Govt’s new Unified Pension Scheme walks back on important reforms. It’s disappointing

There is, as yet, no clarity on how the new scheme is going to be operationalised, and what happens to the existing National Pension System architecture.

28 August 2024
The Print

The Union government announced a new Unified Pension Scheme for its employees, which will replace the National Pension System. One can expect that several state governments will also follow suit. This is a big disappointment – not only because we have walked back on important reforms, but also the confusion that surrounds the decision.

The NPS offers a market-linked pension – the contributions are invested, and the accumulated corpus at retirement is to be used to purchase an annuity. This may result in a pension lower than 50 per cent of the last drawn pay, but there would be no future liability on the government (and hence the taxpayer) once the contributions have been made.

The Unified Pension Scheme offers three main benefits. First, it offers employees – with 25 years or more of service – a pension equal to 50 per cent of their last drawn salary (over the past 12 months). Second, if the employee dies before retirement, the family will get a pension equal to 60 per cent of the employee’s basic pay. Third, if the employee quits government service after a minimum of 10 years, the pension will be proportional to the length of service, with a minimum pension of Rs 10,000 per month.

Fourth, all of these payments will be indexed to inflation. That is, as inflation increases, the nominal value of the pension payment will also increase. The increase will be based on the All India Consumer Price Index for Industrial Workers (AICPI-IW) as in the case of employees in service. Fifth, the gratuity and a lump sum payment at superannuation will be provided.

The government has offered employees the choice to switch to UPS. However, there is, as yet, no clarity on how the new scheme is going to be operationalised, and what happens to the existing NPS architecture.

Lack of clarity on operationalising UPS

One possibility is that the government sets up a separate fund for the UPS, collects contributions, invests them, and uses this fund to pay the pension. The other possibility is that the government continues with the NPS architecture, and everything proceeds as is, except that at retirement, the government guarantees a 50 per cent pension, with an inflation indexation.

There are several unanswered questions for either of these strategies. The government has to clarify the operational and governance guidelines for the UPS. Who will manage the funds, who will do the record-keeping, will an annuity be purchased at retirement, how will inflation indexation be done, will contributions be increased further if funding falls short, what will be the actuarial assumptions that determine the contribution rate, and what happens to existing contributions in the NPS? What are the processes that will ensure that this fund does not see governance failures like we have seen in other Provident Funds, or funding concerns such as that of the Employees Pension Scheme?

If the government chooses to remain conservative in investing the contributions to the UPS and primarily invests in government bonds, then the upside to these contributions is going to be limited. How is it going to ensure the scheme’s fiscal sustainability? What happens to the existing NPS corpus?

If the government plans to continue with the NPS architecture, then presumably the existing infrastructure will continue to plod along. At the time of retirement, however, the current law mandates that at least 40 per cent of the accumulated corpus be annuitised. This 40 per cent may not be enough to buy a pension that is 50 per cent of the last wage. Will the government change the law to say that the corpus should get used to buying an annuity that pays 50 per cent of the last wage, and the rest can be taken on as a lump sum withdrawal? This lump sum withdrawal then acts as the "superannuation" benefit. The annuity market will have to provide an inflation-indexed annuity so that the pensioners get inflation indexation.

Alternatively, is the government going to take the NPS corpus at retirement and provide the annuity itself? Is it going to price the annuity itself, or make a bulk purchase from a life insurance company?

For a scheme that was designed by a high-level committee chaired by the finance secretary, the lack of a report in the public domain, outlining the scheme choices, the transition arrangements and fiscal implications, is disappointing.

The challenge of reform

The larger question that arises from this announcement is how difficult it is to put government finances in order once benefits have been normalised. A pension is seen as a “right” by government employees – part of their overall pay package. We need to start questioning the idea of a compensation package that runs for 30 years post-retirement. And if that is the contract, then suitable adjustments should be made in the compensation up front. Government employees are a small proportion of the country’s labour force, and yet, they consume a large share of the government’s revenues.

The NPS was constituted in 2004 when the country was in fiscal trouble and pension expenditure was considered to be unsustainable. The fiscal situation may look a bit better today than in 2004, but an inflation-indexed pension, even if financed by contributions at the start, runs the risk of becoming unfunded very soon. Government employees should know this more than anyone else. But there is near conviction that fiscal issues will somehow get resolved, and if there are to be cuts in government spending, their pension will not be affected. The country is going to see ramifications of the move back to defined-benefit. Government employees may continue to get their pension, but the consequences will be borne by everyone else.