1. Column: Understanding one-rank-one-pension

Column: Understanding one-rank-one-pension

It is a dramatic escalation of the implicit pension-debt for the government

By: | Published: June 2, 2015 12:46 AM

It seems impossible to reverse one-rank-one-pension in India now, and it seems hopeless to fix the military pension. However, it is worth understanding what the issues are, and the mess that we have landed in.

Nominal annuities in a zero-growth environment

Let us start with a country with no GDP growth. So, a worker earns some income all his life. We want him to tuck some money away every year into a pension account that will buy an annuity at the age of retirement. He builds up this pension wealth, and at age 60, he buys an annuity. It is common to target a “50%-benefit rate”, i.e., the magnitude of the annuity should be half his last wage.

To fix intuition, let us assume the number A is the price of an annuity which yields a flow of income of Rs.1 per month. In this case, the pension wealth to get to half the last wage is Aw/2.

This is the challenge of the ordinary pensions discussion. If you want an unfunded, i.e., a “defined benefit” pension, then you want the taxpayer to pay Aw/2 for each person. There is no other difference; the basic story is the same.

In India today, A is roughly R133. That is, if you buy an annuity at age 60 which pays R1 per month until death, the price is R133.

So far, we have asked the annuity-provider a simple question. We have asked: I want a fixed cash flow of R1 per month until I die. What would you charge for this? The annuity market says: I will charge A for this contract. This is the lowest price of an annuity; this is a simple unindexed nominal annuity.

Now, we can modify the terms of this annuity in many ways.

Real annuities in a zero-growth environment

You could say: Instead of giving me a nominal R1 per month, give me an inflation-indexed R1 per month. This is an inflation-indexed annuity. This will, of course, cost a lot more than A. To produce a nominal annuity, the annuity-provider invests in nominal bonds which produce a stream of cash. But to produce a real annuity, the annuity-provider has to invest in inflation-indexed bonds, which yield a lower stream of cash. Hence, it needs much more than A to produce an inflation-indexed stream of R1 per month. Suppose the price is B, and we know B >> A.

A government that promises an unfunded inflation-indexed annuity is placing an expense on the tax-payer of Bw/2.

The problem of GDP growth

Into this environment, let us inject high GDP growth. Let us go to the higher side by assuming per capita GDP growth of 7%, which means that per capita GDP doubles every decade.

When a person is 60, he was at half the wage of persons who are 59. But when he reaches 70, his pension has stood still, but the persons who are at age 59 have (roughly) got a doubling of their wage. The pensioner has lost ground compared with the worker.

That pensioners lose ground when compared with workers is a fact of life for all pension systems. In the West, where pensions were invented, this was not a big deal, as they have had a slow growth environment. But when there is high GDP growth, this can yield glaring gaps. A pensioner who is at the 90th percentile of the Indian income distribution at age 60 will end up at perhaps the 70th percentile of the Indian income distribution at age 70.

This is just a fact of life and you can’t do anything about it. Anyone who builds up wealth in India over the working years 1980 to 2020 will seem prosperous in relative terms in 2021 but will seem less prosperous in relative terms in 2031 and in 2041. That is the inexorable logic of high GDP growth.

Suppose we go to the annuity provider and say: Sell me an annuity which is not just inflation-indexed, but wage-indexed. The payment per month will go up to reflect the average wage growth of the economy. This is a pension which will keep up with the Joneses.

In my knowledge, there is no private insurance company which will produce such an annuity. It is a very expensive annuity to produce. Let’s use the symbol C for the price of this annuity. C >> B >> A. A government that promises someone a wage-indexed pension is asking the taxpayer to put up Cw/2 which is much bigger than Bw/2 or Aw/2.

That’s one-rank-one-pension

This is the costliest pension imaginable. The Indian government seems to be on the trajectory of offering this for all military personnel. It is a dramatic escalation of the implicit pension debt for the government on account of military personnel.

Once this entitlement is in place, it will be hard for the government to go through with the NPS reform, where the second stage was supposed to be integrating uniformed personnel into the NPS.

It is a disappointment that we did not have adequate thinking on these issues in time. The delays and sloppiness of implementing the NPS have been extremely costly for India.

From the author’s blog: ajayshah.blogspot.in

The author is professor, National Institute for Public Finance and Policy, New Delhi

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  1. L
    Lt.Col. H.
    Jun 3, 2015 at 10:14 am
    The writer has missed the most important point ! The armed forces ( army, Navy, Air Force ) personnel forefeet their lives to the nation & its defence. Not only this, they are the lost resort for any internal security emergencies. Therefore, their services - not job, cannot be compared to any other government job. How tne babus who sit in the luxury of an air conditioned office, can arrogate to themselves NFU ries , without even shouldering hog her responsibilities ! In the context of the GoI throwing thousands of carpers of Rupees on half backed schemes- Ganga River cleaning campaign, it looks very silly to argue / grumble the grant of OROP to the Armed Forces Personnel ? The biggest risk the GoI will be taking is the demoralisation of its Armed Forces. No country can take a chance with this, because defeat is guaranteed. Let there be no more ance on the part of the Political Leadership , call the bluff of the Babudom, and order the implementation of the OROP.
    Reply
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      AKHILESHLIVE
      Jun 2, 2015 at 5:37 am
      The author has looked into only negative aspect. If the pension itself creating so much problem what about thousands of social n economic programmes being run by government. In author's eye that also be a waste. Any problem should not be seen from only economic angle. If that would have been the case govt should have transferred this to NPS. You cant attract youth of the country to join AF just for patriotism. There has to be some compensation. Before putting such article the author should first look into condition in which employee serves.
      Reply
      1. M
        Mahmud Ghazni
        Jun 2, 2015 at 12:45 pm
        please see redux to see how the US military pensions grow with time, based on , what was it you said? oh yes, "wage indexed and inflation indexed". Please stop trying to pull wool over people's eyes in this time and age.
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          Mahmud Ghazni
          Jun 2, 2015 at 12:47 pm
          that was that was h t t p : / / militarypay.defense.gov/retirement/calc/03_redux
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            BOYINA KAMESWARARAO
            Jun 2, 2015 at 7:37 am
            You are calculating all these figures very peacefully in you air conditioned office only because of THE ARMED FORCES are willing to shed their blood if need be. Like you people should be made work in border keeping your family away. You are the real traitors who are demoralizing the armed forces.
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              BOYINA KAMESWARARAO
              Jun 2, 2015 at 7:44 am
              You are writing such non sense by sitting in your air conditioned office very peace fully because THE ARMED FORCES are ready to shed their blood if need be. Like you people are the real traitors demoralizing the armed forces. You should be made to work with out working hours in border sun in hot summer and in open place in freezing cold at mid night with a gun in your hand.
              Reply
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                BOYINA KAMESWARARAO
                Jun 2, 2015 at 7:32 am
                Should we do all these calculations while facing the enemy. If I loose my right hand I will loose my job. How much I would have earned if i would have had the right hand in one year and the second including interest on the first year earning and so on so fourth. How ever the estimated cost is much much much less the concessions given to corporates. Please don't always use ONLY BRAIN some times use your HEART also if at all you have one.
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                1. D
                  DK NAGAR
                  Jun 2, 2015 at 9:37 am
                  The author has shown his financial aen without experiencing the hardships at the frontier a defense person has to undergo. After facing severe hardships he becomes VETERAN at the young age of 37 to 54 (depending on his arm / service) with full family commitment. Govt does not ensure a second career to him unlike civilians who serve till the age of 60. Let country ensure the suitable job for defense person till the age of 60 like civilians in place of one rank one pension. The author is advised to re-analyze the problem in holistic manner and not see it from his own cocoon. Defense is a negative investment then why to have Defense Forces at all? Or Govt may plan to give a contract to big corporates to defend the country and do away with the defense forces. For govt and economic advisers It may benefit corporates contributing with better GDP other hles of defense forces.
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                  1. D
                    dynamag
                    Jun 2, 2015 at 7:28 am
                    since it is such a big burden, why not the author and his ilk volunteer to stand guard at the border after they retire, so that the pension burden is reduced. And do this on the western border with our "stuck record" neighbor who will welcome him with the red carpet, rather than India lose a brave lad like Capt. Kalia. With such members of society in our midst, who needs enemies?
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                    1. G
                      Gavini VN
                      Jun 2, 2015 at 7:33 am
                      This is utter confusion. I cant understand a thing, what is written here sir. It appears that you are totally confused and does not understand even simple things, forget about economics or indexed GDP etc. Mr Prof, all your calculations and arithmetic is completely wrong. You are completely wrong on Military pension or OROP. Come on sir, do your home work properly and understand the history of Military pensions from 1940s, and how the successive babudom, downgraded them and beneed themselves. Funny, your so called 1 rupee month annuity, like the great economist (erstwhile Dy Chm Pl Comm) mentioning that Rs.32 is enough for a person to live for a day in our country. If that is correct, your ry should be just double of that for the knowledge you are imparting. Thanks for showing your complete lack of comprehension on the subject.
                      Reply
                      1. H
                        hradev
                        Jun 2, 2015 at 6:51 am
                        Author is sitting in his office writing such article showing knowledge of economics because he is leading a good & secured life as well as must be having a set working hours that he would work or extended working hour compensated as overtime. Any way he is able to do this because he live safely which is made possible by the soldiers who day& night guard the borders, face the enemy & lay down their lives. But the personnel who are saved are so thankless that they start calculating his wages in terms of hour he fought the war.But the author failed to see or imagine if the soldier start enjoying his holidays & off the working time during the war & resume his war on the next working day at the start of his working hour.The author should have some shame & at least sense before writing this way
                        Reply
                        1. H
                          hradev
                          Jun 2, 2015 at 10:23 am
                          Tell me you big brain trying teach the economics whether the LIFE IS IMPORTANT or NOT & if you feel life is not very important then give your economic calculations to Modi & his able minister Jaitly to disband all Armed forces & stop all the pensions of fauzis .This will save a huge money for their Govt & they can be more richer.Let every body defend their lives.Good luck
                          Reply
                          1. M
                            M.Deva dhason
                            Jun 2, 2015 at 11:03 am
                            The ONE RANK ONE PENSION has been misunderstood and mismanaged by almost everyone; as such, after decades of consideration, decision and judgments, now the new question is WHAT IS THE DEFINITION OF ONE RANK ONE PENSION? Let me tell the fact. The Army/Navy/Airforce has Ranks both in the Officers / below officers cadre. With in one particular rank, there are groups and clification. For an example - a Sergeant of the Group-I Technical trade may have his net ry as Rs.100/- whereas a sergeant of Group-V Non-technical trade may have his net ry as Rs.75/-. Accordingly, their pension payment also differs. IT IS COMMON SENSE WE CAN NOT FIX A COMMON SINGLE PENSION FOR ALL THE PEOPLE IN THE SAME RANK. Then what is meant by ONE RANK ONE PENSION? It means, a Sergeant, Group-I Technical of the year 1970 was paid Rs.100/-as pension Whereas (the same rank) a Sergeant of Group-I Technical of the year 2010 is paid Rs. 1000/- as pension. Since the service people are discharged very early in life, both the Sergeants are alive but draw pension with huge disparity and suffer indignity of social life. Servicemen who sacrificed their personal, family life committing themselves for round the clock duties without any special consideration deserve the nation's generous and gorgeous dealing. IT SHOULD BE OUR NATIONAL CONCERN TO SEE EVERY SERVICE MEN ARE KEPT IN DIGNITY. Instead, high tech theory, irrelevant administrative procedures, needless formalities have enhanced the hurdles to implement the ONE RANK ONE PENSION; Also created non-existent doubts in the minds of responsible people so as disrupt the implementation of OROP. We thank the government that has committed itself for implementing ONE RANK ONE PENSION. A soldier does not think (again) to commit his life in SACRIFICE for the interest of the NATION. In the same way, the NATION need not think a lot to honour the soldier and his family. I see no real hurdle to implement the OROP but he imaginary hurdles of vested interest and ignorance only. I hope the BJP government will see reason in the spirit of Nationality and implement OROP without anymore delay.
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                            1. M
                              MP Sharma
                              Jun 2, 2015 at 8:17 am
                              The author must go through the Armed Forces Pension Regulations before giving his expert comments. It seems he has absolutely no knowledge on this account. His article is bull in context with Military matters.
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                              1. P
                                Philip
                                Jun 2, 2015 at 5:32 pm
                                The writer is unrealistic. More so because in all probability he hails from Gujarat. There is no Gujarat regiment as well as lowest recruitment to armed forces is from Gujarat. No wonder he lacks empathy.
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                                1. R
                                  rkg
                                  Jun 4, 2015 at 6:17 am
                                  How can Financial express even publish articles from authors on the subjects about which they are totally clueless. In this article it is clear that author does not even know what is the OROP demand is about.
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                                  1. R
                                    rkg
                                    Jun 4, 2015 at 6:06 am
                                    The author needs to know that 80% or more of ex service men retire between 35 to 37 years of age and out of the rest 15% retire at 54 years, whereas his civilian counterparts serve till 60 Also the author is totally clueless about service conditions of defense personnel. Such people should be sent to siachin. They will realize how difficult it is to spend even some hours there where soldiers spend months.
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                                    1. M
                                      Maj Devakumar
                                      Jun 2, 2015 at 8:53 am
                                      The author is making all these calculations and putting up on web is only because a strong and reliable army is present.I think there is a need to reverse the role and this so called professor should go to places where Army is deplo and guard the nation like Siachin ,High alude snow bound posts.Shame to have such people in this country.
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                                      1. R
                                        Rajiv
                                        Jun 2, 2015 at 9:35 am
                                        Dear author I strongly believe that your academic brain has conveniently by- ped the very essence of OROP. The basic target of this scheme is to support a solider who is discharged out from age group 37 to 54 years. In our highly compeive job market no corporate hire a Ex solider or the GOI has got a lateral employment scheme. All an ex-solider can get is a security guard post in civil society and I think he deserves a better deal for devoting his youth, limb and even life for his nation. If your academic brain can still decode the word PATRIOTISM please think on these line and come up with an alternative solution. We will be happy to know it. Jai Hind.
                                        Reply
                                        1. S
                                          Shivam
                                          Aug 14, 2015 at 5:38 pm
                                          Why blame the current government for previous decisions
                                          Reply
                                          1. TV Manerajurikar
                                            Jun 2, 2015 at 10:38 am
                                            Economist author Sir there is nothing on One Rank One Pension in your article to understand. All is GDP. NPS etc. Only CAs & Economists will understand it. That too from a country which has no Armed Forces but depends on other countries to support them in War/terrorists situation. And if you join Indian Armed Forces and serve at Siachin, Leh many Indians will give 133 annuity to you with inflation index.
                                            Reply
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