1. Clarity of objective
The NPS-Swavalamban (NPS-S) has been the flagship pension scheme for the informal sector since 2010. While it has taken root over the last few years, problems in the design and process of the scheme persist. The APY seems to be motivated by these concerns. The scheme document says: `… coverage under Swavalamban Scheme is inadequate mainly due to lack of clarity of pension benefits at the age after 60. The Finance Minister has, therefore, announced a new initiative called Atal Pension Yojana (APY) in his Budget Speech for 2015-16′. Clarity of pension benefits could be interpreted as clarity of process for receipt of benefits, or certainty about the amount of benefit. The exact interpretation has not been made clear. It seems that the intent of the government is to migrate the entire existing NPS-S to the APY [See Page 7 of the APY FAQs]. It is not clear that this is the right approach. A careful examination of the lessons obtained from NPS-S over the last four years (e.g. Sane and Thomas, 2015) would have helped design a better response. Perhaps there was a role for co-contribution separately from the pension guarantee.
2. Design of the procedure
There is considerable confusion on how the APY is actually going to work. Initially, the APY was to be sold through the same aggregators that distribute the (NPS-S). New documentation indicates that it is actually only open to bank account holders. All the existing NPS-S customers are to be migrated to the APY with an option to opt-out. Does this place the responsibility of opening bank accounts for NPS-S customers on the aggregators? What happens to those who wish to continue with the NPS-Lite i.e. use the NPS without the co-contributions? In that case, the PFRDA ought to define well-defined standards of skill and care that aggregators will be expected to exercise towards a customer as invariably the aggregator will end up playing the role of an advisor when making a decision on whether to opt-out of the APY, or continue only the APY or continue the APY along with NPS-Lite.
The scheme levies penalties on those who are not able to maintain the required balance in the savings bank account for contribution on the specified date and close bank accounts if contributions are not paid for 24 months. However, we know from the NPS-S experience that informal sector workers often do not have liquidity, are not able to contribute on time, but do come back over subsequent periods. This design of the APY will invariably exclude those who cannot maintain a balance in their savings bank accounts or make regular contributions, defeating the purpose of providing a formal sector savings mechanism.
3. Price of the guarantee
Apparently innocent guarantees can prove to be disastrously costly when viewed in their entirety (e.g. Shah, 2003). The APY seems to be motivated by the desire of the government to ensure that on contributing continuously, a member gets at least a pension of Rs.1,000. While not explicitly specified, the APY seems like a minimum return guarantee which will ensure that accumulated savings at retirement do not fall below a certain value. There are different kinds of guarantees, and several ways to design minimum return guarantees. For example, an absolute rate of return guarantee promises a pre-specified rate of return, while a relative rate of return guarantee promises a return close to the average of all funds. The motivation for the choice of this particular design, and the calculations that influenced the choice have not been articulated. Under the APY the subscriber may actually be getting a sub optimal return. This is not surprising, as all guarantees come at a cost (Pennacchi, 1999). However, policy makers need to show the application of mind: the class of guarantees which was evaluated, and the logic that led up to this choice. The contributions under APY are to be invested as per the investment guidelines prescribed by Ministry of Finance, Government of India. The investment guidelines, and how they would finance the guarantee of the APY are not yet clear.
4. Safeguards against arbitrary increases
Almost all pension guarantees in the world have turned into fiscal problems. Even if a guarantee is fiscally sound at the outset, modifications to the program design later on render it bankrupt. Governments are tempted to increase benefits prior to an election. Apparently innocuous changes are announced, which add up to many percentage points of GDP. Any guarantee program requires an elaborate array of safeguards to protect against reckless actions in the future. The APY features no safeguards. It does not require governments to show actuarial calculations before any changes to the design are introduced. An example of a defined benefit guaranteed return plan running into funding difficulties is the Employees Pension Scheme (EPS). Estimates suggest that the EPS is facing a shortfall of Rs.54,000 crore, and several changes in scheme design have now been put in place owing to these funding difficulties.
5. Improper process
Indian finance has taken a big step forward by committing to the Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial Code. The procedural requirements in the Handbook, for framing regulations include a statement of objectives and a cost benefit analysis of each of the provisions. Many of the mistakes of the APY could have been avoided by the use of this process. It is not too late to apply this process to APY, even now.