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Rational Expectations


By Sunil Jain, Business Standard 


September 8, 2008




One of the reasons why the government is so keen to break the Employees Provident Fund Organisation (EPFO) monopoly over retirement savings is that there is a belief millions of ordinary Indians are desperate for this. That, though the EPFO has just 10-12 million members in a country which has 450 million workers, this is because it is badly run and has not marketed itself well; once the market is opened up, and new private/public pension fund managers come in, they will aggressively start selling products and induce people to come and sign up. Indeed, the latest Invest India Economic Foundation/IIMS Dataworks’ all-India survey showed 80 million individuals were keen to start saving for retirement — according to Invest India, based on their incomes and willingness to invest, this will generate a corpus of Rs 190,000 crore within just three years, rising to Rs 1,203,538 crore by 2019-20 (see “Bye bye EPFO,” 3/7/2008).

There is little doubt the Invest India number is right — after all, if someone asked you whether you wanted to invest for your retirement, after explaining why you needed to, the chances of your saying yes are pretty high. But it’s one thing to want to save and quite another to actually do so. One way to see just how difficult it is to translate intent into purchase behaviour is to look at the performance of the Public Provident Fund (PPF) system in the country.

The PPF, as most know, is one of the simplest accounts to open and the most accessible — it requires a minimum deposit of Rs 100 in a year and can be opened in any post office or large bank in the country. That is, you can’t get a network of distribution points that’s better than this anywhere in India. It is fully guaranteed by the government, so there’s zero risk of default. And while the PPF has no investments of its own, the rates of interest it offers are more or less at par with those offered by the EPFO each year — the EPFO, in turn, invests only in government bonds and other blue-chip debt paper. In other words, the PPF is probably as close to the zero-risk default option that the Pension Fund Regulatory Development Authority (PFRDA) plans to give once it opens up the retirement savings business to more players. The PFRDA will allow subscribers to choose their own investment plans — so you can have your savings invested in equity for a few years, then in debt, and so on — but since most people don’t have the investment savvy to make smart choices, there has to be a default zero-risk option as well.

Yet, the fact is that there are just a little over 3.5 million PPF accounts in the country (2 mn for people in the 18-59 age group), 48 per cent of which are in rural areas (that’s the distribution angle!). The reason for this low number, most will argue, is that since the scheme is government-run, it is simply not marketed well.

That may indeed be true, but why don’t we spend a minute on mutual funds since they’re as many of them that are privately-run as they are those run by government-owned banks and financial institutions. The number here is higher than for PPF accounts, but at 5.3 million (in the 18-59 age group), it isn’t that much higher, either.

Before we try to figure out why even privately-run mutual funds haven’t been as successful as we’d have thought, it’s worth looking at what the similarities are between PPF and mutual fund investors. There are the obvious dissimilarities — while 60 per cent of PPF investors have annual incomes under Rs 100,000 (going by the Invest India figures), the figure’s just 8 per cent for those investing in mutual funds. The stunning similarity, according to the IIEF/IIMS Dataworks latest survey, is the large proportion who invest in life insurance — while over half the PPF investors have life insurance policies, the figure is as high as 90 per cent for mutual fund investors. Not surprising then, that there are over 105 million holders of life insurance policies in the country today — the number of actual policies, of course, is a multiple of this number.

So why are there so many people with life insurance? A large part has to do with LIC’s branch network, but that still can’t beat the postal network, can it? One other possibility that may have something to do with this is the huge margins distributors of life insurance got. These range from 8 to 30 per cent of the first year’s premium (and then a smaller proportion in later years) versus 2.25 per cent in the case of mutual funds and around half this in the case of PPF. So, if a bank or a financial services firm is selling a product, chances are it will push insurance products first.

Given this, it’s obvious that while finalising the details of the new pension scheme for non-government employees, PFRDA chief Dhirendra Swarup will have to keep these relative commissions and their incentive effect in mind if he wants the scheme to succeed. The problem, however, is that pension fund subscribers want to keep this commission as low as possible. In any case, with firms like UTI, LIC and SBI agreeing to become PFRDA-certified pension managers at commission rates as low as 0.03-0.05 percentage points, it’s difficult to see how a significantly higher number can be accepted. If commission levels are so low, it is unlikely the new pension fund managers will be able to do much to really market their schemes. So, unless Mr Swarup is able to come up with an imaginative resolution to the problem, he may as well not waste time coming up with ways to operationalise the new pension scheme

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