PENSION BUSINESS :Issues and Concerns

R.VAIDYANATHAN PROFESSOR OF FINANCE & CONTROL & UTI CHAIR PROFESSOR INDIAN INSTITUTE OF MANAGEMENT BANGALORE BANNERGHATTA ROAD BANGALORE INDIA 560076 TEL: 91-80-658-2450 FAX: 91-80-658-4050 E-mail: vaidya@iimb.ernet.in

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Retirement Schemes - Global Scenario

Social Security Schemes sponsored by the governments Occupational schemes sponsored by the employers for the benefit of their employees and Private voluntary schemes to accumulate savings to provide for retirement needs.

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Challenges
Government schemes-pay as you go- facing crisis. Inverted Pyramid population structure. Post-retirement expectations and standards of living. Inability of existing employees to sustain the system. Moving towards private contribution schemes. Inadequate underwriting returns and reliance on Investment returns.

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Demographics India: Work Force Covered Number of workers - 314 million (1991 census data).
Regular salaried employees - 47 million (15.2%).
Central, State and other departmental employees - 11.13 million (23%). They are covered by non contributory, indexed, defined benefit pension, funded entirely by the government. Nearly 23 million (49%) of the salaried (non-government) workers are covered by mandatory Employee Provident Fund and the Employee Pension Scheme. Hence nearly 34 million ( or less than 11%) of the working population has got old age income security.

Casual/contract workers - 97 million (31%). Self employed - 166 million (53%).

Source : Project OASIS Report, January 2000

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Composition of work force-2000

Table 1 Class of worker Private wage and salary workers Government workers Self-employed: own unincorporated business Unpaid family workers Total
Source: U.S Bureau of Census, Census

Percent 78.5 14.6 6.6 0.3 100

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Demography: Issues Western Europe is developing as a inverted Pyramid structure. Less than replacement levels. More of elderly [ Northern Europe it is negative growth] US helped by Hispanic influx. Issues of Pensions/Social security/ health care. Younger labor force issues [ Un-skilled]
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Demographics - India
Total population to increase by 49% between 1991 and 2016 Number of elderly ( >60 years) to increase by 107% to 113 million. The share of the aged in the total population will be 8.9% in 2016.

Persons at age 60 today are expected to live beyond 75 years of age. Hence an Indian worker needs to have resource to support himself for nearly 15 years after retirement.
Source : Project OASIS Report, January 2000
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Total Population and Workers

Total Population 1027 Mn. Total workers 403 Mn. Agriculture 235 Mn. Industry 17 Mn. Other [service sectors] 151 Mn

Source Census 2001

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Age-wise composition of Indias Population [Projected]

Population [million] Years 2000 2025 2050 0-14 347 337 285 15-59 593 865 938 >60 77 167 308 Total 1017 1369 1531 % to total 2025 2050 24.6 18.6 63.2 61.3 12.2 20.1 100 100

2000 34.1 58.3 7.5 100

Source: Population Division of the Department of economic and social Affairs of the
United Nations Secretariat, World Population Prospects. The 2002 revision and World Urbanization Prospects: The 2001 revision. http//esa.un.org/unpp.

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Three major trends

Improved Life Expectancy. Increased aspiration and lifestyle after retirement. Decline in the Joint Family System.
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Elements of the Indian pension system

Occupation based, earnings related, employer employee participation, insurance coverage Provident Fund, pension and gratuity Provident Fund is the main pillar for retirement income offering lump sum benefit Employees Pension Scheme, introduced in 1995 by partial conversion of Employees Provident Fund scheme Government employees receive a non-contributory, defined-benefit, indexed pension besides GPF Gratuity a second tier of lump sum benefit Voluntary schemes PPF, LIC schemes etc.
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Current Pensions Schemes

Government [Central +States] Schemes Mandated Schemes Private Sector Employer Sponsored Private sector schemes Targeted Social Assistance and other Welfare Funds Voluntary Schemes Other Informal Schemes[including Gold as a Insurance/Pension instrument]
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Characteristic of Government Pension Scheme

Government Employees Pension Scheme(GEPS) Characteristics Coverage Contribution Pension Formula Defined Benefit The scheme covers all government employees Participants make no explicit contribution Pension = 0.5 x wage x min (t, 33)/33 where t is the service period

Vesting Period Benefit Payout Pattern

10 years Monthly Annuity

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Characteristic of Government Pension Scheme

Government Employees Pension Scheme(GEPS)

Minimum and Maximum Benefit Indexation

The minimum monthly pension floor for GEPS is INR 3500 and the maximum is INR 45000 per month
It is indexed to the Consumer price Index [CPI]. The indexation benefit known as Dearness relief is revised twice a year. The relief is payable in addition to the calculated amount shown above using the pension formula.

Commutation

Maximum commutation of 40% is permissible. The commuted portion is restored after 15 years of retirement. Covers Longevity and inflation.
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Risk Coverage

Gratuity
Lump sum payable on retirement / death Amount payable based on length of service and last pay drawn , subject to a ceiling of INR 350,000 Governed by a payment of Gratuity Act, 1972 Three types of gratuity --Retirement --Death --Service

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General Provident Fund

DC scheme , employee contributes 6% of basic pay Provides for lump-sum payment on retirement / death Employees contributions are accumulated and earn administered interest

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OTHER NON-PENSIONARY BENEFITS

Encashment of earned leave Central government employees Insurance scheme Contributory Provident Fund for nonpensionable employees

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Schemes for Employees of State Government / Public /Local Bodies

On the same lines as those for Central Government Employees

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Change in Central Government pension expenditure1990-91---20002001

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Mandated Provisions for the Private Sector

Applicable to 180 industries and classes of establishments notified by the government and covered by the EPF & MP act 1952, and which employ 20 or more persons

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Schemes

Employees Provident Fund Scheme -1952 Employees Pension Scheme - 1995 Employees Deposit-Linked Insurance scheme 1976

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Management

Employees Provident Fund Organisation(EPFO) Coal-miners Provident Fund Assam Tea Plantation Provident Fund Jammu & Kashmir Provident Fund Seamen Provident Fund
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Coverage and Contribution

As on March 2009 Total number of establishments is 573063 Members 47 million . Total contribution in
EPF : Rs 287 billion EPS: Rs. 104 billion. EDLI: Rs 4billion Total contribution Rs 395 bn Cumulative assets Rs 3174 bn
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Synoptic View of the mandatory schemes

EPF[1952] Accumulation plus interest upon retirement, resignation,death. EPS[1958] EDLI[1976] Provides lump sum benefit upon death while in service, Equal to average balance in the EPF account during the preceding 12 months of death if average balance is less than Rs.35,000 In case of average balance exceed Rs 35,000 amount paid will be Rs.35,000 plus 25% of average balance in excess of Rs, 35,000 up to Rs.60,000 Monthly benefits for superannuation / retirement,disability, survivor, widow(er), children. Partial withdrawals Amount of pension based allowed for specific on the average salary expenses such as house during the preceding construction, higher education, marriage, illness twelve months from the date of exit and total years of employment. Minimum pension on disablement. Past service benefit to participants of Family pension Schemes 1971

@Prof.R.Vaidyanathan,iimb 24 Note:EPF:Employees provident Fund Scheme,,EPS:Employees Pension Scheme,EDLI: Employees Deposit Linked Insurance th Source: 50 annual Report EPFO-2002-2003,pp9,Ministry of Labour, GoI, New Delhi

Funding of Mandatory Schemes

Items Contributions [as % of wages] Employer Employee Government EPF[1952] EPS[1995] EDLI[1976] Total Contribution

3.67[175industries] 1.67[5 industries] 12[175 industries] 10[5 industries] Nil

8.33% Nil 1.16%

0.5 Nil Nil

12.5[175industries] 10.5[5 industries]

Total Funding

15.67[175industries] 11.67[ 5 industries]

1.1

9.49

0.5

25.66[175 industries] 21.66[5 industries]

Administrative Charges by employer:unexempted[%of wages] Inspection Charges by Employer:Exempte d[%of wages]

Paid out of EPS fund

0.01

0.18

N/A

0.005

@Prof.R.Vaidyanathan,iimb Note:Jute,Beedi,Brick,Coir other than spinning sector,and Guar Gum are the five industries Source:50th Annual Report, EPFO,2000-2003,pp9.Ministry of Labour, GoI,New Delhi

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Voluntary Schemes
Public Provident Fund [PPF] LICs Pension Plans --Jeevan Dhara --Jeevan Akshay --Jeevan Suraksha etc UTI Unit Linked Plans Personal Pension Plan of Private Life Insurers [HDFC , ICICI, ING, METLIFE, etc] Varishta Bima Yojana LICs group superannuation plans
Tax exemption up to Rs 10,000 of contribution
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Social Assistance schemes

National social assistance programmes --National Old Age Pension Scheme(NOAP) Annapurna Scheme Pension for freedom fighters

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Other Traditional Arrangements

Joint family System Transfers from children / family Community based old age homes/ charity Continuity in work after retirement

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Problems with the Indian pension system

Population aging Narrow coverage Inequity Underperformance of provident funds Rising financial burden of public schemes Government control

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Government Pensions--Issues
Central Govt. Pensions 1990-91 to 2001-2002 by a CAGR of 21%. Dependency Rationearly 60% Replacement Ratio [If Pension/gratuity/GPF is combined]more than 100% States Pension as share of total revenue increased from 2% to 11% during 1980-81 to 2001-2002 During 1995-2000 State pensions grew at 30% Revenue Grew at 11% expenditure at 15%
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Mandatory Schemes--Concerns
Administered interest rate Real Rate of return inadequate [1986-2000: 2.7%] Prescriptive investment norms--90% in Government /Public Sector securities Significant withdrawal and less final sum Portability--difficulties Asset management skills need enhancement

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Emerging Trends--Economic
India one of the fastest growing Economies Growth Rate more than 6% annual [last decade] Current fiscal[2003-2004] to grow at 8.1%[advanced estimate CSO] Poverty Ratio declined from 55% to 24% [1973-74 to 1999-2000] 65% of Household have at least one of the six consumer durable [ Radio,TV,Telephone,Cycle,Scooter,Car] Savings Rate around 24% Household saving 90% of Savings Provident and Pension funds 24% of household Financial savings 12.8 mn. Households[ 19 mn.individuals]8% of all households invest in shares/bonds

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New pension products: Design issues

Income of the self employed is volatile and hence flexible contribution with minimum annual contribution Tax deductible contributions be related to age Carry forward benefits Pension products in combination with insurance products would fund the needs of the dependents Withdrawal facility on premature retirement / disability Investment of the funds based on life cycle model Portability of the pension scheme

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Expansion of pension coverage Structure of the voluntary pension market

Voluntary retirement benefit schemes available to the selfemployed sector are more like tax savings schemes No contribution by the government for the retirement benefit schemes of this sector Schemes are not addressing the needs of the self-employed
No tax benefit to the firm for contributing to a partners pension benefits No past service benefit No carry forward of the benefit to the subscriber

Investment norms of funds are skewed towards government and semi-government securities
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Policy Options
Reforms in Govt. Pension system [Initiated--from DB to DC for post 1-1-04 entrants, PFRDA, State Level Reforms etc] Reforms in Mandatory Schemes [Initiated: returns/management/national id/ computerizations etc] Enhancing the coverage [ Pilot scheme started in fifty centers for unorganised sector] Leveraging on Gold [Voluntary Schemes]
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