Round Table

Pension Business in India

R Vaidyanathan
Guest Editor

Pension Business: Introduction

Liyaquat Khan

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. Thats 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. vaidya@iimb.ernet.in

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The Pension Regulatory Environment in India A Suitable Model

S P Subhedar
The government announced the setting up of a separate regulatory authority, as part of the pension reforms announced in the union budget of 2003-2004, to regulate and supervise pension funds and also to develop pensions in India. In this context, I have attempted to outline a suitable model for regulation and supervision of pensions in India .
This section of the Round Table discussion, Pension Business in India, contains excerpts from the presentations originally made in the discussion on Pension Business in India: Development and Regulation, organised by the Centre for Insurance Education and Research, IIMB, and the Actuarial Society of India. The panellists featured are: Mukul Asher, Professor, National University Singapore. sppasher@nus.edu.sg B K Bhattacharya, formerly of the Indian Administrative Service, now Senior Fellow, Centre for Public Policy, IIMB. bkbhat@iimb.ernet.in

increased coverage for old age income reduction in unfunded pension liability reduction in the role of the government as a pension provider, 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. In order to ensure the above, it is necessary to have a clear regulatory and supervisory framework, as exists in other countries that have initiated pension reforms.
Shubhabrata Das, Associate Professor, Quantitative Methods and Information Systems, IIMB. shubho@iimb.ernet.in S Jyothilakshmi, Visiting Professor, Finance and Control, IIMB. jyothi@iimb.ernet.in Liyaquat Khan, President, Actuarial Society of India. president@actuariesindia.org. R Krishnamurthy, former CEO, SBI Life Insurance Company. rkrishna@bom4.vsnl.net.in Venkatesh Mysore, MD, Metlife India. vmysore@metlife.com S P Subhedar, Senior Advisor, Prudential Corporation Asia Ltd. subhedar@vsnl.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, created awareness about the need to provide for old age income and initiated the debate on the need to reform Indias pension system. The first OASIS report enunciated the basic philosophy of reforms, that old age income has to be self financed by individuals except those who do not have sufficient income to save for old age. Any arrangement that builds up assets for old age income can be termed as pension. The pension system thus encompasses all vehicles that build up assets for old age income, like Employee Provident Fund, Public Provident Fund, Occupational Pensions and Personal Pensions. (In India we do not have any state pension except the small assistance provided by the government to the destitute aged 65 and above.)

Current Pension Regulatory Framework in India

The details of regulations and supervision vary by the type of pension, i.e. whether defined benefit or defined contribution, but the basic aim is to protect the interests of the members/ subscribers and to ensure that they receive a fair deal. Following is the regulatory arrangement for the various pension segments. The means tested and tax financed assistance being provided by the government to the destitute aged 65 and above (DB), does not require any supervision by a regulatory authority. The complementary pension in the form of the proposed defined contribution fully funded individual account pension would require a regulatory framework for supervision. 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. Further, this fund is most likely to be closed once the proposed individual account pension system is introduced. 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. In specific terms, pension reforms must ensure:
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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. This is how the concept of trusteeship has been introduced for such arrangements and this has led to a structure based on this concept.
Employee Provident Fund (EPF) (DC) is both administered and regulated/supervised by the Employee Provident Fund Organisation (EPFO). This is not a very satisfactory arrangement as the body that administers it also regulates and supervises it. Sooner than later, for the benefit of the system, this arrangement will have to be changed with the supervisory function being given to the pension regulator Employee Pension Scheme (EPS) 95 (hybrid, but essentially DB) is again administered and regulated/ supervised by the EPFO. This would also benefit from being rolled into the supervisory control of the pension regulator. Government employees pension for existing employees (DB), is not funded and is paid on Pay As You Go (PAYG) basis out of the current revenue. It is managed by the government and as such is not supervised by any regulatory authority. 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. The other aspects are left to self regulation through auditors and actuaries. In India there are no minimum funding requirements. 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; 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. This being a defined benefit scheme, other aspects are left to self regulation again through auditors and actuaries. As can be seen, the regulation and supervision of pensions is fragmented and this needs total review.

Pension Regulatory Body: Scope, Objectives, 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, the government has sought to give a similar mandate, in respect of pensions, to the proposed pension regulatory authority. 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. 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. It encompasses control on costs, good value for money, rules of pension arrangement, trust deed, expeditious settlement of claims and disputes and adequate choice to the subscribers as also controlling competition amongst the different providers. 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 is how the concept of trusteeship has been introduced for such arrangements and this has led to a structure based on this concept. 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. In this context, 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 trustees, the employer, the service provider and the advisors. 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

 the occupational/affinity group pension schemes which buy products from life insurers, and the occupational pension schemes which provide pension pay out as well. While the profile of the occupational pension structure is well established, the structure for the proposed DC individual retirement account pension has yet to evolve. There is however a general consensus that the possible providers of the proposed pension will include insurance companies, banks and mutual fund companies with foreign participation. 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; a facility for pension business within the existing business with a Chinese wall separating the two businesses; or transaction of the proposed pension business within the setup for the existing business. The regulatory and supervisory structure for occupational pensions could be similar to that of the Occupational Pensions Regulatory Authority (OPRA) of the UK. For the proposed DC individual retirement account pensions, the regulations could be structured by drawing on the basic philosophy of the regulations for stakeholder pensions in the UK. 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. Such licensing or registration should be made a prerequisite for approval of the pension arrangement by the tax authorities. For licensing, it is necessary to lay down the governance structure and if a separate entity is required to be set up by the provider, the capital structure requirement, minimum capital and issue of ceiling on foreign equity will have to be addressed. If an alternate structure is stipulated, then the governance norms would have to be prescribed. The pension regulatory body should be given both power and resources to carry out spot checks and detailed investigations independent of any complaint. 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 pension regulatory body would be somewhat less proactive, particularly in the area of occupational pensions. In this context, the role of professionals associated with the
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The introduction of minimum standards for stakeholder pensions has ensured a level of standardisation across schemes, facilitating easy comparison of what is on offer. In the proposed DC Pension Regulations, minimum standards would have to be set that would cover a variety of aspects including fees charged, minimum contribution, default option and freedom to change providers.
pension arrangements, in particular the auditors and actuaries, will have increased importance.

Stakeholder Pension
As mentioned earlier, for the regulations of the proposed DC individual retirement account pensions scheme, 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. 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 introduction of minimum standards for stakeholder pensions has ensured a level of standardisation across schemes, facilitating easy comparison of what is on offer. In the proposed DC Pension Regulations, minimum standards would have to be set that would cover a variety of aspects such as fees charged, minimum contribution, the limit on charges and what it covers, default option, freedom to change providers, investment choice and information. All charges should be rolled into a single annual management charge as it would be transparent, easy to understand and would facilitate easy comparison between the products on offer. It is essential to ensure that subscribers receive clear and good quality information on their pension accumulations. In the UK, after four years of public debate, it was decided that every provider of DC pensions would be required to give an annual statement showing the likely projected value 63

Actuaries have played a significant role in the financial management of defined benefit pension schemes. Their tasks include: valuation at specified periodicity; monitoring of the schemes compliance with the minimum funding requirement; and advising the trustees on a schedule of contributions and recommending transfer values.
of the individuals fund at retirement age and the amount of pension it might buy at current prices. The values would only be estimates and would depend on unknown variables that would inevitably change over time. But since the statement would be given every year, expectations would practically be managed on an ongoing basis. Other matters for Indian pension regulations include dealing with transfers, clearing house operations, annuitisation, marketing and distribution, winding up and resolution of disputes and withdrawals. With regard to withdrawls, it is proposed to have two types of contributions, Tier I (dedicated contribution for retirement benefit) and Tier II (other savings), with easy withdrawals to be allowed from accumulations of Tier II contributions.

of the trustees and so on but there are certain core expectations of the members, which could be termed as pension promise, that the legislation must protect. These include the expectation that the rights will accrue with service and, once accrued, will be protected and that benefits will be provided in accordance with the scheme rules and any legal requirements. 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. In fact the duties of the trustees as regard to the pension promise must get embedded into the legislation for these pensions. Appropriate funding of the pension schemes 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. In order to achieve this, 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. This requires a minimum statutory solvency or funding requirement in a funded defined benefit scheme.

Scheme Actuary
Actuaries have played a significant role in the financial management of defined benefit pension schemes. Their tasks include: valuation at specified periodicity monitoring of the schemes compliance with the minimum funding requirement advising the trustees on a schedule of contributions and recommending transfer values. The Scheme Actuary is accountable to the trustees, and is therefore required to keep in balance the interests of all participants in the trust, including beneficiaries, as well as employees and the employer. Traditionally there is a fundamental difference between the role of an Appointed Actuary in life insurance business and a Scheme Actuary in pension business. The role of an Appointed Actuary is proactive, whereas that of a Scheme Actuary is reactive. A Scheme Actuary has to report non compliance, if he comes across it, whereas an Appointed Actuary has to ensure compliance. This perhaps could change with the role of the occupational pension regulator becoming more proactive. It would be appropriate for the pension authority, when taking up the task of supervision of occupational pensions, to introduce the system of Scheme Actuary in India.
Pension Business in India

Regulation of Occupational Pension

Though it has not been spelt out by the authorities, 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. The occupational pensions can be of three types: defined contribution; defined benefit; and hybrid, where both the contributions and benefit are defined. However, such schemes are essentially defined benefit as the employers have to make good the deficit in the fund periodically. There are several aspects that the occupational pension regulations should cover. Two important issues are those of pension promise and funding. Trust laws allow the settlers of the trust the freedom to amend the rules, limit the liabilities 64

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, exceptions being the pensions paid by the government. Bringing EPF and EPS 95 under its control may not be feasible immediately, but that should be the ultimate objective. The schemes set up for funding the gratuity benefit, severance pay, 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. For regulation and supervision of these arrangements the legislation framed for the defined contribution individual retirement account could cover the EPF, and the legislation for occupational pensions could cover the EPS 95 and gratuity funds. The pension arrangements and the members relationship and rights therein are governed by a number of different areas of law. These include trust law, contract law, tax law, social security law, employment law, financial services law and other general law, with different regulatory authorities regulating their respective areas.

With increasing longevity and changes in the social structure self financing of old age income has become necessary. In order to make people understand its importance a massive awareness and education programme needs to be undertaken, particularly in the context of the introduction of the defined contribution individual retirement account pension.
assigned to the regulator by the government has to be viewed in this perspective. To sum up, all regulations aim at protecting the consumers and this protection assumes greater importance when dealing with long term financial contracts like pension. It is essential that all pension arrangements, except the pensions paid by the government are regulated and supervised by the pension regulator. 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. A statutory role in the form of Scheme Actuary needs to be created for DB pensions. 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. But the most important and urgent thing is to initiate education and awareness programmes about the need for self financing of old age income.

Public Education on Pension

Because of the social structure, social psyche and nature of the economy, the average Indian was never much concerned about making provision for old age income. But with ever increasing longevity and changes in the social structure a need is increasingly being felt for self financing of old age income. In order to make people understand the importance of building up assets for old age income, a massive awareness and education programme needs to be undertaken right from the school level, by the government, the pension regulatory body and the providers. This is particularly important in the context of the introduction of the proposed defined contribution individual retirement account pension with universal access. The World Bank document India: The Challenge of Old Age Income Security, released in April 2001, has expressed concern in respect of the proposed DC pension scheme. 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). Public education and initiatives to create awareness would address the concern expressed by the World Bank. The developmental role
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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, though the age quake has not assumed the massive proportions that it has in the more developed countries. Worldwide, the percentage of over-60s is expected to rise from 9% to 16% in the next 35 years while in India, the number is expected to double between 1991 and 2016. 65

Government pensions and the mandated pension schemes for the employees of the private sector form the mainstay of the pension system in India. This is followed by tax-advantaged voluntary plans and lastly, by social assistance schemes where the government offers means-tested programmes for people who are well below the poverty line. 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. However such traditional safety nets are increasingly becoming fractured and with the ascendance of the nuclear family, people are depending less on their children or on their families. This is the backdrop against which the pension reform process in India has started assuming more and more importance. 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. The vast majority of Indias labour force is not covered by the pension system. According to the OASIS report, out of 314 million workers, 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, constituting about 11% of the workforce. The remaining 90%, 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.

supported by the World Bank, it is the second pillar which is predominant in the Indian scene. The government pension is an Unfunded Defined Benefit Pension at present, which will change under the new pension system. The maximum replacement rate is about 50% of the last drawn wage the average of the last 10 months salary, to be exact. It is indexed to the CPI as well as to wage revision. There is a commutation facility available. Apart from this there is a General Provident Fund which provides for a lump sum payment on retirement. Gratuity is also payable. In absolute figures, the pension burden was around Rs 220 billion for the Central Government alone in 2001 2002. For states the comparable figure was about Rs 260 billion. Since pension is indexed to the wage increase, every time a Pay Commission report is released, the governments liabilities go up. Thus there was a steep increase in the governments liabilities after the fifth Pay Commision Report was taken into account. The mandated pensions for the organised sector are governed by the Employees Provident Fund and Miscellaneous Provisions Act, 1952. At present they pertain to about 180 industries and classes of establishments which employ 20 or more persons. Three schemes are presently in place the Employees Provident Fund Scheme (EPF), 1952; the Employees Deposit-Linked Insurance Scheme (EDLI), 1976; and the Employees Pension Scheme (EPS), 1995. The schemes are a combination of defined benefits and defined contribution schemes, the EPF being the defined contribution portion and the EPS being the defined benefit portion. Here also the replacement rate is 50% of the terminal wage the average of the last twelve months salary. The significant difference here is that they are not linked to inflation. Voluntary schemes are tax- 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. Voluntary schemes include the Public Provident Fund which is operated by the government, the pension plans of the Life Insurance Corporation (LIC) and the private life insurance companies. There are also group super-annuation plans. 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. There are schemes run by NGOs which operate on a social basis. 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. This is followed by taxadvantaged voluntary plans and lastly, by social assistance schemes where the government offers means-tested programmes for people who are well below the poverty line. Voluntary plans and social assistance schemes cover only a miniscule percentage of the total population. When we consider this against the back drop of the Three Pillar system 66

earlier, these informal arrangements are gradually dwindling because of the break up of the joint family system.

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. 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. The systems offer varying benefits. The benefits offered to the government employees are much more generous than those that private sector employees can look forward to, as the latters pension is not indexed to inflation. This skew may, however, be corrected as we move into the proposed defined contribution(DC) system.

The basic problem is that of poor coverage. 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. Escalating expenditure and the risk of under funding have been highlighted by the Bhattacharya Committee Report.
the result that the actual amount given to the person on retirement is only a small portion of the entire asset. There should be stricter norms on premature withdrawal. The regulatory issues have been dealt with by Mr. Subhedar. Ultimately we should not forget that the consumer is the most important person in the entire exercise. However, given the multiplicity of players involved, how exactly will the regulatory framework be dveloped? That could be a problem in the future. 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.

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. While the proposed Defined Contribution scheme will address this problem to a certain extent, the transition phase is expected to span about thirtyfive years. So, whether these problems will persist in the interim is something to be seen. As far as the EPS is concerned, actuarial valuations of the fund have not revealed any serious under funding at present. However, since actuarial valuations are not very transparent in that they have not yet come to the public domain, the financial sustainability or otherwise of the EPS remains to be seen. 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. This stresses the need for better asset management . 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. Consumers will also be given more choice and they will be allowed to opt for a growth portfolio, a balanced one or a safe one, depending on their risk appetites and the stage of life they are in.
Pension fund administration and record keeping have to improve. Delays in settling pensions and the want of reliable databases of pensioners are just some of the problems encountered. Record keeping is very important especially as the time frame involved spans several decades. The facility of premature withdrawal which applies to the PPF, the EPF and so on has led most terminal accumulations, as documented by the OASIS report, to get depleted with
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Conclusion
Several reports, commissioned by various ministries, have set the reform juggernaut rolling. These include the Malhotra Committee Report, 1994, the Project OASIS Report, 1999, the Wadhawan Committee Report, 2000, the IRDA Report, 2001, the Bhattacharya Committee Report on Central Government Pension, 2002, and the RBI study State Government Pension, 2003. As we move towards the new pension system several questions still remain to be answered. Regarding the new pension schemes for government employees which will be thrown open to the self employed as well, 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, 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, giving a citizen identity number to each person, revamping their IT and other record 67

About 10% of the workforce expect complete support in their retired life from their children while another 35% expect partial support. These percentages are likely to decrease in time with the change in social structure. While there was a relatively high degree of awareness (65%) about the Voluntary Pension Plan, only a small fraction (20%) had bought one already.
keeping facilities and so on. 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 dont 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.

There were six components to the questionnaire seeking demographic information: awareness of and investment in retirement savings funds or voluntary pension plans; 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; product related information such as their considerations while buying a product; their sources of advice/information, how they wished to receive information about their account and their service expectations; their investment preference for their pension fund; and their preferred channel for buying pension products.

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. About 10% of the workforce expect complete support in their retired life from their children while another 35% expect partial support. These percentages are likely to decrease in time with the change in social structure. The workforce itself is expected to increase, as also savings for retirement and disposable income. While there was a relatively high degree of awareness (65%) about the Voluntary Pension Plan (VPP), only a small fraction (20%) had bought one already. The amount invested varied significantly across the different demographic groups this will be analysed further. But the annual contribution of Rs 10,000 (tax incentive u/s 80CCC) appears to be the limiting factor. Further, insurance companies are overwhelmingly the preferred channel for buying VPPs. There is a strong investment preference for the conservative option. However rate of return is the most important factor for choosing a product. Whether this is based on calculated risk is not clear. Promptness in account settlements is the most important service that people are looking for. Advice is most sought from qualified professionals as opposed to licensed representatives or friends. The degree of pension awareness, as measured though the different awareness parameters, depends significantly on the various demographics, excluding possibly age and sex. 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.
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, which was sponsored by the ING Group. 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, business persons and professionals like Chartered Accounts, doctors, etc; we have nearly 16,000 responses. 68

Government Pensions and the Employees Provident Fund Scheme

B K Bhattacharya
In the mid and late 80s, 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. I would like to share some ideas based on those reports. 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. In India as in other developing countries, a large number of people are in the agricultural sector. Many of them are agricultural labourers. 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. The OASIS report has dealt with this subject and the new two tier DC scheme which the Government of India is bringing into effect. 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. It will be open to the self employed and people in the unorganised sector. However, my hunch is that the second tier may be used by the existing central and state government employees as extra savings, by people in the organised sector, by some elite members of the self employed sector. It will be rather unrealistic to expect agricultural labourers and artisans, a large number of whom are uneducated or illiterate to appreciate the second tier of the DC scheme, the role of the fund manager and so on. So for some years to come you have to have some special schemes for the unorganised workers, agricultural labour and others. You have to supervise pension schemes through proper institutional channels with contributions. Coming to the salaried class, I dont think the Indian pension system has done too badly by them. Out of a total estimated number of 47 million, 23 million are covered by the employees provident fund and employees pension scheme. Though the figure for the central and state government employees is about 11.2 million, 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, corporations, most of whom do not
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In the salaried class, out of a total number of 47 million, 23 million are covered by the EPF and the EPS. Pension schemes in most states not only cover the state government employees but employees of local bodies, municipalities and corporations, 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.
pay much contributions and are beneficiaries of the same unfunded pay-as-you-go DB scheme as the state and central government employees. A large number of employees in grant-in-aid institutions such as school teachers and college lecturers, are covered by the scheme. In some states their numbers exceed those of pure state government employees. If one were to add all the numbers, 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. If you take that as a percentage of 47 million, 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. That fact should not be lost sight of. In the report on the central government pension scheme that I had submitted, 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. Within the limited terms of reference, the committee recommended a two tier system. The first tier was supposed to be a hybrid scheme or a mixed DB-DC scheme, with a defined contribution as well as a defined benefit, with the government making up any deficit in earnings. The second tier would be purely voluntary with greater flexibility in investment. 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. 69

Pension payments of the state governments have increased from Rs 2.68 billion in 1980 to Rs 282 billion in 2001- 2002, an annual increase of 23.6%. Pension payments as total revenue receipts of the state rose from 2% in 1980-81 to 11% in 20012002. It is likely to go up to 20% after ten years. Tougher decisions are called for, including structural changes as well as parametric changes of a harder nature.
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, with no wage indexisation and 5% price indexisation cap. If you take the present contribution and the present benefit rate, this scheme is not viable. How can the scheme provide 50% pension replacement, 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. They are probably eating into their capital. 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. 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. It will cause a tremendous drain on the resources of the government if immediate remedial action is not taken. In so far as the state schemes are concerned, in the course of work for the state pensions committee we found that in some states the salaries, pension and interest was exceeding 100% of the revenues of the state government, including central devolution of funds. Unlike the Government of India, state governments do not have free access to either issue of bonds or borrowing from the RBI. Their bond issues are strictly regulated by the Government of India and without its permission, they cannot raise fresh loans. Some states resort to subterfuge, starting new special purpose vehicles (SPV) purportedly to develop infrastructure, borrow through the 70

SPV and use that money to pay salary and pension. Such being the case it was felt that state governments problems are probably more serious than the government of Indias. Pension payments of the state governments have increased from Rs 2.68 billion in 1980 to Rs 282 billion in 2001- 2002, an annual increase of 23.6%. Pension payments as total revenue receipts of the state rose from 2% in 1980-81 to 11% in 20012002. It is likely to go up to 20% after ten years. That is 20% of the states revenues will go for pension. In the case of Bihar it is likely to reach 34% in 2010, approximately 40% in Kerala, 28% in Orissa, 26% in Rajasthan, 32% in Tamil Nadu and 31% in W.Bengal. So we felt while some kind of soft decision could be envisaged for the Government of India schemes, for state governments much tougher decisions would be called for. Here one would need both structural changes as well as parametric changes of a harder nature. In so far as the states were concerned, we suggested three alternatives. They could fall in line with the government of India by having a pure DC scheme, or they could have only single tier DB-DC scheme, with a pension guarantee, without wage indexisation and with capping of price indexisation. 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. This would be for the first year which would be contributory. The second tier would be a pure DC scheme. 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. 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. There is some provision of adding five years service in case of voluntary retirement. Price indexisation might continue but wage indexisation should be done away with. Maximum permissible commutation amount to be brought down from 40% to 33.33% and discount rate for calculating commutation factor should be linked with the rate of return and GPF. 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. They should buy a pension product from any of the pension fund providers or they should join the Government of Indias second tier as the state governments are unable to take these burdens, especially in some states where this number is more than the number of the state government employees. Even in the case of existing employees of the grant-in-aid institutions and the local bodies, we could explore the possibilities of collecting some contribution from the employees as well as the institution. While we have said that the new scheme
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should be compulsory for new employees, we should also think of voluntarily inducing some existing employees to the new scheme. We have suggested that in respect of states where pay, pension and interest burden have exceeded 90% of the total revenue receipts, 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. There were a couple of other suggestions. To improve the states finances it is not enough to tackle only pension but the tax- SDP ratio which is very poor in many states. The other point is that the government database, both state and central, is abysmally poor. Forecasting and projection are not possible with the present set of data. Our projections are often flawed and it is essentially because of faulty assumptions. There is no data regarding age and salary wise composition of the government employees and without that no actuarial calculation is possible. 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. 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, s/he needs to get a replacement rate, possibly between two-thirds and three-fourths of the pre-retirement income, which is protected against inflation and longevity. That replacement rate does not have to come from one scheme. One needs to look at pensions, provident funds, voluntary savings, etc. as components of a social security system.
protected against inflation and longevity. That replacement rate does not have to be obtained from one scheme. One needs to look at the pensions, provident funds, voluntary savings, etc. as components of a social security system and not individually. 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, which is not viable and is contrary to the very basic principles of finance where you have diversification. 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. 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, it has the potential to develop it as the next service industry, as an export industry. 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. Thirdly, there has been an uncomfortably wide gap between the innovations and developments in the sector and their recognition in India. One of the objectives of the new effort is to narrow the gap substantially. The new civil service pension scheme is contemplating international diversification of pension assets. 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. 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, need to improve. 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, you dont need to have professionalism, you dont need to apply good economic and management reasoning. Such lack of professionalism has gone on for many years. 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. How can they afford not to have financial expertise? This is also true of the various small saving schemes, the post office saving schemes, 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. Secondly, there hasnt been a system wide perspective or approach to the issue. When a person retires, s/he needs to get his replacement rate, possibly between two thirds and three fourths of the pre- retirement income, which is
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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. Many such decisions are made ad-hoc in the absence of a good record keeping system. This accountability is what the regulator will have to bring.
are not well understood. A lot of the education and literacy issues are not just at the consumer level, it is with the trustees, it is at the policy making and politician level. 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. Further, there are occupational pension plans where there are no rules and regulations and which involve self dealing. 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. Public sector banks and even the LIC may be seriously affected in this regard. 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. The final point is about accountability and transparency, which Mr. Bhattacharya also spoke about. 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, and if family pensions are included, may be even longer. Many such decisions are made ad-hoc in the absence of a good record keeping system. This accountability is what the regulator will have to bring. Regarding transparency I very strongly endorse Mr Bhattacharyas views that you would want to bring in the GPF, the civil service schemes and the EPFOs schemes under a regulator at earliest possible opportunity. 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. After the initial period, the new scheme may 72

consider a mandatory scheme of survivors benefit to address the gender issues, financed through diverting a part of current 20% contributions. One of our problems has been that we have not taken fully into account the two fundamental macro economic truths about social security. The most important macro economic variable in social security is economic growth. Despite the projections of growth of our GDP, we must acknowledge the disparities in what is available to retired people. Among the olds a few have a lot while others have little. Growth is going to be the most important macro economic variable here. The second thing is that employment in the organised sector has remained stagnant for quite a long time. In the trade-off between job preservation and job creation, the balance will need to shift towards job creation because that will provide the security. EPFOs total number of registered employer firms are around 350,000, which is about the same number as firms registered in Malaysias EPF, but Malaysia has a population of 22 million. In Malaysia even if you have one employee you are registered, here it is 20 employees. Even for those 20 employees there are no reliable records. As an addendum to Mr Subhedars presentation, I would like to add human resource policies of the pension regulatory authority as an area of major concern. On the HR policies will depend the competency, the ability to think forward and so on, of people both at the board level and the technical staff level. Co-ordination between the IRDA, the pension regulator, SEBI, 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. I come back to training and education. 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. Given the varying positions and requirements of the different states, 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.

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
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several months. As we go forward in the pension reform process, it is time to take stock of how these insurance companies have performed in regard to the pension business, the ways in which the pension market has been developed and whether the existing system can be exploited to its full potential. Additionally, from the point of view of a banker-turnedinsurer, I would like to share a few perspectives on how banking and insurance can together provide a great opportunity to accelerate the pension sector. First of all, 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, 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. 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. 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. We seem to be moving in a hurry to pass on investment risk to hapless savers right from day one. 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. It is often mentioned that the new scheme will be extended to the unorganised sector and rural population. 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. 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. It is relevant that a recent market research study conducted by an agency in Delhi, the Invest India Economic Foundation, 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, and the regularity of return that will get added to the retirement saving kitty. This is going to be crucial in our country nurtured for the last five decades by credible public sector institutions. People have been confident
IIMB Management Review, 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, and the regularity of return that will get added to the retirement saving kitty. This is going to be crucial in our country, nurtured for the last five decades by credible public sector institutions.
about their savings being absolutely safe and the dependability of the system to fulfil the commitments assured at the beginning. We may note that despite more than 12 years of banking reforms, the public sector banks still hold more than half of the deposits accruing to the system. In a truly long term saving scheme such as pensions, we need to widely involve the role of public institutions, and prepare the framework to ensure public confidence at every stage. If not, the backlash of any failure or market aberration could be severe and call into question the fundamental pension reform process itself. At this stage, it is useful to review the role of life insurance companies which are licensed to do both life insurance and pension products. Thirteen new players have sold more than one hundred thousand pension policies in the last year. The subscribers who have taken pension policies are mostly in the white collar and middle to upper income segment, those who top up their government pension or other occupational pension. Life insurance companies are now beginning to tap the self employed people and those in the rural areas with pension policies. 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. The insurance companies run the pension schemes with excellent record keeping, in an automated IT environment, with a comprehensive customer relationship management system. People subscribing to insurance and pension policies even in 73

What are the critical success factors in the pension business? To sum up, they are -- investment management, distribution (building distribution is the biggest challenge in a vast country like India), capital and assetliability management.
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. Many companies provide web-based access to the pension policyholders to view the status of policies at any time. An important task undertaken by insurance companies is to spread investor education. Subscribers want to know, if they put in a certain amount year after year, how much will they get at the end of their working life. It is natural for people to demand assurance that they will get back their saving and that they will stand protected adequately. Insurance companies selling endowment type pension policies assure the pension policyholders that their savings are safe, while they give a conservative picture in regard to returns at the end of the period. 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. We rolled out a pension policy, called Lifelong Pension Scheme, which is a saving accumulation scheme until the age of retirement. The policy basically carries a guarantee of the corpus of saving on which we assure a minimum 4% return every year. The rate of return is guaranteed only for a specific period after which we will come up with a fresh rate. We try to top up this guaranteed rate with additional return. Recently, our board reviewed our investment performance and gave an additional 4% return for last year. The minimum contribution is just Rs 3000 per year or Rs 250 per month. We encourage regular payment by way of automatic debit from the bank account. We keep the pension fund management charges low at only 5% of the saving contributions, with no charges on the corpus. Most pension policy buyers from insurance companies also 74

prefer to bundle life insurance as an option along with their savings. We also provide this option in our product. All insurance companies provide extensive training to the agency force on product selling. By distributing the pension product along with the insurance product, we are able to lower the distribution cost of pension products, which is a sort of cross subsidy from other products. Mr. Subhedar made a very valid point on what should be the role of a Pension Actuary. When integrated into a combined insurance company, the actuary gives a balanced assessment and looks at the overall interest of all stakeholders, and keeps a vigil on the sustainability of all the products, be it an endowment product, a standalone insurance product or a pension product. We must hasten slowly in this critical area and initially play safe by involving those who are already regulated, those who have created a track record of performance under the watchful eye of the regulator. In fact, the system should demand that the existing players perform better, and provide a wider, more customer friendly and more economical service.

Venkatesh Mysore
I will try to add a perspective from a private insurer. Insurance players have always looked at being in the space of protection accumulation and retirement, which are complementary in nature. 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 Id like to stress on the expertise that is required to maintain a long term focus in pensions, particularly in balancing the risks versus the returns, keeping in mind that there is always a long term minimum guarantee that pension business demands. The second factor is distribution. The fact is, if pension products were offered at a discount, there wouldnt be too many takers. In fact, if an insurance company sees a queue forming outside, it gets worried. Pension clearly falls in the same category. When you are thinking long term, you ideally want to get people to start early and that is a big sale. In an ideal world there is a full end-to-end financial needs analysis that the intermediary does with the potential customer. 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. When we try to address these two we are talking about protection products, accumulation products and pension and retirement products.
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Building distribution is the biggest challenge in a vast country like India, considering the kind of scale and critical mass that needs to be reached to build distribution in a meaningful way. When insurance companies are investing in building the distribution network, 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 second aspect of distribution is one of cross-selling. When you have a huge customer base like LIC with 140 million policies or so, and you have the right type of intermediary to go out and talk to the people, then the kind of trust that is necessary could be built up. But we are far from achieving that in India right now because the professionalism that is needed is lacking. The entire structure for developing the right type of intermediaries is not fully in place. For enabling such a structure, there is an immediate need for appropriate changes to be effected in the regulatory framework.

The third critical success factor is capital. Insurance companies are used to bringing in huge amounts of capital for funding the initial capital strain, maintaining solvency; and getting into the investment management function, keeping a long term perspective in mind. The fourth one is the asset-liability management aspect of the business which ultimately is going to determine the success of this business. 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. 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.

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