Content

1. Introduction
1.1 Introduction
1.2 Objectives of the study
1.3 Need for study
1.4 Scope of the Study
1.5 Research Methodology
2. Background
2.1 Introduction to Pension Plans
2.2 Types of Pension Plans
2.3 Pros and Cons of Pension Plan
3. Pension system in India
3.1 Changing Social Patterns
3.2 Demographics
3.3 Current status of pensions in India
3.4 New Pension Scheme vs. Old Pension Scheme
3.5 Future of pensions business in India
4. Major challenges, risks and issues
A. Inflation risk in retirement benefits
B. Managing risks and role of actuaries
C. Customer awareness
5. Conclusion
6. References

INTRODUCTION
A pension is a fund into which money is added during an
employee's employment years, and from which payments are
drawn to support the person's retirement from work in the form
of periodic payments. A pension may be a "defined benefit
plan" where a fixed sum is paid regularly to a person, or a
"defined contribution plan" under which a fixed sum is invested
and then becomes available at retirement age. Pensions should
not be confused with severance pay; the former is usually paid
in regular installments for life after retirement, while the latter
is typically paid as a fixed amount after involuntary termination
of employment prior to retirement.
The terms "retirement plan" and "superannuation" tend to refer
to a pension granted upon retirement of the individual.
Retirement plans may be set up by employers, insurance
companies, the government or other institutions such as
employer associations or trade unions. Called retirement
plans in the United States, they are commonly known
as pension
schemes in
the United
Kingdom and Ireland and superannuation
plans (or super)
in Australia and New Zealand. Retirement pensions are typically
in the form of a guaranteed life annuity, thus insuring against
the risk of longevity.
A pension created by an employer for the benefit of an
employee is commonly referred to as an occupational or
employer pension. Labor unions, the government, or other
organizations may also fund pensions. Occupational pensions
are a form of deferred compensation, usually advantageous to
employee and employer for tax reasons. Many pensions also
contain an additional insurance aspect, since they often will pay
benefits to survivors or disabled beneficiaries. Other vehicles
(certain lottery payouts, for example, or an annuity) may
provide a similar stream of payments.
The common use of the term pension is to describe the
payments a person receives upon retirement, usually under
pre-determined legal or contractual terms. A recipient of a
retirement pension is known as a pensioner or retiree.
The term "pension plan" is now used to describe a variety of
retirement programs that companies establish as a benefit for
their employeesincluding 401(k) plans, profit-sharing plans,
and simplified employee pension (SEP) plans, and Keogh plans.
In the past pension plans were differentiated from other types

of retirement plans in that employers were committed to

providing a certain monetary level of benefits to employees
upon retirement. These "defined benefit" plans, which were
common among large employers with a unionized work force,
have fallen into disfavor in recent years.
Some individuals also choose to establish personal pension
plans to supplement their retirement savings. Making sound
decisions about retirement is particularly important for selfemployed persons and small business owners. Unlike the ever
declining numbers of employees of large companies, who can
simply participate in the pension plans and investment
programs offered by their employers, entrepreneurs must set
up and administer their own plans for themselves and for their
employees.
Though establishing and funding pension plans can be both
time-consuming and costly for small businesses, such programs
are worth the effort for a number of reasons. In most cases, for
example, employer contributions to retirement plans are tax
deductible expenses. In addition, offering employees a
comprehensive retirement program can help small businesses
attract and retain qualified people who might otherwise seek
the security of working for a company that does offer such
benefits.
The number of small firms establishing pension plans grew
considerably during the 1990s, but small employers still lag far
behind larger ones in offering this type of benefit to employees.
According to a 2005 Small Business Administration report,
fewer small companies (those with 500 or fewer employees)
offer any sort of retirement benefits to their employees than do
larger firms35 percent versus 75 percent respectively in
2002. For firms with five employees or fewer, only 11 percent
offer a retirement savings program, like a 401(k) or Simplified
Employee Pension (SEP) plan.
A person usually has two phases of investment; the
accumulation phase and the distribution phase. Accumulation
phase: this is the phase when you earn money and
accumulates wealth. During this period you tend to invest in
various kinds of investment plans like mutual funds, stock
market, securities, bonds, life insurance, pension plans etc.
Distribution phase: this is the phase when you tend to consume
the wealth you have already accumulated. This is usually when

you have retired from your job. Some of you might start
withdrawing money even before retirement.
1.2 Types of Pension Plans
There are different types of pension plans. It would depend on
how much you earn today and how much you would like to
invest in pension plans, apart from other types of investments.
The various types of pension plans can be categorized as
follows:
A. Deferred Annuity Plan: As the name suggests, the
pension is not paid immediately after you retire but it is
delayed till the time you plan to retire. You pay a fixed
amount as premium and the wealth accumulated is kept
aside till you retire. You get your money back in regular
installments every month. If you have taxable income and
are investing this kind of scheme, then after this scheme
starts generating a fixed income post retirement, it is given
to you after tax deductions.
B. Immediate annuity plan: You can invest a lump sum
amount of money in this plan. When you retire, you get a
fixed amount of money for a fixed amount of time as long
as you live. There are different types of plans that insurance
companies offer. They are as follows:
Guaranteed Period Annuity: As the name suggests, you
get a certain amount of money for a fixed number of years
as mentioned in the pension plan. So if someone decides
to buy this plan and get pension for 15 years, the money
will be paid irrespective of the fact that the person
survives or not after this plan. For example, if the policy
holder expires after 10 years, the money will be given to
the nominee for the next 5 years.
Annuity Certain: If you buy this plan, you will be paid a
fixed amount of money for a fixed duration. However, the
best advantage of this plan is that if you survive the plan
you would get pension for as long as you live. For
example, a person invests in this plan and is supposed to
receive money for the next 15 years. If after 10 years, he
dies the nominee will get the pension for the next five
years and then the pension will stop.
Life Annuity: If you opt for this plan, you will get pension
for as long as you live. If the person dies, then the
nominees will get the purchase price of the annuity. The
purchase price here means the assured amount to be
received on maturity, plus the bonus.

1.3 Pros and Cons of Pension Plan

No Investment Risk
A big advantage of a pension plan is it completely protects you
from investment risk. Your employer also plans the pension's
investment strategy. If the stock market tanks, the company
needs to make up the lost money. You won't see a drop in your
retirement benefit. Even if your employer goes bankrupt, your
pension is still safe. A government agency, the Pension Benefit
Guaranty Corporation, will take over your payments.
Payments for Life
When you reach retirement, your pension plan will give you
monthly payments for the rest of your life. It's as if you're still
getting paid by the company even though you're no longer
working. If you're married, you can base the pension on your
spouse's life as well. This means if you die first, payments
would still go to your spouse. However, this shared pension
means you'll have smaller monthly payments than you'd have
with a regular pension.

No Investment Control
On the down side, your pension won't grow with any market
gains. If the stock market goes through the roof, the extra
money stays with your employer. You also can't move it into
your own investments. Your pension could also freeze you out
of an Individual Retirement Account. The IRS doesn't want
taxpayers to have too many retirement tax breaks. As of 2012,
couples making more than $112,000 combined can't contribute
to an IRA if they're also enrolled in a pension.
No Early Access
If you run into a financial emergency, you can't count on the
pension money to bail you out. You can take out early
withdrawals or loans from other retirement plans, like a 401k,
but there's no such choice with a pension. That money stays
with the employer until you actually retire. The only way to get
it early is if you quit and your employer chooses to send you a
lump sum payment. That's his decision, not yours. Once you do
retire for real, you get the money once a month and can't take
out any advances.
There are better options for growth of your wealth

The accumulation of your wealth happens in a pension plan for

many years, but its not the best way your money can grow,
ultimately if you had to invest your money in equity (underlying
asset class), you have simple and no-cost options like mutual
funds, index funds. Also you can choose to put money in real
estate. A regular SIP in an equity diversified mutual funds
should give much better returns then accumulation in a pension
plan (read unit linked products).
No predictable returns for annuity
The core function of a pension plan is to give you pension. But
do you know how much returns you will get out of your pension
plans when time comes for retirement? A lot of pension
products do not give a clear idea on how much will you get at
the end. What is the return earned is around mere 4%? What
will you do? The same is true for NPS.
One major DRAWBACK is you have no clue what will happen
once you finish the accumulation stage and go on to the
withdrawal stage. Let us say you have accumulated Rs. 500
lakhs in a NPS account. They allow you to withdraw say 50% of
the amount and the balance has to be invested BACK in an
annuity. Let us say you ARE FORCED to invest Rs. 250 lakhs in
an annuity which pays Rs. 11,000 per month as a pension
looks good? Well depends on what you are capable of doing
with your own money!
At this point of time, the better alternatives would be old
fashioned products like Post office monthly schemes, fixed
deposits with monthly payouts or even senior citizen savings
scheme. These all give near inflation returns at least.
Rigidness and no flexibility
Almost all the pension products are rigid in taxation and what
you can do with your money at the end. Under current laws you
can withdraw only 1/3rd of your accumulated money tax-free,
where as there is long term capital gains at the moment is
100% tax-free. Also its compulsory to buy annuity for the
remaining money. What if I want all my money for some reason
at the end? What if I dont have a requirement for income later?
These problems wont be there if you accumulate your money
in plain vanilla mutual funds or PPF or other simple investment
products.
High charges
Who does not know how ULIPs and other similar products have
charged so high costs for initial years without giving clarity to

customers. These annuity plans also have high allocation

charges many times and customers do not know about it and
cant do much later when he acknowledges it! So why do you
want to pay high fees for these products?

Chapter 3
Pension Plan in India
The debate on the pension system reforms is intensifying in
India. The ongoing financial sector reform have made
significant progress in the spheres of banking, capital and
currency markets and now provides an opportunity to revamp
the hitherto untouched sectors like insurance and pension.
While insurance sector reform is already underway, the effect
of which to a certain extent is expected to percolate to the
private pension market - a comprehensive policy for pension
system restructuring is yet to be undertaken.

A variety of problems plague the pension system in India. The

gradual collapse of the traditional old age support mechanisms
and the rise in elderly population highlights the need for
strengthening the formal channels of retirement savings. The
imperative, more proximate reasons for pension reform are also
well known - skewed coverage of the existing benefit schemes
favoring organized workforce while informal employment is on
the rise, worsening financial situation of government pension
schemes against a background of rising system expenditure,
unfair treatment of private sector workers vis--vis public sector
employees, an under developed private annuity market, and
finally the need to increase the domestic rate of savings
through higher contractual savings.
Major retirement savings schemes like provident and pension
funds predominantly cover workers in the organized sector,
constituting only about 10 percent of the aggregate workforce.
The majority of workers, around 90 percent of the working
population is engaged in the unorganized sector and has no
access to any formal system of old age economic security. This
skewed coverage is further shrinking as informal workforce is
growing while the size of formal workforce has remained more
or less stagnant.
Additional impetus for pension reform comes from the
fragmented nature of the existing benefit schemes. In spite of
its limited scope and size, the Indian pension system in its
current form, can at best be described as an extremely
complicated and fractured one inducing distortion in the labor
market. A large number of occupation based retirement
schemes with wide diversity in plan characteristics and benefit
provisions are in existence, and have created a wedge of
disparity between public and private sector workers. While
private sector workers are aggrieved with low returns from their
benefit schemes, public employees are privileged with
generous pension provisions.
In recent years, there have been attempts to address these
problems. These efforts, however, have largely been piecemeal.
The diverse and often conflicting set of problems faced by the
Indian pension system requires a more serious and coherent
approach. For example, on one hand, there is an urgent need to
contain the escalating expenditure on public pension programs
while there is also an urgency to extend the coverage to the
unorganized sector. The government initiatives in recent years
like advancement of retirement age for its employees, partial

conversion of provident funds into pension schemes for private

workers and introduction of new means-tested social assistance
schemes for the poor have met with limited success, further
underlining the need for an early and lasting reform of the
current system.
Structure of the pension system
India, like most other developing countries, does not have a
universal social security system to protect the elderly against
economic deprivation. Perhaps, persistently high rates of
poverty and unemployment act as a deterrent to institute a
pay-roll tax financed state pension arrangement for each and
every citizen attaining old age. Instead, India has adopted a
pension policy that largely hinges on financing through
employer and employee participation. This has however
restricted the coverage to the organized sector workers denying the vast majority of the workforce in the unorganized
sector access to formal channels of old age economic support.
Notwithstanding the limited size and scope, India has a long
tradition of pension and other forms of formal old age income
support system. The history of the Indian pension system dates
back to the colonial period of British-India. The Royal
Commission on Civil Establishments, in 1881, first awarded
pension benefits to the government employees. The
Government of India Acts of 1919 and 1935 made further
provisions. These schemes were later consolidated and
expanded to provide retirement benefits to the entire public
sector working population. Post independence, several
provident funds were set up to extend coverage among the
private sector workers.
Today, major retirement schemes in India include provident
fund, gratuity and pension schemes. The first two schemes
provide lump sum retirement benefit while the last one makes
payment in the form of monthly annuity. These schemes are
characterized by the following common features i.e. they are
mandatory, occupation based, earnings related, and have
embedded insurance cover against disability and death. Table 1
elaborates salient features of the major provident fund and
pension schemes. The central government, states and union
territories provide pension benefits to the public employees. In
addition, a large number of public and local bodies and

autonomous institutions run their

guaranteed by the government.

own

pension

schemes

The central government alone administers separate pension

programs for civil employees, defense staff and workers in
railways, post, and telecommunications departments. These
benefit programs are typically run on a pay-as-you-go, definedbenefit basis. The schemes are non-contributory i.e. the
workers do not contribute during their working lives. Instead,
they forego the employers contribution into their provident
fund account. The entire pension expenditure is charged in the
annual revenue expenditure account of the government. Full
superannuation benefit is a monthly pension fixed at fifty
percent of the average monthly earnings during the last year of
service. The pension is indexed to provide a real annuity to the
retirees. Public employees, in addition to their pension benefits
are also covered under the General Provident Fund (GPF)
scheme. The GPF is a noncontributory program where only
workers themselves contribute a minimum of six percent of
their monthly earnings. The accumulation under the GPF
account is returned to the worker in lump sum at the time of
retirement.
Private sector workers are less fortunate and until recently had
access only to a provident fund system for their old age income
security. Provident Fund is a defined-contribution, fully funded
benefit program providing lump sum benefit at the time of
retirement. The provident fund system, consisting of the
Employees Provident Fund (EPF) and a number of smaller
provident funds is the largest benefit program operating in
India. Together, the schemes provide retirement benefits to
about 10 percent of the labor force. Workers (and private
employers) contribute between 10 - 12 percent of monthly
earnings, to be returned to the worker in a lump sum payment
at retirement, including accumulated interest at a rate currently
set at 11 percent. In 1995, the government partially converted
the EPF scheme and introduced the Employees Pension
Scheme (EPS).
In addition to the provident fund, workers in both public and
private sectors receive a second tier of lump sum retirement
benefit known as gratuity. It is paid to the workers who fulfill
certain eligibility conditions like a minimum qualifying service
period of five years. It is equivalent to 15 days of final earnings
for each years of service completed subject to a maximum of

Rs. 350,000. The cost of gratuity is entirely borne by the

employer.
These schemes are largely the privilege of the organized sector
workers. Workers in the unorganized and informal sectors4
have access only to a few voluntary schemes like Public
Provident Fund and pension plans offered by the Life Insurance
Corporation of India. Organized sector employees can also
subscribe to these schemes to augment their retirement
savings.
For people in the lower end of the economic strata, there are
several central as well as state government-run means-tested,
targeted, social assistance programs and welfare funds. The
criteria of eligibility varies, but generally the destitute, the
poverty stricken and the infirm aged 60 years and above are
provided pension at rates ranging between Rs. 30 and Rs. 100
per month. However, the combined coverage of these social
assistance schemes is insignificant and covers anywhere
between 5 and 10 percent of the total elderly population. In an
effort to widen the reach of the social safety net for the aged
poor, the central government, in 1995, introduced a more
comprehensive old age poverty alleviation program called the
National Old Age Pension (NOAP) under the aegis of the
National Social Assistance Programme (NSAP). The scheme
aims to provide monthly pension to thirty percent of the
poorest elderly.
The formal old age income security system in India can thus be
classified into three categories. The upper tier consists of
statutory pension schemes and provident funds for the
organized sector employees; the middle tier is comprised
voluntary retirement saving schemes for the self-employed and
unorganized sector workers while the lower tier consist of
targeted social assistance schemes and welfare funds for the
poor.
PFRDA Act
Countries are moving from a defined benefit pension system to
a defined contribution one to meet pension related
commitments. The formation of the National Pension system
under the PFRDA Act was a step in this direction. The Act gives
a statutory status to the PFRDA and aims to address
apprehensions relating to safety and yield under the NPS.

The following are the details of the PFRDA Act, which was
passed by the Parliament in September 2013.
It applies to the following pension schemes:
a) The National Pension System
b) Any other pension scheme that is not regulated by any other
enactment
Schemes that are not covered under the PFRDA Act:
1. The Coal Mines Provident Fund and Miscellaneous Provisions
Act, 1948.
2. The Employees Provident Funds and Miscellaneous
Provisions Act, 1952.
3. The Seamens Provident Fund Act, 1966.
4. The Assam Tea Plantations Provident Fund and Pension Fund
Scheme Act, 1955.
5. The Jammu and Kashmir Employees Provident Funds Act,
1961.

Features of the National Pension System proposed by the Act:

An individual pension account under the National Pension
system.
Subscribers having the option to choose pension fund
managers and investment schemes.
Availability of minimum assured return schemes, based on
the risk appetite of the investor.
Option of investment only in government securities.
Successful implementation of NPS is dependent on the
following factors:
Need for pension funds to provide good real returns
Focus on unorganized sector.
Presence of highly capable pension fund managers on board.
Publicity to create awareness about NPS.
Appropriate incentives provided to all stakeholders to
encourage them to provide professional services to subscribers.
Current tax provisions
The process of saving through a funded pension involves three
potentially taxable transactions:

a. When money is contributed to a pension fund.

b. When income from investments and capital gains accrue to a
fund.
c. When members receive benefits on retirement.
Tax benefits under NPS:
Tax benefits can be accrued on own as well as employers
contributions, as shown below:
1. Employees own contribution: eligible for tax deduction of up
to 10% of salary (Basic + Dearness Allowance) under Section
80 CCD (1) within the INR 100,000 limit under Sec 80 CCE.
2. Employers contribution: eligible for tax deduction of up to
10% of salary (Basic + Dearness Allowance) under Section 80
CCC (2), over and above the limit of INR 100,000 provided
under Sec 80 CCE.
3. For self-employed: exemption of up to 10% of gross income
under Sec 80 CCD (1) with an overall ceiling of INR 100,000
under Sec 80 CCE.

PENSION PLAN OPTIONS FOR SMALL BUSINESSES

Small business owners can set up a wide variety of pension
plans by filling out the necessary forms at any financial
institution (a bank, mutual fund, insurance company, brokerage
firm, etc.). The fees vary depending on the plan's complexity
and the number of participants. Some employer-sponsored
plans are required to file Form 5500 annually to disclose plan
activities to the IRS. The preparation and filing of this
complicated document can increase the administrative costs
associated with a plan, as the business owner may require help
from a tax advisor or plan administration professional. In
addition, all the information reported on Form 5500 is open to
public inspection.
A number of different types of pension plans are available. The
most popular plans for small businesses all fall under the
category of defined contribution plans. Defined contribution
plans use an allocation formula to specify a percentage of
compensation to be contributed by each participant. For
example, an individual can voluntarily deduct a certain portion
of his or her salary, in many cases before taxes, and place the
money into a qualified retirement plan, where it will grow tax-

deferred. Likewise, an employer can contribute a percentage of

each employee's salary to the plan on their behalf, or match
the contributions employees make.
In contrast to defined contribution plans are defined benefit
plans. These plans calculate a desired level of benefits to be
paid upon retirementusing a fixed monthly payment or a
percentage of compensationand then the employer
contributes to the plan annually according to a formula so that
the benefits will be available when needed. The amount of
annual contributions is determined by an actuary, based upon
the age, salary levels, and years of service of employees, as
well as prevailing interest and inflation rates. In defined benefit
plans, the employer bears the risk of providing a specified level
of benefits to employees when they retire. This is the traditional
idea of a pension plan that has often been used by large
employers with a unionized work force.
In nearly every type of qualified pension plan, withdrawals
made before the age of 59 1/2 are subject to an IRS penalty in
addition to ordinary income tax. The plans differ in terms of
administrative costs, eligibility requirements, employee
participation, degree of discretion in making contributions, and
amount of allowable contributions.
The most important thing to remember is that a small business
owner who wants to establish a qualified plan for him or herself
must also include all other company employees who meet
minimum participation standards. As an employer, the small
business owner can establish pension plans like any other
business. As an employee, the small business owner can then
make contributions to the plan he or she has established in
order to set aside tax-deferred funds for retirement, like any
other employee. The difference is that a small business owner
must include all no owner employees in any companysponsored pension plans and make equivalent contributions to
their accounts. Unfortunately, this requirement has the effect of
reducing the allowable contributions that the owner of a
proprietorship or partnership can make on his or her own
behalf.
For self-employed individuals, contributions to a qualified
pension plan are based upon the net earnings of their business.
The net earnings consist of the company's gross income less
deductions for business expenses, salaries paid to no owner
employees, the employer's 50 percent of the Social Security
tax,
andsignificantlythe
employer's
contribution
to
retirement plans on behalf of employees. Therefore, rather than
receiving pre-tax contributions to the retirement account as a

percentage of gross salary, like no owner employees, the small

business owner receives contributions as a smaller percentage
of net earnings. Employing other people thus detracts from the
owner's ability to build up a sizeable before-tax retirement
account of his or her own. For this reason, some experts
recommend that the owners of proprietorships and partnerships
who sponsor pension plans for their employees supplement
their own retirement funds through a personal after-tax savings
plan.
PERSONAL PENSION PLANS FOR INDIVIDUALS
For self-employed persons and small business owners, the tax
laws that limit the amount of annual contributions individuals
can make to qualified retirement plans, may make these plans
insufficient as a sole vehicle through which to save for
retirement. A non-qualified plan can be used to supplement
retirement savings plans for business owners. Broadly defined,
a nonqualified deferred compensation plan (NDCP) is a
contractual agreement in which a participant agrees to be paid
in a future year for services rendered this year. Deferred
compensation payments generally commence upon termination
of employment (e.g., retirement) or pre-retirement death or
disability.
There are two broad categories of nonqualified deferred
compensation plans: elective and non-elective. In an elective
NDCP an employee or business owner chooses to receive less
current salary and bonus compensation than he or she would
otherwise receive postponing the receipt of that compensation
until a future tax year. Non-elective NDCPs are plans in which
the employer funds the benefit and does not reduce current
compensation in order to fund future payments. Such plans are,
in essence, post-termination salary continuation plans.
Establishing such a plan can be done in a number of ways. A
variable life insurance policy is one way to structure the plan. A
company purchases a variable life insurance policy for each
participant and paying premiums for the policy annually. The
amount paid in is invested and allowed to grow tax-free. Both
the premiums paid and the investment earnings can be
accessed to provide the individual with an annual income upon
retirement. The only catch is that, unlike qualified retirement
plans, the annual payments made on a personal pension plan
are not tax-deductible.

Although other types of insurance policiessuch as whole life

or universal lifecan also be used for retirement savings, they
tend to be less flexible in terms of investment choices. In
contrast, most variable life insurance providers allow
individuals to select from a variety of investment options and
transfer funds from one account to another without penalty.
Many policies also allow individuals to vary the amount of their
annual contribution or even skip making a contribution in years
when cash is tight. Another worthwhile provision in some
policies pays the premium if the individual should become
disabled. In addition, most policies have more liberal early
withdrawal and loan provisions than qualified retirement plans.
The size of the annual contributions allowed depends upon the
size of the insurance policy purchased. The bigger the
insurance policy, the higher the premiums will be, and the
higher the contributions. The IRS does set a maximum annual
contribution level for each size policy, based on the
beneficiary's age, gender, and other factors.
Upon reaching retirement age, an individual can begin to use
the personal pension plan as a source of annual income.
Withdrawalswhich are not subject to income or Social
Security taxesfirst come from the premiums paid and
earnings accumulated. After the total withdrawn equals the
total contributed, however, the individual can continue to draw
income in the form of a loan against the plan's cash value. This
amount is repaid upon the individual's death out of the death
benefit of the insurance.

Life 7.9%

Single
Premium 9%

General
Annuity 1%

Pension 0.1%
Traditional
42.8%
Life 33.0%
Regular
Premium
33.8%

Pension 0.7%

Health 0.1%

Individual(56.
5%)

Life 6.9%
Single
Premium7.1%
Pension 0.2%
Unit Linked
13.6%

Life 6.3%
Regular
Premium
6.5%

Pension 0.1%

Health 0.1%

Source: Insurance Regulatory and Development Authority (IRDA)

3.1 Changing Social Patterns

India is seeing a change in its family structures from the joint
family system to the nuclear family system. It is mainly
because of the increasing migration of younger generations to
different places of the work which diminishes the old age
financial support. Moreover, the increased life span and
increased medical expenses during old age are beyond the
means of a common man to sustain. Hence there is a pressing
need to re-examine the existing formal and informal pension
systems.

3.2 Demographics
India, like many other countries in the world, has been forced to
face the phenomenon of a `graying society- a major concern
the world over since the past two decades. According to the
World Bank Statistics 2001 on Population, nearly one-eighth of
the worlds elderly population lives in India. As per the Census
2011, the total population of India is 1210.2 million and the
elderly population (defined as being aged 65 years and above)
is 5.6% (male 31,892,823/female 35,225,003) as per CIA World
Fact Book, February 2013. As per the Old Age Social and
Income Security (OASIS) Project, the total population is
expected to rise by 49% from1991 to 2016, and the number of
elderly (person aged 60 and above) is expected to increase by
107%. In other words, the percentage growth in the elderly
population is more than double than that of the population as a
whole. Both male and female population in India at age 60
today is expected to live beyond 75 years of age. Thus, an
average person should have adequate resources to support
approximately 15 years post retirement.
Demographic patterns in India will also exert pressure on the
informal system in the coming decades. Fertility rates have
dropped from 6.57% in 1960 to 3.22% in 1998. As per the
National Sample Survey Report, 6% of the elderly did not have
surviving children. Individual longevity risk arises because it is
impossible to know when a particular individual will die. This
can be managed through risk pooling which is performed by
pension funds and insurers who sell annuities. The annuitants
who die early generate a `mortality profit that funds the
annuities of those who live longer than average. It is by now a
well recognized reality of the Indian financial market that most
financial instruments in India are `push products and not really
`pull products. Thus according to Mr. D. Swarup Pension
products globally are wholesale products sold to employers.
3.3 Current Status of Pensions in India
The pension sector plays an important role in the growth of the
economy. The current state of the sector has been assessed in
this section by estimating the size of the retirement funds
corpus, discussing changes in regulations in recent times, and

considering the profile of retirement benefit plans and role of

insurance companies/mutual funds.
Retirement funds corpus
The current retirement funds corpus is expected to be in the
range of INR 12,000 billion. Since some pension schemes e.g.,
Central Government, coal miners, and seamens pension funds,
mutual fund pension plans, are not included in the estimates
shown below, the estimated fund corpus could be close to INR
15,000 billion. Almost one third of the corpus is in the
Employees Provident Fund, which is the principle source of
retirement planning for workforce in Indias organized sector.
Retirement funds

Size of corpus (as on 2012)

(INR billion)
EPFO
5,461
Private
Pension (BSE Top 3,600
100)*
Life Insurance/Annuity
2,367
Public Provident Fund
360
National Pension System
151 (351 as on 2013)
Total corpus size
11,939
* Liability estimate, which may not be fully funded.
Evolution of pension sector in India

2003:
Establishme
nt of PFRDA
Prevalence
of Defined
Benefit(DB)

2003:
Initiation of
Pension
Reforms

2004:
Introduction of
Defined
Contribution(D
C)
under new
pension
scheme

2004:
Conversion of
DB to DC for
Central
Government
employees

2009:
Extension of
DC for all
citizens

2009:
NPS becoming
available for
all citizens - a
big boost for
pillar 3

2010:
Mandatory 4.5%
guaranteed
return to be
offered by
insurers

2010:
Welcome initiative
from customers'
perspective, but
insurance industry
unprepared to
offer such a long
term guarantee

2011:
Removal of 4.5%
guaranteed
return to revive
industry

2011:
Regulator
accepting industry
feedback and
revising regulation
to provide capital
guarantee

Any pension system comprises a three-pillar system pillars

one, two and three. Pillar one is funded by the Government,
pillar two is sponsored by employers and pillar three is selffunded by citizens.
WORLD BANKS THREE PILLARS
The World Bank came up with a three-pillar pension model as
follows:
a) Non-contributory Pillar (Basic Pension) - The first pillar is
an antipoverty pillar that is non-contributory and
guarantees a minimum income in old age.
b) Contributory Pillar (Forced Savings) This benefits only
contributor to the scheme.
c) Contributory Pillar (Voluntary Savings) The third pillar is a
voluntary savings pillar, available to anyone who cares to
supplement their retirement income as provided by the
first two pillars. It was observed that India is lacking the
first pillar of pension. The second pillar was comparatively
stronger consisting of Government and occupational
pensions. However, the coverage was limited to just 11%
of workforce, indicating that the majority of the workforce
in the unorganized sector was yet to come under any such
pension plans. Even regular salaried employees, the
organized sector were not fully covered. Most workers
opted for schemes under the third pillar i.e. voluntary
savings.
Details of the schemes enlisted under pillar two are mentioned
below:
Central Civil Services Pension (Pension Rules 1972)
This is an unfunded, defined benefit, pay-as-you-go scheme.
Employees of the Central Government, recruited prior to 1
January 2004, are eligible. Ten years of qualifying service is
required for an employee to gain monthly pension rights. The
various benefits of this scheme include a maximum monthly
pension of 50% of an employees average basic pay in the last
10 months of his or her service. Survivor pensions, subject to a
minimum qualifying period of service of one year, and disability
pensions, subject to the cause of disability being work-related,
are also payable. Pensions are indexed to wage and price
movements.

General Provident Fund

This is a voluntary defined contribution scheme, with an
administered rate of return paid by the Government. Permanent
employees of the Central Government (recruited prior to 1
January 2004) are eligible for the scheme. The benefits include
lump-sum payment of contributions and interest at retirement
or earlier, provided employees have completed 20 years
service. Premature withdrawal is permitted for specified
purposes such as marriage and education related expenses.
Death related benefits are equal to the average of the last
three years accumulation, subject to a limit of INR 60,000.
Contributory Provident Fund (CPF)
This is a defined contribution scheme with an administered rate
of return paid by the Government. It is applicable for
permanent government employees and those of departments,
offices and organizations where CPF rules apply. The benefits
are the same as that of the General Provident Fund.
Employees Provident Fund
This is a defined contribution scheme with an administered rate
of return, and is managed by the Employees Provident Fund
Organization (EPFO). Administered rates are usually higher than
the actual earning rate of EPFO investments. Interest is credited
to members accounts annually. Once employees become
members, they must make compulsory contributions during
any
subsequent
employment
in
an
EPFO-covered
establishment, irrespective of salary amount. The benefits
include lump sum payment of contributions and interest at
retirement.
Employees Pension Scheme
This is a defined benefit scheme with fixed contribution and
pension rates. The benefits include full pension from the age of
58 or earlier in the event of permanent disability or death. An
early retirement benefit option from the age of 50 is available
with a reduced rate of pension. One-third of the pension value
may be commuted to draw a lump sum amount at retirement.
Monthly family pension is payable to the family in the event
of the death of an employee.
Public Sector Bank Pension
This is a defined benefit scheme. The minimum qualifying
period is 10 years of service. The benefits include monthly

pension after retirement, with a pension commutation option

available. Survivor pensions are also payable in cases where
the deceased has completed at least one year of qualifying
service, but the payment period is limited to the lower of seven
years or the number of years between the date of death and
the year in which the deceased would have turned 65.
Seamens Provident Fund
This is a defined contribution scheme with an administered rate
of return. It is a plan for seamen in the Indian Merchant Navy.
Benefits include the lump sum of contributions and interest on
retirement. Premature withdrawals are permitted for specified
purposes.
Coal Miners Pension and Provident Fund
This is a defined contribution with an administered rate of
return, whereas the pension scheme is a defined benefit with a
fixed contribution and pension rate. It is a plan for the
employees of coal mines. The benefits of the provident fund are
the same as those of the Seamens Provident Fund. The
benefits of the pension scheme include maximum pension,
based on salary on exiting an organization after 20 years of
qualifying service. The disability pension amounts to 25% of
average salary and the survivor pension to 60% of the
retirement pension value of the deceased, in addition to exgratia payment of INR 5,000 to the families of those who die
while in service.
Employer Trust Funds
These are either defined benefit or contribution schemes
(Provident Fund or superannuation funds). The eligibility of
employees is based on the voluntary plans put in place by their
employers for them. The benefits include a lump sum payment
on retirement with mandatory annuitization of two-third of
the accumulated amount.
Group Superannuation schemes
These are defined contribution plans offered by life insurance
companies. The benefits provided are the same as those of the
superannuation funds created as employer trust funds.
The evolving third pillar
In India, pillar three includes PPF and the individual
pension/annuity plans offered by life insurers, Mutual Fund
pension plans and the National Pension system (NPS) for non-

government employees and any other personal savings of

individuals for after retirement. NPS for non-government
employees was a landmark initiative undertaken to strengthen
pillar three system. A brief description of this is given below:
National
Pension
System
(for
non-government
employees)
The NPS is a defined contributory pension scheme introduced
by the Government of India, making it mandatory for all Central
Government employees with effect from 1 January 2004. The
government-authorized PFRDA is mandated to offer NPS on a
voluntary basis to all Indian citizens, including workers in the
unorganized sector. NPS has been available to all Indian
citizens, other than government employees already covered
under it, with effect from 1 May 2009.
The NPS is an important milestone in the development of a
sustainable, efficient and well-defined contribution pension
system in India.
It has the following broad objectives:
To provide old-age income
Provide safe and reasonable market based returns over the
long term
Extend old age security coverage to all Indian citizens
PFRDA has established the institutional framework and
infrastructure required to administer the NPS for government
employees as well as other Indian citizens. Various
Intermediaries such as the Central Recordkeeping Agency
(CRA), Pension Fund Managers (PFMs) for professional
management and investment of subscribers funds, Points of
Presence (POPs) for distribution of products, trustee banks, and
custodians and the NPS Trust have been appointed to service
subscribers of the NPS.
Public Provident Fund
This is a funded and defined contribution scheme with an
administered rate of return. It is offered to individual investors
without restrictions. The benefits include total accumulations
that can be withdrawn after 15 years of service. Partial
withdrawals are possible after five years. Only one withdrawal
per year is permitted. The 15-year period may be extended by
rolling over accumulated balances for further periods of 5
years.

Unit-linked pension plans and annuities

Pension products offered by life insurance companies at present
can be classified into three types of products:
Accumulation
Immediate annuity
Deferred annuity
Accumulation products provide a corpus on maturity, which is a
lump sum amount that is similar to an endowment product.
Annuities provide a regular income for life or for a certain
period.
Some examples of annuity products:
Annuity with a uniform rate payable for life
Annuity payable for 5, 10, 15 or 20 years or for as long as the
annuitant is alive
Annuity for life with return of purchase price if annuitant dies
during the term
Annuity payable for life, increasing at a simple rate of interest
per annum
Annuity for life, wherein 50% of it is payable to spouse during
his/her lifetime on the death of the annuitant
Annuity for life wherein 100% of the annuity is payable to
spouse during his/her lifetime on the death of the annuitant
Annuity for life wherein 100% of the annuity is payable to
spouse during his/ her life time on the death of annuitant (The
purchase price is returned on the death of the last survivor)
Mutual Fund Pension plans
These are defined contribution schemes and are typically open
to subscribers who are at least 18 years old. The benefits
include a choice between full redemption of accumulation on
attaining the age of 58, partial withdrawal on retirement or a
systematic withdrawal plan.
CHARACTERISTICS OF PENSION SYSTEM
Traditionally, specialists have divided pensions into the
following three categories.
a) Unfunded Pension - Also known as `Pay-as-you-Go (PAYG), it
functions on a defined benefit basis. It is also called
noncontributory pension. The benefit is given from the current
government revenue. It adds to the burden on the Government
treasury, leading to a rise in contributions.

b) Fully Funded Pension - In this system, the accumulated

pension reserves equate to the present value of all pension
liabilities owed to current members. The reserves are invested
in a fund of specifically held identifiable and available assets.
c) Partially Funded Pension - Partially funded pension system
shares features of both PAYG and Fully Funded individual
accounts. This system has both the contribution and benefits
defined and any shortfall is met through contribution at the
time of payout.
3.4 New Pension Scheme VS Old Pension Scheme
Importan
tFeatures
Employee
s
Contribut
ion

Old
Scheme Pension
On
the Pay,
aggregate
of
Basic
Special
Pay
and ranking
other
allowances
for
P.F,
10% has by
to
be
contributed
the
employee.
This
will
be
kept
in
the
Individuals
P.F.
account.
Banks
Bank
will contribute
Contribut
an
equal
amount,
ion
matching
the
employees
contribution.
This in
will
be
kept
another
account
separately
balances
in and
this
account
will
become
the corpus
fund
to
service
the
future
pension
of
the
employee.
But,
most
of
the
banks
state
this
amount
alone
is service
not
sufficient
to
the
pensions.
There
is
a
huge
uncovered deficit.
Additiona
can
lContribut Employees
voluntarily
contribute
an
ion
from
additional
amount
the
is equal toP.F.
the
employee that
compulsory
Employees
the
freedom
to have
stop
VPF
contribution,
as
and
when
they
want,
by
giving
1
month notice.
Where
the
funds
will
be
invested?

Who
Manage
Funds?

New
Scheme Pension
On
the
aggregate
of
Basic
Special
Pay Pay,
and
other
allowances
ranking
for
P.F.
and
also
Dearness
Allowance,
10%
has
to
be
contributed
employee. by the
Bank
will
contribute
an equal
amount,
matching
the
employees
contribution.
Both
employees
contribution
and
the
banks
contribution
will
be
clubbed
and
kept
in
a Balances
single
account.
in
thisinvested
account will
be
pension
funds. in

Intricacies
Implicationsand
There
no
longer
bewill
anyThe
P.F.
account.
take
home
pay
of
the
will
getemployee
reduced,
because
of
the
additional
amount
deducted
on D.A.). (10%
Because
of
higher
contribution
by
the
bank,
the
Pension
Corpus
Fund
will
be
much larger.

Tier
II account
is a
voluntary
saving
facility,
wherein
the
subscriber
is
permitted
to save
any
additional
amount.
Withdrawals
from
Tier
II Account
are
allowed,
as per the
subscriber's
choice.

From
Tier
II
account,
unlimited
number
of
withdrawals
is
permitted,
with
the
only
condition
that
a
minimum
balance
of Rs
2000
is
maintained
at
the
end of Year
the
Financial
st
(i.e.
as
on
31 March).
Since
the funds
are
invested
in
bonds
and
securities,
their
prices
and
their
earning
potential
have
high
degree
of volatility.
Fixed
income
securities
are
also
notmarket
free
from
risks,
one
must
remember.
Though
it that
is
claimed
professional
fund
managers
will
take
decisions
with
regard
to
investment
of
the
funds,
ordinary
subscribers
do
not
have
sufficient
time
and
requisite
knowledge
to
understand
such
investment
decisions
and
question
the
fund
managers.
How
far 100%
the
assured
transparency
in
the
functions
of
the
pension
fund
manager
will
be
maintained
is
also
a
moot
question.

(a)
40% of
PF Each
of
the PFMs
funds
willthe be
invest
the
invested
in will
funds
inof 85%
the
Government
proportion
securities
and
in
fixed
income
Government
instruments
and
guaranteed
15% in equity
and
securities.
(b)
Another
30%
will
be equity
mutual funds.linked
invested
in
Bonds
and
Securities
of
Public
Financial
Institutions
which There
are in3 which
types
include
public
funds
sector
banks
and of
subscribers
can
Short
Term
Deposits
invest.
of
public(c) sector
banks.
The
remaining
30% be
of
the
fundsin may
are
Asset
invested
any
of They
Class
E
1. Equity
the
aboveMarket
instruments
mentioned
2.
Asset
Class
G
securities.
(d) Government
Notwithstanding
Securities
3.
Asset
the
above,
up
to
Class
C

Credit
10%
of may
the total
bearing Fixed
funds
be Risk
Income
invested
in private
instruments.
sector
bonds/securities,
which
have grade
an
investment
subscriber
has
rating
from atrating
least A
got
a choice
to
two
credit
switch
between
agencies.
schemes
and
change
the
fund
manager too,isif not
his
Banks
do not have performance
satisfactory.
total
transparency
or
consistency
with
regard
to policies
their
investment
and
decisions
made,
insofar as
the
now.P.F. funds, as of
As
regards
investments
made
out
of
Banks
contribution,
nothing is known.
will
present,
a P.F. ICICI
Prudential
the At
Trust
comprising
Pension
Funds
of
members
Management
drawn
from
the
Company
Ltd,
management,
IDFC
Pension
award
staff
Fund
union
and
Management
officers
union
Ltd,
manage
the Company
Kotak
Mahindra
funds.
They
Pension
Fund
meet
at
fixed
Ltd,
Reliance
intervals
and Capital
Pension
take
decisions
Ltd,
SBI
with
regard
to Fund
Pension
Funds
investments,
Private
Limited
roll
and
UTI
over/extension, Retirement

It
is difficult the
to
forecast
efficiency
in the
performance
of
the
fund
managers.
Having
only
6
fund
managers
makes
it a risky
proposition.
If
we
take into
account
the
working
population
of
India,
this
number
is very
less.
As
the

withdrawal,
Solutions
Ltd number
of
loans
and final
the 6 fund
subscribers
payment
on are
managers
increases,
VRS/CRS/
approved
by
hopefully
the
Superannuation. PFRDA.
government
will
allow
players
in more
this
filed.
Fees/Charg
There
are
no Following
costs
are NPSthe
is touted
es
charges
deducted.
be borne
by
lowest
deducted
Even
the to
Subscribers
at the
the as
cost
pension
administrative
time
of
registration
scheme.
Other
expenses
like
and/or
performing
handling
and
postage,
stationery, any
transaction. administrative
telephones,
The
contribution
charges
are
electricity
and
rent
will
be
also
claimed
are
absorbed
by the
remitted,
net
of to
be There
the
bank.
As
there
is
bank
charges.
lowest.
no
full
are
no loads.
entry
member
for salaries
thetime
P.F.
and exit
trust,
no
are
paid
to
Fixed
cost:
them.
This cost
way, no
additional
is One-time
account
it
passed
on to the
to
beremains
seen
opening
cost
and But,
subscriber.
issuance
of
PRAN
how
the
actual
costs
move
in
Rs.50
the
future.
With
inflation,
Initial
subscriber
the
costs
may
registration
and
up further.
contribution
upload go
When
more
Rs.40
pension
fund
managers
Annual
enter
the
fray
maintenance
the
charges Rs.225 and
subscriber
base
also
expands
vastly,
the
Variable cost:
may
also
come
PoPs
can100 plus
now charges
down
in
charge
Rs
0.25
per cent as
of future.
the
investment,
against
a
flat
fee
of
Rs 20 earlier.
Whatever
be
the
charges,
Annual
custodian
they
result
in
charge
0.0075diminution
of
0.05
pervalue
cent of the
pension
the fund
wealth.
Annual
fund
management
charge
- of
0.0102
per
cent
the
fund value
Loans

Loans
may
be
availed
for
various
purposes,
within
the
limit
fixed
for
each
purpose,
as
per
the
guidelines
fixed
banks.by individual
Withdrawal
s
while in Non-refundable
withdrawals
from
service
individual
contributions
are
permitted
for
purposes
like
(a)
purchase
of
vacant
plot and
construction
house thereonof a
(b)
outright
purchase
a
house/flat of
(c)
marriage
of
children and
(d)
medical
expenses
in
connection
with
treatment
of
major
ailments
subject
to
certain
conditions
on
limits,
length of
service
etc.
Withdrawal
s
after
retirement

Payment
death
ofon
subscriber,
before
retirement

Payment
on
the
death
of
the
subscriber,
after
retirement

Loan
facility is not Even
in
available.
emergency
situations,
an
employee
cannot
borrow
against
his
own
contribution.
At
anybefore
point 60
of This negative
time,
acts as
years
of age,
80% clause
a
dampener
to
of
the
pension
those
who
wealth
is
to
be
want
to
take
invested
in
a
life
VRS
before
annuity
attainingIt takes
60
from
any scheme
IRDA
regulated
life years.
away
the
insurance
company
freedom
of
namely,
Life
choices
Insurance
available
to the
Corporation
of
India
subscribers.
(LIC),
SBI ICICI
Life
Insurance,
Prudential
Life
Insurance,
Bajaj
the NPS
Allianz
Life Since
is
meant
for
Insurance,
Star
retirement
and
Union
Dai-ichi
and
financial
Reliance
Life
security,
it
Insurance.
does
not
permit
flexible
withdrawals
as
possible of
in
The
remaining
20% are
the
of
the may
pension
mutualcase
funds.
wealth
be
withdrawn
as lump
sum.
On
the
amount
withdrawn
too,
tax
has
to be
paid.
The
individuals
60
and
70 After
attaining
contribution,
along Between
years,
less
than
60
years
with
accumulated
40%
ofnot
the
pension
one
does too,
not
interest,
will
be
wealth
is
to
be
have
the
paid
back to The
the invested
in balance
annuity freedom
to
employee.
and
the
withdraw
his
employers
can
be
withdrawn
own
contribution
along
in
installments
or
contribution
i.e.
with
the will
interest
a lump
sum by
to 50%
of
thereon
be as
the
employee.
In up
the
pension
utilized
to build for
up
case
of
phased
wealth.
Thus,
the
corpus
withdrawal,
much
of
the
payment
of minimum
of 10%
of lifetime savings
monthly
pensionfor
to
the
pension
wealth
the
the
employee
should
be of
employee
gets
the rest
of his life.
withdrawn
every
locked
up
in
year.
On
attaining
annuity,
much
the
age
of 70 against
his
years,
the
amount
wish.
It
is
a
lying
to subscriber
the credit major
of
the
to
the setback
senior
should
be
citizens
and
it
compulsorily
a
great
withdrawn
in lump is
injustice.
sum.
Pensioners
aged
between
60
and
70
years
are the
worst affected.
the
the subscriber
In
the Most of the
the If
dies
before
of legal
the
retirement,
his unfortunate
event
of
the heirs
deceased
individual
death
of
the
employee
will
contribution
to
subscriber,
be
compelled
to
P.F.
with
the option
will
be accept
the lump
accrued
interest
available
to the
sum
only,
as
is
paid
to
the
nominee
to
they
do
nominee.
either of
receive
derive
Banks
the not
extra
benefitany
by
contribution
is 100%
pension
wealth
continuing
in
retained
to
in
lump
sum
or
the
scheme.
service
Family
to
continue
with
Pension.
the
NPS
in
his
individual
capacity,
after
complying
with
the KYC norms.
If
the
pensioner
Same
as
above.
Same
as
dies
after
above.
retirement,
the
spouse
receives
family
pension
at
reduced
rates
as
discussed
above.
In
case
of
dependent
son/daughter,
family
pension
is
payable
to him/her
till
he/she
attains
the
age
of
25
years
or
starts earning
Rs.2,550
per
month
whichever
occurs earlier.

Amount
Pension
paid

of The
pension
payable
is linked
to
the
average
pay
drawn
during
the
last
10
months
of
service.
D.A.
is alsoBesides,
paid on
the
Basic
Pension,
even
after
commutation.
These
rates
are
decided
at
the
time
of
each
wage
revision
settlement.

The
value of the
annuity
at
the purchased
time will
of
retirement
determine
the
amount
of
monthly
pension.
Monthly
pension
under
NPS
is
a itfixed
amount
and
will
attract
any
D.A.
and
therefore,
in case
of
rise in AICPI,
no
additional
benefit
will
accrue to the
pensioner.

Over
a period
of
time,
the
value
of
pension
amount
will
diminish
in
real
terms,
due to
inflation.
Therefore,
pension
received
NPS
is notunder
at all
beneficial
to
the
pensioner
during
his
life
time,
as
compared
to
the
pension
under
scheme.the old

Family
Pension

Besides,
the
spouse
of
the
deceased
is paid
family
pension
at
a
reduced
rate
(which
ranges
from
15%
to
30%
of
the
Basic
payable). pension

No
familyafter
pension
is
paid,
the
death
of
the
subscriber/pension
er.
Only
the
pension
wealth
lump sum is paid. in

Income
Individual
Benefits Tax For
Employees
contributing
totheir
the
NPS,
investment
is
eligible
for
deduction
from
Income
under
Section
80-CCD Tax
(1)
of
the Income
Act,
1961.
However,
the
aggregate
of all
investments
Section
80-Cunder
and
the
premium
on
pension
products
on
Section
80CCC
should
not
exceed
Rs.1
lakh yearper
assessment
to
claim
for
the
deduction.

Under
Section
80CCD(2)
of Income
Tax
Act,
if an
employer
contributes
10% of
the
salary
salary
plus (basic
dearness
allowance)
the
NPS
accounttoof that
the
employee,
amount
gets
tax
exemption
up
to
Rs However,
1 ofthis
lakh.
is
within
the
overall
limit
of
Rs.1
lakh
for
all
eligible
investments
put
together
under
Sec.80-C.

Income
tax
is deducted
liability tax No
on
loans,
partial
withdrawals
(nonrefundable)
while
in
service
and
total
withdrawal
after
retirement.

On
retirement,
60%
of
savings
may
bethe
withdrawn
in
cash
and itThe
is
taxable.
remaining
40% will
have
to
be
invested
in
a
Pension/Annuity
Fund
and
ittime
is tax
free
(at
the
of
investment).

The
dependents
of
the
pensioner
do
not
receive
any
family
pension
which
attracts
D.A.
It
may
please
be
noted
that
D.A.
also
stands
revised
periodically,
whenever
is
a risethere
in
consumer
price
index.
Though
the
employer
also
gets
tax
benefit
under
Section
36 hisI
(IV)
A
for
contribution,
it
hardly
makes
any
difference
for
the
employees.
Moreover,
for
an
employee
who
has
already
exhausted
his
full
limit of Rs.1
Lakh
for
investments
under
Sec.80C,
contributions
made
to NPS
under
CCD
(1) Sec.80do any
not
confer
extra benefit.
At
the timethe
of
withdrawal,
lump
sum
would
be
taxable
as per
the
individuals
tax
slab.
It is
a
case
of
EET
(exempt
on
contributions
made,
exempt
on
accumulation,
taxed
on
maturity)
unlike
EPF,
PPF
which
are
EEE
(exempt,
exempt,
exempt).
Hence,
the
tax
liability
will the
be
huge
at
time
of
withdrawing
the funds.

3.5 Future opportunities and challenges

Looking forward, the NPS in India has thrown up an entire new
dimension for Pension Asset Management locally. It is estimated
that pension assets under the NPS will be USD 175 billion by
2015. Without doubt, the Indian pension system still has the
long way to go, yet it provides many opportunities for
experienced international experts in Pension fund arena to step

in various forms of collaborations. According to a study

conducted by Mercer (Melbourne Mercer Global Pension Index,
October 2011), certain key improvements to the Indian system
provide excellent opportunities for foreign ventures in the
pension management market in areas such as :
improving the regulatory requirements for the private pension
system
improving the level of communication from pension
arrangements to members
increasing the pension age as life expectancy continues to
increase, and
Increase in the level of contributions in statutory pension
schemes.
Given the relative stages of development of the retirement
industry in India, there are indeed various points for
cooperation to be found.
Privately managed EPFs, for instance, can be outsourced to
foreign pension fund managers who have abundant
experiences and expertises. Similarly, the government
managed funds could seek professional expertise from their
foreign counterparts. This mutual learning can not only
accelerate the knowledge transfer to India but also allow
foreign pension fund managers to better diversify their
portfolios by investing in India. In light of the small size of
present Indian pension fund market, sector-wise pension plans
might be the most appropriate model for implementation. For
example, agriculture is the dominant industry in India and
therefore agricultural sector pension plans could be setup for
each state. This scheme will cater to the needs of all farmers
within the zone and would be managed privately- outsourced to
foreign pension professionals with the advantages of
manageability and feasibility. Even further, large foreign
pension fund managers could partner their Indian counterparts
and form a joint collaboration to manage Indian pension funds.
As an alternative, marketing the pension schemes run by Indian
branches of foreign could be the simplest first step in this
process.
The challenge of creating an inclusive, affordable and fair
pension system is immense, but as the experiences
internationally shows, it is still possible. Structures, terms and
conditions constantly need to be revised and adapted to
economic, cultural and demographic changes. For foreign

experts who aim at expansion in India, it means their

investments will not have significant returns in the short term;
however, it might bring tremendous growth from the long term
perspective. Another difficulty would come from the
unfamiliarity of the local capital market. Compared to the EU for
instance, India is a relatively young emerging country and its
capital market has not achieved maturity yet. It would increase
the complexity for foreign investors and pension expertises to
apply their investment knowledge into the Indian market. But
foreign investors are already there and benefit from local
expertise.
Pension fund industry has a very bright future in India.
Favorable savings pattern, growing life expectancy and
government initiatives like pension reforms are making India as
one of the potential prospects for investors looking for pension
businesses.
The majority of working population in India expects to have
better quality of life or at least maintain the current living
standards after retirement. This is the prime reason why
pension plans today account for around 39% of insurance
industrys total business. The Life insurers pension and annuity
funds are forecasted to grow at a CAGR of around 39% between
2008-09 and 2012- 13. However, more potential lies under the
New Pension System (NPS) proposed by the central
government.
PROJECTED PENSION MARKET (in Rs. billion)
Contributions

Funded schemes EPF EPS

- Voluntary
- Contribution
GPF
PPF
Individual Pension
Group Pension
Total Contribution

2015

2020

2025

696

1023

1498

9.3%

10.1%

11%

64

103

164

201
127
306
824

295
186
513
968

431
272
756
1108

2154

2986

4064

Chapter 4 Major Challenges and risks

The challenges are broadly described below:
1. Framework for development of pensions business Perhaps
the biggest challenge in designing an efficient and stable
pension system in the future will be the role played by the
Government, which will need to ensure that appropriate
regulations are in place and appropriate incentives are
available for all stakeholders. It will also need to facilitate
the establishment of a long- term asset market to support
the development of pension plans by insurance
companies.
2. Challenges relating to product pricing According to the
OASIS report on the discussion about costing, An increase
in the rate of return by one percentage point over a
lifetime of accumulations increases the terminal wealth of
a pension accumulation program by over 20%. Following
the same principle, reducing expenses and administrative
fees, even by 1%, will have the same impact on the wealth
created by a pension plan. Therefore, the main challenge
in pricing products will be in securing the lowest possible
fees and expenses for the system, and at same time,
enabling the manufacturer of the product to offer
guarantees ( if any), and earn a reasonable profit and
decent sales volume. The report also provides a
benchmark rate of 0.25% of pension assets per year,
under which all functions will be possible. This figure will
be one of the lowest levels of cost when compared with
individual account systems elsewhere in the world, it
claims.
3. Role of private players In its proposal, Report of the High
Level Expert Group on New Pensions System, the IRDA
Committee has suggested various recommendations on
increasing the liberalization initiative to bring in more
private players into the pensions sector. The report
advises the Government to create a system that is based
on
private,
individual-funded defined
contribution
accounts. The IRDA report also brings out the fact that
private companies will be able to provide better old age
security products to retirees. Pension providers should
play a key role in developing pension products that cover
longevity and investment guarantee risks as well as
identify innovative distribution channels.

4. Lack of customer awareness According to the OASIS

report, 49% of the salaried non-Government employees
are covered by a mandatory Employee provident fund and
Employee pension scheme. Such a low number of people
with social security truly requires a red flag to be raised on
low awareness levels and knowledge about pension
schemes among the people. Moreover, since a large
number of workers in the rural and un-organized sector
are excluded from these schemes, it makes this segment
of the population more vulnerable to sinking below the
poverty line in their old age.
The challenge ahead is not only for the urban population,
but also for the rural population, who are in greater need
of understanding and becoming aware of current pension
programs. To achieve this, the Government must
strengthen its information-dissemination channels to
enable improved and more personalized communication,
since 94% Indian respondents say that personal
interaction is essential, very or fairly important while
purchasing life and pension products (as validated by the
Global Consumer Insurance Survey 2012, conducted by
Ernst & Young).
5. High perceived risk in pension products of insurers The
undeniable characteristic of pensions is that they entail
risk and present an opportunity for insurers to pool their
risk. Defined benefit and contribution plans allocate risks
in different ways. Defined contribution plans pass on all
risks to members of a plan. In defined benefit plans, the
risk rests with the employer or insurance company. The
challenge is to create a hybrid defined benefit/defined
contribution scheme to address the needs of customers
who are financially sophisticated and believe in ownership
and choice, as well as those who are not so financially
sophisticated and value assured returns in pension plans.
Furthermore, insurers need to have a risk appetite to
design pension plans according to the needs of their
target market. Insurance companies are in the business of
accepting risk this presents an ideal opportunity to
accept risk and price it appropriately. The associated risks
in designing pension products are addressed in the
following section:
4.1 Inflation risk in retirement benefits
Impact of inflation on retirement income

The incomes of people who are employed (formally/ informally)

normally rise with the cost of goods and services, although with
some lag, but they eventually catch up in the long term.
Therefore, normal inflation may not be much of a concern.
However, for people who are totally dependent on savings,
inflation reduces the value of their income and may eat into
their savings far more rapidly than they had anticipated, and
may lead to insufficient income in old age when it is most
required.
During a low inflation period, most people (or their financial
planners) make inappropriate allowances for inflation when
planning for retirement. The problem arises when there is
sustained high inflation in the future, which erodes the value of
money. This is what we are witnessing in India today. The
current high inflation scenario also means that it is not only
important to plan your retirement savings from an early age,
but also through products that offer market-linked and inflationadjusted returns. The following graph depicts the historical
variability of inflation in India.
Illustration of impact of Inflation on retirement benefits
The following example will help us understand the impact of
inflation on retirement needs. For example, let us assume if a
person retires with savings of INR 10 million and is expected to
live for 20 years. It is assumed that the entire amount is saved
in a bank FD.
If long-term inflation is 3% per annum, the retirement fund will
be exhausted in the 15th year. Therefore, the amount needed
to maintain lifestyle and living standards would have been INR
12.5 million. The table below depicts other scenarios.
Sr.
no.
1
2
3
4

Inflatio
n
0
1
2
3

Number
of fund
yearswill
in which
original
be
exhausted

Funds
required
on retirement
to
maintain
lifestyle
standards
up
to 20thand
yearliving
(INR
million)

20
17.4
15.60
14.30

10
10.70
11.60
12.50

13.30

13.50

12.40

14.70

11.70

15.90

Service providers including banks, mutual funds, insurance

companies and pension schemes, may be providing retirement

benefit services either in the accrual phase (before retirement)

or drawdown phase (after retirement). They may offer products
that are cost-effective due to their specialization, and pooling of
risk and costs. One needs to allow for inflation in determining a
retirement corpus and also how a retirement corpus should be
built. Of course, Instruments offering guaranteed high returns
may in the first instance seem lucrative in the pre-retirement
and post-retirement phases, but investing in these assets may
lead to a shortfall in real income required. Therefore, it may be
appropriate, depending on ones risk appetite, to invest in
assets that help hedge against inflation and provide reasonable
real return on investment.
4.2 Managing risks and role of actuaries
Pension and annuity constitute two phases the accumulation
phase and the pay-out phase. The risks and challenges are
unique in each of the phases. Historically, the accumulation
phase has been much longer than the pay-out phase, and
therefore, attention was always focused on the former
(occupational pensions and Individual pension).
Occupational pension moved from Defined Benefit (DB) to
Defined Contribution (DC). The actuaries, in consultation with
individual members and organization, aim to provide the
scheme members with appropriate benefits at an acceptable
cost. They help to address the following:
They study how different scheme designs can meet different
objectives. They can work out tiered contribution structures,
provision of death and ill-health benefits, and provide advice on
the effect of future conditions on these benefits. Thereby they
can help in assessing the risk.
To determine the benefit on normal retirement, since this
would have implications on the benefits payable in other
contingencies.
They review the continued ability of the scheme to meet
targeted benefits in light of changing economic circumstances
and age profiles under the scheme.
They elaborate on possible benefits to members. It is critical
from the perspectives of members that their expectations are
realistic and they understand the risks in a DC pension plan.
They provide advice on allocation of assets and methods of
minimizing various risks. They can give generic advice to
trustees (to be communicated to members), since individual
advice can be costly.

The increase in life-expectancy is making it necessary to make

changes in customers expectations during the payout phase,
e.g., flexibility in the pay-out phase to allow for facilities such
as liquidity, variation in asset allocation post retirement or
changes in pay out, based on the changing economic
environment.
In order to cater to the annuitants requirement mentioned
above, there have been innovations in the product offering
worldwide in the pay-out phase over the last decade. Variable
Annuity (VA) has gained importance over the years. Variable
annuities offer various guarantees including guaranteed
minimum income benefit, guaranteed death benefit and
guaranteed minimum withdrawal benefit. However, the risks of
offering these products were felt during the recent economic
turmoil when:
Stock market volatility increased considerably
The risk free interest rate reached an all-time low, with short
rates on treasury bills occasionally drifting into negative
territory
Financial liquidity evaporated for many products the bid-ask
spread on long-term options increased markedly and trading
volumes were significantly reduced.
These conditions exposed the industry to several painful
realities. This brought the issue of managing the risks of
guarantees to the forefront.
Therefore, managing risks of guarantees are often driven by
product design, regulatory constraints and the risk appetite of a
company, either in the accumulation phase or the pay -out
phase. It is important to balance the expectation of higher
required return while ensuring the security/solvency of a
fund/company.
4.3 Pension distribution under pillar three
In India, there are broadly two main avenues through which
pension products are distributed:
Life insurance players
The National Pensions System (NPS)
Pension products received a strong thrust from the life
insurance industry in the initial years after the opening up of
the sector to private players. The insurance sector, including
pensions, in India, as in most other parts of the world,

continues to be driven by distributors push rather than a

strong customer pull. There were several factors that
contributed to the success and strong uptake of pension
products by distributors in the life insurance space. Some of
these factors included:
Innovatively designed zero death benefit (ZDB) products with
problem-free over-the-counter (OTC) issuance
Ability of customer to liquidate accumulated corpus at any
given point in time
Attractive new business commissions
The combination of the factors mentioned earlier resulted in
ease of sale for distributors historically struggling to
successfully push an intangible and complex financial product
in the market.
Consequently, pension products ended up being one of the
strong growth drivers of the Indian life insurance industry prior
to the regulatory changes effected in September 2010.
Circa September 2010, the IRDA implemented a slew of
regulatory changes that focused on Unit Linked Insurance
Products (ULIPs).
This included the pension products that were on offer by life
insurers at the time.
Some of these specific regulations included:
IRDA mandated insurers to offer a minimum guaranteed
return of 4.5% p.a. on unit-linked pension plans
The regulator disallowed partial withdrawals in such pension
products during the accumulation phase
Annuitization on maturity and surrender were made
mandatory
This ended up being a non-starter for the industry since
insurers were concerned about long-term investment guarantee
and the cap on charges limited the incentive payable to
distributors. Almost all life insurers, with the exception of one,
were forced to exit the pensions space in the immediate
months after September 2010, and as a result, the industry saw
a massive drop in new business premiums.
However, after several discussions with life insurance players,
IRDA changed its guidelines on pension products. The regulator
amended the guidelines on unit-linked pension plans, whereby
insurers now had to guarantee an assured benefit (non-zero
return) in the form of a rate of return that would have to be
disclosed upfront.

While some insurers have slowly begun re-entering the market

with new and compliant pension products, distribution
challenges have not yet been addressed. Some of these
include:
Compulsory annuitization of pension plans
Annuity income being treated as taxable income
Level of benefits lower than customers expectations
Pension coverage and distribution
The pensions industry, like any other financial services industry
such as banks and insurance, would do well to factor in the
distributor mind set to ensure sustained uptake as well as
maximum coverage of pension products in the long term. This
would mean getting the best possible distributor proposition.
Many life insurance players are slowly but surely moving toward
developing truly multi-channel architectures that would require
individual agents, banc assurance partners, broking tie-ups,
direct sales and other innovative distribution models. For
instance, pension funds could structurally bundle life insurance
and pension plans.
It is also a known fact that postal savings schemes end up
being a significant accumulator of savings in India, especially in
rural areas with limited access to banking services. This is
possibly another distribution avenue that can be tapped to
enhance and expand the pensions market.
Similarly, another example of insurers leveraging existing
distribution setups can be found in insurance corporate sales
teams providing retail customer leads from their corporate
relationships, to enable sale of retail pensions and NPS.

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