One for the nest egg

Dawn at dusk

As the building blocks of the government’s New Pension System fall into place, there is change on the anvil even at India’s largest private sector pension fund— the Employees’ Provident Fund Organisation. Indians may finally be on their way to getting some semblance of social security.

Calm prevails at the office of Employees’ Provident Fund Organisation at Bhikaji Cama Place, a busy commercial office complex in south Delhi. The office is an archetypal government set-up with its spacious but somewhat confusing corridors and dim-lit interiors. Yet, within the somnolence there are small changes that are taking place. On April 17, 2008, EPFO, which administers pension for workers in the organised private sector, invited bids from fund managers to manage its hefty corpus of more than Rs 1,30,000 crore. Elsewhere, the building blocks of the revamped pensions system under the New Pension Scheme are being put in place. Here central government employees (those who have joined after January 1, 2004) are part of the scheme where they contribute a defined amount, as against the prevailing scheme earlier where the pension benefits were defined.

Nineteen state governments, too, have promised to join the NPS. For governments creaking under ballooning pension liabilities, the NPS will go a long way in reducing the burden, besides providing employees better returns on their mandatory savings. For EPFO, too, similar forces are at play.

Better returns to workers is, however, just one reason why pension management in the country needs sweeping reforms. Inadequate coverage is another. Of the more than 321 million paid workers (in the age group of 18-59 years) in India, a bare 37 million are covered under any pension scheme. For the rest, retirement is not really an option. In fact, even for those with pension, not working isn’t an option because of the value of their accumulated savings doesn’t beat inflation, as pension funds (at least the EPFO’s) only get invested in debt instruments; but more on that in a bit. The vast majority has to keep working to ensure a monthly income. There are ways in which such workers can be brought under a pension scheme (see Cover for the Uncovered). Meanwhile, it’s the existing pension schemes that are getting a makeover. Let’s start with EPFO.

Come September (hopefully), the EPFO’s corpus will be managed by not one fund manager (State Bank of India) but multiple ones. Why? A. Viswanathan, Central Provident Fund Commissioner, EPFO, says the decision stems from a need for comparative monitoring of the investment performance and improvement in returns. “Even if we earn about 10-15 basis points more, it is a good return for our stakeholders,” he says. EPFO’s rate of return follows an administered rate— it was 8.5 per cent for 2006-07.

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The rate for 2007-08 has not been decided, leave alone for the current financial year i.e., 2008-09. The objective of improved returns may have been better served by investing a small portion of the corpus in equities as it is a wellproven fact that equities as an asset class provide superior returns in the long run. Yet, on that issue EPFO’s 45-member Board of Trustees remains opposed to investment in equities, even when the Finance Ministry allows investment of up to 15 per cent of the corpus in equity-linked instruments for non-government pension funds. Viswanathan is quick to clarify that the trustees’ position is not carved in stone, but adds that they are leery of equities, given that there is an element of speculation in stock prices. They feel ‘workers’ money should not be speculated upon.

This despite the fact that in trying to stay good on its administered rate of return, the EPFO has been running into a deficit of nearly Rs 450 crore. Viswanathan says that the situation is not problematic as of now but may become so in another 30-40 years.

Given its predilection for debt, what is the reason for the EPFO to be seeking multiple fund managers? After all, the fund managers will continue to invest in fixed income instruments. Does the arrival of the New Pension Scheme—an alternate pension system that comprises the defined contributions of government servants (barring defence forces) who joined service after January 1, 2004—have something to do with the speed of work? Viswanathan merely says: “I look forward to the setting up of the NPS.” That is likely to be the case.

The NPS will allow fresh wind to blow even in the moribund EPFO office. The organisation for years has been accused of not catering to its chief constituency. In over 55 years of its existence, it covers only 444,464 establishments and has a membership of 40 million.

It seems like a large number till you consider that a country like Malaysia, which has a population of 24 million, has a similar number of establishments in the country’s Employees’ Provident Fund scheme. For years, the EPFO in India has been plagued by high premature withdrawals, high costs, complicated and inefficient administration, among other things. So certainly, appointing multiple fund managers seems like a step forward, even though a small one in this vast journey.

Numbers of note India’s population of people above 60 years of age is expected to quadruple from 80 million in 2005 to 330 million by 2050 Only 12-13% of the total workforce of 425 million is covered by any formal pension system today Implicit pension debt of providing pension security to less than 3 per cent of the workforce is estimated at around 65 per cent of GDP 92% of all workers in India are in the unorganised sector 80 million informal sector workers are already interested in saving for retirement The aggregate private pension fund corpus in India will grow to over Rs 12 trillion ($300 billion) by 2019-20

The technical and financial bids of the 17 short-listed bidders are expected to be in by mid-June. And the EPFO says it is moving fast on the issue. It intends to select maybe three managers for an initial period of two years. And it is the cream of the crop ranging from ICICI Prudential, BNP Paribas, Reliance Capital to several more that is in competition. “We intend to transfer the funds to the pension fund managers by September,” says Viswanathan.

NPS trigger

In the meantime, a small beginning has been made on what were steadily bloating government pension liabilities. Recruits into the central government service from January 1, 2004 onwards have moved to the defined contribution pension scheme. This was a major departure from the defined benefit scheme, which was prevalent till then. The earlier scheme merely fixed the pensions benefits that one continued to receive through old age, whereas the new scheme requires fixed monthly contributions, which then lead to market-linked returns at retirement.

A major step in this journey was taken at the beginning of this financial year when about Rs 1,200 crore was transferred to three public sector pension fund managers selected by competitive bidding. These are sponsored by Life Insurance Corporation of India, State Bank of India and the UTI Asset Management Company. This sum will now be invested in a ratio of 85:15 in fixed income and equities as a default option till more choices are made available to the contributors.

And the returns are likely to be an improvement on the 8 per cent that the government was assuring. An added advantage has been the fund management fee of 3-5 basis points of assets under management— a far cry from at least 2 per cent and more charged by mutual funds and insurance companies. However, there is more to come.

Pension ‘pillars’ According to the World Bank, a multiplicity of solutions needs to be incorporated in the design of the pension systems. Zero pillar: A noncontributory social pension that provides a minimal level of protection First pillar: A contributory pension that is linked to earnings and seeks to replace a portion of the income Second pillar: Mandatory, almost like an individual’s savings account Third pillar: Voluntary arrangements that can take many forms (individual, employer-sponsored, defined benefit, defined contribution) but are essentially flexible and discretionary in nature

The National Securities Depository (NSDL), the central record-keeping agency (CRA) for the NPS, too, is ready with the backbone for the system. Government offices and the Pension Fund Regulatory and Development Authority (PFRDA) have been testing the system over the last month. And it is likely to be operational anytime in June. The CRA will maintain subscriber accounts and issue a unique Permanent Retirement Account Number (PRAN) to each subscriber. “In this system, deductions towards NPS will be made from the subscriber’s salary on a monthly basis and an equal amount of contribution will be made by the government.

The accumulated amount will be reflected in the employee’s Permanent Retirement Account while the employee is working and shall use the accumulations at retirement to procure a pension for the rest of her life,” says Gagan Rai, MD and CEO, NSDL.

The CRA will provide portability to the users across jobs and locations, choice of pension funds and investment schemes, freedom to switch between service providers and capping these services with an annual statement. Hence, the subscriber will also have nationwide access of CRA system through Internet and toll-free telephone number. CRA will also provide an online platform to the subscribers for logging grievances and viewing their resolution.

That apart, CRA will record compliance of mandatory contributions by governments, ensure efficient and timely transfers between fund managers, and capture errors in transfers. And it will charge an annual fee of Rs 350 for its services.

Ajay Shah, senior fellow at Delhibased think tank National Institute for Public Finance and Policy (NIPFP), believes that in scale and breadth of its attempt, the NPS is similar to the revolution that occurred in the equity markets between 1994 and 2001. However, he cautions: “The challenge in NPS is to deliver on the promises that have been made.”

Implementation issues

And that in itself is a gargantuan task. At present, even as the NSDL’s system has been tested and is ready to run, no individual data has been transferred by the government to the NSDL or the fund managers. There are concerns that the data of contributions of government employees joining after January 1, 2004 is neither complete nor clear. “Nobody knows names, contributions, account balances for all these employees. It’s going to be a real struggle to catch up with this past,” says NIPFP’s Shah, adding that in some other countries, efforts at eating into such a backlog have floundered, resulting in a big mess.

How pension reforms could help It will improve returns and unlock capital. Pension contributors could earn better returns The pension burden on the Union and state governments will ease Post-retirement financials of more Indians will be secured Capital markets will get not just more funds but more professionalism More Indians will be encouraged to save and thus create capital

Shah also fears that the pension fund managers can lobby with PFRDA to wriggle out of the good auction outcome of low fees. “It’s just like what we are seeing with many infrastructure projects: winning bidders quote very low prices but then renegotiate,” says Shah. And it does seem to be a serious issue with the fund managers. Deepak Chawla, Deputy Managing Director, SBI, which is one of the NPS fund managers, says that “a fee of 3 basis points is clearly low at current volumes.”

U.K. Sinha, Chairman and Managing Director, UTI Mutual Fund, agrees and points out that the fee for managing National Investment Fund (NIF was formed from the disinvestment proceeds) is 12 basis points.

However, this seems like a shortterm pain point, as volumes are only likely to grow strongly over the next few years. According to Gautam Bhardwaj, Director, Invest India Economic Foundation (IIEF), around 1 million employees with funds of over $1 billion are already a part of NPS. Another glitch may be the tax treatment for the NPS—exempt, exempt, tax (EET) at the time of contribution, accumulation and withdrawl—while other savings options such as EPFO are fully exempt (EEE) at all stages.

Even as PFRDA Chariman D. Swarup is confident of an equitable treatment for the NPS, IIEF’s Bhardwaj points out that there is merit in EET treatment. “Since EET is a consumption tax, it encourages a smoother consumption pattern in old age and is more likely to ensure that the elderly do not end up splurging their savings.”

True, NPS is the big hope as far as providing social security to vast swathes of Indian population is concerned. And as IIEF’s Bhardwaj says: “No pension system is perfect on Day One.” He believes that the NPS offers identical rights, low costs and high returns to all sections of the social network as it puts a civil servant on par with the informal sector employee.

More importantly, “each year of delay is expensive as it affects the terminal wealth of the saver. And we have already lost a decade,” Bhardwaj adds. Yet, the whole process has been caught in political posturing with the PFRDA Bill still pending. However, PFRDA’s Swarup is optimistic about moving forward on pension reforms even during the current government’s tenure (see page 112). After all, he says, the PFRDA Bill is an enabling legislation that allows PFRDA to penalise and fine fund managers for indiscretions. The same purpose can well be achieved through contractual arrangements with fund managers. There are enough indicators that the government may also allow non-government employees to participate in the NPS on a purely voluntary basis. That will indeed be a major step in pension reforms.

Pension drawbacks The existing pension systems are far from perfect. There'sjust one investment option (debt) irrespective of the risk appetite as well as the age profile of the contributor Portfolio is almost completely invested in government securities or government-linked securities, which result in low returns to the contributor Funds have no exposure to equities, which could help build a sizeable nest egg No scope for diversification of country or political risk with entire proceeds invested in India

Once that comes through, the PFRDA will appoint institutions for points of service through the country where the NPS contributions can be collected. The very structure of NPS, which is relying on existing institutions to deliver its promise, is geared to cater to the bottom of the pyramid by virtue of its low costs. Swarup pushes his point when he says: “This is a very transparent, cost-effective and efficient system that we are promising to deliver to the country. The systems are in place. The intermediaries have confidence of the people. There is no reason for the system to not succeed.”

Cover for the uncovered

Indeed. And there is a huge pent-up demand for pension products. There are more than 80 million workers who see the need for, and value of, a voluntary contributory retirement savings system. This is roughly four times the estimated 20 million people who are currently saving for their retirement in life insurance and other financial products. “If the latent demand for pensions from these groups were fully harnessed, Indian workers could contribute an estimated Rs 57,000 crore to the NPS in the first full year of operations and that number is estimated to increase to Rs 12,03,538 crore by 2019-20. Up to a fifth of these workers (16 million) we believe are prime prospects and likely to start saving for their retirement as soon as appropriate products are offered to them,” says the Invest India Dataworks Income and Saving Survey 2007.

Even among the 37 million government and private sector workers who are covered by various mandated pension schemes, there are many who feel that their entitlements are inadequate. For this chunk, currently, pension plans of insurance and mutual fund companies come in handy. Deepak Satwalekar, MD and CEO of HDFC Standard Life Insurance, points out that the customers have recognised that while taking advantage of tax breaks is important, it is even more important to save beyond that, since tax-driven savings will not help them live comfortably in their retirement. “Our average premiums are higher than what can be justified if they were influenced only by tax consideration,” he says. Pension savings account for over 40 per cent of HDFC Standard’s premium collection.

This latent demand is also visible in some private organisations combining pension benefits with ESOPs to retain employees. “Companies have been rolling in some punch into the employee pension schemes as part of their retention strategy, where deferred benefits are sought to be given to employees as part of their overall package,” says Sanjay Aggarwal, National Industry Director, Financial Services, KPMG.

In fact, in times to come, companies will increasingly look at pension options as part of overall employee packages, especially in infrastructure and real estate sectors, where projects take time to fructify. However, as K.P. Kannan, member of National Commission for Enterprises in the Unorganised Sector, points out: “Currently, neither the EPFO nor the NPS deals with unorganised workers.” Especially at the bottom of the pyramid. What exists for them is a form of old age pension that does not depend on their work status. For example, under Indira Gandhi National Old Age Pension Scheme (IGNOAPS), Rs 200 per month per beneficiary is provided by way of central assistance to a person who is 65 years or older and belonging to a household below the poverty line. Notwithstanding government initiatives, there seem to be other interesting efforts too.

For instance, UTI Asset Management Company is now tapping nearly 100,000 unorganised workers across the country through a ‘micro-pensions’ initiative. The scheme, a sub-set of the existing UTI Retirement Benefits Scheme that has been running since 1994 and has delivered 12.5 per cent in returns over the years, is targeting many of these workers through self-help groups and worker unions.

For instance, some 30,000 SEWA Bank members in Ahmedabad joined the scheme last year. They pooled together over Rs 2.2 crore to invest for their pension requirements in the UTI scheme. This underscores yet again the latent demand for pension products. “We were also surprised to see that women who earn such low incomes were keen to save for such a long term. There is a huge demand; the question is how to reach it,” says Renana Jhabvala, National Coordinator, Self Employed Women’s Association (SEWA).

“There is no single button that can be pressed and the poor then line up for support,” says Ashish Aggarwal, Executive Director, Invest India Micro Pension Services, adding that addressing them through groups is a viable option. Low delivery costs have to be buttressed by high returns for the poor, since even when they save for long periods of time, they often do not save enough for them to live above poverty in their old age. Here, people like Jhabvala and Aggarwal believe the government could step in with a co-contribution to make the effort worthwhile. The good news is that there are some good signs here (see Rajasthan’s Co-contribution Pension Scheme). Perhaps, instead of wasting money in unproductive schemes that don’t benefit the poor, the government should consider this route to reach its much-vaunted goal of inclusive growth.

Rajasthan’s co-contribution pension scheme Last year the Rajasthan government announced a social security scheme for low-income unorganised workers. Known as the Vishwakarma Contributory Pension Scheme, it intends to benefit 20 categories of unorganised sector workers between the age of 18 and 60 years. These employment-based categories such as beedi workers or taxi drivers are targeted through their professional associations. The scheme, of course, excludes the agriculture occupations, small and marginal farmers and the workers who benefit from other pension schemes. The state government would match the amount contributed by the workers with the highest limit of Rs 1,000 per worker per year. Launched on 1st Sept., 2007, the scheme currently has 5,069 workers within its fold but state labour secretary Lalit K. Panwar expects around 60,000 workers to be enrolled by end of the current financial. The state has set aside Rs 50 lakh for 2008-09. “We are in the process of short-listing the public financial institutions where the contributions would be accepted,” he says, adding that there will be no budgetary constraints for this open-ended scheme. In the interim, the whole contribution of the workers as well as that of the government will be credited into interest-bearing public account. Initially, the interest being paid is 8 per cent on the combined contributions. Eventually, the corpus will be invested in accordance to pension sector guidelines by pension fund managers. Invest India Micro Pension Services, jointly owned by SEWA Bank, UTI Mutual Fund and other pension experts, is the implementation agency for the scheme. The whole record of the pensioners would be maintained by the central record-keeping agency that will shortly be appointed broadly along the lines of the New Pension Scheme.