Govt should ensure quick & smooth passage of the new PFRDA Bill

The UPA’s emphatic victory in the general elections provides an opportunity to develop a modern and robust pension system architecture, which can withstand demographic trends and macro-economic cycles.

First, the number of persons aged 60 and above is expected to grow from 100 million in 2010 to 330 million by 2050. Average life expectancy at 60 in India is already 20 years, with women living longer than men.

Second, only about a fifth of the labour force is currently covered by any formal scheme of social security. A significant proportion of retirement financing will therefore be borne by individuals.

Third, there has been a marked lack of professionalism exhibited by the Employees Provident Fund Organisation (EPFO). This has resulted in low capability in providing quality services to its members, and to expand its membership in a sustainable manner.
Even after being in existence for nearly 60 years, the EPFO’s active contributors are only 5% of India’s labour force of 475 million.

Thus, an overwhelming proportion of private sector workers are outside the purview of the EPFO. This necessitates an alternative arrangement. Reforms involving design, governance and management structures of the EPFO and its schemes are long overdue. The dual role of the EPFO as a service provider and as regulator is inconsistent with sound pension architecture.

Fourth, with some expectations, the retirement plans of business organisations in public and private sectors are currently not supervised and governed according to international best practices. This is also the case with other retirement related benefits, such as gratuities, and leave encashment allowances.

There is, therefore, a strong case for providing individuals, organisations, and the pensions industry with a predictable long-term policy, regulatory and tax environment in which all stakeholders have a high degree of deserved confidence. The above requires that a pension regulator with requisite resources be set up with the full Parliamentary authority.

Its main role will be to ensure that each provident and pension fund organisation adheres to sound international benchmarked practices, and that there is a degree of coordination and consistency between different schemes.

It is therefore essential to expedite the Passage of the new Pension Fund Regulatory and Development Authority (PFRDA) Bill. The interim PFRDA has been operating since 2003. The PFRDA Bill was introduced in 2005, but with the end of the 14th Lok Sabha on February 26, 2009, the Bill has lapsed.

The interim PFRDA has taken commendable steps towards implementing the New Pension Scheme (NPS) architecture comprising the NPS trust, central recordkeeping agency, pension fund managers, trustee bank and a custodian.

The NPS, which is a defined contribution scheme, has two components. The first is the mandatory membership of Central government employees (except armed forces) joining since January 1, 2004 and 21 states which have so far decided to introduce NPS-type schemes.

As there are 20 million civil servants in India, if all the government entities join, the mandatory NPS membership would be at least around 20 million in the next 3-4 decades. As the contribution rate for the mandatory NPS is 10% each by the member and by the government as employer, the total assets will grow substantially. As the mandatory NPS does not permit pre-retirement withdrawals, the power of compound interest is harnessed till age 60.

The NPS architecture for the mandatory component was made operational from April 1, 2008. Accumulated funds in one year amount to Rs 2,100 crore for Central government employees alone. The weighted average return by approved fund managers is 14.5% for 2008-09, substantially higher than the 8% rate the NPS balances were granted under the Public account.

Experts such as Monika Halan have illustrated how the administration and investment costs of NPS are much lower than alternative investments such as unit-linked insurance plans, and diversified equity mutual funds. This could translate into substantially higher accumulations under the NPS.

Accumulations under the NPS have the potential to be channelled into infrastructure financing, and helping to develop corporate and municipal bond markets.
The second component of the NPS is voluntary, open to all citizens between the age of 18 and 55. It became operational on May 1, 2009. By December 2009, the withdrawable component of NPS (called Tier II) will be operational.

The architecture for voluntary component will need to be more complex than for the mandatory component. In particular, points of presence are needed as contact and collection points. All members will receive permanent retirement account number. The voluntary NPS also has limited pre-retirement withdrawal provisions and flexible contributions. These increase the administrative complexity.

There are well-considered investment choices, including default option, which in a voluntary NPS is the lifecycle fund, which automatically varies asset class exposure with age. The equity exposure in all cases is only through indexed funds, tracking BSE or NSE.

As PFRDA’s role expands, and pension sector develops rapidly (a total NPS membership of around 50 million is achievable in the next two decades), it is imperative that the PFRDA receives full mandate and authority. In deliberations on the new Bill, at least two areas in the NPS design merit closer examination.

The first concerns the payout phase. Under the current provision, at age 60, a member may withdraw up to 60% of the accumulations in a lump sum, and for the remaining 40% one must mandatorily by immediate annuities. Given the uncertainties in longevity, and possible asset-liability mismatch, mandatory annuities may not be appropriate for all, and may be subject to large contingent fiscal liabilities.

Some flexibility at the payout phase needs to be considered. This may involve programmed withdrawals, which do not involve insurance products, and which may permit some risk sharing by the government, merit consideration. When combined with social pensions or assistance to the elderly, the NPS could provide a reasonable degree of retirement income security till death.

The second concerns the tax treatment of the NPS, which is less favourable than for the other retirement products such as the EPFO schemes. The case for the expeditious passage of the PFRDA Bill is indeed very strong. The urgency with which the UPA government accomplishes this task will reveal its priorities in providing secure retirement for Indian citizens.

The writer is professor of public policy, National University of Singapore. Views are personal.