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August 19, 2015

Pricing the OROP

In this article that appeared in Mint, Ajay Shah and Renuka Sane discuss the importance of considering the cost of implementing OROP.

 

"Before we make up our minds on OROP, it is useful to ask what it would cost. A pension is like an annuity, a stream of payments until the recipient is alive. The price of the annuity is the premium, the cost of providing the stream of payments. What does this premium amount, or cost, depend on? It depends on a) how many people survive and b) the discount rate..."

A nominal pension of Rs.30 per month from the age of 35 will cost Rs.4,520. A wage-indexed pension from age 35 onward would cost Rs.14,998 -- almost 231% more expensive than the nominal pension. Thus if the government goes from a nominal annuity to a wage-indexed annuity for people retiring at age 35, pension expenditures may rise by 231%.

 

"What does this mean for the fiscal deficit? In 2005, when civil servants were moved to the National Pension System, the implicit pension debt on account of civil servants alone was 64.5% of gross domestic product (GDP). With wage indexation of military pensions, this would be even higher. On a horizon of 60 years, we go through four cycles of taking in a person at age 20 who retires at age 35, who will live till 80."

 

Therefore, for each person who is presently serving there will be four alive who are drawing pensions. We may speculate that the implicit pension debt on account of the armed forces pension may also be in the region of 50% of GDP. If so, policy changes which double or triple the value of the annuity map to 50 or 100% of GDP.

Read the full article here.

TAGS: OROP , Defence , Pension
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