The Hindu Business Line : Pillars of strength?

"Will there be enough to live on when I retire?" Increasingly, this question of old-age financial security is being asked across the world. To quote Leon Trotsky, "Old age is the most unexpected of all things to happen to man."

The OASIS report of 1999 draws heavily upon the World Bank's recommended multi-pillar system to provide for old age financial security. The three pillars are:

A mandatory, publicly managed, tax financed pillar for social insurance.

A mandatory, privately managed, fully funded pillar for old age savings.

A voluntary pillar for those who want more protection in their old age.

The first pillar resembles public pension plans, providing a social security net for the old and poor, particularly for those whose lifetime income was low or who cannot afford to pay for building a reasonable retirement income. These are based on the principles of social insurance and are wholly financed by the state either out of general tax revenue or by some kind of special tax or cess. The US, for example, levies a social security tax on all working people to finance this pillar.

The second pillar requires that people save mandatorily for old age and benefits are actuarially linked to contributions. It should preferably be privately managed, fully funded, and managed competitively.

The third pillar, voluntary savings and annuities, is meant to provide supplemental retirement income for those who want more generous old age pensions. The World Bank suggests that the first pillar providing basic security needs must be publicly managed, and only the second and third pillars are to be privately managed.

Multi-pillar system in India

In India, the first pillar is almost non-existent. The government does have some poverty alleviation programmes but they are too insignificant compared to the country's needs and their implementation is mostly political in nature.

Some mistakenly believe that pensions paid by the government to its employees constitute the first pillar since they are paid on pay-as-you-go (PAYG) basis from current tax revenue. Pension to civil servants are more akin to deferred wages paid by the employer and, according to the World Bank's guidelines, should be included in the second pillar of the multi-pillar pension system.

The second pillar is found mostly in the organised sector and is in the form of employment-linked schemes. Against a working class population of 400 million, only 35 million have access to a pension system. Of these, 11 million are in civil service (Central and State governments) and 24 million are members of various employees' provident fund and pension schemes (Ramesh Gupta of IIM — `Pension Reforms in India: Myth, Reality & Policy Choices').

The third pillar, that is voluntary contribution for extra protection, is found in a wafer-thin segment of the population. This is that class of society that has surplus funds at its disposal — and there are no prizes for estimating the number of such people.

Global update on pension norms

Developments in the US: A December 2005 study of 85 big public pensions in all 50 states in the US covering three-fourths of public employees nationwide found that governments continued to enhance benefit formulas, ease early retirement and improve other benefits from 2000 through 2004 despite states' financial problems.

The increases were enacted on top of even larger benefit changes approved from 1996 to 2000. The study, conducted by the Wisconsin Legislature, is one of the most comprehensive on the issue.

The New Jersey Legislature has approved 17 benefit enhancements since 2000 that increased the unfunded obligations of public pensions in the state by $6.8 billion, according to a task force studying the issue.

Average annual benefits for retired state and local workers grew 37 per cent to $19,875 from 2000 to 2004, the most recent data available, according to the Census Bureau. The rising payments reflect the early retirement of baby boomers, who started to qualify for full benefits in 2001, at age 55, under most government pensions.

(To be concluded)

(Kaushik Dutta is partner, Price Waterhouse, and Kshama V. Kaushik is a chartered accountant.)

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