White Paper on Pension

7/21/2019 White Paper on Pension

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RESEARCH

White paper onJune 2015

Brought to you by



Jiju Vidyadharan

Director – Funds & Fixed Income Research

Email: [email protected]

Piyush Gupta

Associate Director – Funds & Fixed Income Research


Prahlad SalianManager – Funds & Fixed Income Research


Saloni Singh

Associate – Funds & Fixed Income Research


Sandhya Dhar

Sector Head – TCL – BCCL


Sowmia Gopinathan

Manager, Sponsorship Sales – TCL – BCCL


Contacts Details

CRISIL ET Edge



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Table of Contents

State of the pension industry ............................................................................4

Scope of the pension industry - past, present and future ..............................5

- EPFO – a behemoth ....................................................................................5

- NPS – the new plan on the block ................................................................6

- Potential for NPS .........................................................................................8

- Dened Benet-Contribution mix – a move to create a universal pension

system .........................................................................................................9- Accumulation-annuity model – Need a long-term system for assetliability

management ..............................................................................................10

Reinventing the regulatory wheel ...................................................................11

- Need to set the NPS design right .............................................................. 11

- Need for pension and insurance coordination ........................................... 11

Key takeaways from the report .......................................................................12



State of the pension industry

The $36 trillion1 global pension industry has grown at an average 6.0% annually over the past ten years,led predictably by developed economies, which realise the importance of retirement planning and havedeveloped nancial structures for it.

The industry follows the World Bank’s three-pillar framework, formed in the late 1990s, which segregates themajor objectives of pension plans as:

■ Pillar 1: Comprises universal/ standardised social security coverage, covering even the lowest strataof society. This is the base on which other schemes are developed. Here, the governments of therespective economies fund the schemes from their exchequer – for instance, the US’ OASDI (Old Age, Survivors and Disability Insurance) programme, which has nearly universal coverage.

■ Pillar 2: Comprises occupational pension schemes, where both recipients and employers contribute.These are mandated pension plans for employees in an organisation; for instance, the 401K plan inthe US.

■ Pillar 3: This comprises personal savings and investments, such as private pension funds createdby asset management companies.

India presents a unique case. The joint family structure, which traditionally provided a social security net, isfast giving way to nuclear families. From over 5 people per household in 2001, there were 4.3 per householdin 2011. Within the private sector, only about 8% of retirees receive pension2, while pure pension corpus isabout 2% of the GDP currently3. (Source: CRISIL report)

1Global Pension Assets Study 2015, Towers Watson2Pensioner base in the Employees’ Provident Fund Organisation, Coal Mines Provident Fund Organisation, Assam Tea PlantationsProvident Fund and Pension Fund as per latest available data3 Assets under Employees’ Pension Scheme of Employees’ Provident Fund Organisation data as of March 2013, National Pension

System data as of March 2014 and pension assets of Assam Tea Plantations Provident Fund and Pension Fund data as of March 2012



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Table 1 – Indian pension industry vis-à-vis the World Bank’s pillar model

Pillar 1

The Swalambhan Scheme, which was started under the National Pension System (NPS) to cover thelower strata, has met with limited success. The recently launched Atal Pension Yojana aims to renewthis model.

Pillar 2

The Employees’ Provident Fund Organisation (EPFO), Coal Mines Provident Fund Organisation(CMPFO) and NPS (for Central and State government employees) fall under this category. EPFO,with 8 crore subscribers, is the largest. Even so, a signicant mass of population is not covered.

Pillar 3This category, which includes NPS for the private sector, retirement plans by mutual funds, and insur-ance, too, has met with limited success.

The Indian pension industry seems to be a victim of low awareness of the importance of retirement planningand lack of distributor focus for NPS schemes (due to low incentivisation). Further, people tend to have amyopic view on pension; they focus on the short term and expect the government to cover their future social

security. The pension industry needs to deepen its penetration in a holistic manner.

Scope of the pension industry - past, present and future

EPFO – a behemoth

The pension industry in India is led by the 60-year-old EPFO. Benecial taxation policies, mandatory saving

under the plan for eligible citizens, and the country’s afnity to invest in ‘safe’ xed income instruments have

grown its corpus to Rs 8 lakh crore and subscriber base to 8 crore individuals.

In a high-ination economy such as India, provident funds, or PFs, are not exactly the most appropriate

pension product. Being xed income-oriented, PFs give marginal real returns (returns – ination)

(see Chart 1).

Source: EPFO, RBI

Chart 1 – EPFO declared interest rate vs retail ination rate

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

1990 1994 1998 2002 2006 2010 2014

Retail Inflation Rate EPF Declared Interest Rate



Realising the need for higher returns to build a better retirement corpus, the Ministry of Labour & Employment(MoLE) has introduced equity and other investment schemes. In a country where the median age fallsbetween 25 and 30, equities can easily provide a windfall for a long-term goal such as pension.

Table 2 - Change in investment structure for provident funds

Investment product Old investment pattern (%) New investment pattern (%)

Government securities Up to 55 45-50

Debt securities and bank term deposits Up to 55 35-45

Money market instruments Up to 5 Up to 5

Equity and equity-related instruments(includes Exchange Traded Fund, or ETF) Nil 5-15

Asset-backed securities, units of real estate/infrastructure investment trusts

Nil Up to 5

MoLE has also revised the aspects of the investment policy. It has introduced concepts of cost management,duciary responsibility, established investment safeguards and allowed trading to an extent rather than

holding the portfolio until maturity. Such reforms display a shift from regulated management of assets to aprudent management system, and are progressive steps for the industry at large.

NPS – the new plan on the blockThe Government of India launched NPS in 2004 to enhance pension coverage in the country and bring in theinformal sector into the pension fold. Initially launched for government employees, it was opened to all Indiancitizens from May 1, 2009.

NPS marked the government’s shift from the Dened Benet (DB) model to the Dened Contribution (DC)

model of pension management with the aim of reducing the scal pressure on the country. For instance, if

private coverage stays chronically low at its current level of 8% even by 2030, the government will have toformulate a pension scheme to support the old-age population, raising its scal burden to as high as 4.1%

of GDP. For the record, the Central government today spends 3-3.4% of GDP on education and just over1% of GDP on medical and public health, water supply and sanitation (source: CRISIL Report). Greece, withpension provision4 accounting for 16% of its GDP, is the freshest example of a scally imbalanced liability.

Currently, the bulk of household savings in the country is in bank Fixed Deposits (FDs) and physical savings(real estate, gold, etc). (Source: RBI report 2013-14). In comparison, NPS allows investments in xed income

instruments as well as in equity and newer investment options such as equity mutual fund, Infrastructure DebtFunds (IDFs), Asset-Backed Securities (ABS) and Credit Default Swaps (CDS).

NPS offers a variety of asset allocation patterns for contributors, including one with a moderate exposure toequities. Contributors can choose the pattern that best suits their risk prole. It offers two strategy options:

active and default.

4http://blog-imfdirect.imf.org/2015/06/14/greece-a-credible-deal-will-require-difcult-decisions-by-all-sides/



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32%68%

Financial savings Physical savings

Components of nancial savings

Currency 9%

Deposits 59%

Shares, debentures (private companies, banks,PSUs and mutual funds)

3%

Life funds of LIC and private insurance companies 17%

Provident and pension funds 12%

Active choice: Subscriber has the option to decide how to invest his/her NPS pension in the following threeoptions:

■ Asset Class E - investments in predominantly equity market instruments

■ Asset Class C - investments in xed income instruments other than government securities (G-sec)

■ Asset Class G - investments in G-sec

Subscribers can choose to invest their entire pension wealth in C or G asset classes and up to a maximumof 50% in E.

Default choice is lifecycle fund: If subscribers are unable/ unwilling to exercise any choice on assetallocation, their funds will be invested in accordance with the auto choice option. Here, investments will bemade in a life-cycle fund. The fraction of funds invested across three asset classes will be determined by apre-dened portfolio based on the age of the investor.

Chart 2 – Break-up of household savings

Source: RBI



The pace of coverage under NPS has been increasing, but the absolute gure still has a long way to go. Here

are the challenges:

■ NPS is voluntary: There is no successful social security scheme dependent on voluntarycontributions. A strong, mandatory basis is required to ensure schemes such as NPS succeed.

■ Taxation: A consistent, equitable taxation policy is required across pension products. Tax arbitragedistorts markets as people invest as per post-tax calculations.

■ Lack of clarity regarding regulation: There is a need to align frameworks across insurance, assetmanagement, EPFO and PFRDA. The Financial Sector Legislative Reforms Commission (FSLRC)mechanism may help to resolve the issue by introducing a standard regulatory structure and codeacross regulators.

■ Trust: The level of trust in products is weak in emerging economies such as India. This is largelyreective of the quality of intermediation, which is crucial for the sustainability of the pension industry.

Long-term contribution schemes are yet to garner enough trust.

■ Lack of awareness: There is a need for nancial literacy. The general mindset should favour long-

term investing.

Potential for NPS

It would be wrong to write off NPS based on modest growth over the past 11 years. We just need to directthe demographic dividend of the country into apt investment avenues and leverage the optimistic phase ofgrowth.

The infrastructure required for distribution is in place. There are more than 60 points of presence (PoPs)with a network of more than 36,000 branches, and more than 70 aggregators across the country 5. NationalSecurities Depository Limited or NSDL, the Central Recordkeeping Agency (CRA) for NPS, updates NPSsubscribers on the status of their investments. The distribution channel, however, has to be adequately

incentivised to sustain the industry's growth potential.

Chart 3 – Growth of NPS assets

Source: NPS Trust

5 As on March 31, 2014, Source: PFRDA

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2011-12 2012-13 2013-14 2014-15

A U M i n R s C r

Central Government State Government Corporate Sector

Unorganized Sector NPS Swavalamban



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Reinventing the regulatory wheel

Need to set the NPS design right

From a regulatory perspective, NPS has certain design limitations, which need to be addressed to ensureuniversal social security. These include:

■ Distribution: Operational barriers between regulators are preventing effective use of the distributionnetwork. Depository participants can be directed to combine distribution, marketing and servicingroles to tap economies of scale.

■ Competition: With one CRA monopolising the system, efciency is limited. Introducing some

competition here can help.

■ Product and process innovation: Factors such as imposing a penalty for non-contribution, nodirect accounts and imposition of service charges make NPS inexible for the informal sector, which

often lacks funds to make regular, sizeable contributions.

Need for pension and insurance coordination

In the NPS context, fund managers are responsible for the accumulation phase and have to be mindful of themortality element. For an insurer, the annuities phase is the focus and longevity element cannot be ignored. Allowing pension fund managers to offer annuities can help them raise economies of scale and thus providebetter return to investors. Cross-pooling of expertise among insurers and fund managers could increase

efciency. For e.g. in Australia, several pension fund managers are from insurance companies.

Further, a separate healthcare account could be explored as a part of NPS’s current unbundled structureonce a universal pension system is in place.



■ Social security provisions in India remain inadequate

■ For NPS to succeed, a mandatory basis should be introduced

■ A uniform tax code and regulatory structure for the pension industry are required

■ Financial literacy and awareness are key challenges

■ Incentive for distribution and quality of intermediation are crucial for expandingreach

■ Asset allocation should be more exible

■ Need for a vibrant annuities market

■ Government funding is necessary along with variations in DB-DC mix

■ Cross-pooling of expertise across mutual funds and insurance could increase

efciency signicantly

Key takeaways from the report



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