A CASE STUDY
DEFINED BENEFIT PENSION SCHEME vs.
DEFINED CONTRIBUTION based SUPERANNUATION
(By Ashit K. Sarkar Retired Senior Advisor & VP - HR, & Past Trustee of Pension Funds, Britannia)
3E Palmtree Place, 23 Palmgrove Road, Victoria Layout,
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E-mail: [email protected] Home Page: http://www.ashitsarkar.co.nr
o Many organizations offer a Pension scheme as a part of the employee's terms over and above the statutory retirement benefits (Provident Fund, Family Pension & Gratuity), and such Pension Funds are often non contributory by the member employees, and are funded by the Company. Some DB type of schemes provide for benefits to continue to the surviving spouse and/or to the children after the pensioner's death, with the objective of "taking care" of even the late pensioner's family.
o Pension schemes are mostly either "Defined Benefit (DB)" type or "Defined Contribution (DC)" type. In the former DB scheme, the monthly Pension is computed as a proportion (usually by dividing the Years of Service by a stated factor) of the Final or highest Salary. For DC, the annual contributions made (@15% of Annual Salary normally) during the career of each member, along with the interest, or any special contributions or unused surpluses applied from the Fund, are utilized for the purchase of an Annuity offered by the Life Insurance Corporation (LIC) from such total amount, on retirement. The DC system is similar to Providend Fund. It may be noticed that unlike DC type of schemes, in the DB scheme since the pension is related to the final or highest salary, this system provides a higher pension generally, since salaries tend to rise at a faster rate with time. Any promotion or upgrading during the service further enhances the final pension figure in DB schemes.
o It will be seen that for DB the total contributions have to be sufficient to keep the Fund solvent and viable, to meet the purchase price required for the future Pension liability for all the members entitled to pensions on retirement - which is uncertain and at best has to be actuarially estimated. For DC, only the accumulated contributions made for each member is sufficient to keep the Fund viable, and there is no estimation or uncertainty regarding solvency of the Funds.
o As such, for DB, the "Ordinary Contribution" requirement varies with estimated total future liability taking into account the projected Salary trends, inflation, current fund situation, interest rates, annuity costs by LIC, resignations or early retirement etc. [Ordinary Contribution @ 5% to 15% of Gross Annual Salary (for all members) is usually required], and which necessitates Actuarial evaluation periodically to determine if any further "unfunded liability" exists for solvency (which has to be met through Additional contributions), based on Accounting Standard 15 laid down by the Institute of Chartered Accountants of India. These contributions may not be tax exempt. There is no individual account for any member, and for purchasing individual benefits due as per the rules, the Trustees have to draw from the Fund's total reserves, unlike the DC pension individual accounts.
o Pension Funds are created by the Companies under the Income Tax Act 1961, Income Tax Rules 1962 and in conformity with the Indian Trusts Act 1882, to take advantage of the tax exemption permitted to approved Funds for the contributions made, and to facilitate the administration, manage the finances and to purchase the annuity policy from LIC in accordance with the Fund's rules for the entitled pension, under the control of unbiased, impartial & independent Trustees. Any "approved Pension or Superannuation Fund" (& their Rules - and/or any proposed changes) require prior ratification by the jurisdictional Commissioner of Income Tax (CIT). The Income Tax Rules 1962 define & state conditions for granting such status to a Trust. Currently, in addition to the Initial contributions for any past services, "Ordinary Contribution" (limited to 15% of the Member's gross Salary from the employer) as tax exempt as per Income Tax rules. (Contributions in excess of 15% gross salaries remain taxable as Income)
o Consequent to the trend of exploding and sharply rising basic salaries of Management staff in recent years (from late nineties), and the increased Annuity costs due to drop in interest rates (which has also has reduced the interest income to the Funds), additional contributions beyond the Ordinary contributions have become essential from time to time to keep any DB Pension Funds solvent to meet the increasing future liabilities. Tax benefits to the Company may not be available for such additional or special contributions.
o Some organizations decided to continue with the DB scheme, as the attractive Pension benefit was a good strategy for the retention of executives, and they accepted that the added cost of contribution was a part of result generating compensation cost in line with the objectives. Some reduced the divisor for future members while continuing with the DB scheme (ITC used this method).
o Many deliberately decided to change to DC type of schemes to reduce future pension costs, and therefore, after getting necessary statutory approvals, and careful planning and extensive communication with the affected members, introduced changes to DC system after ensuring that either alternative benefits, or choice and protection to accumulated DB pension benefits were available to the existing employees (Smithkline Beecham, Philips, Cadbury, BASF, Marico, Novartis, Murugappa Group, Tata Tea & VST Industries are a few examples). This was usually done by taking the Actuarial valuation of the earlier defined benefits on the "transition date", and making it as the individuals opening balance for the DC superannuation scheme post transition.
o The 2005 Budget proposal for taxability of all contributions to the Pension Funds, as against earlier tax relief provisions will have further need to review the Retiral benefit schemes.
CASE STUDY "BRITANNIA INDUSTRIES LIMITED (then part of Groupe DANONE) - The SITUATION:
o Britannia Officers & Managers (throughout India) have been covered by two generous DB schemes as a part of their service conditions (including provision for surviving spouse & children of deceased pensioners), for which no contributions are required from them, and only the company makes the necessary contributions to meet the liability as per Fund Rules and actuarial evaluation periodically. The two funds (OPF and CSPF) have been operating for more than three/four decades ago respectively, and had met their due obligations till March 2003 without any dispute. The Funds & the Rules had been approved by the Commissioner of Income Tax (CIT) III at Kolkata, and any changes required his prior approval.
o The Trustees of OPF & CSPF are appointed by the Company, and consist of Directors and a few senior managers, who regrettably are not independent. Lately, they have tended to toe the Company's instructions in recent years in order to safeguard their jobs, despite having personal misgivings, or have not been neutral. They are now advocating opposite views to what they had themselves followed and stated earlier.
o A number of employees from the unionized Workmen or Clerical staff level were promoted periodically to the Officers grade, who had on inducement to the offer of participating in the attractive DB Pension Scheme, accepted a lower Salary after promotion (from their earlier Basic + VDA), and had given up their earlier rights to (a) consequential increased PF & Gratuity eligibility, (b) Overtime, and (c) automatic increasing Variable Dearness Allowance amounts with passage of time (as were applicable in the unionized category prior to their promotion).
o Some of the important relevant rules of the current OPF and CSPF are as follows:
Rule 19A(b) of both the Funds empowers the Trustees to increase the Pension on a recommendation from the Company. Rule 28 of OPF and 27 of CSPF confirms the same through a Supplemental Deed, but restricts such addition or amendment with: provided however that such alteration does not adversely affect the benefits to be paid or currently being paid.....provided always that no alteration in the Rules, constitution or conditions of the Fund shall be made without the prior approval of the Commissioner.
Monthly Pension is payable in arrears and shall commence as from the date immediately succeeding the date of retirement.. (Rule 20).
Rule 27 of OPF and Rule 28 CSPF clearly forbids that No money belonging to the Fund in the hand of the Trustees shall be recoverable by the Company nor shall the Company have any lien or charge of any description on the same (Similarly, IT Rule 91(2) also debars any such withdrawal by the Company, further strengthened by "under any circumstances").
The Funds are required to be audited annually (Rule 10), and the Actuary of the Fund is required to carry out an actuarial valuation of the Funds from time to time to report on the viability of the Funds-Rule 19A(b).
o The Trustees had made many improvements in the Fund Rules from time to time in the past on Company's recommendations, and these were given affect to till March 2003, without being considered to be in conflict with the IT Act and Rules in any way till then. Significant changes were:
Britannia celebrated its
Platinum Jubilee year in 1992 and in
accordance with the Board of Directors resolution of
All Officers and Managers Annual Revision of Terms Letter affective 1st April 1992 included the above Platinum Jubilee Scheme providing for 15% pension increase every 3 years to the eligible Pensioners, as a part of their future service conditions (given in writing by the Company), and which was later confirmed by the Fund Trustees in their letters to the Pensioners at the time of retirement.
Based on a Board of Directors resolution in 1996, (under the present Chairman, and supported by Danone directors), the Trustees revised the divisor factors in Rule 11(a) of both the Funds, and made other improvements, which resulted in very substantial increases in the future pensions for all. This clearly establishes that both the Board of Directors and the Trustees not only supported, but were fully conversant with the DB pension scheme being in no way conflicting with the IT Act and Rules, contrary to the reasons now stated in October 2004 and later, and further claiming now that Pension increases are against the Fund rules and the IT Act, and therefore, cannot be done!
Additional contributions based on actuarial recommendations were made from time to time by the Company to the Funds to ensure the viability of the funds as required, particularly to meet the added liability resulting from the above mentioned Board resolutions. The Accounting Principles stated in the Annual Reports of the Directors to the Shareholders confirmed such policy, and both the internal and external auditors found no flaw with these contributions in the annual accounts during the audits.
o During the latter part of the nineties, Britannia's top team embarked on a massive growth plan with substantial modernization of its plants and equipment post liberalization, and new brand & product strategy. It established a very prominent reputation in the Industry as the market leader during this period, which established household high brand value in the pursuit of the vision. (Sales jumped from Rs 4428 million in 1993/94 to Rs 14705 million in 2003/4 " PBT from Rs. 240 to Rs.1963 million in the same period - to more than eight fold, and Profit After Tax at ten times " from Rs.119 to Rs.1188 million!)
o This was achieved amongst other strategy, with strengthening of the Human Resource within the Company through building up professional competency, and creating a very desirable work environment with openness and humanism as a central theme - which were also the announced values of Groupe Danone, Britannia's international partner. Employee satisfaction was a key strategy followed, along with Customer satisfaction as the primary focus.
o Britannia became an important part of Danone's South East Asia Pacific business, and contributed significantly in the region's Human Resource development activities and conferences during this period.
work philosophy, value system, compensation and reward systems were reviewed
constantly in order to attract the best talent, and retention levels were high,
and the Company results were consistently amongst the best in
HOW NOT TO MANAGE - Post 2003 PERIOD:
o Instead of a prospective change through an open & planned communication process, by an underhand and a very ingenious strategy, Britannia is now covertly attempting to change the current DB Pension Funds for their Officers and Managers to a "Defined Contribution" type of Superannuation Scheme, and the Board of Directors have allegedly approved a resolution in 2004 to replace the existing DB Pension with DC type of Superannuation retrospectively (for the entire service period of Officers & Managers), and also to withdraw the applicability of the Platinum Jubilee Scheme (of 15% tri-annual increase) even though it had by that date already become overdue on April 1st 2004 to all past pensioners. This was contrary to their advised Terms, and also specifically against the implied promise made to those promoted to the Officers grade, but now being ignored by the Company. This change could have been managed easily with openness, after announcing a prospective transition date.
though any proposed change requires the prior approval of the CIT (for which
the application was only made by the Trustees in November 2004, and such
approval has still not been granted, and was rejected in June 2008), the Company illegally & arbitrarily
refused to pay the due Pensions (as per the approved Fund rules) to the
the Company has every right to change the terms, changing earlier terms to the
disadvantage of the pensioners, & existing staff without consent,
retrospectively and arbitrarily is certainly unethical, if not illegal. The Company is banking on their huge
financial strength and the relative helplessness of the scattered and aged
retirees with limited means in the scenario of the inevitably prolonged delay
and vulnerability of the judicial system (e.g.:
o Surprisingly, the Company appears to have stopped considering their motivated managers as human beings, and decided to rely on shady legal opinions instead of fair and just attitude without any openness that had been the clear HR policy earlier. All dissent was harshly dealt with resulting in total loss of motivation amongst one and all, which had taken years to build. Any queries were referred to lawyers, and delay tactics became the rule. The reputation of the market leader and "the cherished Company to work for" only a few years ago because of the perceived highly respected BRITANNIA brand, has nose-dived into a dejected and a demotivated organization now - more than 60 managers, including all the functional heads at the Executive Office in Bangalore (every single one!), have left or had to leave this Company in the last two years, with many more just waiting to leave!
Company also illegally withdrew Rs.
121,199,000 from one of the Pension Funds in Jan/Feb 2004 which amounts to
serious criminal offence, and makes the Fund unviable to meet its future due
commitments. This deliberate action
was taken just before the purchase of LIC annuities was to be made for the
committed 15% increase affective
association of the suffering pensioners scattered around
prolonged follow-up and correspondence by many pensioners and also the
Pensioners Welfare Association, a very weak and deliberately mischievous and
misleading response was received from the Trustees in November 2004, which has
been point by point refuted and replied to by the Association on
of the aggrieved pensioners have filed court proceedings - but which may take
years before they are decided and any relief becomes available, despite full
justification. However, the High Court
of Madras has accepted the Writ Petitions on
o As can be very clearly seen, the actions taken by BIL & the Trustees go specifically against the Rules or laws, and it is only a matter of time before their decisions will have to be overturned - unfortunately, due to the inevitable delay in such decisions, the Pensioners will have to suffer in the meanwhile. Some of the actions will not only attract financial penalties, but also legal retribution. However, the damage to the Company's reputation and integrity will be even worse, but the Directors seem to be unmindful of this loss of credibility, and the dishonour to the Company.
o Britannia's effort to distance itself from the Pension Funds (& through their lawyers) does not in any way reduces the Company's liability in meeting the terms of service. The Company employed the pensioners (and not the Funds), and their Salaries & revisions (on which pensions are computed) are decided, advised and controlled by the Company, as also the Pension Rules. Since Pensions are deemed to be "deferred wages" for the services given, the primary liability to meet the Pension commitments continue to remain with the Company even if the Fund is unable to pay for any reason whatsoever. In such an event, the Company must directly meet the pension provisions from their own funds.
o What is surprising is that both Britannia & Danone with such great reputation of earlier value systems and capable management, are content to lose their reputation and create demotivated management staff with their absolutely unethical and unfair actions, which are so obvious, but they are instead relying on legal loopholes, and considering them to be somehow legally tenable.
POST SCRIPT (Jan 2009):
As mentioned above, despite The Commissioner of Income Tax, Kolkata having rejected the rule change proposals in June 2008, the Trustees continued to insist on computing pension amounts as per their proposed rules (that had been rejected), ignoring the past practice, and the earlier approved fund rules that remained valid.
The Pensioners Welfare Association thereafter approached the City Civil Court at Bangalore regarding the illegality of the Company and Trustees actions in 2008, including a plea to replace Trustees with court appointed neutral Trustees. After a number of Hearings, the Court gave interim orders, pending final decision:
(1) forbidding the defendants to alter any Fund Rules (in June 2008), and
(2) to immediately pay interim pensions from dates of retirement to the 70 PWA members whose pensions were withheld - from the accumulated contributions and interest admitted to be held by the Trustees to the Court, without diluting the pensioners right to the pension amounts claimed by them as per fund rules - pending the final decision on the pension computation method, and on all other issues raised by PWA by the court. (ordered on Jan 1st 2009).
2nd POST SCRIPT (Oct 2016):
The Court upheld the petition on Apr 8th, 2010 and ordered for pension payments within two months to all eligible plaintiff members from the date of their entitlement or due date strictly as per Rule 11(a) of CSPF and OPF ........ after deducting the interim pension paid to them as per interim court order. Click here to see the Business Standard Newsreport on Apr 9, 2010 . This order was challenged at the High Court by the Trustees & BIL, and was referred back to the Civil Court for complete disposal of all the issues urgently. However, the case kept getting delayed due to various reasons including the transfer of the judge etc., and finally a very comprehensive detailed judgment of over 200 pages (Order here) was pronounced on Sep 21st, 2015 holding the Trustees guilty of breach of trust and ordering their replacement, and directed to pay unpaid pension and enhancement to all the beneficiaries. As expected, this was challenged at the High Court, but the Hon'ble judge directed the parties to consider an amicable settlement through mediation, which process is much faster, and was accepted. Long drawn out formal and informal meetings were held for almost eight months, and on number of occasions the parties were at the verge of a failure, but the mediator, Mr Shiv Kumar managed to persuade parties to reach a solution. This was finally achieved on Aug 29th 2016 and the compromise agreement was signed by both the parties. The mediator forwarded this agreement to the High Court, and after completing various formalities a decree was issued on Oct 18th, 2016. The payments will be released in due course. Only then will the pensioners be getting their benefits in their old ages - instead of from their retirement dates as per the expectations promised by the Company!