the rate of return -- i.e. from 12% to 13% - has

the potential to yield a 20% higher corpus at age 60. If the interest rate goes up from 12%

to around 15%, it can double the terminal accumulations. Improving the rate of return by

such percentage points, without sacrificing long-term safety of funds, is possible by

appropriate modifications in investment guidelines, and by entrusting funds to

professional managers.

(h) From a political economy perspective, a large stock of pension assets is a dangerous

thing. Pension programs face large political risk. Pension systems in all countries have

faced pressures from a host of special interest groups who seek to obtain "minor"

alterations of pension-related policies in order to benefit themselves. This has ranged

from buying shares of public sector companies, financing the Government debt,

transferring resources to states, financing infrastructure, subsidising inefficient financial

sector entities all the way to directed credit to "priority" sectors. Regardless of the merits

of any of these claims, the only goal that the pension system should serve is the well



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being of individuals who are the contributors and hence preparing themselves for old age.

This requires sound governance and sound pension system design. Individuals

participating in the pension system should have incentives to take interest in the

functioning of the system and block appropriation of their retirement savings by such

special interest groups.

(i) The challenge in building a pension system also lies in obtaining low administrative

costs, nation-wide collection, and adequate simplicity for participation by millions of

people with highly limited financial sophistication. The challenge also lies in obtaining

freedom from fraud, and in resisting the pressures which seek to apply pension assets to

further any agenda other than that of old age income security of members.

(j) Research commissioned by Project OASIS shows that regular savings at the rate of

between Rs 3 and Rs 5 per day through the entire working life easily suffice in escaping

the poverty line in old age provided the pension assets are invested wisely. This is an

extremely heartening feature of pension system design in India, since we can visualise an

extremely large number of people in India today who can save between Rs 3 and Rs 5 per

day and thus prepare themselves for old age income security. These numbers also remind

us that low contribution rates are not the essence of the problem.

(k) Systemic distortions and preferential treatment to certain provisions is undesirable

and we need to strive towards creating an equitable environment and simplified

provisions to encourage universal coverage both for salaried employees as well as self-

employed persons.



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(l) The pension system recommended in this Report can make an enormous difference in

the form of removing millions of people from the ranks of the destitute elderly in the

years to come. Each additional person who is able to plan for old age income security is

one less from the ranks that require the minimum support safety net in old age. This

powerful motivation is the central inspiration for the Report of the O.A.S.I.S. Committee.

Features of the Report

The Committee presented its report in January 2000 recommending a system for private-

sector management of pension funds to generate market-linked returns with, inter-alia,

the following features given in brief as below:

The pension system would be based on individual retirement accounts with full

portability across geographical locations and job changes.

The account would be accessible on a nationwide basis through points of presence

such as post-offices, bank branches, depository participants, etc.

Contributions to the pension account would be flexible; though pre-mature withdrawals

will not be permissible, micro-credit facility would be available against the pension

account.

Six pension fund managers would be appointed

to manage the pension funds based on the lowest fee bids.



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Each pension manager would offer three schemes, viz safe income, balanced income

and growth plans of which the pension account holder could select any one; further the

pension account holder would be free to switch between pension schemes.

Records of the pension accounts would be centralised with a central depository to

minimise overheads.

A separate Pensions Regulatory Authority would be set-up to regulate the pension

system.

Funds accumulated by the pension provider would be handed over to an annuity

provider on the pension account holder attaining retirement age.

A detailed explanation of the main points covered by the report is as under:

The new pension system should be based on individual retirement accounts. An

individual should create this account; have a passbook where he can see a balance that is

his notional wealth at that point in time; he should control how this wealth is managed;

this account should stay with him regardless of where he is or how he works. He would

make contributions towards his pension into this account through his working life

(whether employed in the organised sector or not), and obtain benefits from it after

retirement for the rest of his life. A heuristic sketch of the operations of this system may

be offered here.

(a) A person will open a single Individual Retirement Account (IRA) with the pension

system at as early a point in his life as possible. The account will provide the individual

with a unique IRA number that will stay with the individual through life. The individual



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Project O.A.S.I.S.

would save and accumulate assets into this account in his working life, subject to a

minimum of Rs 100 per contribution and Rs 500 in total accretions per year. Individuals

would be free to decide the frequency of accretions into their accounts; there will be no

pressure to make a fixed monthly contribution. The account would stay with the

individual across job changes, spells of unemployment, and can be accessed at any

location in India. The individual would always have access to an account balance

statement showing his assets. All through, the individual would be empowered in having

control of how his pension assets should be managed. Finally, upon retirement, the

individual would be able to use his pension assets to buy annuities from annuity

providers, and obtain a monthly pension.

(b) In this entire process, a sound regulatory framework would give individuals an

umbrella of safety with respect to problems of risk management and prevention of fraud.

c) A key feature of the system described ahead is a high ease of access to the pension

system through myriad Points of Presence (POPs) which would be located all over India

and will include post offices, bank branches, etc. The individual would be able to visit

any POP in India (not just the POP where he had opened the IRA) and conduct

transactions on his individual retirement account. Every POP would exhibit identical

features, processes and procedures. These transactions would be extremely simple and

convenient, so as to require minimal knowledge about the financial sector.

(d) Individual accounts imply full portability: i.e. the individual would hold on to a single

account across job changes across geographical locations. Individual accounts will also



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give individuals the opportunity to alter their risk profile in the life cycle in an optimal

fashion (from high-risk, high-return investments at a young age to a low-risk, low-return

portfolio when approaching retirement) if they so desire, while allowing them full

freedom and flexibility in making their own choices. Individual accounts also interpret

individual accumulations as individual wealth; they eliminate the free-rider problem of

collectivist programs. The accumulation of retirement assets, in a form which is

manifestly visible as individual wealth, helps reduce the political risks that many pension

systems have suffered from.

Service delivery

(a) Individuals should be able to access and operate their retirement accounts from

"Points of Presence" (or POPs) located all over India. Any individual would be able to

obtain identical services from any POP located anywhere in India.

The facilities that individuals should be able to access are extremely simple :

Open an individual retirement account and obtain a permanent and unique IRA number

Submit contributions into this account

Obtain an account balance statement, and

Submit instructions governing pension fund management



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(b) The committee proposed a two-tier system where POPs with good information

technology and telecommunications facilities would offer better services than other

technologically constrained POPs. At a POP that has IT and telecommunications

facilities, all these transactions would be satisfactorily completed instantaneously. At

other POPs, there would be delayed responsivity: for example, when the individual asks

for an account balance statement, he would get it a few days later.

(c) The committee emphasized a need to harness the largest number of POPs possible,

while preferring POPs that have IT and telecommunications facilities. The universe of

POPs would include: Bank branches, Post offices, Depository participant offices.

Any other location from which electronic connectivity into a central computer system is

possible .

Centralisation of record-keeping and individual access

(a) The committee recommended that the Government should obtain centralisation of

record-keeping and individual transactions through a centralised depository. The

depository would be connected to the myriad POPs spread across the country. An

individual would be able to access any POP and conduct all transactions. Individuals

would be able to submit instructions with any POP which would transmit these to the

depository, which would in turn implement them with the relevant Pension Fund

Managers (PFMs). The accent on modern IT and communications, with a modern

depository, would yield superior services and a reduced risk of fraud, at a lower cost.



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(b) The basic architecture of the system is hence one where individuals deal with POPs,

which carry these instructions to the depository. The depository would maintain the

database of all individual accounts as well as the instructions given by each individual.

The depository would consolidate individual instructions into blocks of funds, which will

be handed over to PFMs. In this system, PFMs would be able to focus purely on what

they do best -- i.e. Fund Management. They would only obtain a single instruction from

the depository everyday, which will drive the assets under their management. This would

make it possible to sharply drop the fees and expenses in fund management.

(c) PFMs would be provided the database of individuals who have chosen them. This

would make it possible for PFMs to understand their user profiles, optimise sales

strategies, and offer improved services directly.

(d) The Depository will provide an IRA balance statement to each individual once every

six months. This statement will be forwarded at no cost to the individual through the POP

located closest to the individuals contact address.

The role for IT in lowering transactions costs

Technology-intensive solutions are often conceived to be expensive. However, an

essential insight into the problem of transactions costs is that the deployment of

computers and telecommunications is the essence of lowering transactions costs.



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The OASIS report was followed up by the World Bank report on pension reforms in

April 2001. The World Bank report critically reviewed the OASIS report and endorsed

that privatisation of pension sector was the need of the hour.

While the OASIS report suggested a pension framework for the organised sector, the

Finance Minister in his Budget speech for 2001 acknowledged that the Central

Governments pension liability had reached unsustainable proportions and announced

that a high level committee would be formulated to design a contribution based pension

scheme for new Government recruits. Further, the Finance Minister required the

Insurance Regulatory and Development Authority (IRDA), the Indian insurance

industry regulator, to devise an implementation plan for the OASIS report so as to

formulate a pension scheme for the unorganized sector.

As requested, the IRDA submitted its report in October 2001 in which it examined

various aspects of the OASIS report and suggested, inter-alia, the following:

Pension fund managers should constitute a separate legal entity to conduct pension

business.

The IRDA should regulate the pension sector since international experience suggests

that pension and life insurance industry is regulated by a common regulator due to

similarities in the sector.

There should be no ceiling on the number of pension fund managers.



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The pension fund managers should be vertically integrated to offer the full lifetime

process of fund management and annuities, though the pension account holder would

have the option of choosing an annuity provider of his choice.

Fund management would be on a passive basis so as to minimise transaction costs.

For about a year and a half after the IRDA submitted its report, no announcement was

made as regards either the policy on pension reform or the mechanism to implement the

suggested reforms.

Finally, the Finance Minister in his Budget speech for 2003 announced that the

restructured pension scheme in respect of new entrants to Government service was being

finalised and would soon be introduced. The Finance Minister also indicatedthat the

scheme would be available to all employers for their employees and to the self-employed

on a voluntary basis.



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Indian Pension Reform 2003

A major change did occur in 1995 however, with the conversion of part of the defined-

contribution, EPF scheme to a defined benefit scheme in the form of the Employees

Pension Scheme. This was an important break with previous policy in two ways. First, it

extended the concept of a mandated annuity to the private sector for the first time.

Second, it added a new pension liability to the one that already existed with regard to

civil servants. In doing so, India became one of the last countries to join the century-long

march to dependence on publicly-managed, defined benefits schemes that are financed on

a pay-as-you-go basis.

India, however, can exhibit stark contrasts at times. Satellites and firms producing the

cutting edge of information technology are juxtaposed with brown-outs in the capital and

hugely inefficient state enterprises. While reforms open the insurance sector for the first

time in five decades to competition and set up a new insurance regulator, the government

is forced to bail out a quasi-public sector mutual fund. The introduction of a new, public

DB pension scheme in 1995 is followed a few years later by proposals for introducing the

first privately-managed, defined contribution pension provision in South Asia. The latter

pension reform was first proposed in 1998 by a special commission known as the Old

Age Security and Income Security (OASIS) Project.

In his annual budget speech in February 2003, Indias Union Finance Minister,

Mr. Jaswant Singh, announced a bold and progressive pension reform initiative with the

core elements of a privately-managed, defined contribution scheme that would eventually



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replace the non-contributory, defined benefit scheme of the civil service. In his Budget

speech, the Finance Minister said :

My predecessor in office had, in 2001, announced a road map for a restructured pension

scheme for new Central Government employees, and a scheme for the general public.

This scheme is now ready. It will apply only to new entrants to Government service,

except to the armed forces, and upon finalization, offer a basket of pension choices. It

will also be available, on a voluntary basis, to all employers for their employees, as well

as to the self-employed. This new pension system, when introduced, will be based on

defined contribution, shared equally in the case of Government employees between the

Government and the employees. There will, of course, be no contribution from the

Government in respect of individuals who are not Government employees. The new

pension scheme will be portable, allowing transfer of the benefits in case of change of

employment, and will go into individual pension accounts with Pension Funds. The

Ministry of Finance will oversee and supervise the Pension Funds through a new and

independent Pension Fund Regulatory and Development Authority.



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The key feature of this new system is the individual, defined contribution account. This

is a fundamental change and the first system of its kind in South Asia. The details of the

proposal began to emerge in the following months and included the following:

Reliance on private asset managers to be selected through a bidding process.

Centralized record-keeping and administration of individual retirement accounts.

Limited choice among investment portfolios.

Contribution rates set with the intention of providing roughly the same

replacement rate as current levels to a central government worker with a full

contribution history.

Also important is the population targeted for coverage by this new pension system. To

start with, only new entrants to central government service would be obliged to join the

new DC scheme while other workers would be allowed to do so on a voluntary basis, but

without contributions from the state. While this strategy avoids difficult issues related to

those civil servants that already have acquired pension rights in the old system, it also

prolongs the transition period and results in relatively small numbers of contributors in

the early years of the scheme.

Another significant element in the new system is the new pension fund supervision

agency. The first of its kind in the region, the Pension Fund Regulatory and

Development Authority (PFRDA) would be responsible for enforcing a set of regulations

which have yet to be issued. Presumably, the rapidly growing voluntary private pension



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sector as well as the enterprise-based schemes that operate in parallel, such as the

electricity board pension plans, would also fall under the new regulatory framework.

Finally, following recommendations by The World Bank and the Asian Development

Bank in two major studies, this new agency may eventually be charged with oversight of

the schemes currently supervised by the EPFO. In short, the PFRDA could bring the

entire pension sector under one supervisory umbrella for the first time in Indias history.

While the broad policy framework of the reformed civil service scheme has been

described, a plethora of design and implementation questions remain. Among the most

pressing are the following :

How soon can the appropriate information technology for collection and record-

keeping be constructed ?

What is the required size and budget of the new supervisory agency ?

What regulations must be issued and how are these to be coordinated with those

falling under the securities and insurance sectors (SEBI and IRDA, respectively).

How will the fund managers be selected and on the basis of what criteria ?

These are only a few of the several challenging issues facing public officials responsible

for implementing the reform, and the list of policy decisions to be made is much longer.

For example, the rules regarding the payout period have yet to be defined. Each of these

questions requires discussion about policy objectives as well as analytical work to spell

out the possible solutions.



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While a daunting task, there is ample international experience that shows systemic reform

is possible. Roughly a dozen Latin American countries have already introduced

individual account schemes and have managed (some better than others) the transition

from an unfounded, DB scheme to a funded, DC scheme. With regard to civil service

schemes in particular, most of the Latin American reformers have integrated their civil

service pension schemes with those of the private sector. In Eastern Europe, special

schemes for civil servants had already been eliminated during the socialist period.

While India will become the first South Asian country to introduce a privately-managed,

defined contribution scheme for its civil servants, there is some precedent elsewhere. A

similar arrangement to the one proposed, known as the Thrift Savings Plan (TSP), was

introduced for federal government workers in the United States after 1984 and has been

deemed a success after almost two decades. More recently in 2000, HongKong required

new civil servants to join the Mandatory Provident Fund system, a privately-managed,

employer-based, DC scheme that covers the entire labour force. Interestingly, the

pension scheme being replaced is essentially the same type of scheme as that found today

in India having been inherited from the colonial period.

In short, while this is a bold reform with far-reaching implications, it is a reform that is

demonstrably feasible. However, the task is huge and will take some time to implement

even under the best of circumstances.



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The New Pension Scheme

As promised by the Finance Minister in his Budget speech, the Government on August

23, 2003 approved contours of the radical transformation of Indias pension sector; the

pension scheme would initially be available to central Government employees. The

service delivery features of the new pension scheme are broadly based on the

recommendations of the OASIS report complemented by certain suggestions made in the

IRDA report, as illustrated in the following diagram.



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Project Report By: AyeshaGagrat 53

Indian Pensions

Authority

Depository

PFM

POPs

Annuity

Providers

POPs

PFM

PFM

POPs

POPs

I

N

DI

VI

D

UA

L

W

O

RK

ER

S


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While exiting at the age of 60 years or above, the individual would have to mandatorily

invest atleast 40 percent of the pension money to purchase annuity from an IRDA

regulated life An interim Pension Fund Development and Regulatory Authority

(PFRDA) will be set up to regulate the pension industry.

The Government has constituted the PFRDA on October 11, 2003 and proposed to put in

place the central registry and other necessary legislation/regulations, such that the new

pension scheme could be launched effective January 1, 2004.

On the other hand, the short-term fiscal pressures partly due to pension payments

made it more difficult to move quickly from an unfunded to a funded pension scheme.

The Union government as well as state governments have grown dependent on an

automatic source of deficit finance by way of the EPFO schemes, and the introduction of

an employer contribution to the new civil servants scheme would require additional

resources.

After several years, the rationale for pension reform, the cost of inaction and the

constraints to be taken into account, have percolated to the higher levels of government

and public awareness has increased. Even so, the reform announced by the Minister of

Finance in March 2003 represents but the first step in the proverbial thousand mile

journey.


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Pension Fund Regulator & Ordinance

Chapter 8

Pension Fund Regulator & Development

Authority Ordinance 2004

As the Government decided to have a defined contribution pension scheme for all their

recruits, steps had to be taken to implement the scheme. The Government has passed an

Ordinance titled The Pension Fund Regulator and Development Authority Ordinance

2004. this Ordinance lays down the framework for the operation of the defined

contribution scheme for the civil service recruits as also for any other pension scheme

which is not regulated by any other enactment. The salient features of this Ordinance are

reproduced below:

Objects:

An Ordinance to provide for the establishment of an Authority to promote old age income

security by establishing, developing and regulating pension funds, to protect the interests

of subscribers to schemes of pension funds and for matters connected therewith or

incidental thereto.


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Short title, extent and commencement:

(1) This Ordinance may be called the Pension Fund Regulatory and Development

Authority Ordinance, 2004.

(2) It extends to the whole of India.

(3) It shall come into force at once.

Definitions:

(1) In this Ordinance, unless the context otherwise requires,

(a) Authority means the Pension Fund Regulatory and Development Authority

established under sub-section (1) of section 3;

(b) central record keeping agency means an agency registered under section 24 to

perform the functions of record keeping, accounting, administration and customer service

for subscribers to schemes;

(c) Chairperson means the Chairperson of the Authority;

(d) individual pension account means an account of a subscriber, executed by a

contract setting out the terms and conditions under the New Pension System;

(e) intermediary includes pension fund, central record keeping agency, pension fund

adviser, retirement advisor, point of presence and such other person or entity connected

with collection, management, record keeping and distribution of accumulations;

(f) member means a member of the Authority and includes its Chairperson;

(g) New Pension System means an the contributory pension system


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referred to in section 20 whereby contributions from a subscriber are collected in an

individual pension account using points of presence and central record keeping agency

and accumulated by pension funds for pay offs as specified by regulations;

(h) notification means a notification published in the Official Gazette;

(i) pension fund means an entity registered with the Authority under subsection (3) of

section 24 as a pension fund for receiving contributions, accumulating them and making

payments to the subscriber in the manner specified by regulations;

(j) Pension Regulatory and Development Fund means the fund constituted under sub-

section (1) section 37;

(k) point of presence means an entity registered with the Authority under

sub-section (3) of section 24 as a point of presence and capable of electronic connectivity

with the central record keeping agency for the purposes of receiving and transmitting

funds and instructions and pay out of funds;

(l) prescribed means prescribed by rules made under this Ordinance;

(m) regulated assets means the assets and properties, both tangible and intangible,

owned, leased or

the emerging pension scenario in india

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