Rhea Paul
I. Introduction
Population ageing is expected to be one of the biggest transformations in the 21st century, with an impact on almost all aspects of social and economic functioning. India, in particular, is predicted to experience a multi-fold increase in the elderly population in the coming years, with more than 227 million persons by 2050. The potential surge in the old-age dependency ratio calls for the development of strong pension frameworks to provide old-age income security. However, instead of improving the existing pension system in India, several Indian states are now backsliding to the Old Pension Scheme (“OPS”), despite the vast sea of critical literature against it. As a result, the Finance Minister, Nirmala Sitharaman, assured the public earlier this year that a committee headed by the Finance Secretary would be formed to investigate the grievances associated with the New Pension Scheme (“NPS”) and solve for the same.
With reductively framing the problem as a question of the OPS versus the NPS, the larger regulatory issues with the pension framework in India have been ousted from the conversation. In this essay, I make two arguments. First, one of the fundamental problems with the Indian pension framework is the regulatory fragmentation of different pension schemes, leading to inadequate population coverage and inequity in the operationalization of the system. Second, these issues can be best addressed by expanding the role of the Pension Fund Regulatory and Development Authority (“PFRDA”) and developing it into a single unified regulator. Accordingly, this paper has been divided into five sections. In Part I, I analyse the disparate investment guidelines across different pension schemes and their impact on the returns generated by pensioners. In Part II, I examine the National Pension System (“NPS”) and identify the shortfalls of this scheme. In Part III, I investigate the reasons for poor pension coverage in the unorganised sector of the workforce. Building on this, I present the need for a unified regulatory authority in Part IV and propose that the regulatory scope of the existing PFRDA may be extended to best harmonize the framework. Lastly, in Part V, I conclude.
The primary issue with the existing Indian pension framework is its fragmented nature, characterized by various different regulators and governing guidelines. The disparity between the schemes adds a layer of complexity and uncertainty in the minds of consumers. In a country with a vast illiteracy rate, educating the public about their available options for creating life-long savings is a mammoth task. This becomes exponentially harder when there are multiple legislations and subordinate regulations with conflicting standards. In this section, I analyse the disparate investment guidelines across different pension schemes in India and highlight the need for harmonization and regulatory reform.
When describing the goals of the New Pension Scheme (now the NPS) in 2000, the Project Old Age Social and Income Security Project (OASIS) Report noted that there are two requisites to reliable pension planning, one of which is sound pension fund management to maximise the rate of return. The benefits of the same extend beyond pensioners – at a broader level, it increases the depth of the capital market. This may be effectuated through well-designed investment guidelines.
The manner in which pension assets should be invested and regulated has been a subject of intense policy debate in numerous countries. While some argue that quantitative portfolio regulations are best suited to regulate the investment of pension assets, others endorse the prudent-person principle. Quantitative portfolio regulations refer to the prescription of limitations on certain types of assets which are perceived to be risky. On the other hand, the prudent-person principle is a behavioural standard which guides financial managers to restrict their investment choices to those assets which would be preferred by a person seeking a reasonable income. This protects investors against undue risk. At present, there are different guidelines for each pension scheme in India, as detailed below, thereby reflecting contrasting approaches to pension fund regulation within the country.
The investment guidelines for the NPS in India adopt a ‘directed investment’ approach, operationalizing a quantitative portfolio regime wherein the asset classes in which pension investments can be made are stipulated by the PFRDA, as are the investment caps for each of these classes. This approach has been employed to shield public savings from volatility, in light of the cautious shift from a defined benefits (“DB”) (i.e., the payment of pre-determined amounts to subscribers upon reaching the eligible age) to a defined contribution (“DC”) regime (i.e., the payment of varied amounts to subscribers, calculated on the basis of their respective contributions until the eligible age).
The Committee to Review Investment Guidelines for NPS Schemes in Private Sector (“Investment Review Committee”) has opined that in today’s economy, the ‘directed investment’ approach is unfair for investors who wish to grow their savings with a higher rate of return. As a result, it has suggested a shift in the investment philosophy from ‘directed investment’ to a ‘prudent-person’ strategy which entrusts investors with the choice of investing their own pension assets depending on their financial position. This would involve the introduction of new asset classes, easing of investment ceilings and expansion of instruments under each asset class.
Crucially, the employment of this principle must be carried out in a similar manner across regulatory regimes. The prescribed ceiling limits presently vary across pension schemes available to different subscribers in the private and public sector. The multiplicity of investment mandates has created an uneven playing field for investors, allowing only certain classes of employees (i.e., private sector NPS subscribers) to invest in assets with higher returns. Unfortunately, this inequity is not limited to the NPS, but also applies to the entire pension framework in India. Different statutes and rules applicable thereunder have devised different investment guidelines for its subscribers. For instance, central government employees appointed before 2004 are subject to the Central Civil Services (Pension) Rules, 2021, under which Rule 44 provides a formula for the calculation of the amount of pension accrued by a civil servant upon retirement or dismissal. Likewise, the Employees Provident Funds and Miscellaneous Provisions Act, 1952, lays down the amount to be collected as pension from employees in factories and other specified establishments with more than twenty people. Under Regulation 52 of the Employees’ Provident Fund Scheme, 1952, the corpus collected from member employees must be deposited in the RBI, SBI or other pre-approved banks. Alternatively, the amount may be invested in certain securities specified under the Indian Trusts Act, 1882.
It is observed that changes have been implemented gradually to expand investment choices and move towards a prudent-person approach under the NPS. For example, in July 2021, the PFRDA allowed pension funds to invest in initial public offerings (IPOs) with a certain market capitalization, thereby evidencing a clear growth in the investment choices available to pension fund managers and subscribers under the NPS. However, this has not been mirrored by other regulators like the Employee’ Provident Fund Organisation (“EPFO”) which still employs a conservative investment strategy. If the Employees’ Provident Fund (“EPF”) corpus is only invested in low-risk assets, the rate of return will be correspondingly low. Accordingly, the corpus amount will be unable to keep pace with inflation. Consequently, the cautious approach under the EPF could end up adversely affecting subscribers in the long term.
The NPS was first introduced by the Ministry of Finance vide an interim order in 2003. It was originally intended to create an efficient pension planning system for government employees by shifting from a DB to a DC structure. Until 2009, the NPS was only mandated for civil servants who were recruited post 1 January 2004. This was carried out through a series of amendments to different rules applicable to the Central Government service, such as the Central Civil Services (Pension) Rules, 1972 and General Provident Fund Rules. From 2009 onwards, the NPS was gradually extended to all Indian citizens, corporates and non-resident Indians on a voluntary basis. In this section, I examine the two main drawbacks of the NPS, namely, the poor literacy around the NPS and the unfavourable taxation of withdrawn pension sums under the Income Tax Act, 1961.
Considering the merits of the NPS investment guidelines over other schemes, one would naturally assume that a vast majority of the Indian population would be covered by the NPS. However, there are only 6.24 crore subscribers to the NPS today, 72.5% of whom have opted for the Atal Pension Yojana (“APY”) Scheme. This is a meagre number against the country’s 52 crore workers. The question thus arises – why has pension planning under the NPS attracted so few subscribers?
One answer theorized by experts is the lack of awareness associated with the NPS. This stems from a number of reasons. Among other things, the limited marketing of pension products has been linked by some analysts to the low fee cap that intermediaries are permitted to charge under the PFRDA regulations. Accordingly, private pension fund managers are not adequately incentivised to invest in sales efforts. While this cap has been understandably set by the regulator to minimise the costs to investors, experts have contended that a better balance must be struck to motivate intermediaries to reach more people. At a larger level, the regulator must itself intervene to address the lack of education and awareness around the NPS. From a behavioural standpoint, individuals prefer present consumption to future savings, especially when their earnings are low. This makes it especially difficult to capture those with paltry salaries.
Another impediment of the NPS is that it suffers from unfavorable tax exemptions compared to other pension schemes in India. In other words, it does not offer the same tax benefits as competing schemes like the Public Provident Fund (“PPF”) and EPF, placing it at a marked disadvantage. Under Sections 80CCD(1) and 80CCD(1B) of the Income Tax Act, 1961, a subscriber can claim tax deductions on the contributions made to the pension scheme. The income raised at the accumulation stage is exempt from taxes. However, at the time of withdrawal, only 60% of the corpus can be withdrawn as a lumpsum without tax. The remainder must be converted into any annuity which is taxable.
While financially sophisticated investors may be able to distribute their savings across different schemes so as to exploit these tax distortions, the average person does not have the same ability to do so. Therefore, this has led to an anomalous situation wherein only one set of investors are able to reap the benefits of these variations, thereby leading to inequity in the operationalization of the pension system in India. Considering the importance of ensuring old-age income security, the State should take steps so as to bring the NPS on par with the EPF and PPF in terms of the tax exemptions. This would go a long way in harmonizing the different Indian pension schemes.
In India, there are around 450 million people employed in the informal sector. This figure represents approximately 93% of the labour force and contributes to over half of the country’s GDP. Unfortunately, most of the pension schemes in India, including the NPS and EPF, are directed towards the organised sector. This leaves a majority of the workforce with no form of retirement income security. In this section, I examine some of the pension schemes which target the unorganised sector and present a critique of the same.
To provide pension coverage to the unorganised sector, the Swavalamban Scheme was introduced in the 2010-11 Union Budget as a specially designed model under the NPS. Although the country had moved beyond the DB regime at this point, under the Swavalamban Scheme, an amount of Rs. 1,000 per annum for three years was granted by the government to new NPS accounts. However, the scheme did not attract many subscribers due to ambiguity around the pension benefits offered at the age of 60. With this in mind, a new scheme known as the APY was introduced in 2015. The APY is a central government scheme administered by the PFRDA. Subscribers to the APY are guaranteed a monthly pension between Rs. 1,000 to Rs. 5,000 depending on their monthly, quarterly or half-yearly contributions. These requisite monthly contributions vary from a modest Rs. 42 to Rs. 210 at 18 years of age and increase with the entry age of the individual. As a part of the NPS architecture, the APY is subject to the same tax exemptions as the NPS (as described in Part II). Considering the goal of the APY is to provide pension coverage to the economically disadvantaged, it is surprising that the government has not offered the same tax benefits as the EPF and PPF under this scheme. Since October 1, 2022, this scheme has become unavailable to taxpayers.
Recently, in 2019, the Pradhan Mantri Shram Yogi Maandhan (“PMSYM”) was launched by the Ministry of Labour and Employment as a new pension scheme for unorganised workers with incomes less than Rs. 15,000. This is meant to cover individuals who are not covered by the EPF due to their employment in the informal sector. The structure of the PMSYM and APY is broadly the same, i.e., a monthly pension of Rs. 3,000 is granted to subscribers upon reaching the age of 60. Like the APY, the entry age to the PMYSM is 18 to 40 years. However, apart from government co-contributions, the PMYSM falls short of the APY system in many ways. For instance, subscribers can choose to make their contributions monthly, quarterly or half-yearly under the APY. This allows them much needed flexibility in case their incomes are irregular. The same option is not granted under the PMSYM wherein only monthly contributions are permitted.
The biggest advantage of the APY over the PMSYM is that the accumulated corpus is transferred to the spouse or nominee of the subscriber upon death. As against this, under the PMSYM, this amount is forfeited to the overall fund. Additionally, while the PFRDA – which regulates the APY – has a relatively transparent governance mechanism, the government has offered very little information about the governance or investor pattern of the PMSYM.
Instead of improving the APY by introducing government co-contributions or greater distribution channels, the PMSYM represents a retrograde step in the social security of informal workers. These drawbacks beg the question of why similar schemes are being administered to the same target audience by the Ministry of Labour and Employment and the PFRDA. It illustrates further fragmentation in an already complex pension framework. A unified approach could combine existing resources and potentially lead to far greater pension coverage over the unorganised sector.
The above discussion reveals how the institutional design of the pension system in India is spread across various authorities and statutes. As described by Renuka Sane and Susan Thomas, there are four grounds to integrate the Indian pension framework. First, the quality of policy analysis can be significantly improved under a unified regime. If academic research and policy reports are concentrated on the operations of a single regulator, the chance of regulatory arbitrage upon implementation is lower. Second, fragmentation increases the complexity of financial choices to the consumer and impedes investor education efforts. A simple and easily comprehensible system would attract greater sympathy for the purpose of retirement-planning, thereby leading to more subscribers. Third, the existence of multiple regulators damages economies of scale and unnecessarily raises the overall administration costs, as evidenced by the duplication of efforts under the APY and PMYSM. Lastly, a single regulator enables a streamlined grievance redressal mechanism for the entire pension sector. This would be a huge step towards providing greater consumer protection.
Therefore, the most urgent reform required by the pension framework in India is the unification of regulatory standards under extant schemes. The most prudent step towards harmonizing the Indian pension system is to consolidate the different pension schemes under the aegis of a single regulator. Not only would this exponentially simplify the framework, the existence of an apex regulator would eliminate regulatory gaps in the system. In turn, this could potentially prevent the exploitation of regulatory arbitrage. Accordingly, this paper proposes an expansion of the regulatory role of the PFRDA as a tool for consolidation and simplification of the pension framework in India.
Under the PFRDA Act, 2013, the PFRDA was established as the regulatory authority overseeing the NPS and all related intermediaries. It has been vested with a wide range of powers under Section 14, ranging from the approval of pension schemes to the education of the general public on retirement savings. The need for a new and separate regulator arose from the recognition that the NPS had many different elements that required effective coordination. As per the preamble of the PFRDA Act, the object of the PFRDA is two-fold, i.e., to promote old-age income security and to protect the interests of pensioners.
At the time the PFRDA was still being conceptualised, the main argument against its creation was the potential overlap in jurisdiction with the Insurance Regulatory Development Authority of India (“IRDAI”). As the name suggests, the IRDAI is responsible for the regulation of the insurance sector. Through the years, there have been numerous cases of conflict between the PFRDA and IRDAI. For example, before the enactment of the PFRDA Act, the IRDAI monitored over 1.4 lakh crore in retirement saving schemes through the regulation of insurance products with pension features. It argued that the scope of the PFRDA was limited solely to the regulation of pensions under the NPS. However, the chairman of the interim PFRDA claimed that the insurance regulator was disinclined to yield its jurisdiction over this domain, as pension schemes were the fastest growing product for life insurers (second only to unit linked funds). Since its inception, the PFRDA has repeatedly urged the government to allow it to assert its power over the pension schemes of insurers.
In 2019, the Ministry of Finance extended the above proposal and introduced the idea of transforming the PFRDA into the sole regulator for all pension products, including the EPF. This was expected to be formalized in the following 2020 budget but is yet to be done. As explained by the PFRDA Chairman, Supratim Bandopadhyay, the logic behind this move was to eliminate the confusion caused by the multiplicity of pension funds. However, there remains hesitancy over whether the PFRDA should take control of the regulatory role of the EPFO.
There are three main factors that build a strong case for the PFRDA to handle the EPFO. First, as discussed in this paper, there is a clear fragmentation in the regulation across pension schemes in India. The resulting regulatory arbitrage must be eliminated to ensure the equal treatment of all individuals in the workforce. Creating a single regulatory authority over different schemes offers a viable means of achieving this goal.
Second, the investment regulation of the EPF should mirror that of the NPS because, as discussed in the previous section, the conservative investment practice is contrary to the objective of ensuring old-age income security. This goes against the aforementioned second prong of reliable pension planning laid down by Project OASIS, i.e., the rate of return should be maximised without undue risk. The NPS itself should look to shift from a directed investment approach to a prudent-person regime, as recommended by the Investment Review Committee.
The third contention for change in the regulation of the EPF is the information asymmetry between subscribers and the EPFO’s fund management. There is complete opacity around how the rate of return for the EPF is determined at present. Ideally, the investments made with the corpus and the corresponding returns which are generated should be disclosed to the EPF members. As argued by Luca Enriques and Sergio Gilotta in their article, ‘Disclosure and Financial Market Regulation’, the primary purpose of disclosure in financial markets is to provide the common person with enough information to enable them to make good investment decisions. This is especially true when the lifetime savings of an individual are on the line. Considering the lack of transparency in the accounting practices of the EPFO, it is essential that the regulator is subject to significantly higher disclosure standards.
In light of the above factors, if the EPF were to be subject to the same regulations as the NPS, it would make sense for the PFRDA to take over the EPFO’s regulatory role. The conceptual bifurcation of the EPFO’s managing and regulatory functions was initiated by the Ministry of Labour and Employment in 2018, upon the suggestion of the Ministry of Finance. The same was also recommended by the Working Group on Insurance Pensions and Small Savings (“Working Group”) in order to obviate the conflict of interest arising from the dual role of the EPFO. The regulatory responsibilities of the EPFO is a mammoth task as the EPF currently has over 69 million active members with nearly Rs.15.7 trillion in assets under management. However, this shift will go a long way in integrating the pension framework in India.
Additionally, the schemes targeted towards the unorganised sector should be streamlined under the PFRDA’s regulatory ambit. As mentioned in Part III, the administration of largely duplicate schemes (i.e., the PMYSM and APY) by different regulators could have been avoided by routing government co-contribution through the APY scheme and refining the distribution mechanism. Harnessing economies of scale would also enable the PFRDA to ensure greater pension coverage over the informal workforce.
As suggested by the interim chairman of the PFRDA before the enactment of the PFRDA Act, 2013, eventually all pension products should be brought under the jurisdiction of the entity. At present, there is regulatory overlap between different authorities which have introduced similar products. As a result, the current method of activity-based regulation leaves room for regulatory arbitrage and requires reconsideration.
With population ageing, there is an increasing need for countries to develop a robust pension system to ensure old-age income security. Pension systems in most countries seek to achieve two main objectives – poverty alleviation and consumption smoothening. This allows one to maintain a dignified standard of life post retirement.
As discussed in this paper, the Indian pension framework is in need of urgent reform. Many of the problems associated with the existing system arise from the fragmentation in the regulation and administration of different schemes. To tackle this, India should adopt an integrated regulatory approach. Building on the recommendations of the Working Group, Ministry of Finance and other expert bodies, I believe that the harmonisation of the pension system in India can be best achieved through the expansion of the PFRDA’s regulatory role into a single unified regulator.
The transition process is likely to be lengthy, considering the groundwork, preparation and resources involved. In the meantime, the government should take certain steps to optimize the current system, including the delineation of regulatory functions between different entities, the harmonization of investment guidelines, the co-ordination of various pension authorities and improvement of investor awareness campaigns.
Rhea Paul is a 2022 graduate of the National Law School of India University (NLSIU), Bengaluru. She is currently an Associate with Saraf and Partners, New Delhi.
