India's demographic dividend will help protect the retirees' income for some years
In 2013, the Saradha Group financial scam threatened to bring down the ruling government in West Bengal. The group ran fraudulent investment schemes, collecting thousands of crores from lakhs of investors, promising astronomical 50% returns. However, it did not use investors' money to build assets, but took it from new investors to pay the older ones. It was a classic example of a Ponzi scheme.
It is ironical that while governments try to stem such fraudulent investment structures, they themselves perpetrate these schemes. In 2014, the US Congress announced severe cuts in the pension benefits of one million employees covered under the Pension Benefit Guaranty Corp (PBGC). PBCG is a government agency that protects the pensions of almost 1.3 million people covered by more than 200 pension plans. The largest cuts are proposed for the younger employees, and the smallest for the older ones. Newer employees are forced to fund the deficit in investment earnings to pay older pensioners.
Aren't there uncanny similarities between Saradha and the PBGC? Both were money pooling schemes that needed a constant flow of new money to keep their operations afloat. The schemes kept growing until pay outs to existing members exceeded the cash inflow. Both are in a state of collapse because of over-commitment and under-delivery.
Do pension plans in our country bear the same risk as in the US? There are two kinds of pension schemes--defined benefit and defined contribution. Under defined benefit, the employer or sponsor promises to pay a specific amount to the employee as pension during his retirement years. This amount is predetermined and based on parameters such as annual contribution during working years, years of service, life expectancy and investment returns. Using actuarial calculations, the sustainability of the pay out is determined. The pensions of most government employees and army personnel in India are defined benefit programmes.
In a defined contribution plan, the employer and the employee make regular contributions to the fund. There is a promise to contribute a fixed amount, usually a percentage of the employee's income, during his working years. There is no obligation to pay a fixed amount during retirement. The employee can choose the investment vehicle and the amount he accrues depends on his and the employer's contribution to the fund and the term of growth. Members are entitled to benefits in proportion to what they have contributed. This is a more sustainable and equitable way of building a pension fund. The National Pension Scheme in India is an example.
The defined benefit plans are a cause for concern. When there is a change in the economic growth, investment returns or demographic expectations on which the benefit pay outs are based, the quantum of pay out is threatened. So, if the return on corpus fall due to slow economic growth or if the pay out tenure increases because of a rise in pensioner life expectancy, the stream of periodic payments or projected returns may not be viable, resulting in benefit cuts.
Should we be concerned about the defined benefit plan in India? I don't think so. These tend to fail in countries with ageing populations. India has a young population, an advantage over developed countries. The number of people in the working age group surpasses that of retirees. This demographic dividend will ensure that even defined benefit plans protect the retirees' income for some years to come.
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