THE BUSINESS SCHOOL

UNIVERSITY OF JAMMU

REPORT ON - “INNOVATIONS IN FINANCIAL SERVICE

INDUSTRY : PENSION SECTOR”

Submitted To : SUBMITTED BY:

MS. FARAH CHOUDHARY RADHIKA GUPTA

ROLL NO – 32- Mba -14

INNOVATIONS IN FINANCIAL SERVICES INDUSTRY : PENSION SECTOR

Introduction

India has a diversified financial sector, which is undergoing rapid expansion. The sector

comprises commercial banks, insurance companies, non-banking financial companies, co-

operatives, pension funds, mutual funds and other smaller financial entities. The financial sector

in India is predominantly a banking sector with commercial banks accounting for more than 60

per cent of the total assets held by the financial system.

India's services sector has always served the country’s economy well, accounting for about 57

per cent of the gross domestic product (GDP). In this regard, the financial services sector has

been an important contributor.

The Government of India has introduced reforms to liberalise, regulate and enhance this

industry. At present, India is undoubtedly one of the world's most vibrant capital markets.

Challenges remain, but the future of the sector looks good. The advent of technology has also

aided the growth of the industry. About 75 per cent of the insurance policies sold by 2020 would,

in one way or another, be influenced by digital channels during the pre-purchase, purchase or

renewal stages, as per a report by Boston Consulting Group (BCG) and Google India.

Market Size

Investment corpus in India’s pension sector is expected to cross US$ 1 trillion by 2025,

following the passage of the Pension Fund Regulatory and Development Authority (PFRDA) Act

2013.

Indian Financial Sector – The way forward

India’s services sector has been the most dynamic part of its economy, leading GDP growth for

past two decades. India serves as an example as to how services sector can play an important role

in a country’s economic growth. India is doing reasonably well in retail sector and the financial

sector including insurance. India is now eager to open up the pensions sector also to foreign

investors. The way these sectors have been developed with a robust regulatory and policy

framework also holds important lessons for other countries. India’s financial services sector has

been one of the fastest growing sectors in the economy. The economy has witnessed increased

private sector activity including an explosion of foreign banks, insurance companies, mutual

funds, venture capital and investment institutions.

Financial services in India still remain largely under-penetrated and there lies the opportunity for

high growth. Foreign banks are likely to be allowed to acquire local banks when the next stage of

banking reforms is proposed and increased FDI limit in insurance will offer good opportunities

in the insurance sector. Low penetration in the pension market makes it a lucrative business

segment. India also offers a once in a lifetime opportunity for PE funds to invest in the

infrastructure asset class across the board ranging from core sectors such as power, roads,

transport to social asset classes such as healthcare, education, environment. Other service

economy infrastructure sectors like telecom, ISPs, financial payment gateways also offer

massive opportunities.

National Pension System

Pension plans provide financial security and stability during old age when people don't have a

regular source of income. Retirement plan ensures that people live with pride and without

compromising on their standard of living during advancing years. Pension scheme gives an

opportunity to invest and accumulate savings and get lump sum amount as regular income

through annuity plan on retirement.

According to United Nations Population Division World's life expectancy is expected to reach 75

years by 2050 from present level of 65 years. The better health and sanitation conditions in India

have increased the life span. As a result number of post-retirement years increases. Thus, rising

cost of living, inflation and life expectancy make retirement planning essential part of today's

life. To provide social security to more citizens the Government of India has started the National

Pension System.

Government of India established Pension Fund Regulatory and Development Authority

(PFRDA) - External website that opens in a new window on 10th October, 2003 to develop and

regulate pension sector in the country. The National Pension System (NPS) was launched on 1st

January, 2004 with the objective of providing retirement income to all the citizens. NPS aims to

institute pension reforms and to inculcate the habit of saving for retirement amongst the citizens.

Initially, NPS was introduced for the new government recruits (except armed forces). With effect

from 1st May, 2009, NPS has been provided for all citizens of the country including the

unorganised sector workers on voluntary basis.

Additionally, to encourage people from the unorganised sector to voluntarily save for their

retirement the Central Government launched a co-contributory pension scheme, 'Swavalamban

Scheme - External website that opens in a new window' in the Union Budget of 2010-11. Under

Swavalamban Scheme - External website that opens in a new window, the government will

contribute a sum of Rs.1,000 to each eligible NPS subscriber who contributes a minimum of

Rs.1,000 and maximum Rs.12,000 per annum. This scheme is presently applicable upto

F.Y.2016-17.

NPS offers following important features to help subscriber save for retirement:

The subscriber will be allotted a unique Permanent Retirement Account Number

(PRAN). This unique account number will remain the same for the rest of subscriber's

life. This unique PRAN can be used from any location in India.

PRAN will provide access to two personal accounts:

Tier I Account: This is a non-withdrawable account meant for savings for retirement.

Tier II Account: This is simply a voluntary savings facility. The subscriber is free to

withdraw savings from this account whenever subscriber wishes. No tax benefit is

available on this account.

EXTENDING PENSION AND SAVINGS SCHEME COVERAGE TO THE INFORMAL

SECTOR: KENYA’S MBAO

Pension Plan:

The Mbao Pension Plan is a voluntary individual account savings plan to which all workers in

Kenya may contribute without regard to income or age. It is designed to provide a programme

that is suitable for the unique nature of the informal sector and to encourage a savings culture for

those workers. The key innovation is that low-income workers can easily make small

contributions at relatively low cost, considering the small contributions and small account

balances.Participants can conveniently make contributions anytime and anywhere using their cell

phones. This savings innovation is made possible by technological innovations that have reduced

the costs of cell phones and airtime, and by the entrepreneurial innovation of mobile money. The

plan is provided through private-sector businesses

The Mbao Pension Plan

The combination of widespread cellular phone use and the ability to transfer money

instantaneously, safely, and inexpensively are having widespread effects onthe organization of

economic activity and on risk management and mitigation (Mbiti and Weil, 2011). In particular,

they may provide the basis for a new approach to extending pension systems to persons in rural

areas and the informal sector.Going a step beyond M-Kesho, at the end of June 2011, the

Retirement Benefits Authority in Kenya, which is the retirement benefits sector regulator in

Kenya, with National Federation of Jua Kali Associations and the participation of privatesector

providers launched an innovative programme for extending pension and savings scheme

coverage to the informal sector: the Mbao Pension Plan. The Mbao Pension Plan is a voluntary

individual account savings plan provided through private-sector businesses. The government

bears a small cost through a loss of tax revenue on the savings and through the cost of the

regulator, the Retirement Benefits Authority.Mbao is Swahili slang for 20 shillings, and the

name of the plan refers to the minimum contribution of 20 shillings (approx. USD 0.25).9 It is a

micro-pension or savings scheme in that it provides a plan where low-income workers can make

small contributions at flexible intervals of their choosing.10 Since it is designed and marketed as

a pension plan, the goal is to encourage retirement savings, but it can also be used for savings for

other purposes. Experience in India has suggested that small, convenient, and frequent pay-ins

make it easier to save (Rutherford, 2012). It is designed primarily for low-income workers who

are not participating in social security, and thus is a substitute for social security, but can also be

used as acomplement to social security by workers who are covered by such programmes.

Workers must pay KES 100 to register with the Mbao Pension Plan, and must fill out a

registration form and present ID documentation. The forms are sent to the fund administrator’s

office. The user needs a national photo identification card to establish an account. However, this

registration procedure will change in the near future as the administrator is updating the platform

to cater for full electronic registration using the phone. Though the Mbao Pension Plan is barely

over a year old, as of November 2012 it had 38,000 members who have saved KES 37 million

(USD 463,000). By the end of December 2012, that amount had increased to KES 41

million.While voluntary savings programmes often have limited impact, and many people may

not participate, the early experience with the Mbao Pension Plan suggests that it is an appealing

programme to some people.

Contributions

The minimum contribution to the Mbao Pension Plan of KES 20 a day largely appeals to the

lowest income earners, such as hawkers, who foresee for themselves a decent retirement. Scheme

members commit to contributing at least KES 100 a week and KES 500 a month, but

contributions are not mandatory, and no penalty is charged for not contributing. Contributions of

KES 500 a month (KES 6,000 a year) would be roughly equal to USD 75 a year. The Mbao

Pension Plan does not have a maximum contribution, but the mobile phone companies will not

handle contributions of more than KES 140,000 a day, which is the daily maximum remittance.

For all pensions in Kenya, the maximum tax deductible contribution is KES 20,000 a month.

Contributions are made only by members,with no matching contributions by employers or the

government. Though the system is designed with its low minimum contribution to be a system

that informal-sector workers can use, all workers may participate. With Safaricom, the fee for a

contribution of KES 20 is KES 3, which is the set fee for transfers between KES 10 to KES 49.

This ensures that all low-income members are subsidized by those making larger contributions,

who pay higher fees. In addition, Safaricom charges the Mbao Pension Plan a fee of KES 2. The

fee rises in steps with higher contributions, but as a per cent of contributions it falls. Safaricom’s

market competitor, Airtel, charges workers a 10 per cent fee for small contributions. If

contributions are withdrawn in the first year, a penalty is levied, but after that no penalty or fee is

charged for withdrawals. The key innovation of the Mbao Pension Plan is that low-income

workers can easily make small contributions at relatively low cost, considering the plan is

dealing with small contributions. Workers can conveniently contribute anytime and anywhere

using their cell phones. This innovation is made possible by the technological innovations that

have reduced the costs of cell phones and have reduced the costs of airtime, and by the

entrepreneurial innovations of pre-paid phone cards and mobile money. The current average

contribution is KES 180 (Kwena, 2012). A survey found that 42 per cent of the informal-sector

workers participating in the Mbao Pension Plan earned less than KES 6,000 (approx. USD 75) a

month (Anami, 2012). Thus, the system is serving the needs of substantial numbers of

lowincome persons. The fact that members can make such small contributions towards pension

saving has helped to demystify the notion that saving for pensions is only for people with

disposable income. It further confirms longstanding arguments made in the financial services

literature concerning the needs of lowincome persons for financial services.

Investment and savings aspects for participants

To prepare for the launch and to encourage participation in the Mbao Pension Plan and other

pension schemes in Kenya, in June 2009, the Government amended the Retirement Benefits Act

to allow retirement benefit scheme members to assign up to 60 per cent of their accumulated

pension or savings accounts to access mortgage facilities. This enables the mortgage financier to

lend up to 115 per cent of the property value, with the additional lending going to finance the

initial fees which consist of the government tax in the form of stamp duty, valuation fees, and

legal fees. Mortgage lending in Kenya without this backing generally requires a down payment

of 10 per cent of the purchase price of the house. When members use their Mbao Pension Plan

for this purpose, they cannot make a withdrawal from the plan until the mortgage is paid off. The

pension-backed mortgage serves as a key incentive to saving through a pension or savings

scheme rather than through other saving vehicles like bank accounts, cooperative societies,

insurance products and investment groups. Members therefore understand the importance of

accumulating substantive reserves in their pension or savings scheme in order to qualify for a

mortgage. This programme provides an immediate, tangible benefit to workers for participating

in a pension or savings scheme. The house is the first form of guarantee of the mortgage. If an

individual loses his or her job and defaults on his or her mortgage, but the value of their house

exceeds the amount remaining on the mortgage, the house is sold but the individual does not lose

any of his or her pension or savings account. The worker would lose part of his or her pension or

savings account only if the price of the house had fallen below the value of the mortgage.

Contributions to the Mbao Pension Plan are taxed under the same tax regime as contributions to

other pension schemes in Kenya. That is the EET tax regime, where contributions are tax

deductible, investment earnings are tax exempt, and benefits are taxable. However, lump-sum

payments in Kenya of up to KES 600,000 per year are tax exempt, so most payments from the

Mbao Pension Plan will be tax exempt. Most workers in the informal sector pay no income taxes,

so they do not benefit from the preferential tax treatment. Policy-makers in Kenya are

considering whether low-income participants should receive a subsidy to encourage their

participation and to increase the amount in small accounts. A complication in doing this may be

that participation in the Mbao Pension Plan is not limited to low-income participants. A subsidy

for participants would need to be structured so that it only went to low-income participants not

benefiting from a tax subsidy because they did not pay taxes. The Mbao Pension Plan as of the

end of 2012 was invested entirely in interest bearing assets, with more than a third (37.8 per

cent) in Kenyan government bonds, and another third (37.0 per cent) in fixed-term bank deposits.

The remainder is in corporate bonds (15.6 per cent) and cash (9.6 per cent). As of this writing,

the rate of return for 2012 had not been declared. By way of international comparison, like in

Kenya, rural workers and farmers in China do not pay income tax, so in both countries workers

do not have a tax incentive for participating in the pension system. The lack of a tax incentive

may explain in part the matching contribution in China. In China, subsidies are used to

encourage participation in the National Rural Pension System, where participation also is

voluntary. The subsidy, which is provided by the government, varies across regions, but the

minimum subsidy is a flat 30 Chinese Yuan (CNY) a year, wherethe minimum contribution is

CNY 100 a year (approx. USD 16), with nearly half of participants making the minimum

contribution (Dorfman et al., 2013).

Benefit payments

Individual savings in the Mbao Pension Plan can only be drawn down as a lumpsum payment,

and in this respect the Mbao Pension Plan is similar to a provident fund. A lump-sum withdrawal

can be made at any age, after a year of participation in the plan. Upon death of the account

holder, the plan makes a lump-sum payment to the designated beneficiary. Members can access

their account balance using their mobile phone. Clearly, with the plan having only been in

existence for little more than a year it is too early to assess the level of benefits that it will

ultimately

provide. Kenya’s social security programme, the National Social Security Fund, is also a

provident fund, providing benefits as a lump sum. However, the Kenyan government as of 2013

is considering converting it to a social security fund, providing periodic benefits. Kenya could

also consider offering periodic benefits through theMbao Pension Plan.

Possible future changes to the Mbao Pension Plan

The Mbao Pension Plan is new, and it is likely to undergo changes as experience with it

develops. The Women’s World Banking (2003) recommends that micro-pensions develop first as

a hybrid between micro-savings plans and micropensions as a step toward building capacity for

micro-pensions. This section discusses possible changes to the plan as it develops that would

strengthen the plan and provide greater options for participants. The financing options could be

changed in various ways. The plan could allow employer contributions to worker’s accounts,

offering a low-cost option to employers for providing pensions. The plan could be changed to

allow workers to borrow from it, providing liquidity and an added benefit of participating, while

maintaining the account (Rutherford, 2012). A government subsidy through a matching

contribution could be provided for workers who do not receive a subsidy through the tax system

because they do not pay income taxes. Such government expenditure could be justified because

the government would otherwise be incurring tax expenditure through lost tax revenue if these

workers had benefited from a tax preference. Matching contributions are provided for voluntary

government social security pension programmes in China (Dorfman et al., 2013), India (Palacios

and Sane, 2013) and Thailand (Wiener, 2013). In India, one pension programme offered for a

four-year period a matching contribution for workers who made contributions under a certain

small amount (Shankar and Asher, 2011). While studies in the United States have found only a

limited effect of matching contributions on increased participation (Madrian, 2013), the effect

could be more substantial in Kenya where workers do lot also have a social security pension and

are not also receiving a financial incentive through a tax subsidy. Also, the benefit options could

be changed so as to allow other benefit payment options than lump-sum payments, including

phased or periodic withdrawals or partial withdrawals, or the purchase of an annuity when the

accumulated account balance had reached at least a threshold level. An alternative could be that

an annuity would be offered for a fixed term, such as ten years (Rutherford, 2012). These options

would provide participants greater flexibility in risk management. The option of withdrawal of

funds after one year could be modified so that funds could only be withdrawn after five or ten

years, or before a set age only for particular purposes, such as education or medical expenses.

These changes would move the plan toward being a pension plan rather than a savings plan. One

option would be to start on a trial basis offering a savings plan that could not be withdrawn for

five years. Finally, continued efforts at financial education may lead to increased participation as

the target population better understands the need for accumulating financial savings for

retirement, and better understands the advantages of participating in the Mbao Pension Plan.

REFORMS WAVE IN INSURANCE, PENSION

 Reforms are the flavour of the season. The insurance sector is no exception. Its long pending

demand for raising the foreign direct investment (FDI) limit may be fulfilled. The government

has cleared a Bill that allows for 49% FDI as against 26% at present .

The FDI limit for pension funds under the New Pension System (NPS) is also sought to be

aligned with that for the insurance sector. A minimum assured return is also proposed for NPS

plans in line with insurance pension plans.

Withdrawals up to 25% of the contribution made in an NPS scheme by a subscriber can also be

allowed. At present, only 20% of the contribution can be withdrawn before the subscriber turns

60, with the remaining being used to buy an insurance annuity scheme.

25% of the New Pension System corpus can be withdrawn before the investor turns 60

"The biggest hurdle for the NPS is lack of awareness. More capital in the sector would mean

fund managers would be able to invest more in creating awareness and, thus, push the product

among a larger number of people," says Vikas Raj, chief executive officer, IDFC Pension Fund

Apart from the FDI limit, the insurance sector is also preparing for a bevy of reforms.

Draft guidelines on a number of issues have been issued by the Insurance Regulatory and

Development Authority of India, which plans to implement them soon. Here are the main

proposed changes.

Tax Sops

Some insurance pension policies have been recommended for being included along with the NPS

for deduction in addition to the Rs 1 lakh limit under Section 80C of the Income Tax Act.

"A separate limit for insurance pension products will promote pension policies and allow

customers to save more," says Sanjay Tripathy, head (marketing, product and direct channels),

HDFC Life, a private insurer.

Service tax on the first-year premiums for regular and singlepremium policies may also go down

while making the levy payable only on realisation of the money.

Third-party Claims

To help general insurers, who are bleeding money due to third-party motor claims , it has been

proposed to cap the third-party liability at Rs 10 lakh. Currently, there is no cap on insurance

claim for injury or death. For damage of property, the maximum claim amount is Rs 7.5 lakh.

When damages exceed the cap, vehicle owners have to bear the additional cost.

The provision of immediate compensation under which victims can claim up to Rs 50,000 can

also be omitted.

"As the risk (for insurers) is being capped, the insurers may slightly reduce the premium

charged," says K N Murali, head, motor vertical, Bharti AXA General Insurance.

Wider Coverage

In order to widen the coverage of health cover, it has been proposed to include sickness benefit

on foreign travels. Currently, health insurance plans only cover hospitalisation within India.

Group insurance policies may also be extended to non-employee groups such as self-help groups

and professional associations. Additionally, any insurance policy would not be challenged on

grounds of false declarations after three years.

TO INVEST INDIA MICRO PENSION SERVICES

IIMPS educates, encourages and enables low income informal sector workers to accumulate

micro-savings for their old age in a secure, convenient, affordable and well regulated

environment using its scalable and sustainable Micro Pension model.

Bihar Innovation Forum Awards

IIMPS was awarded the second prize at the Bihar Innovation Forum for Excellence & Innovation

in Financial Services in January 2014. There were over 120 organizations competing for this and

IIMPS was presented this award and a cash prize by the Hon’ble Chief Minister of Bihar Shri

Nitish Kumar

Micro Pension Prepaid Card

Most IIMPS clients do not have a bank account. Such clients now use their "Micro Pension

Prepaid Card" for cashless transfer of micro-savings directly to regulated product providers

CCTs Linked to Retirement Savings by the Poor

The Viswakarma Scheme (2008) of the Rajasthan Government has demonstrated that pension

co-contributions by the State can motivate voluntary enrolments and retirement savings

discipline among low income informal sector workers.

Ujjivan and IIMPS launch Micro-Pension scheme for women

Ujjivan, one of India’s leading microfinance institutions in partnership with IIMPS (Invest India

Micro-Pension Services) launched two micro-pension products for over 10 lakh urban poor

women across India.

Pensions for Overseas Migrant Workers

Ministry of Overseas Indian Affairs has launched a new co-contributions based scheme that will

encourage 5 million overseas Indian workers to voluntarily save for their return and resettlement

and old age.

Retirement Literacy

An innovative pension and savings literacy toolkt has been developed with NABARD and KfW

to inform and educate low income informal sector workers about pensions, savings and insurance

concepts and products.

Regional Cooperation on Pension Inclusion

ADB and IIMPS have developed an institutional mechanism for regional cooperation within

South Asia on pension policy design and implementation strategies targeting the working poor.

IIMPS-NABARD Rural Micro-Pension Initiative

This joint initiative is field-testing innovative strategies and secure micro-payment solutions to

encourage and enable SHG members in 8 districts of 4 States to save for their old age.

INDIA NEEDS INNOVATIVE PENSION FUND PRODUCTS: JAYANT SINHA

NEW DELHI: India needs to have innovative products and services under retirement

architecture to match the risk appetite of various types of customers, junior minister for finance

Jayant Sinha said on Wednesday.

"In National Pension System (NPS) you have the ability to invest in a wide variety of asset

classes. I generally believe, with 30 years of compounding, small amount invested in NPS will

over time overcome tax disadvantage," he said.

The pension sector has been demanding exempt exempt exempt (EEE) status for NPS which will

mean that accumulated investment in pension schemes will not be taxable at the time of

withdrawal.

"I would not unnecessarily keep highlighting tax matters. When you sit down and do Monte

Carlo analysis, you will find this becomes a matter of less significance," said Sinha at an event

organised by the Pension Fund Regulatory and Development Authority (PFRDA).

Sinha also highlighted the role of pension funds as a source of long-term funds for infrastructure

development and the need to have increased pension flows in the debt and equity markets to

reduce volatility.

PFRDA chairman Hemant Contractor said the pension fund regulator will take a view on G N

Bajpai panel report that suggested investment into venture capital, in the next 2-3 weeks. The

committee was set up to look into the issue of investment pattern of pension funds.

Under the current norms, NPS funds can be invested only in government securities, corporate

bonds and equities. At present, NPS has more than 87 lakh subscribers with total asset under

management (AUM) of more than Rs 80,800 crore.

PFRDA is readying itself along with banks to roll out the Atal Pension Yojana (APY), as

announced by finance minister Arun Jaitley in the Union budget.

INDIAN PENSION FUND CONGRESS

Indian Pension Fund Congress 2014 is India’s only conference dedicated to providing

investment strategies for pension funds and asset managers.

The Indian Pension Fund Congress discusses investment strategies, benchmarks, risk

management, diversification and diverse investment structures that can be used to maximise

returns.

Indian Pension Fund Congress 2014 provides a platform for fund managers and asset managers

to access investment opportunities.

Key issues being addressed include how to:

Make the Indian Pension Fund market attractive to foreign pension funds

Optimise portfolio construction and find the best balance between risk and reward

Develop innovative products to grow funds under management

Tips, tools and strategies to deal with regulatory issues

Benefit from emerging market allocation by foreign pension funds

Develop and implement new risk management systems to better manage volatility

Indian Pension Fund Awards 2014

Celebrating Excellence in India’s Pension Fund Industry

Award Categories

Pension Fund of the Year Award

Best Product Innovation

Special Recognition for Outstanding Contribution to the Indian Pension Fund Industry

PENSION SECTOR REFORMS IN INDIA

Proposed System:

Dr. S.A.Dave observed that a regular savings of Rs.3 to Rs.5 per day throughout the working

life can rescue an individual from old age poverty, if those funds are invested wisely. He

correctly recommended about the future pension system on the basis of the Individual

Retirement Accounts (IRA) in the project OASIS report. Here, one is required to hold only

one account,irrespective of the number of job changes. The new system consists of the

following:

Points Of Presence (POPs):

The place from where one can open the IRA as soon as he starts his working life in any post

office or in any bank. All the POPs should be equipped with information technology and

telecommunication facilities so that one can access the account from any part of India at any

given point of time.

Depository Participants (DPs):

They should be responsible for the centralized record keeping and the individual database

management, on being connected with each POP through the centralized depository like

NSDL.

Lastly DPs should transfer the funds and convey the individual preferences to the respective

Fund Managers.

Pension Fund Managers (PFMs):

The total amount of pension corpus is to be handed over to the PFMs who will be responsible

to manage the funds as per the preference of each account holder. Moreover, the account

holder should have total flexibility to choose the PFM and the DP.

Annuity Providers (AP):

They will be provided the entire amount of accumulated funds to design a suitable annuity

plan to meet the income needs of the account holder during the post-retirement days. The

pension plans are the anti-thesis of the life insurance products but follow the same

mathematical and economic principles in product design. Therefore, the life insurance

companies are expected to play an important role as Annuity Providers that is evidenced by

the entry of the private life insurers in the pension business. Stringent competition will lead

to a better pricing of the products, thereby benefiting the customers to the greatest extent.

The above system will offer every type of flexibility and enormous choices like, opening

account, selecting DP, Pension Fund Manager and Annuity Provider as well as the amount to

be saved, etc. to the individuals. Competition and technological upgradation will reduce the

cost of the administration and management of funds. As investment professionals, the fund

managers will maximize the return on investment with active portfolio management. The

Government may also channelise the savings easily for building infrastructures, developing

debt markets and stabilizing the capital markets. However, the Government should also

maintain a strong vigil on the activities of various entities in order to avoid a pension scandal,

as we have already experienced the securities scam, CRB fiasco, collapse of the NBFCs,

failure of the plantation companies, problems due to the vanishing companies from the stock

markets, etc.

INTEGRATION OF THE FINANCIAL MARKETS IN INDIA:

To ensure the efficient management of the substantially large volume of funds a vibrant

financial system is required. Therefore, complementary reforms in the areas like debt

markets, capital markets, disclosure norms, etc. are to be carried out to integrate the

operations of these markets.

The convergence of the risk-adjusted returns is a necessary precondition for the integration of

thefinancial markets, supported by the existence of a reference rate. A growing integration

among the several financial markets is being observed with the financial sector reforms in

India that is evidenced by the inter linkages between the turnover and the rates of return.

A reasonable rate of integration is observed among the money market segments i.e. call

money,commercial paper (CPs), certificates of deposits (CDs) and the gilt market. The 91

days Treasury bills rate can have the potential to emerge as the reference rate. The equity

market remains separated from this integration and the cross-border integration of the forex

market is weak except some evidence of covered interest rate parity.Integration among the

various market segments helps in better risk management. Any development in any of the

market segments will influence the corresponding development in the other segments, may

be with some time lag. Pension plans and Insurance companies will be immensely benefitein

product designing, with such integration. Apart from this, it will also enable them to maintain

a reasonable rate of return on their investment. Ultimately, a multi-tier system will emerge to

suit the needs and aspirations of the people of any country based on their capacity and the

prevailing circumstances.

Investment Avenues:

In any investment game, the fund manager must select the assets in such a way, so as to meet

the liabilities properly. But asset-liability mismatch is quite common in the management of

the pension and provident funds due to the following reasons:

The duration of the liabilities may go up to 30 to 40 years while the general tenure of

the available assets is 20 years. Only recently, the RBI has come out with 30 year

bonds.

Lack of knowledge of the pension and provident fund managers about the employee

demographics, hence they only consider the liability due in terms of number of years.

In India, presently the provident funds corpus are dealt by the accounting

professionals whose knowledge and skills about investment management is

significantly little. So, they are neither aware off nor practicing Asset Liability

Management (ALM).

Therefore, in today’s volatile financial world, a pension fund manager is not only expected to

apply ALM but is also required to adopt suitable Risk Management strategies. These will

enable him to maximize the returns at an acceptable level of risk. In this context, the

Government should come out with comprehensive regulations regarding ALM techniques

and risk management strategies for the pension funds as the RBI has directed the banks.

However, the following important points are to be considered also:

a) Investment in the Money Market Instruments:

Instead of letting the funds uninvested and lying idle, pension funds should be allowed to

invest in the short-term instruments like, commercial paper, certificates of deposit, treasury

bills, etc. This will enable them to earn something that is definitely better than nothing and

will also reduce the volatility in the money market, prior to the availability of suitable long-

term investment opportunity.

b) Long-dated GOI Paper for tenure risk and Asset-Liability Mismatch:

The RBI should introduce 40 year and 50 year Rupee yield-curve through suitable GOI

Papers.This will help the pension fund managers to manage the tenure risk while the

investors of the projects, especially the infrastructure projects with a very long gestation

period, can be able to set the targeted rate of returns.

c) Indexed Bonds:

Investment in the indexed bonds e.g. inflation indexed bonds offers an excellent hedge

against inflation risk, thereby leading to a constant real rate of return. But such type of

instrument is hardly available in India. Therefore, more instruments should be encouraged for

hedging inflation risk and better Asset-Liability Management.

d) Equity Investment:

. For the pension plans, equity investments can be considered as one of the best to manage the

inflation and tenure risks as well as for ALM.

However, the Indian capital markets are not yet developed for allowing the pension funds into

the equities due to the following reasons:

Weak Regulatory environment regarding the safety of the funds

Inadequate knowledge and skill of the PFMs to deal in the equity markets

e) Infrastructure Development:

India’s inadequate infrastructure has long been identified as a serious bottleneck point for the

growth of the Indian economy. Earlier, the Government made the budgetary allocation for

developing roads, telecom facilities, ports, etc. But today, it also includes the social infrastructure

like housing, education, power, healthcare, etc. Investment in these sectors not only enhances the

overall growth of the economy but also improves the standard of living of the masses that will be

reflected with better labor productivity. The World Bank observed that one percent growth in

infrastructure development leads to one percent growth in GDP.

Development of efficient and quality infrastructure services needs huge investments for a long

gestation period that may be perfectly synchronized with the maturity of the pension plans.

Private participation in infrastructure financing is also necessary in many areas like power,

transportation, telecommunications, etc. where the Government can facilitate investments.

However, in other areas, the government has to play a significant role to meet the increasing

demand e.g. rural infrastructure, urban infrastructure, etc

The reforms requirements in the Indian pension sector can be compared with the tip of an

iceberg. The more it is delayed, the more it will aggravate the problem and the less will be the

extent of the benefits that can be reaped. Improper policy formulation, less emphasis on this type

of dire need and lack of public awareness may be considered responsible for the present

situation. Major part of the working population is left uncovered by the available schemes.

Presently, these people maintain a satisfactory standard of living but the absence of any income

security may throw them below the poverty line. This threat will ultimately result in the

emergence of a large number of sick and old age destitutes in the streets and public places.

Therefore, pension reforms are to be carried out at the earliest. But a lot of ground work has to be

done prior to the launch of the pension schemes. An efficient regulator is to be appointed, not

only to supervise the activities of the various entities but also to develop the market through

healthy competition among the players. Banks and Depositories are to be beefed up to sustain the

requisite amount of savings mobilization. Simultaneously, the investors are to be educated

properly regarding the changing social and financial scenarios vis-à-vis the needs for old age

income security. Better awareness among the common masses and the professional skill of the

fund managers will tap a large sum from the Indian middle class. The entrants are expected to

exploit the untapped potential through need based products with flexible options. Those funds on

proper utilization would go a long way in making India an economic superpower. Increasing

level of infrastructure activities will increase domestic consumption thereby, boosting up the

economic growth. Better infrastructure will sharpen the competitive edge of India Inc. Moreover,

the pension funds will build up a stronger financial system. These will bring better stability in the

capital markets by providing long term funds as against the short term funds of the speculators

and the foreign institutional investors (FIIs). With the successful passage of the Securitization

Bill, pension funds will lead to the development of a stronger bond market. In one hand, it will

reduce the possibility of an economic crisis by reducing the chances of foreign exchange and

maturity mismatches while on the other hand; an effective yield curve on Rupee for a longer

duration will emerge. Only then can it be concluded that the marriage between the requirement

of social security and sound business concept is a great success.

THE ROAD AHEAD

The NPS scheme has several advantages over other schemes in terms of cost and equity

exposure. Mutual funds can charge up to 2.25% and ULIP Pension plans from life insurers can

charge up to 1.35% as fund management fees. NPS charges just 0.25%, making it one of the

cheapest pension products in the world.6 The difference in fees/charges affects the total corpus

significantly over longer periods of investment. NPS also instills a sense of disciplined savings

and offers tax benefits.

Policy initiatives are also required to encourage voluntary subscription to this scheme. These

initiatives could include establishing a comprehensive national pension policy, improvements in

the security and returns from NPS investments, setting up distribution channels and increasing

the incentives for them and increasing the channels’ regional coverage. Designing customized

marketing strategies for different market segments will also be effective; marketing through SMS

or street events/road shows could be one option. Telecommunication companies’ support can be

sought to build a database of prospective customers.

Also, the virtues of this scheme need to be communicated to the investing public. One of its

biggest pluses is that the cost of administration remains the cheapest in the world.7 Also, the

scheme is portable anywhere within the country – i.e., employees can “carry” their accounts with

them when they change jobs. The scheme offers a choice of investment mix and pension fund

managers. All transactions can be tracked online through the central record keeping system, and

there is an efficient grievance management system in place. The scheme offers an auto choice

(default) option for subscribers who do not have sufficient knowledge about these instruments.

A concerted effort by the regulators, pension fund administrators and the service provider is

needed to make this laudable social initiative a true success.

A study of the retirement income system in G20 countries indicates that in a country of India’s

size and complexity, a defined contributions model is the model for the future. There are a few

provisions which need to be incorporated from other pension models to make the system more

beneficial: provision of minimum pension under social security, provision for early and late

retirement and benefits calculation modeling in line with price increases.

For Indian pension reforms to truly succeed and be an example for emerging economies, it is not

just essential to move to a defined contribution model; it needs to create a basic pension from

public finances. A formal old-age income support especially for financially impoverished senior

citizens is needed urgently.

In its influential report “Averting the Old Age Crisis,” the World Bank (1994) recommended a

multi-pillar system for the provision of old-age income security comprising:

• Pillar 1: A mandatory publicly managed tax-financed public pension.

• Pillar 2: Mandatory privately managed, fully funded benefits.

• Pillar 3: Voluntary privately managed, fully funded personal savings.

Subsequently, Holzmann and Hinz (2005) of the World Bank extended this three-pillar system to

the following five-pillar approach:

• Pillar 0: A basic pension from public finances that may be universal or means-tested.

• Pillar 1: A mandated public pension plan that is publicly managed with contributions and, in

some cases, financial reserves.

• Pillar 2: Mandated and fully funded occupational or personal pension plans with financial

assets.

• Pillar 3: Voluntary and fully funded occupational or personal pension plans with financial

assets.

• The fifth pillar is a nonfinancial pillar that includes the broader context of social policy such

as family support, access to healthcare and housing, etc.

The key challenge in India is to continue the pension reforms while addressing the needs for

Pillar 0 and create a universal security net for the most needy.