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Pension Business in India
Pension Business: Introduction
In other parts of the world pension reforms have led to funding, not of the defined benefit (DB) kind but the defined contribution (DC) kind. All over the world there has been a tendency to switch over from DB to DC and this is not because DB is bad. The forces of globalisation have caused a high flux of employees from one organisation to another, from one country to another, making it almost impossible to run a DB system. Other reasons include the weakening of trade unions across the globe and the decreasing rate of interest which led to employers finding it increasingly difficult to sustain the funding required to build up the benefits on the DB system. However, this has also become the exit route for some employers to get out the liability of pensions. Some of these factors are playing their role in India too. Under the DB system the pension was defined and arrangements were made to make sure assets were available, whether the pension was funded or not. The DC system defines the contribution but one still needs to ensure that the accumulated contribution will meet the desired amount of pension one will get. That’s where the role of actuaries comes in. India does not have the required regulatory regime, particularly one that applies across the field. We still require a holistic approach to regulating pension providers. The time has come now to set up regulatory measures for pensions. There are a number of models to look at, such as that of the UK and Australia. While we need not copy them, we do not have to invent the wheel all over again either. The key to any pension system is the financial regulatory mechanism and that is monitored through the actuarial system. The role of the actuary in pension provision is important and must be addressed along with many other issues.
Pension Business in India
ndia has never had a pension system for the population across the country, as has been in existence in other parts of the world, even though we have had some schemes mainly directed at government employees.
R Vaidyanathan is Professor, Finance, and UTI Chair Professor in Capital Market Studies, Indian Institute of Management Bangalore. email@example.com
contains excerpts from the presentations originally made in the discussion on ‘Pension Business in India: Development and Regulation’. Public Provident Fund. President. Actuarial Society of India. pension reforms must ensure: IIMB Management Review. and the Actuarial Society of India.in • increased coverage for old age income • reduction in unfunded pension liability • reduction in the role of the government as a pension provider. Following is the regulatory arrangement for the various pension segments. rkrishna@bom4.) Current Pension Regulatory Framework in India The details of regulations and supervision vary by the type of pension. • The means tested and tax financed assistance being provided by the government to the destitute aged 65 and above (DB). • Public Provident Fund (PPF) (DC) is managed by the government with 75% of the net accretions being given as loans to the states and the balance credited to public account of the Government of India and as such does not require supervision by a regulatory authority. September 2004 .vsnl.ernet. bkbhat@iimb. except as the provider of the means tested and tax financed pension • better return and protection to the subscribers. and • higher availability of funds for means tested tax financed pension. 61 Pension Reforms and Regulatory Framework Pension reforms must ensure removal of deficiencies in the existing system and create a new system for pension savings. Any arrangement that builds up assets for old age income can be termed as ‘pension’. it is necessary to have a clear regulatory and supervisory framework. (In India we do not have any state pension except the small assistance provided by the government to the destitute aged 65 and above. Quantitative Methods and Information Systems. subhedar@vsnl.The Pension Regulatory Environment in India — A Suitable Model S P Subhedar The government announced the setting up of a separate regulatory authority. The panellists featured are: Mukul Asher. like Employee Provident Fund. I have attempted to outline a suitable model for regulation and supervision of pensions in India . National University Singapore. as exists in other countries that have initiated pension reforms. SBI Life Insurance Company. Associate Professor.ernet. In order to ensure the above.in Venkatesh Mysore. The pension system thus encompasses all vehicles that build up assets for old age income. former CEO. Senior Advisor. i. Professor. created awareness about the need to provide for old age income and initiated the debate on the need to reform India’s pension system. The first OASIS report enunciated the basic philosophy of reforms.com S P Subhedar.in S Jyothilakshmi. formerly of the Indian Administrative Service. Finance and Control. as part of the pension reforms announced in the union budget of 2003-2004. IIMB. • The complementary pension in the form of the proposed defined contribution fully funded individual account pension would require a regulatory framework for supervision. IIMB. Metlife India. now Senior Fellow.e.com The two reports of the Expert Committee (the OASIS Committee) constituted by the Ministry of Social Justice and Empowerment under its project Old Age Social and Income Security (OASIS) for devising a pension system for India. ‘Pension Business in India’. this fund is most likely to be closed once the proposed individual account pension system is introduced.net. but the basic aim is to protect the interests of the members/ subscribers and to ensure that they receive a fair deal. jyothi@iimb. sppasher@nus. Centre for Public Policy. to regulate and supervise pension funds and also to develop pensions in India. IIMB.sg B K Bhattacharya. In specific terms. MD. firstname.lastname@example.org. In this context. This section of the Round Table discussion. Further. IIMB. whether defined benefit or defined contribution.org. Occupational Pensions and Personal Pensions. organised by the Centre for Insurance Education and Research. R Krishnamurthy. that old age income has to be self financed by individuals except those who do not have sufficient income to save for old age. president@actuariesindia. Prudential Corporation Asia Ltd. Shubhabrata Das. email@example.com. does not require any supervision by a regulatory authority.in Liyaquat Khan. Visiting Professor.
• Government employees’ pension for existing employees (DB). the trustees. This would also benefit from being rolled into the supervisory control of the pension regulator. This is how the concept of trusteeship has been introduced for such arrangements and this has led to a structure based on this concept. This is how the concept of trusteeship has been introduced for such arrangements and this has led to a structure based on this concept. expeditious settlement of claims and disputes and adequate choice to the subscribers as also controlling competition amongst the different providers. for the benefit of the system. the service provider and the advisors. The other aspects are left to self regulation through auditors and actuaries. what is important is to get the regulatory structure right which sets out the basic rights and obligations of the relevant parties – the pension scheme members. the government has sought to give a similar mandate. Structure and Role In keeping with the parliamentary mandate to the Insurance Regulatory and Development Authority (IRDA) to not only regulate and supervise the insurance business but to play a role in its development.It is a generally accepted premise that the funding of retirement benefits should be independent of the government and that the employers should make arrangements for building up of retirement benefits. other aspects are left to self regulation again through auditors and actuaries. The trust structure for funding of retirement benefits ensures that the contributions that are collected and invested are held in trust for the benefit of persons who have contributed or for whom the contributions are collected. This is very significant since considerable developmental work will have to be done to make the community at large understand the need and importance of self financing of old age income. In this context. • Gratuity funds set up through approvals from the CITs are 62 envisaged to be supervised by the relevant CITs but this supervision also remains confined only to adhering the prescribed investment pattern. The aim of any regulation and supervision is to protect the subscribers and this protection does not remain confined to ensuring the financial viability of pension arrangement. Objectives. • Employee Provident Fund (EPF) (DC) is both administered and regulated/supervised by the Employee Provident Fund Organisation (EPFO). It is a generally accepted premise that the funding of retirement benefits should be independent of the government and that it is the employers who should generally be making arrangements for building up of retirement benefits. this arrangement will have to be changed with the supervisory function being given to the pension regulator • Employee Pension Scheme (EPS) 95 (hybrid. Sooner than later. the employer. It encompasses control on costs. good value for money. rules of pension arrangement. is not funded and is paid on Pay As You Go (PAYG) basis out of the current revenue. The pension regulator may have to basically deal with the following three types of pension schemes: • the proposed defined contribution individual retirement account pension Pension Business in India . • Personal pensions and group pension products (essentially DC) offered by the life insurers are regulated and supervised by the IRDA and those offered by the MFs are regulated and supervised by the SEBI. Pension Regulatory Body: Scope. As can be seen. to the proposed pension regulatory authority. This is not a very satisfactory arrangement as the body that administers it also regulates and supervises it. In India there are no minimum funding requirements. the regulation and supervision of pensions is fragmented and this needs total review. It is managed by the government and as such is not supervised by any regulatory authority. trust deed. • Occupational pensions (DC and DB) set up through approvals from the Commissioners of Income Tax (CIT) are envisaged to be supervised by the relevant CITs but this supervision remains confined only to adhering to the prescribed investment pattern. in respect of pensions. but essentially DB) is again administered and regulated/ supervised by the EPFO. This being a defined benefit scheme.
The regulatory body should ensure the security of pensions and the soundness of management systems by laying down a broad framework so that the objective is achieved mainly through self regulation rather than through legislative processes. the capital structure requirement. The pension regulatory body should be given both power and resources to carry out spot checks and detailed investigations independent of any complaint. freedom to change providers. minimum capital and issue of ceiling on foreign equity will have to be addressed. In the UK. facilitating easy comparison of what is on offer. particularly in the area of occupational pensions. the structure for the proposed DC individual retirement account pension has yet to evolve. Such licensing or registration should be made a prerequisite for approval of the pension arrangement by the tax authorities. Pension regulation would include licensing the Pension Fund Managers under the proposed pension scheme and registering other pension scheme arrangements such as occupational/ affinity group pension schemes. Pension as an instrument should be easily understandable to the retail customer but the wide variation between the terms and conditions offered by different schemes make it difficult to understand.• the occupational/affinity group pension schemes which buy products from life insurers. it is necessary to lay down the governance structure and if a separate entity is required to be set up by the provider. for the regulations of the proposed DC individual retirement account pensions scheme. ‘minimum standards’ would have to be set that would cover a variety of aspects including fees charged. banks and mutual fund companies with foreign participation. default option and freedom to change providers. pension arrangements. the role of professionals associated with the IIMB Management Review. the limit on charges and what it covers. There is however a general consensus that the possible providers of the proposed pension will include insurance companies. If an alternate structure is stipulated. For the proposed DC individual retirement account pensions. minimum contribution. or transaction of the proposed pension business within the setup for the existing business. The introduction of minimum standards for stakeholder pensions has ensured a level of standardisation across schemes. the regulations could be structured by drawing on the basic philosophy of the regulations for stakeholder pensions in the UK. ‘minimum standards’ would have to be set that would cover a variety of aspects such as fees charged. facilitating easy comparison of what is on offer. in particular the auditors and actuaries. The possible structure of the vehicle set up by the providers could be one of the following — a separate trust company which could operate just as the trustees of the occupational pensions do. It is essential to ensure that subscribers receive clear and good quality information on their pension accumulations. and • the occupational pension schemes which provide pension pay out as well. investment choice and information. a facility for pension business within the existing business with a Chinese wall separating the two businesses. In the proposed DC Pension Regulations. All charges should be rolled into a single annual management charge as it would be transparent. we could draw on the philosophy and important features of the Stakeholder Pension regulations in the UK. which distinguish themselves from other pensions in the market place because of ‘minimum standards’. then the governance norms would have to be prescribed. While the profile of the occupational pension structure is well established. For licensing. minimum contribution. In the proposed DC Pension Regulations. default option. September 2004 The introduction of minimum standards for stakeholder pensions has ensured a level of standardisation across schemes. The pension regulatory body would be somewhat less proactive. The regulatory and supervisory structure for occupational pensions could be similar to that of the Occupational Pensions Regulatory Authority (OPRA) of the UK. it was decided that every provider of DC pensions would be required to give an annual statement showing the likely projected value 63 . In this context. easy to understand and would facilitate easy comparison between the products on offer. will have increased importance. Stakeholder Pension As mentioned earlier. after four years of public debate.
This perhaps could change with the role of the occupational pension regulator becoming more proactive. that the legislation must protect. marketing and distribution. whereas that of a Scheme Actuary is reactive. Traditionally there is a fundamental difference between the role of an Appointed Actuary in life insurance business and a Scheme Actuary in pension business. it is necessary that the pension regulator also supervises the occupational pensions – both where the fund pays out the annuities and where the fund buys annuities from the life insurers. It would be appropriate for the pension authority. ‘Tier I’ (dedicated contribution for retirement benefit) and ‘Tier II’ (other savings). funding needs to be set at a level which ensures that the scheme is in a position to meet the liabilities as they fall due. with easy withdrawals to be allowed from accumulations of ‘Tier II’ contributions. However. The values would only be estimates and would depend on unknown variables that would inevitably change over time. and advising the trustees on a schedule of contributions and recommending transfer values. including beneficiaries. These include the expectation that the rights will accrue with service and. Appropriate funding of the pension scheme’s accrued liabilities is fundamental to the pension promise as it provides means whereby the accrued benefits are protected even if the sponsoring employer becomes insolvent. The Scheme Actuary is accountable to the trustees. Pension Business in India Regulation of Occupational Pension Though it has not been spelt out by the authorities. In order to achieve this. But since the statement would be given every year. Their tasks include: • valuation at specified periodicity • monitoring of the scheme’s compliance with the minimum funding requirement • advising the trustees on a schedule of contributions and recommending transfer values. and is therefore required to keep in balance the interests of all participants in the trust. limit the liabilities 64 . The occupational pensions can be of three types: defined contribution. Trust laws allow the settlers of the trust the freedom to amend the rules. Their tasks include: valuation at specified periodicity. if he comes across it. as well as employees and the employer. to introduce the system of Scheme Actuary in India. This requires a minimum statutory solvency or funding requirement in a funded defined benefit scheme. clearing house operations. Scheme Actuary Actuaries have played a significant role in the financial management of defined benefit pension schemes. such schemes are essentially defined benefit as the employers have to make good the deficit in the fund periodically. which could be termed as pension promise. The trust deed should not normally allow powers to the employer or to the trustees to make any amendments that will influence this core of pension promise. expectations would practically be managed on an ongoing basis. winding up and resolution of disputes and withdrawals. In fact the duties of the trustees as regard to the pension promise must get embedded into the legislation for these pensions. when taking up the task of supervision of occupational pensions. it is proposed to have two types of contributions. will be protected and that benefits will be provided in accordance with the scheme rules and any legal requirements. and hybrid.Actuaries have played a significant role in the financial management of defined benefit pension schemes. A Scheme Actuary has to report non compliance. With regard to withdrawls. once accrued. whereas an Appointed Actuary has to ensure compliance. The role of an Appointed Actuary is proactive. of the individual’s fund at retirement age and the amount of pension it might buy at current prices. Other matters for Indian pension regulations include dealing with transfers. of the trustees and so on but there are certain core expectations of the members. There are several aspects that the occupational pension regulations should cover. annuitisation. defined benefit. where both the contributions and benefit are defined. Two important issues are those of pension promise and funding. monitoring of the scheme’s compliance with the minimum funding requirement.
tax law. the average Indian was never much concerned about making provision for old age income. social psyche and nature of the economy. These include trust law. This is particularly important in the context of the introduction of the proposed defined contribution individual retirement account pension with universal access. except the pensions paid by the government are regulated and supervised by the pension regulator. all regulations aim at protecting the consumers and this protection assumes greater importance when dealing with long term financial contracts like pension. assigned to the regulator by the government has to be viewed in this perspective. For regulation and supervision of these arrangements the legislation framed for the defined contribution individual retirement account could cover the EPF. A statutory role in the form of Scheme Actuary needs to be created for DB pensions. the percentage of over-60s is expected to rise from 9% to 16% in the next 35 years while in India. severance pay. and the legislation for occupational pensions could cover the EPS 95 and gratuity funds. Worldwide. 65 . In order to make people understand its importance a massive awareness and education programme needs to be undertaken. released in April 2001. a massive awareness and education programme needs to be undertaken right from the school level. exceptions being the pensions paid by the government. But the most important and urgent thing is to initiate education and awareness programmes about the need for self financing of old age income. contract law. In order to make people understand the importance of building up assets for old age income. It is essential that all pension arrangements. The World Bank document – ‘India: The Challenge of Old Age Income Security’. To sum up. The regulations for the proposed DC pension with universal access need to be framed on the philosophy of ‘minimum standards’ to provide a fair deal to the subscribers. the number is expected to double between 1991 and 2016. but that should be the ultimate objective. ‘There is little evidence that a significant number of individuals in the informal sector will voluntarily save with a multi-decade horizon if not encouraged by direct subsidy’ (which is very unlikely). also need to be under the control of the regulator and that should be done when the supervision of occupational pensions is taken up by the regulator. The pension arrangements and the member’s relationship and rights therein are governed by a number of different areas of law. the pension regulatory body and the providers. Bringing EPF and EPS 95 under its control may not be feasible immediately. with different regulatory authorities regulating their respective areas. by the government. But with ever increasing longevity and changes in the social structure a need is increasingly being felt for self financing of old age income. The schemes set up for funding the gratuity benefit. With increasing longevity and changes in the social structure self financing of old age income has become necessary. particularly in the context of the introduction of the defined contribution individual retirement account pension. Public education and initiatives to create awareness would address the concern expressed by the World Bank. though the age quake has not assumed the massive proportions that it has in the more developed countries. has expressed concern in respect of the proposed DC pension scheme. employment law.Enlarging the Scope of Regulation and Supervision All arrangements for building up old age income need to be under the purview of the pension regulator. Public Education on Pension Because of the social structure. The measures should ensure that all issues are addressed in a holistic manner and cohesiveness is brought in the regulation and supervision of the business. financial services law and other general law. The developmental role IIMB Management Review. social security law. September 2004 Pension Systems in India – Issues and Concerns S Jyothilakshmi Pension reform is very much on the agenda of policy makers in India and it is very timely.
out of 314 million workers. Gratuity is also payable. There are schemes run by NGOs which operate on a social basis. The maximum replacement rate is about 50% of the last drawn wage – the average of the last 10 months’ salary. 1976. which will change under the new pension system. There is a commutation facility available. When we consider this against the back drop of the Three Pillar system 66 . This is followed by taxadvantaged voluntary plans and lastly. to be exact. Since pension is indexed to the wage increase. Voluntary schemes are tax. Thus there was a steep increase in the government’s liabilities after the fifth Pay Commision Report was taken into account. the government’s liabilities go up. 1952. The vast majority of India’s labour force is not covered by the pension system. consisting mainly of the unorganised sector including the self employed and people working under casual contract are totally outside the safety net of pensions at present. Apart from this there is a General Provident Fund which provides for a lump sum payment on retirement. It is indexed to the CPI as well as to wage revision. constituting about 11% of the workforce. The mandated pensions for the organised sector are governed by the Employees Provident Fund and Miscellaneous Provisions Act.Government pensions and the mandated pension schemes for the employees of the private sector form the mainstay of the pension system in India. the EPF being the defined contribution portion and the EPS being the defined benefit portion. For states the comparable figure was about Rs 260 billion. 1995. Here also the replacement rate is 50% of the terminal wage — the average of the last twelve months salary. However such traditional safety nets are increasingly becoming fractured and with the ascendance of the nuclear family. In absolute figures. 47 million are regular salaried employees of whom only 11 million are covered by government pension and about 23 million are governed by the mandatory EPS and the EPF. Backdrop of Pension Reforms India has always had a traditional joint family system on which people banked for their succour in their post retirement days. supported by the World Bank. We also have informal arrangements such as transfers from children but as noted Pension Business in India Pension Systems in India Government pensions and the mandated pension schemes for the employees of the private sector form the mainstay of the pension system in India. The government pension is an Unfunded Defined Benefit Pension at present. According to the OASIS report. The remaining 90%. There are also group super-annuation plans. The significant difference here is that they are not linked to inflation. There also exist social assistance schemes which are operated by the government but which provide very nominal benefits – in the range of Rs 75 to Rs 100. Voluntary schemes include the Public Provident Fund which is operated by the government. every time a Pay Commission report is released. the Employees Deposit-Linked Insurance Scheme (EDLI). the pension plans of the Life Insurance Corporation (LIC) and the private life insurance companies. At present they pertain to about 180 industries and classes of establishments which employ 20 or more persons. The schemes are a combination of defined benefits and defined contribution schemes. Voluntary plans and social assistance schemes cover only a miniscule percentage of the total population. 1952. people are depending less on their children or on their families. Three schemes are presently in place — the Employees Provident Fund Scheme (EPF). it is the second pillar which is predominant in the Indian scene. Other indications of changing social mores include increasing urbanisation and migration and the fact that post retirement life styles are becoming increasingly similar to pre-retirement life styles. This is the backdrop against which the pension reform process in India has started assuming more and more importance. the pension burden was around Rs 220 billion for the Central Government alone in 2001 – 2002. by social assistance schemes where the government offers means-tested programmes for people who are well below the poverty line.advantaged schemes that are offered either to people who are already covered by the above two schemes (and can use this to top up their retirement plans) or the majority of the people who are in the self employed sector. and the Employees Pension Scheme (EPS). by social assistance schemes where the government offers means-tested programmes for people who are well below the poverty line. This is followed by tax-advantaged voluntary plans and lastly.
The basic problem is that of poor coverage. 2000. September 2004 Conclusion Several reports. the IRDA Report. a balanced one or a safe one. the Project OASIS Report. and the RBI study – State Government Pension. since actuarial valuations are not very transparent in that they have not yet come to the public domain. will fund management be thrown open to a number of players? What will be the administrative costs involved? The EPFO has already undergone an Indiawide overhaul of its operations. the result that the actual amount given to the person on retirement is only a small portion of the entire asset. While the proposed Defined Contribution scheme will address this problem to a certain extent. the Wadhawan Committee Report. these informal arrangements are gradually dwindling because of the break up of the joint family system. Consumers will also be given more choice and they will be allowed to opt for a growth portfolio. This skew may. how exactly will this operate? What will be the real role of the pension regulator? Who will be the fund managers? How will they be selected? Will there be a limit on the number of fund managers or as the Confederation of Indian Industry (CII ) and other trade bodies have proposed.earlier. As far as the EPS is concerned. commissioned by various ministries. There should be stricter norms on premature withdrawal. Escalating expenditure and the risk of under funding have been highlighted by the Bhattacharya Committee Report which has talked about the difficulty of sustaining the financial burden in the long run. However. Delays in settling pensions and the want of reliable databases of pensioners are just some of the problems encountered. The EPF and the EPS operate under very strict investment norms and hence the rate of return might not be the optimum which could be obtained if these rules did not prevail. It is expected that pension fund management will be opened up to professional fund managers who will have a range of investment options including investment in equities. the Bhattacharya Committee Report on Central Government Pension. Record keeping is very important especially as the time frame involved spans several decades. The benefits offered to the government employees are much more generous than those that private sector employees can look forward to. as documented by the OASIS report. 2002. to get depleted with IIMB Management Review. Pension fund administration and record keeping have to improve. the transition phase is expected to span about thirtyfive years. The facility of premature withdrawal which applies to the PPF. So. As we move towards the new pension system several questions still remain to be answered. however. This stresses the need for better asset management . Subhedar. the EPF and so on has led most terminal accumulations. be corrected as we move into the proposed defined contribution(DC) system. have set the reform juggernaut rolling. Ultimately we should not forget that the consumer is the most important person in the entire exercise. actuarial valuations of the fund have not revealed any serious under funding at present. These include the Malhotra Committee Report. depending on their risk appetites and the stage of life they are in. 2001. giving a citizen identity number to each person. The regulatory issues have been dealt with by Mr. how exactly will the regulatory framework be dveloped? That could be a problem in the future. Escalating expenditure and the risk of under funding have been highlighted by the Bhattacharya Committee Report. The OASIS report has highlighted how only 11% of the total work force of the country is covered by any formal scheme and almost 90% of the labour force is totally out of the purview of this safety net. Regarding the new pension schemes for government employees which will be thrown open to the self employed as well. The systems offer varying benefits. 1994. as the latter’s pension is not indexed to inflation. the financial sustainability or otherwise of the EPS remains to be seen. given the multiplicity of players involved. whether these problems will persist in the interim is something to be seen. However. Areas of Concern What are the problems with the present pension system and those that are envisaged in the transition phase? The basic problem is of course that of poor coverage. 2003. Consumer awareness and education are very important especially as we move towards a system with individual retirement accounts where asset management choices will be given to the subscribers. revamping their IT and other record 67 . The OASIS report has highlighted how only 11% of the total work force of the country is covered by any formal scheme. The systems offer varying benefits. 1999.
While there was a relatively high degree of awareness (65%) about the Voluntary Pension Plan (VPP). we have nearly 16. Whether this is based on calculated risk is not clear. The amount invested varied significantly across the different demographic groups – this will be analysed further. business persons and professionals like Chartered Accounts.000 responses.000 (tax incentive u/s 80CCC) appears to be the limiting factor. Advice is most sought from qualified professionals as opposed to licensed representatives or friends. which was sponsored by the ING Group. The degree of pension awareness. About 10% of the workforce expect complete support in their retired life from their children while another 35% expect partial support. their sources of advice/information. Government institutions are preferred for buying pension plans. The details of the survey and findings are to be published in the form of a book soon. keeping facilities and so on. insurance companies are overwhelmingly the preferred channel for buying VPPs. only a small fraction (20%) had bought one already. excluding possibly age and sex. These percentages are likely to decrease in time with the change in social structure. as also savings for retirement and disposable income. Will the EPFO be integrated into the overall system or will it operate in isolation? What about the role of insurance companies? Will they be relegated only to the benefit provision stage when they provide annuities or will they also be allowed to play a part in the pension fund management? And who will regulate them? What about self employed persons – the vast majority of people who don’t find a place in the pension system? These are some of the questions which we have to answer as we decide on the reform process and firm up the role of the regulatory body and other policy matters regarding pension. While there was a relatively high degree of awareness (65%) about the Voluntary Pension Plan. Promptness in account settlements is the most important service that people are looking for. depends significantly on the various demographics. Further. These percentages are likely to decrease in time with the change in social structure. product related information such as their considerations while buying a product. Pension Business in India Survey on Pension Perceptions Shubhabrata Das We would like to share with you some of the initial results of a field research on pension perceptions undertaken by the faculty at the Centre for Insurance Research and Education (CIRE) at IIMB. how they wished to receive information about their account and their service expectations. and their preferred channel for buying pension products. However ‘rate of return’ is the most important factor for choosing a product. Initial Results We would not want to put too much of an emphasis on numbers because these are from an ongoing survey and can only indicate a broad direction. provider related information such as from whom they would like to buy insurance products and what people looked for in a provider while buying a pension plan. only a small fraction (20%) had bought one already. as measured though the different awareness parameters. 68 . etc. There were six components to the questionnaire seeking demographic information: awareness of and investment in retirement savings funds or voluntary pension plans. But the annual contribution of Rs 10.About 10% of the workforce expect complete support in their retired life from their children while another 35% expect partial support. The survey was administered by the Insurance Institute of India through its various associates spread across India. We conducted the survey to gather information particularly on the unstructured and rural market and thus adequate emphasis was given to ensure that we receive information from agriculturists. The workforce itself is expected to increase. There is a strong investment preference for the conservative option. doctors. their investment preference for their pension fund.
one fact which is not taken note of is that the state government pension schemes in most states not only cover the state government employees but employees of local bodies. municipalities and corporations. corporations. In India as in other developing countries. Pension schemes in most states not only cover the state government employees but employees of local bodies. There are a large number of people in the informal sectors both in the rural and the urban areas and the government is in the process of working out some schemes for their retirement benefits. However. That fact should not be lost sight of. my hunch is that the second tier may be used by the existing central and state government employees as extra savings. In some states their numbers exceed those of pure state government employees. 23 million are covered by the EPF and the EPS. the committee recommended a two tier system. are covered by the scheme. It will be open to the self employed and people in the unorganised sector. the terms of reference were limited because the government had already made up its mind that the existing pension burden is unsustainable because it is reaching 1% of the GDP and we should move over to a defined contribution scheme. The first tier was supposed to be a hybrid scheme or a mixed DB-DC scheme. I would like to share some ideas based on those reports. almost 75% to 80% of the salaried people of this country are covered by a pension scheme established either statutorily or created by an executive order retirement benefit scheme. a large number of whom are uneducated or illiterate to appreciate the second tier of the DC scheme. It will be rather unrealistic to expect agricultural labourers and artisans. municipalities. So for some years to come you have to have some special schemes for the unorganised workers. out of a total number of 47 million. with the government making up any deficit in earnings. You have to supervise pension schemes through proper institutional channels with contributions. 69 . as the Central Provident Fund Commissioner I had given a report regarding the central government pension reforms after which I was invited to chair a committee in performing a similar exercise with the pension burden of the state governments. If you take that as a percentage of 47 million.Government Pensions and the Employees Provident Fund Scheme B K Bhattacharya In the mid and late 80s. a large number of people are in the agricultural sector. I don’t think the Indian pension system has done too badly by them. September 2004 In the salaried class. Though the figure for the central and state government employees is about 11. pay much contributions and are beneficiaries of the same unfunded pay-as-you-go DB scheme as the state and central government employees. Out of a total estimated number of 47 million. by some elite members of the self employed sector. The government of India has of course decided that they will have a two tier system but the first year will be a DC scheme with no pension guarantee and the second tier would be voluntary. 23 million are covered by the employees provident fund and employees pension scheme. In the report on the central government pension scheme that I had submitted. The second tier would be purely voluntary with greater flexibility in investment. about 39 million people are covered by the pension scheme today which is larger than the population of most of the countries in the world.2 million. most of whom do not IIMB Management Review. Coming to the salaried class. A large number of employees in grant-in-aid institutions such as school teachers and college lecturers. Many of them are agricultural labourers. by people in the organised sector. The point has been made that out of large number of workers in this country only a small fraction is covered by a pension scheme or a retirement benefit scheme. But this coverage should not be denigrated in any way. agricultural labour and others. The OASIS report has dealt with this subject and the new two tier DC scheme which the Government of India is bringing into effect. with a defined contribution as well as a defined benefit. If one were to add all the numbers. most of whom do not contribute much and are beneficiaries of the same unfunded pay-as-you-go DB scheme as the state and central government employees. The first tier will have contribution by the central government for the central government employees and the second tier will be voluntary – anybody can join. the role of the fund manager and so on. Within the limited terms of reference.
They are probably eating into their capital. approximately 40% in Kerala.6%. It is likely to go up to 20% after ten years. they cannot raise fresh loans. This would be for the first year which would be contributory.68 billion in 1980 to Rs 282 billion in 2001. This is a very serious matter because the coverage of the scheme is 23 million people and if the pension scheme is fundamentally unviable then it will show up in 5-8 years.Pension payments of the state governments have increased from Rs 2. They should buy a pension product from any of the pension fund providers or they should join the Government of India’s second tier as the state governments are unable to take these burdens. Even in the case of existing employees of the grant-in-aid institutions and the local bodies. pension and interest was exceeding 100% of the revenues of the state government. Pension payments as total revenue receipts of the state rose from 2% in 1980-81 to 11% in 2001–2002. for state governments much tougher decisions would be called for.Bengal. Tougher decisions are called for. If you take the present contribution and the present benefit rate. or they could have only single tier DB-DC scheme.6%. Their bond issues are strictly regulated by the Government of India and without its permission. 28% in Orissa. So we felt while some kind of soft decision could be envisaged for the Government of India schemes. we suggested three alternatives. Some state governments felt that they would like to give a pension guarantee not of 50% but 25% to 30% of the last 12 months pay or 36 months pay. Here one would need both structural changes as well as parametric changes of a harder nature.68 billion in 1980 to Rs 282 billion in 2001. in the course of work for the state pensions committee we found that in some states the salaries. especially in some states where this number is more than the number of the state government employees. Pension payments of the state governments have increased from Rs 2. we could explore the possibilities of collecting some contribution from the employees as well as the institution. this scheme is not viable. 26% in Rajasthan. an annual increase of 23. In so far as the states were concerned. While we have said that the new scheme Pension Business in India . including central devolution of funds. There is some provision of adding five years service in case of voluntary retirement. It is likely to go up to 20% after ten years. This was introduced to reduce the hassle of calculating the 12 month or 36 month pay but it might not be sustainable over a long period. including structural changes as well as parametric changes of a harder nature. In so far as the state schemes are concerned.2002. Pension payments as total revenue receipts of the state rose from 2% in 1980-81 to 11% in 2001–2002. state governments do not have free access to either issue of bonds or borrowing from the RBI. Price indexisation might continue but wage indexisation should be done away with. They could fall in line with the government of India by having a pure DC scheme. That is 20% of the state’s revenues will go for pension. Some states resort to subterfuge. It will cause a tremendous drain on the resources of the government if immediate remedial action is not taken. The most important recommendation was that the pension burden relating to future employees of grant in aid institutions and local bodies should be shifted to the respective institutions. I am told that the government has set up a committee to look into the overall EPF structure and I hope they go into this question in great detail. Maximum permissible commutation amount to be brought down from 40% to 33. The second tier would be a pure DC scheme. While working out the DC-DB scheme we had consulted an actuary who had worked out that with a 10% employee contribution plus 10% government contribution it is possible to give a defined benefit which is 50% of the average of the last 36 months pay. 32% in Tamil Nadu and 31% in W. In the case of Bihar it is likely to reach 34% in 2010. starting new special purpose vehicles (SPV) purportedly to develop infrastructure. an annual increase of 23. Unlike the Government of India. without wage indexisation and with capping of price indexisation. given the contribution? At the moment they are able to manage because they started the scheme with the transfer of balance from the old family pension fund.33% and discount rate for calculating commutation factor should be linked with the rate of return and GPF. borrow through the 70 SPV and use that money to pay salary and pension.2002. with no wage indexisation and 5% price indexisation cap. with a pension guarantee. The group also had certain other suggestions — immediate withdrawal of the system of fixing pensions on the basis of only the last one month pay. How can the scheme provide 50% pension replacement. Such being the case it was felt that state governments’ problems are probably more serious than the government of India’s.
there may be no alternative but to make the new contributory scheme obligatory for even existing employees with less than ten years of service – ten years will have to be the cut off point because they have not yet earned the right to pension. both state and central. there hasn’t been a system wide perspective or approach to the issue. One needs to look at the pensions. which is IIMB Management Review. provident funds. So on the one hand we have got a sort of state of the art investment strategy and on the other hand we have an EPFO which does not even allow government bonds to be traded in the market – the basic principles of financial management 71 Pension Reforms: Room for Improvement Mukul Asher There are four areas where the Indian social security reforms or pension reforms. The EPFO for example is the second largest non bank financial institution in the country but does not come to the IIM campuses to hire their staff. One of the objectives of the new effort is to narrow the gap substantially. We have also suggested that whether it is DB scheme or DC scheme or DB-DC scheme there has to be periodic actuarial evaluation of the scheme. What is encouraging however is that for the first time there is a certain degree of understanding that if India does its provident and pension funds reforms right. Our projections are often flawed and it is essentially because of faulty assumptions. as an export industry. Again it will be better if we try to under-promise and over-perform rather than the other way round which has been the case in the past. voluntary savings. Such lack of professionalism has gone on for many years. This will not only benefit the Indian economy by reducing the transaction costs but we can leverage the scale and develop it into a full-fledged industry which can generate employment. This has been the case both in Thailand and Malaysia where their respective EPFs have been imploring their governments to allow them to invest internationally. There is no data regarding age and salary wise composition of the government employees and without that no actuarial calculation is possible. How can they afford not to have financial expertise? This is also true of the various small saving schemes. Many of the civil service schemes or even the EPS scheme were set up as if the individual should get all of the replacement rate from one scheme. possibly between two thirds and three fourths of the pre. provident funds. which is not viable and is contrary to the very basic principles of finance where you have diversification. pension and interest burden have exceeded 90% of the total revenue receipts. LIC and others. The insurance reforms have done a lot for LIC and others to try to move their mindset to more professionalism and the IRDA has played a welcome role there. protected against inflation and longevity. One needs to look at pensions. September 2004 . Thirdly. which is protected against inflation and longevity. Actuarial evaluation will also generate a demand for better database management by the various government organisations and ensure the viability of the funds. When a person retires. need to improve. To improve the state’s finances it is not enough to tackle only pension but the tax. s/he needs to get his replacement rate. That replacement rate does not have to be obtained from one scheme. is abysmally poor.SDP ratio which is very poor in many states. We have suggested that in respect of states where pay. it has the potential to develop it as the next service industry. In the past the social security schemes have generally been regarded as welfare schemes and the general thinking has been that if you have a welfare scheme. That replacement rate does not have to come from one scheme. you don’t need to have professionalism. Forecasting and projection are not possible with the present set of data. The other point is that the government database. Secondly.retirement income. The new civil service pension scheme is contemplating international diversification of pension assets. When a person retires. as components of a social security system. etc. we should also think of voluntarily inducing some existing employees to the new scheme. as components of a social security system and not individually. There were a couple of other suggestions. you don’t need to apply good economic and management reasoning. etc. possibly between two-thirds and three-fourths of the pre-retirement income. s/he needs to get a replacement rate. voluntary savings. there has been an uncomfortably wide gap between the innovations and developments in the sector and their recognition in India. the post office saving schemes.should be compulsory for new employees.
000. Should there be any separate training for those who advise on pensions? For it was pointed out that the economics of life insurance and the economics of pension are very different and actuarial calculations will have to be very different. This is true of the pension fund trustees as well and I hope the pension regulator addresses this at an early rather than a later stage. After the initial period. Among the ‘olds’ a few have a lot while others have little. This accountability is what the regulator will have to bring. and if family pensions are included. My view with respect to the new government pension scheme and the pension regulator is to let the best not be the enemy of the good. Many such decisions are made ad-hoc in the absence of a good record keeping system. The second thing is that employment in the organised sector has remained stagnant for quite a long time. Growth is going to be the most important macro economic variable here.There has been very little understanding of the fact that if you take on anybody on a defined benefit or a defined contribution system you are really taking on a responsibility for fifty to seventy five years. On the HR policies will depend the competency. A lot of the education and literacy issues are not just at the consumer level. we must acknowledge the disparities in what is available to retired people. including a demographer in the committee that Mr Bhattacharya was talking about would be a good idea to get a much more nuanced idea about the demographic situation in India. The most important macro economic variable in social security is economic growth. there are occupational pension plans where there are no rules and regulations and which involve self dealing. which is about the same number as firms registered in Malaysia’s EPF. which Mr. RBI and the proposed new regulator for the non bank financial institutions will be important as these things are not as seamless as it is currently being made out to be. Regarding transparency I very strongly endorse Mr Bhattacharya’s views that you would want to bring in the GPF. the ability to think forward and so on. financed through diverting a part of current 20% contributions. Despite the projections of growth of our GDP. There has been very little understanding of the fact that if you take anybody on a defined benefit or a defined contribution system you are really taking on a responsibility for fifty to seventy five years. Bhattacharya also spoke about. In the trade-off between job preservation and job creation. but Malaysia has a population of 22 million. So there is a very strong case just from the purely business point of view to get these guys in the regulatory mode so that the professionalism and prudential fiduciary responsibilities are addressed better. One of our problems has been that we have not taken fully into account the two fundamental macro economic truths about social security. They may be under funded and eventually the accounting standards are going to require that those contingent pension liabilities be reflected on the profit and loss statements of the organisations. SEBI. are not well understood. it is at the policy making and politician level. As an addendum to Mr Subhedar’s presentation. the new scheme may 72 consider a mandatory scheme of survivor’s benefit to address the gender issues. The final point is about accountability and transparency. In Malaysia even if you have one employee you are registered. Further. the pension regulator. may be even longer. This accountability is what the regulator will have to bring. here it is 20 employees. Even for those 20 employees there are no reliable records. Many such decisions are made ad-hoc in the absence of a good record keeping system. the civil service schemes and the EPFO’s schemes under a regulator at earliest possible opportunity. Given the varying positions and requirements of the different states. EPFO’s total number of registered employer firms are around 350. the balance will need to shift towards job creation because that will provide the security. of people both at the board level and the technical staff level. I would like to add human resource policies of the pension regulatory authority as an area of major concern. Public sector banks and even the LIC may be seriously affected in this regard. I come back to training and education. Co-ordination between the IRDA. Insurance Company Perspectives of the Pension Market R Krishnamurthy In India today there are thirteen life insurance players and almost all of them have been in the pension business for Pension Business in India . it is with the trustees.
September 2004 People consciously saving for old age benefits are extremely sensitive about the trustworthiness of the institutions with whom they place their long term savings. in an automated IT environment. There is a high level of ignorance even among educated people on how the new scheme is going to affect the savers several years hence. It is relevant that a recent market research study conducted by an agency in Delhi. the Invest India Economic Foundation. about their savings being absolutely safe and the dependability of the system to fulfil the commitments assured at the beginning. It is often mentioned that the new scheme will be extended to the unorganised sector and rural population. nurtured for the last five decades by credible public sector institutions. Additionally. and the regularity of return that will get added to the retirement saving kitty. the backlash of any failure or market aberration could be severe and call into question the fundamental pension reform process itself. In a truly long term saving scheme such as pensions. Life Insurance companies offer endowment type pension products where the companies manage the investment risks. and they also offer unit linked products where the policyholder takes the investment risks. We need to define the target population to benefit from the new DC Plan apart from the new government staff to be compulsorily brought under its purview. The subscribers who have taken pension policies are mostly in the white collar and middle to upper income segment. with a comprehensive customer relationship management system. we are perhaps pushing too radical a reform by introducing a universal pension scheme with undefined pension benefits based on a Defined Contribution approach to cover all economic strata without preparing the target beneficiaries sufficiently. We may note that despite more than 12 years of banking reforms. It is not clarified how the socalled vulnerable sections who desperately need social security in the form of pensions coming out of their little savings accumulated over long years will be effectively serviced by the new system. I would like to share a few perspectives on how banking and insurance can together provide a great opportunity to accelerate the pension sector. If not.several months. We seem to be moving in a hurry to pass on investment risk to hapless savers right from day one. We have not prepared the public on how to assess the risk of a DC Plan. how to make informed choices and how to protect the savings from downside risks associated with marketbased returns. those who top up their government pension or other occupational pension. As we go forward in the pension reform process. At this stage. the ways in which the pension market has been developed and whether the existing system can be exploited to its full potential. it is useful to review the role of life insurance companies which are licensed to do both life insurance and pension products. Life insurance companies are now beginning to tap the self employed people and those in the rural areas with pension policies. This is going to be crucial in our country nurtured for the last five decades by credible public sector institutions. and the regularity of return that will get added to the retirement saving kitty. First of all. it is time to take stock of how these insurance companies have performed in regard to the pension business. Thirteen new players have sold more than one hundred thousand pension policies in the last year. and prepare the framework to ensure public confidence at every stage. People have been confident IIMB Management Review. We should perhaps in the first instance post a Discussion Paper on the subject on the official website to elicit views from general public so that the new framework is built on public confidence. The insurance companies run the pension schemes with excellent record keeping. People subscribing to insurance and pension policies even in 73 . we need to widely involve the role of public institutions. are we biting off more than we can chew while ushering in a new system? With a low per capita income and with little social security benefit available to the general population. from the point of view of a banker-turnedinsurer. revealed that people consciously saving for old age benefits are extremely sensitive about the trustworthiness of the institutions with whom they place their long term savings during their working life. This is going to be crucial in our country. the public sector banks still hold more than half of the deposits accruing to the system.
Most pension policy buyers from insurance companies also 74 prefer to bundle life insurance as an option along with their savings. the system should demand that the existing players perform better. be it an endowment product. which is a saving accumulation scheme until the age of retirement. In fact. we are able to lower the distribution cost of pension products. a standalone insurance product or a pension product. with no charges on the corpus. while they give a conservative picture in regard to returns at the end of the period. We encourage regular payment by way of automatic debit from the bank account. The minimum contribution is just Rs 3000 per year or Rs 250 per month. they are -. remote places are able to remit their money through a network of capable and trained intermediaries and the pension savings get into their accounts promptly. We keep the pension fund management charges low at only 5% of the saving contributions. When integrated into a combined insurance company. We try to top up this guaranteed rate with additional return. In an ideal world there is a full end-to-end financial needs analysis that the intermediary does with the potential customer. those who have created a track record of performance under the watchful eye of the regulator. particularly in balancing the risks versus the returns.investment management. Subscribers want to know. the actuary gives a balanced assessment and looks at the overall interest of all stakeholders. how much will they get at the end of their working life. We also provide this option in our product. capital and assetliability management. called Lifelong Pension Scheme. All insurance companies provide extensive training to the agency force on product selling. The rate of return is guaranteed only for a specific period after which we will come up with a fresh rate. We must hasten slowly in this critical area and initially play safe by involving those who are already regulated. Subhedar made a very valid point on what should be the role of a Pension Actuary. When you are thinking long term. keeping in mind that there is always a long term minimum guarantee that pension business demands. Pension clearly falls in the same category. Many companies provide web-based access to the pension policyholders to view the status of policies at any time. We rolled out a pension policy. Insurance companies selling endowment type pension policies assure the pension policyholders that their savings are safe. if they put in a certain amount year after year. It is natural for people to demand assurance that they will get back their saving and that they will stand protected adequately. When we try to address these two we are talking about protection products. Mr. you ideally want to get people to start early and that is a big sale. The fact is. In fact. it gets worried. and keeps a vigil on the sustainability of all the products. The second factor is distribution. Pension Business in India . An important task undertaken by insurance companies is to spread investor education. if pension products were offered at a discount. accumulation products and pension and retirement products. What are the critical success factors for success in the pension business? Four things come to my mind: One of them is investment management and I’d like to stress on the expertise that is required to maintain a long term focus in pensions. if an insurance company sees a queue forming outside.What are the critical success factors in the pension business? To sum up. I wish to share an experience of our company which is designed to rely on bank branches as essential distribution outlets for insurance and pension policies. distribution (building distribution is the biggest challenge in a vast country like India). there wouldn’t be too many takers. In that process they try to educate the customer about the two potential risks – one is of dying too soon and the other is of living too long. our board reviewed our investment performance and gave an additional 4% return for last year. which are complementary in nature. more customer friendly and more economical service. By distributing the pension product along with the insurance product. The policy basically carries a guarantee of the corpus of saving on which we assure a minimum 4% return every year. which is a sort of cross subsidy from other products. Insurance players have always looked at being in the space of protection accumulation and retirement. Venkatesh Mysore I will try to add a perspective from a private insurer. Recently. and provide a wider.
keeping a long term perspective in mind. maintaining solvency. But we are far from achieving that in India right now because the professionalism that is needed is lacking. they have to make sure that there is a full basket of offerings for the customer because that is what the customers are expecting. The entire structure for developing the right type of intermediaries is not fully in place. The third critical success factor is capital. But is the life insurance industry prepared to do it? In India there is still a long way to go for the life insurance industry to say ‘We are better prepared than the asset managers’. The second aspect of distribution is one of cross-selling. September 2004 75 .Building distribution is the biggest challenge in a vast country like India. and you have the right type of intermediary to go out and talk to the people. The fourth one is the asset-liability management aspect of the business which ultimately is going to determine the success of this business. But I think that it would be a mistake to leave out the life insurance industry from being participants in this business — both in the accumulation phase and the annuity phase — because life insurers have a lot to offer in terms of nurturing and growing this business. When insurance companies are investing in building the distribution network. there is an immediate need for appropriate changes to be effected in the regulatory framework. For enabling such a structure. When you have a huge customer base like LIC with 140 million policies or so. and getting into the investment management function. then the kind of trust that is necessary could be built up. considering the kind of scale and critical mass that needs to be reached to build distribution in a meaningful way. Reprint No 04305 a IIMB Management Review. Insurance companies are used to bringing in huge amounts of capital for funding the initial capital strain.
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