Indian Streams Research Journal

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1 Vol 5 Issue 11 Dec 2015 ISSN No : ORIGINAL ARTICLE International Multidisciplinary Research Journal Indian Streams Research Journal Executive Editor Ashok Yakkaldevi Editor-in-Chief H.N.Jagtap

2 Welcome to ISRJ RNI MAHMUL/2011/38595 ISSN No Indian Streams Research Journal is a multidisciplinary research journal, published monthly in English, Hindi & Marathi Language. All research papers submitted to the journal will be double - blind peer reviewed referred by members of the editorial board.readers will include investigator in universities, research institutes government and industry with research interest in the general subjects. International Advisory Board Flávio de São Pedro Filho Federal University of Rondonia, Brazil Kamani Perera Regional Center For Strategic Studies, Sri Lanka Janaki Sinnasamy Librarian, University of Malaya Romona Mihaila Spiru Haret University, Romania Delia Serbescu Spiru Haret University, Bucharest, Romania Anurag Misra DBS College, Kanpur Titus PopPhD, Partium Christian University, Oradea,Romania Mohammad Hailat Dept. of Mathematical Sciences, University of South Carolina Aiken Abdullah Sabbagh Engineering Studies, Sydney Ecaterina Patrascu Spiru Haret University, Bucharest Loredana Bosca Spiru Haret University, Romania Fabricio Moraes de Almeida Federal University of Rondonia, Brazil George - Calin SERITAN Faculty of Philosophy and Socio-Political Sciences Al. I. Cuza University, Iasi Editorial Board Hasan Baktir English Language and Literature Department, Kayseri Ghayoor Abbas Chotana Dept of Chemistry, Lahore University of Management Sciences[PK] Anna Maria Constantinovici AL. I. Cuza University, Romania Ilie Pintea, Spiru Haret University, Romania Xiaohua Yang PhD, USA...More Pratap Vyamktrao Naikwade Iresh Swami ASP College Devrukh,Ratnagiri,MS India Ex - VC. Solapur University, Solapur R. R. Patil Head Geology Department Solapur University,Solapur Rama Bhosale Prin. and Jt. Director Higher Education, Panvel Salve R. N. Department of Sociology, Shivaji University,Kolhapur N.S. Dhaygude Ex. Prin. Dayanand College, Solapur Narendra Kadu Jt. Director Higher Education, Pune K. M. Bhandarkar Praful Patel College of Education, Gondia Sonal Singh Vikram University, Ujjain Rajendra Shendge Director, B.C.U.D. Solapur University, Solapur R. R. Yalikar Director Managment Institute, Solapur Umesh Rajderkar Head Humanities & Social Science YCMOU,Nashik S. R. Pandya Head Education Dept. Mumbai University, Mumbai Govind P. Shinde Bharati Vidyapeeth School of Distance Education Center, Navi Mumbai Chakane Sanjay Dnyaneshwar Arts, Science & Commerce College, Indapur, Pune Awadhesh Kumar Shirotriya Secretary,Play India Play,Meerut(U.P.) G. P. Patankar Alka Darshan Shrivastava S. D. M. Degree College, Honavar, Karnataka Shaskiya Snatkottar Mahavidyalaya, Dhar Maj. S. Bakhtiar Choudhary Director,Hyderabad AP India. S.Parvathi Devi Ph.D.-University of Allahabad Sonal Singh, Vikram University, Ujjain Rahul Shriram Sudke Devi Ahilya Vishwavidyalaya, Indore S.KANNAN Annamalai University,TN Satish Kumar Kalhotra Maulana Azad National Urdu University Address:-Ashok Yakkaldevi 258/34, Raviwar Peth, Solapur Maharashtra, India Cell : , Ph No: ayisrj@yahoo.in Website:

3 ISSN: Impact Factor : (UIF) Volume - 5 Issue - 11 Dec Indian Streams Research Journal NEW PENSION SYSTEM 1 2 Robin Malik and O P Midha 1 Research scholar, 2 Dean, Rayat Bahra University Mohali. 1 Robin Malik ABSTRACT In view of the continuous expenditure on pension effecting the State budget adversely, the Central and State Governments were spell bound to think over to `change Pension System. An NDC (Nonfinancial defined contribution and also notional defined contribution) scheme is a defined contribution i.e. pay-as-you-go (PAYG) Pension scheme.1 On the rationale for undertaking pension sector reforms by switching over to the New Pension System viz Contributory Pension System for new recruits to Central Services joining service from 1 January 2004 onwards and constituted the PFRDA as a Statutory Body to regulate and promote growth of pension schemes and funds. KEYWORDS :Pension Liabilities, promote growth, New Pension System. INTRODUCTION : Major among the reports that have examined old age income and financial security encompassing the workforce at larger both in Government and other sectors and were considered by the Government are: - 1.Project OASIS committee report, December 29, 1999 (OASIS Report) 2.Pension reforms in the unorganised sector a report prepared by the Insurance Regulatory and Development Authority, October 2001; 3.Reports of the HighLevel Expert Group on New Pension System, Government of India, February 2002; and 4.Report of the Group the Pension Liabilities of the State Government (RBI Oct, 2003) 1

4 During the period , pension payments of the State Government have sharply risen at an annual compound rate of 2306 per cent from Rs. 268 crore in to Rs crore in Statewise trends show that the growth rates varied widely across the States. Pension Payments as percentage of Total Revenue Receipts of the States rose 2.1 percent in to 11.0 percent in , during the same period, the ratio of pension payments to States on Revenue Receipts rose at a faster rate from 3.4 percent to 17.2 percent. The rapid increase in States Pension was attributable to a number of factors which inter-alia, include expansion in the number of State Government employees during the earlier decades; extension of pension facilities to employees; impart of various pay revisions; introduction of wage indexation and significant improvement in life expectancy. The above factors compelled for introduction of Contributory Pension Scheme/s for the new employees of the State Government in place of existing Non- Contributory Defined Benefit Pension Scheme. Since a system analogous to Pay-as-you-go (PAYG) is presently used for making budget estimation of the pension payments, prediction of future payments becomes critical for facilitating fiscal planning, especially in the short and medium term. The attention of the Government in recent years has focused on fiscal consolidation, both at the Centre and States, through a variety of measures aimed at both the revenue and expenditure sides, so as to bring about a reduction in the fiscal and revenue deficits. It is also acknowledged that progress in fiscal consolidation involves not only rationalization of Government expenditure but also a shift in its focus away from the non-plan, non-developmental activities to growth inducing, asset creating activities. The entire gamut of the Government s non-plan, non-developmental expenditure has accordingly come under close scrutiny. It is in this context that pension reforms of Government employees acquire great significance. Wages and salaries, health benefits and pension payments comprise major components of revenue expenditure of the Government. Of these, health care and pension benefits are both unfunded, and worse, involve continuing expenditures even after the employee retires from service or dies. Ideally, reforms in these benefit schemes should proceedalong side civil service reform. However, given the complexities of the latter and the urgency of fiscal consolidation, it may be necessary to tackle the former, especially pension reforms, first. However as evident from the projections for financial years , this would go up further primarily on account of: a.regarding increased life expectancy, Japan boasts some of the longest life spans of any country in the world, and by 2050 average life expectancies could reach around 81 years for men and nearly 90 years for women. 2 b. Indexation of pension to the wage of serving employees; c. Full neutralization of inflation linked to cost of living index. d. Higher rate of retirement in the next 10 years because of a fifty-seven percent increase in employment over the period ; e. Revision of pay scales by successive Pay Commissions resulting in increase in average pension; f. Increase in promotional avenues leading to increase in final salaries and hence in pensions; g. Revision of pension of past pensioners in line with successive Pay Commission recommendations. The researcher would like to emphasize that proper estimation of pensionary outgoes and also planning for funding of future payments requires an accurate estimation of (i) number of existing pensioners, (ii) number of serving employees, (iii) age wise break up of pensioners and serving 2

5 employees; (iv) statistical data regarding conversions from superannuation to family pension; and (v) projections of pensioners/family pensioners finally exiting the pool by way of death. But this data was some what difficult for accurate estimation. Other important elements are used for getting the accuracy regarding pension liability. The total pension liability is the discounted present value of the payments arising in future. There are five important elements in making: (a) total number and age distribution of existing pensioners age wise break (b) estimated number of retirements in coming year, i.e, the pension pool. (c) statistical data of conversions from pension to family pension cases. (d) average annual pension for relevant sub-categories. (e) Number of pensioners exiting the pool through death. There are no firm estimates of either the number of existing pensioners (including family pensioners) or the total pension liabilities of the Government. In the absence of authentic information available in organisaions, estimates of the number of existing pensioners can be made on the basis of surveys to be conducted at disbursement points i.e. Treasuries and bank branches, and through Pension Payment Orders. Such surveys should enumerate both ordinary as well as family pensioners, i.e, the surviving dependants of Government pensioners to get estimates of continuing liabilities even after the death of the existing pensioners. Needless to emphasis that the more disaggregated the data collected the more reliable and accurate would be the estimates. Mortality tables of L.I.C can be used for estimating number of likely casualties in a year. This would enable determining the number of cases where pension would get converted to Family Pension or there would be discontinuance of family pension altogether. Keeping in mind the above requirements, the researcher has arrived at a standardised format, incorporating various information requirements necessary for an accurate projection of pensionary liabilities. It is suggested that this format may be uniformly extended to all accounting formations.however, software development should be undertaken in consultation with nodal organisaions such as NIC, RBI, Public Sector Banks and Treasuries. The researcher emphasised that the creation of a centralized data resource through effective application of technology would help in making available accurate, reliable and timely data on pensionary liability. It would also help in improving the quality of Government accounting. Given the present day as on volume of pension payments Rs.4602 croresp.a.like inharyana State It is imperative that information technology may be used in increasing measure. The researcher emphasiseda transition to a funded system of pension payments for new government employees and a system of incentives to encourage migration of existing employees to funded systems.the most important effect of such a fund is to make explicit and transparent the pensionary liability of the Government. It should be stressed, however, that pre-funding pension liabilities from the general budget does not reduce the quantum of the liability. If anything, there will be an adverse impact on the Government s fiscal position in the short term in the process of establishing the pension fund. This fiscal impact can only be mitigated for the incremental liability of new employees with the introduction of a Defined Contribution (DC) component from these employees, whether partial or total. The greater the magnitude of the DC component in the pension package of the new employees, the lower will be the incremental impact. There should also be no corresponding (onefor-one) increases in employees salary levels to compensate them for this contribution 3

6 1.2 INTERNATIONAL EXPERIENCE IN PENSION GROWTH AND REFORMS: Pension system is different in different countries but the Civil Service Pension Plan is partially funded.3 Latin American pension schemes are generally considered to have transitioned successfully. The main problem with these schemes initially was that the systems' running costs had been high (though in Chile's case not big enough to alter the fact that returns to investors had been high). Competition among the specially instituted funds had failed to curb their operating costs, which amounted to a steep 3% of wages in some countries instead of competing on price, the firms had spent heavily on advertising and sales agents. This was partly because funds were obliged to let \ investors switch managers almost as they pleased which had led to "transfer wars". In Chile, 50% of contributors used to change funds every year; new rules have now cut this by half. Mexico too has put limits on transfers. However, Chile's pension reforms have cut down on the Government's deficit funding of pension liabilities. Whatever the path of reform, it is now amply clear that there has to be a transition from the current unfunded pension to funded mechanisms. There have to be curbs on increasing and indexing Defined Benefits of Unfunded Systems. Individual retirement accounts based on increasing Defined Contributions are the way forward. In South Africa, it is true, that royal commission has recommended a Non-Contributory System, but only as a stop-gap arrangement. In the present circumstances, the trend is strongly away from the non- contributory, deserving-poor system and in the direction of the contributory system.4 A combination of the various methods is being increasingly adopted allover the world. The problem is not confined to developing countries, with comprehensive social security structures, face similar problems. The chilean government was a pioneer in pension reformsregarding Pension Reforms, and Britain s new state pension scheme came into effect in In 1981, the military Government introduced sweeping reforms in the retirement system. The reform replaced a basically insolvent PAYG system with a. capitalisation system, based on individual retirement accounts managed by private companies known as AFPs. Workers employed in the formal sector (including Government employees) are required to pay 10% of their wages to the AFP of their choice and can transfer funds freely among them, upto four times a year. The system also has survivor benefits (Family Pensions) and a disability programme funded through an additional insurance premium of 3% of wages. There is a modem regulatory framework, the superintendency of pensions, that regulates investment portfolios, ensures free determination of fees and commissions, and free entry into the industry. The appeal of mandatory defined contribution plans has been spurred by the recent experiences of chile s new retirement system. 6From a fiscal point of view, the reform process gave rise to major forms of public expenditures. One was the servicing and payment of the "Recognition Bonds". The other was the payment of retirees in the old system. The bulk of the costs are related to the payment of pensions to old retirees. These costs are financed directly out of general Government revenues. Recognition Bonds were issued by the Government to transfer past contributions of transferees to provide the base for the new retirement fund. It turns out that the required payments into the private system were substantially less than the taxes required for the old system, a change that effectively provided a large tax cut for those who opted for the new system. The reduction was justified because with the substantial investment returns of the private system, much more in benefits could still be paid even with the lower payments during working years. Australia, far away from Latin America, has also reformed its pension system. 7The New Pension System was beneficial to the Government in terms of lessening the fiscal stress on pension outgo and time period by when a positive gain could be witnessed in this regard, the Ministry cited the findings of the report of the High Level Expert Group (HLEG) which interalia examined the issue of the budgetary impact of introducing the alternate pension system recommended by it. As per the HLEG report: The 4

7 positive gain of a switch over to a DC Scheme would be witnessed from the year The saving to the State Government increases steadily from this stage onwards and within a decade after this point of tune, Government saves approximately Rs crore per annum by undertaking reform, which increases to about Rs crore per annum in another decade. The main aspect is to raise pension revenues and decrease pension expenditure STEPS FOR PENSION REFORMS AT NATIONAL LEVEL: In view of the prevalent circumstances, many countries are replacing existing pay-as-you-go (PAYG) defined benefit, and unfunded system. 9 The Government approved on 23rd August 2003 the proposal to implement a new restructured defined contribution pension system for new entrants to Central Government service, except to Armed Forces, in the first stage replacing the existing system of defined benefit pension system. He would make contributions towards his pension into this account through his working life and obtain benefits from it after retirement for the rest of his life. 10 The new system will also be available, on voluntary basis, to all persons including self employed professionals and others in the unorganised. However, mandatory programs under the Employee Provident Fund Organisation (EPFO) and other special provident funds would continue to operate as per the existing system under the Employee Provident Fund and Miscellaneous Provisions Act, 1952 and other special Acts governing these funds. The Government approved the basic features of the new pension system; and setting up of an interim Pension Fund Regulatory and Development Authority (PFRDA).The main features of the new pension system are given below: It is true to say that the old pension system was financially unsustainable. 11The new pension system would be based on defined contributions, which will use the existing network of bank branches and Treasuries etc. to collect contributions and interact with participants allowing transfer of the benefits in case of change of employment and offer a basket of pension choices. The system would be mandatory for new recruits to the Central and State Government service except the armed forces and the monthly contribution is 10 percent of the salary and DA to be paid by the employee and matched by the Central and State Government. The key feature of this new system is the individual, defined contribution account. 12However, there will be no contribution from the Government in respect of individuals who are not Government employees. The contributions and investment returns would be deposited in a non-withdrawals pension tier-i account. The existing provisions of defined benefit pension and GPF would not be available to the new recruits in the Central and State Government service. I. In addition to the above pension account, each individual may also have a voluntary tier-ii withdraw able account at his option. This option is given as GPF is proposed to be withdrawn for new recruits in Central Government service. Government will make no contribution into this account. Theseassets would be managed through exactly the above procedures. However, he would be free to withdraw part or the entire second tier of his money anytime. This withdrawable account does not constitute pension investment, and would attract no special tax treatment. II. Further individuals can normally exit at or after the age of 56/ 60 years for tier I of the pension system. At exit the individual would be mandatory required to invest 40 percent of pension wealth to purchase an annuity. In case of Government employees the annuity should provide for pension for the lifetime of the employee and his dependent parents and his spouse at the time of retirement. The individual would receive a lump-sum of the remaining pension wealth, which he would be free to utilise 5

8 in any manner. Individuals would have the flexibility to leave the pension system prior to age 58/ 60. However, in this case, the mandatory annuitisation would be 80% of the pension wealth. 1.4 ARCHITECTURE OF THE NEW PENSION SYSTEM The proposed structure of the New Pension System is given as below: i.it will have a Central Record Keeping and Accounting (CRA) infrastructure, several Pension Fund Managers (PFMs) to offer three categories of schemes viz. option A, B and C. ii.the participating entities (PFMs, CRA and POPs) would give out easily understood information about past performance, so that the individual would able to make informed choices about which scheme to choose Regulatory Authority (I) An independent Pension Fund Regulatory and Development Authority (PFRDA) is to regulate and develop the pension sector. PFRDA has developed its own funding stream based on user charges. (ii) Till such time when a statutory PFRDA is established, an interim PFRDA, on the pattern of SEBI and IRDA, has been appointed by an executive order. (iii) The interim PFRDA is headed by a Chairman with a status of not less than a Secretary to the Government of India and would be appointed by the Central Government. Other members of the interim body not exceeding four in number, of whom not more than two shall serve full time, shall be selected by the Central Government from amongst persons having experience and knowledge in Economics, Finance, Legal and Administrative matters with one person from each discipline Investment strategy (I) There are different investment choices such as option A, B and C. The option A implies predominant investment in fixed income instruments and some investment in equity. Option B implies greater investment in equity. Option C implies almost equal investment in fixed income and equity. (ii) Pension Fund Managers would be free to make investment in international markets subject to regulatory restrictions and over-sight in this regard. (iii)it is proposed to evaluate market mechanisms through which certain investment protection guarantees can be offered for the different schemes Tax treatment Pension contributions and accumulation would be accorded tax preference upto a certain limit, but benefits would be taxed as normal income. Pension Fund Contributions were also exempt from social security taxes Scope of the New Pension System The option of joining the new system would also be available to the State Government and as and when they decide, the new system would be capable of accommodating the new participants. A contributory scheme is imbued with the spirit of a joint venture and will thus help to encourage further co-operation between men and management. 14The benefit of DC scheme would be observed after 30 years. The real benefit would be seen in crore of rupees after one decade. The main aspect is to raise pension revenue and reduce pension expenditure for a balance budget like in Haryana State. Mandatory programmes under the Employee Provident Fund Organisation (EPFO) and other special provident funds would continue to operate as per the existing system. However, individuals under these programs could voluntarily choose to additionally participate in this scheme. 6

9 FOOT NOTES 1.Holzmann Robert, Pension Reform, The World Bank Washington D.C., USA, 2005, P SumikoIwao, Editor In Chief Of Japan Echo, Public Pensions, Japan Echo Inc., 2004, P.7. 3.Leechor Chad, Reforming Indonesia s Pension System (Policy Research Paper-1677), The World Bank, Washington D.C., USA, 2006, P.5. 4.Johnsen Julia E., Old Age Pension, The H.W. Wilson Company, New York, 1935, P Fogarty Michasel, Retirement Policy, Heinemann, London, 1982, P Mitchell Olivia, Public Pension Governance And Performance, The World Bank, Washington D.C., USA, 1993, P James Estelle, Pension Reform (Policy Research Working Paper-1767), The World Bank, Washington D.C., USA, 1997, P James Estelle, Pension Reform (Policy Research Working Paper-1767), The World Bank, Washington D.C., USA, 1997, P Andrews Emily S., And Rashid Mansoora, The Financing Of Pension System In Central And Eastern Europe, The World Bank Washington D.C., USA, 1996, P Srinivas, P.S., And Yerno Juan, Do Investment Regulations Compromise Pension Fund Performance? The World Bank, Washington D.C., Usa, 1999, P Gressdorff Hermann Von, Pension Reform (Policy Research Working Paper-1832), The World Bank, Washington D.C., USA, 1997, P Bordia Anand And BhardwajGautam, Rethinking Pension Provision For India 2003, Tata Mcgraw-Hill Publishing Company Limited, New Delhi, 2003, P VittasDimitri, Private Pension Funds In Hungary (Policy Research Working Paper-1638), The World Bank, Washington D.C., USA, 1996, P PilchMichacel and Wood Victor, Pension Schemes, Hutchiuson& Co. Ltd., London, 1960, P.55. 7

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