Unified Pension Scheme: Old, bad ideas in a new package

UPS is an improvement on the OPS in terms of funding because it puts a defined amount into an investment corpus every month.

Saturday evening, the union cabinet undid over 20 years of painstaking effort to control the pension payouts of government employees and, thereby, create fiscal space to meet the needs of other sections of society.

The unified pension scheme (UPS) which was cleared that evening is being packaged as a version which captures the best of old pension scheme (OPS) and the national pension system (NPS). That may well be the case for central government employees right now. But for the rest of society, it will mean that the central government will earmark a higher proportion of its annual budget to create a corpus for UPS limited to just its employees. In addition, a guaranteed pension payout under UPS means that the budget will always carry the risk of additional funds being earmarked to cover shortfalls in pension commitments.

How we got here

Between 2000 and 2005, two coalition union governments, led by AB Vajpayee and Manmohan Singh respectively, saw through a huge pension reform. Building a consensus across major political parties, they moved government employees from a pension which guaranteed a payout to one that most Indians in formal private sector jobs are familiar with, at retirement what one would receive is the return on the corpus built through a contribution of employee and employer.

This was done prospectively beginning January 2004. Many states followed suit and NPS took off. The important point is that every employee joining after that date knew what was in store.

A guaranteed return is always bound to be more comforting than depending on the swings of financial markets. There were often calls from government employees to go back to OPS, but answers provided by governments in Parliament show that they believed the OPS was unsustainable.

A guaranteed payout adds to the risks that future governments have to confront.

UPS assumptions

UPS offers a guaranteed payout without taking away the need for both employee and employer to contribute to the corpus.

For the central government, the employee contributes 10 percent, while employer started with a matching contribution and later enhanced it to 14 percent. Therefore, there was a conscious decision to push up annual pension outgo in the union budget by increasing the percentage of the government’s contribution.

Now, under UPS, the government’s contribution will go up to 18.5 percent of an employee’s salary. The extra 4.5 percentage points the government will contribute, which in the first year will add another Rs 6,250 crore to the pension bill, is based on an assumption that it’s the amount needed each year to cover for the guarantee. An undisclosed assumption of the government here is the expected return on investment which would have been factored in to decide that 4.5 percentage point enhancement in government contribution is adequate.

Is the guaranteed payout fully funded?

No, because it all depends on the rate of return the government has assumed.

If the actual market performance is short of the government’s assumption, the union budget will have to make good the shortfall to honour its commitment. That’s the risk of a guarantee which is what the 2004 pension reform bypassed. UPS effectively takes on the risk again which has to be backstopped by tax payers.

Read | UPS vs NPS: Which is better for you?

Has government ever had to refill fully funded pension schemes?

UPS is an improvement on the OPS in terms of funding because it puts a defined amount into an investment corpus every month. But fiscal stress can undo good intentions.

Take the case of Indian Railways. IR has a pension fund which was created to cover current pension payments and meet accumulated liability on account of pension benefits earned each year of service. Well intentioned it may have been but inflows in the pension fund weren’t always enough.

For example, in 2020-21, the government had to provide concessional support of Rs 79,398 crore to IR to offset the damage of Covid-induced lockdowns, and compensate for an adverse balance in the pension fund. The adverse balance due to years of financial stress had reached Rs 28,398 crore.

Blaming politics is a cop-out

It’s easy to blame the return of a coalition political era for the introduction of UPS. However, it’s important to keep in mind that pension reform was carried out by coalition governments where the anchor party in each government had less than 200 Lok Sabha seats.

It shouldn’t have been difficult to say no to a tiny proportion of India’s workforce which have perhaps the best deal as a class of employees. For instance, even if all state governments and PSUs shift to UPS, it will benefit less than 10 million employees, or less than 2 percent of India’s workforce.

To conclude, it’s important to remember that in 2004, it was assumed that for a generation or two government pension payout would increase as there would be both defined benefit, or guaranteed pension, outgo and monthly employer’s contribution for those who joined after 2003. But eventually the defined benefit outgo would decline and all that would be left is the monthly employer’s contribution. That’s where 20 years of effort have been undone.