By Kulin Patel,

The Cabinet briefing on Saturday, introducing the Unified Pension Scheme (UPS), marks a significant milestone for the government. The announcement is set to positively impact millions of central government employees, and potentially many more state government employees if states decide to adopt the UPS framework.

As an actuary, the briefing evoked a mix of emotions in me. I was pleased to hear the ministers acknowledge that actuarial projections were conducted during the review process and will continue to be required. In India, the actuarial profession is quite niche, with only a few experienced social security and pension actuaries. However, my initial satisfaction soon gave way to curiosity and a feeling like we were going back to policies from two decades ago.

The UPS is a defined benefit pension scheme, a stark contrast to the National Pension Scheme (NPS). A defined benefit scheme guarantees a benefit formula to beneficiaries, which is excellent news for employees eligible for UPS as they are assured 50% of their last 12 months’ average basic pay at retirement as a pension. Additionally, there is a family pension and dearness relief. The inclusion of a lump sum and minimum pension are positive developments that likely won’t significantly strain the overall benefit cost. What sets UPS apart from NPS is the inherent uncertainty about the ultimate cost, which now becomes the government’s responsibility.

While the employee’s fixed contribution is 10% of their pay and the government’s contribution is 18.5%, these are just contributions towards UPS, not the fixed cost. This distinction is crucial because, during the briefing, there were several mentions of UPS being fully funded. Although contributions will be made, funds set aside, and the scheme will be budgeted for, this shouldn’t create the misconception that current contributions can fully fund the promised benefits in the long term. The ultimate cost of any defined benefit scheme is unknown today.

This uncertainty stems from unknown factors such as investment returns, mortality rates, changes in longevity, future inflation, and salary growth. Assessing the sustainability and adequacy of contribution rates in social security or pensions financing can be approached from two perspectives:

Projected cashflow measure: This involves comparing year-on-year actuarially projected inflows and outflows from the fund. As long as inflows exceed outflows in that year, the fund can be called sustainable. This perspective is commonly used in social security financing when the number of contributors far exceeds the number of retirees. Given India’s demographics and the fact that UPS will primarily cover employees joining after April 1, 2004, it will be a while before pension outflows come close to matching contribution levels.

Present value of actuarially projected obligations: This approach involves comparing the present value of future projected contributions plus any existing accumulated fund (projected contributions plus existing fund assets) with the present value of the projected pension obligations for each individual (projected total obligation).

These two measures can yield very different conclusions. Under the second method the statement about “not burdening future generations” would hold true if the present value of future contributions, based on the 28.5% total contribution rate, remains significantly positive, even when accounting for future uncertainties and risks.

In a paper I co-authored and presented at the Institute of Actuaries of India’s global conference in Mumbai in February, we estimated that the cost-neutral standard contribution rates for new entrants into a scheme resembling the old pension scheme, using common demographic and financial assumptions, would be considerably higher than what is proposed under UPS. Understanding the calculations and actuarial assumptions used to assess the long-term sustainability of the UPS framework is essential. As mentioned earlier, any risk and future cost will ultimately be borne by the government, although the establishment of a separate fund is a significant positive step.

There may be some nuanced operational details within UPS that could help reduce long-term costs, though these remain unclear at present. I look forward to learning more about these details before drawing any firm conclusions. For example:

  • Is there a difference between the contributory salary and the salary definition used for pension calculations, aside from the 12-month average provision?
  • Are there changes to the dearness relief indexation method compared to the Old Pension Scheme (OPS)? For instance, could it be adjusted to a simple inflation-based cost of living adjustment like in other countries?
  • Will there be changes to investment allocation benchmarks, given that the government is now assuming the risk, as opposed to employees under NPS?

One concern I have is the potential impact on public perception of the NPS, which I still believe is an excellent framework for pension savings. NPS has gained traction in the corporate and private savings sectors in recent years, and I hope the introduction of UPS for government employees does not negatively affect public participation in NPS.

Only time will reveal the full implications, but, for now, it seems we are returning to the defined benefit world, albeit with potential mitigations. The positive aspect is that the government has acknowledged the importance of separate funding and the need for actuarial reviews, similar to those already performed for the Employees’ Pension Scheme 1995 and Atal Pension Yojana. As an actuary I have many unanswered questions about the scheme’s design details and actuarial assumptions that would have been considered for the 28.5% contribution rate’s sustainability. I look forward to knowing more before coming to a firm conclusion.

The author is CEO, partner at KA Pandit Consultants and Actuaries.

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