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Federal, military, and provincial governments pension expense is growing out of the bound; and almost all the pension is unfunded. The pension expense was Rs164 billion in FY11 and increased to Rs988 billion in FY21. The federal government (including military) pension increased by 5.2 times in the last ten years while the provincial toll increased by 7.1 times. The tax revenues increased by mere 2.7 times in the same period.

The question is what is behind this pension bomb. It’s certainly not just the retirees growing at this exuberant pace. For example, in Punjab by June 2013, the number of pensioners were 440,000 while the pension expense was Rs55 billion in FY13. Today, the pensioners have grown by 25 percent to 550,000; but the pension expense is up 4.3 times to Rs238 billion. The story of federal and other provinces is similar.

By digging the data, some astonishing findings surfaced to explain the abnormal hike in pension in the last decade. In 2009-10, when the federal government increased the pension pay, a line was added to it, that the increase will be applicable to the future retirees. This meant that the government employee retiring in 2020, will be entitled to all the previous increases (from 2010 onwards) in pension pay. And all the provinces followed suit.

In most of the subsequent circulars of pension increase, this clause remained. The pension was increased by 15 percent in 2010, 20 percent in 2012 (it was taken out in 2016-17 for future retirees), 7.5 percent in 2015, 10 percent in 2017, 10 percent in 2018 and 10 percent in 2019. Now in 2020, a pensioner gets these increases retrospectively (barring 2012 increase) in the monthly pension. However, those retiring prior to 2010 do not enjoy the same.

Let’s see the impact in a simple example. A grade 17 officer, after completing his service of 30 years while in grade 17 for 15 years, has retired in 2020. His last drawn basic salary was Rs64,870. His gross salary (after subtracting executive allowance, utility, and special allowance) was Rs92,305. On retirement, his pension was set at 70 percent of basic salary at Rs47,109. But he is entitled to all past increases from 2010 onwards.

The pension is compounded on past six increments and reaches at Rs85,104. There was a medical allowance added in 2010 of 20 percent of base pension, also applicable to today’s retirees. Later there was an increase of 25 percent in medical allowance. Add the medical allowance and its increase, and his monthly recurring pension stands at Rs96,859. This number is higher than his last gross salary of Rs92,305. For simplicity, we have assumed that the retiree is not opting for commutation (to be explained below).

In case of an officer with same service years and grade who retired in 2008, the amount he is getting is Rs35,519 in 2020 – a mere 37 percent of what today’s retiree is getting. Now the past retirees put pressure on annual pension increment as they are deprived of past increases.

The fact that a government official retries today would take more money home than what he was drawing as last salary is shocking. This implies that he has an incentive to take early retirement. He can spend his retired time in leisure or work in the private sector. It is beneficial for him to take an early retirement. Data is validating this assertion. In 2006-10, the early retirement to total retirees in Punjab was 22 percent. This increased to 26 percent by 2011-15; and in 2019, the toll stood at a whopping 63 percent.

This largely explains why pension expense has grown out of bound in the last decade. The other way to look at the growing pension expense is by looking at pensioners as percentage of employees. In Punjab, in 1970, the pensioners were 1.7 percent of employees and the ratio is 48.3 percent in 2019. With more people opting for fresh retirement, this ratio is bound to increase further.

It is pertinent to note that when someone takes an early retirement, in many cases, he is replaced by a fresh employee. Though, the fresh employee’s salary would be low, the expense grows, by adding the retiree’s pension to it.

The other issue is that in most cases, pensioner dies much earlier than his respective pension claim. Pensioner’s widow is the beneficiary after him, and after her death, the pensioner’s unmarried (or widowed) daughter is entitled to the pension. This can go up till (say) 100 years from retirement. Earlier, the pensioner dependents, after his death, were entitled to 50 percent of his pension. In 2010-11, this was also increased to 75 percent. This is another reason for ballooning pension. There are live examples of 80 years old widowers claiming their own and died father’s pension!

Now take commutation into the equation. It is optional for retirees. If someone is retiring at 60, commutation factor is applied for 12 years assuming the average life of 72 years - a lump sum payment is made at retirement for the next 12 years, and the monthly pension payment is discounted by that factor. The commutation factor varies with the age of retirement. Lower the retirement age, higher is the commutation factor i.e. higher the lump sum amount being paid.

In our example, the grade 17 officer retiring at the age of 60 opting for commutation gets lump sum payment of Rs2.5 million and his monthly recurring pension reduces to Rs62,958 versus Rs96,859 without commutation. Had he retired at the age of 50, the lump sum payment would have increased to Rs3.7 million. And if the pensioner lives beyond 72 years, the pensioner gets additional pension amount of Rs11,140, in case of retiring at 60 years. The retroactive increase in pension is also applicable for this additional pension amount.

Almost 99 percent of employees are opting for commutation in Punjab and that one-time expense is increasing with higher number of people opting for early retirement. The overall problem becomes bigger when none of these pensions are funded. The employees are being added at fast pace and those retiring are growing at an even faster rate. No government can back out from these. Even in case of financial emergency, government can reduce salaries of existing employees, but cannot touch pensioners’ liabilities.

It is good to see that finally the PM is taking notice of it. The first thing required is to undo this retrospective increase, as this magnifies the problem multifold.