How the power of compounding gave birth to the National Pension System

Published: August 17, 2016 at 10:19 am

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My mother retired 13 years ago and started receiving a pension that was indexed to inflation. Not only did it increase twice a year, thanks to DA hikes, it also increased as a result of pay commissions. The average year on year growth of her pension is close to 13%. This is an astounding number – not for her, but for the government who has to pay a similar pension to the lakhs of central and state government pensioners.

Paying a pension that tries to keep pace with inflation, or an indexed pension is a debt trap for the government. The projected strain on our fiscal deficit was alarming. Hence the government decided to stop defined-benefit pension schemes that offered indexed pension and moved over to a defined-contribution pension – the national pension system (NPS), also known as the new pension scheme.

In a way, a retiree receiving an indexed pension is a government employee for life. The NPS seeks to severe ties with the employee post-retirement.

Why was the National Pension System Introduced?

Here are some facts that gave birth to the NPS.

In 1998, the Committee for Old Age Social and Income Security (OASIS) was set up. It noted that the population of the 60+ age group is expected to increase by ~ 107% between 1991 and 2016.  Senior citizens represent 9-10% of our population today and this is expected to grow to13.3% by 2026.

The life expectancy after normal retirement at 60 is expected to be at least 15-20 years.

As per 1991 census data, only 11% of the total workforce is eligible for subscribing to a pension scheme!  The fear that most of them would not have retirement savings to speak of is the main reason for the introduction of the NPS Swavalamban Yojana for the unorganised sector.

Even if one assumed no increase in government employment after 1992 (true in many areas) the pension expenditure for the central government will increase from Rs. 35,690 million in 1995 to  Rs. 2,71,830 million in 2015. A CAGR of ~ 17.5%!

Pic Credit:
Pic Credit: Josh Adams

The 7th Pay Commission report notes that

the total pension liability on account of Central Government employees had risen from 0.6 percent of GDP (at constant prices) in 1993-94 to 1.66 percent of GDP (at constant prices) in 2002-03. Pension expenditure of the Central Government grew at a compound annual growth rate (CAGR) of 21 percent during the period 1990 to 2001

The tax burden on the state government is also similar as noted here.

A CRISIL report notes that pension burden for the government is expected to remain close to 2.2% of the GDP between 2015 and 2030 and only then decrease to about 0.7% ~ 2050.

These are the manifestation of the negative power of compounding in the number of 60+citizens, life expectancy due to increase in technology and health consciousness and of course in the burden to the government that has to pay an indexed pension.

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