Informal sector workers have limited benefits in the absence of any provident fund or gratuity. What solutions then can the Indian government come up with to help them build wealth for old age? When there is no food on the table, one cannot discuss savings.
However, the informal sector is quite heterogeneous, and to the extent that there is some saving capacity among workers, could they be brought into the fold of pension schemes?
Encouraging voluntary contributory pensions is an important strategy to achieve greater pension coverage in the informal sector. There are two possible reforms the government should consider. First, create an enabling framework for Union and state governments to plug into the National Pension System-Lite (NPS-Lite). Second, widen the variety of drawdown policies for those exiting the workforce at the age of 60.
Using existing infrastructure
Government employee pensions are provided through the NPS. Under this framework, a central record-keeping agency (CRA) documents the pension contributions, licensed fund managers handle the money, NPS Trust holds responsibility for the assets and funds, and the regulator — the Pension Fund Regulatory Development Authority (PFRDA) — maintains the sanctity of the system.
This infrastructure is readily available for use in any other scheme as well. It was used to set up the NPS-Lite in 2009. Through NPS-Lite, informal sector workers can use the same set of institutions as government employees to manage their pension savings.
If a government—Union or state—wants to start another pension scheme, it should consider plugging into the NPS ecosystem. In fact, this was the initial goal of the NPS.
For example, if a state government wants to start a pension scheme for its constituents, it should be able to open NPS-Lite accounts for them. The objective of the sponsor (in this case, the government) should be to identify those eligible and steer their contributions to the NPS-Lite.
The government could easily provide co-contributions to incentivise those taking up the scheme. It could choose a reliable pension fund to manage the contributions so that the informal sector workers are able to enjoy the same level of transparency and regulatory scrutiny of their investment as the formal sector workers.
If a worker moves to another state, the pension account stays with her. This is a better strategy than starting a new scheme with a separate fund for each state.
The Ministry of Finance and the PFRDA need to create an enabling framework that reduces friction for a state government to plug into the NPS ecosystem. On the other hand, the Ministry of Labour and Employment needs to use the existing NPS infrastructure instead of starting separate welfare funds.
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Reforming drawdowns
The distinguishing feature of a pension scheme from any other savings product is the periodic payment (also known as an annuity) that a pensioner receives from retirement to death. Without this, the corpus in a pension account is not too different from the corpus in a savings account.
The current NPS framework requires a member to purchase an annuity from a licensed service provider at the time of retirement. The member has to use at least 40 per cent of the accumulated surplus to purchase an annuity plan, which continues to pay a specified amount until death.
The problem with annuities is that while everyone pays the same premium at retirement, only those who live longer benefit from the payment. Essentially, those who live longer get subsidised by those who die early. This becomes an important issue in the case of informal sector workers, whose life expectancy is likely to be lower than those in the formal sector.
We don’t want a situation where the poor are subsidising the rich.
The PFRDA needs to invest in infrastructure that can price annuities for NPS-Lite customers more accurately. It can build life tables that reflect the appropriate mortality scenario for the informal sector. This may require a tie-up with the birth and death registration system.
Another approach is to allow phased withdrawals from the pension account based on specific formulae. The PFRDA has already proposed setting up a Systematic Lump Sum Withdrawal facility for NPS account holders. This could be extended to the informal sector workers.
Why not Atal Pension Yojana?
The PFRDA offers another scheme called the Atal Pension Yojana (APY), which guarantees a pension if the member contributes continuously for a specific number of years. The appeal of the APY over the NPS is that it provides a guaranteed return. However, one must not forget that both contributions and the pension amount are capped in the APY. It is not possible to contribute more to get a higher pension. This forces the informal sector workers to sign up for pensions that are low in nominal terms.
The NPS-Lite, on the other hand, does not provide a guaranteed return but offers the possibility of higher pensions. It also offers various investment choices to its members.
The other option is to start separate funds or schemes for specific categories of workers. However, several such funds in India have seen poor governance and even fraud. The funds are not “regulated” in any sense. On the other hand, fund managers for pension schemes regulated by the PFRDA are under constant scrutiny and have to disclose the net asset value of their funds on a daily basis.
So far, we have not seen poor governance by these fund managers and the PFRDA can be relied upon to conduct its supervisory function appropriately. India has been a proponent of state involvement in building public infrastructure, from digital payments to e-commerce. It already has the “rails” for pension systems; all it has to do is leverage them.
Renuka Sane is managing director at TrustBridge, which works on improving the rule of law for better economic outcomes for India. She tweets @resanering. Views are personal.