The Hindu Business Line : Pension reforms

In line with the global trend, the Government has announced its intention to migrate from the ‘defined benefit’ to ‘defined contribution’ scheme in a phased manner.

M. R. Rajaram

One has been hearing a lot about various initiatives towards reforming the pension regulations. Before going into the details, it will be useful to understand these .

Pension benefits in the broader sense of the term covers three types of retrial benefits — provident fund (PF), gratuity and pension. PF and gratuity are somewhat peculiar to India and are required to be provided legally once the number of empl oyees exceeds the threshold level.

Pension is not required to be provided legally. Hence, it is a not-so-common benefit provided by the government and a small number of “employee friendly” companies. Under this structure, the pension benefits are restricted to a small fraction of the workforce.

Benefit vs contribution

Pensions can be either under the ‘defined benefit’ scheme or the ‘defined contribution’ scheme. In line with the global trend, the Government has announced its intention to migrate from ‘defined benefit’ to ‘defined contribution’ in a phased manner.

Though the ‘defined contribution’ scheme for government employees joining after January 1, 2004, was announced long back, its implementation is picking up steam only now. The change over to ‘defined contribution’ is a welcome change from the government’s budgetary control point of view.

‘Defined contribution’ scheme as distinct from ‘defined benefit’ scheme caps the financial obligations of the pension provider and the value of the pension will depend on the corpus available on retirement with no assurance on the quantum of pension value to the beneficiary. Hence, the risks of return on the pension fund get transferred to the employees from the employer. While this is a desirable result from the employer’s point of view, there is urgent need to provide certain options to the employees to mitigate this risk. The proposed reforms aim to achieve this objective.

First, there is a need for efficient management of the corpus to optimise the pension for the employees under the ‘defined contribution’ scheme. Also, the return should reflect the financial scenario in which the investments are made.

The earlier scheme of government retaining the funds at an agreed interest rate doesn’t meet this criterion. The proposed change of managing the funds through a few set professionally managed pension funds is a right move.

Option to select

As per the scheme, the individual members have the choice of not only selecting the pension fund manager ( from among the short-listed managers) but also the scheme depending on the risk profile. The allocation between the fund manager and the schemes can be changed by each employee. Such flexibility provides the employees an opportunity to optimise the return and thereby maximise the pension.

Another issue under debate is about the access to the new scheme. In the western world, pension benefits are widely available by way of social security grants which are provided to the total population. Hence the proposed move of the Government to provide universal access to pension under Pension Fund Regulatory and Development Authority (PFRDA) is a welcome move.

The provident fund scheme is also being reformed. A recent action in this context is the enhancement in the limit for investment in equity from 5 per cent to 15 per cent. Allowing PFs to invest in equities requires careful handing. Hence, there are two extreme views on the subject. This is reflected in the differences between the Finance and Labour ministries owing to which many privately managed PFs are not able to utilise the opportunity of investment in equity. The stalemate should be resolved at the earliest.

As PFs will have members at different age group, the risk profile of individuals will be different. Also, the returns from investments in equity don’t flow uniformly. Hence equity investment is not advisable for people in the higher age bracket with retirement round the corner. At the same time, for a young person equity investment will make sense.

To address this diversity in the requirements, the model under PFRDA for pension fund should be adopted. Investments in equity schemes should be kept separately and employees should be given an option of diverting a portion of the contribution to the equity schemes.

Considering the prime purpose of PF is security, there should be a cap on investment in the equity scheme. It is time both the Finance and Labour ministries got together and came up with a new set of guidelines for PFs using the experience in developing PFRDA.

(The author is Director, ICL India Ltd. blfeedback@thehindu.co.in)

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