Several states in India have reverted to the Old Pension Scheme (OPS) for their employees, which could pose financial challenges for governments due to the increasing burden of pension payments. This concern arises from potential underestimations of the full fiscal impact, including future salary and pension increases based on recommendations from upcoming pay commissions. It is suggested that a future pay commission should aim to align OPS pensions with the National Pension System (NPS) and control pension increases, possibly by considering the cost of indexation.
Under OPS, government employees typically receive a defined benefit pension equivalent to around 50% of their last wage upon retirement.
Pay commissions influence government employee pensions in two ways:
Pay Escalation: If an employee experiences a significant wage hike in the final years of their service, it automatically results in a higher initial pension.
Dearness Relief and Pay Structure Changes: Changes in dearness relief and the pay structure can substantially increase pension benefits. For instance, dearness relief rates are adjusted every six months based on the All India Consumer Price Index for Industrial Workers (AICPI-IW). Government employees benefit from inflation and wage indexation in their pensions.
In contrast, the National Pension System (NPS) allows employees to access their NPS account accumulations and requires them to purchase an annuity with at least 40% of the accumulations. While NPS might match OPS pensions with proper investments and annuitization, it may struggle to keep up with pension increases resulting from dearness relief.
Indexation in pension schemes acts as a form of insurance, with the burden placed differently depending on the system. OPS relies on future taxpayers to bear the burden of indexation, while in NPS, subscribers must buy the necessary insurance from the market, which can lead to higher premiums and necessitate higher accumulations over one's working life.
Defined benefit schemes like OPS can be financially vulnerable due to factors like increasing life expectancy. Indexation can help maintain the actuarial balance by adjusting various aspects of the pension scheme, such as the retirement age or initial pension payout, based on factors like longevity and inflation.
One approach to indexation is to consider "anticipated" inflation as distinct from insurance against inflation, with individuals paying for the cost of this insurance. This approach can be customized based on regional variations in inflation. Such indexing can be more cost-effective than complete inflation indexation.
The cost of government employee pensions, when considering pay revisions and dearness allowance increases, is expected to rise substantially under the OPS. This trend disproportionately allocates revenue receipts to government employees, leaving less for public welfare and capital expenditure that benefits all citizens. It is suggested that the future 8th Pay Commission should evaluate the cost of wage indexation and inflation indexation on a net present value (NPV) basis to address these fiscal concerns.