India: Contributory pension system: Approach with caution

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India: Contributory pension system: Approach with caution

S. Subramanyam

December 23, 2003

By 2016, the number of Indians above age 60 is expected to exceed 113 million and comprise 8.9 per cent of the population. And projections suggest that by 2026 the aged will form 13.3 per cent of the population. This has serious implications for social security, particularly because the traditional systems that provide income security, such as the joint family system, are increasingly unable to cope with the enhanced life span and medical costs during old age. It was realized that only a contributory pension arrangement could help address the problem.

To seek recommendations on a contributory pension system, the Ministry of Social Justice and Empowerment commissioned a national project, Oasis (the Old Age Social and Income Security), to which it nominated eight experts in 1999.

Since the submission of the Oasis report, the issue of setting up a separate regulator for the pension sector had been debated. Views varied widely on this issue. The report favored a separate regulator. Others had advocated the setting up of a single regulator for the entire financial sector.

Another view was that pending a wholesale change from the current system of multiple regulators to a single regulator, the pension sector may also be looked after by the insurance regulator. The insurance regulator was, thus, asked to temporarily hold the `pension baby'.

The final decision has now gone in favor of a separate regulator for the pension sector. Thus, the Centre recently announced its decision to set up a five-man Interim Pension Fund and Regulatory Authority.

It is to be headed by a chairman with a rank of no less than a secretary to the government, and four other members. The nitty-gritty of the structure and systems are yet to be announced. The lobby for a separate regulatory body had been powerful enough for its view to has prevailed.

Marketing potential

The sky is the limit for pension marketing. It does not need any great effort, and one hardly needs to look at the statistics to foresee how huge the pension market will be in a few years. A recent article "Shake-up of pension market will make for better public finances," (Business Line, November 26) put it at Rs 3.5 lakh crore. Indians are proverbially savings-conscious and selling the idea of pension provision is not difficult. The Government's policy of going cautiously in this regard is appropriate.

Going by media reports, the Government seems to be toying with the idea of permitting pension funds to invest up to 50 per cent in equities. It also seems to have an open mind on introducing new and innovative financial instruments.

While fund managers operating in a competitive environment, and with the sole objective of maximising returns, would certainly like to opt for innovative instruments and diversify their investment portfolios, there is need for caution.

A few trends followed by Western countries, and the related pitfalls, need to be noted by all concerned. These and other related issues obviously call for more detailed consideration at the regulatory and government levels and need to be debated both inside and outside Parliament when the relevant draft legislation comes up.

Developed countries' experience

Financial Times columnist John Kay recently wrote in an article: "The real culprits in Europe's pensions crisis" that "market gyrations are a greater threat to livelihoods than demography, and the financial services industry is part of the problem and not the solution." Note the caution from one who is the most outspoken advocate for economic reforms, globalisation and market economy.

He adds: "The incompetence and lack of professionalism of people employed by the Financial Services Round Table have created such extreme equity market volatility that this market cannot now provide a secure basis for the retirement savings of 347 million people. After Enron and Equitable Life, as bonus rates tumble and occupational pension schemes are closed, a period of silence from the financial services industry on the superiority of private to public pension provision is appropriate."

UBS' unconventional views

Only last month, a new — and controversial — report from the highly rated UBS Fund Management said that "pension funds should consider not investing in equities at all". Says Norma Cohen, reporting this study for The Times, London that this goes against the "conventional wisdom followed by American and British pension funds in the last 40 years" . The paper quotes analysts Stephen Cooper and David Bianco as saying: "We believe that the case against equity investment by pension funds is robust and worthy of serious consideration." These analysts were aware that their caution would be harshly received in some quarters.

They added that they recognised the controversial nature of the subject and the wide range of opinions held, including among their own colleagues.

It needs to be noted that roughly 60 per cent of the average of pension funds in the US and the UK is invested in equities. In an editorial "Accounting for retirement," Financial Times observed recently: "Enron has become a byword for dishonest accounting. But a bigger and far more widespread scandal is beginning to emerge.

As the tide of the bull market goes out, the state of corporate defined pensions stands revealed, with dire consequences for corporate finances and the security in retirement of tens of millions of people.

Globally, according to Watson Wyatt, pension funds have lost $2,700 billion since 1997 and the total funding deficit is now $2,700 billion. In the case of pensions, there are two big questions. The first is whether scheme managers should assume superior returns on equities."

So, the performance of fund managers needs to be watched carefully and periodically, not only by the regulators but by experts and the financial press.

LIC's new pension scheme seems to have become popular. That it should have committed to a guaranteed return in the face of what happened to the 253-year old Equitable Life in the UK is surprising. Similarly surprising is the Centre's commitment to fill the gap between the actual return and the guaranteed 9 per cent.

If we analyse the break-up of sales and the profile of those who buy these plans — paying, cash down, Rs 2.16 lakh — it may reveal that at some point in time, the tax-payers will have to bear the burden of fulfilling the returns promised to these "wise investors."

This issue also needs consideration from the point of view of social equity.

Regulatory chief

The selection of the chief of the pension regulatory body and its top personnel is another important issue the Government will have to carefully deal with.

The Government has been following a policy of appointing top civil servants for manning most regulatory bodies. They can bring to bear the administrative expertise necessary for nurturing this infant body and ensure co-ordination with the insurance regulator.

This is a better proposition than the one where the incumbent selected to police the industry comes from the same industry. At the same time, the Government will have to pack this new body with expertise in pension fund management.

Professional groups such as chartered accountants, lawyers and finance experts are being mentioned. The Government should consider the appointment of eminent senior actuaries as members. An experiment such as the one the UK government has tried, of having a chairman different from the CEO for the financial services authority, may also be considered.

Mumbai again misses

Another key issue is the location of the pension regulatory authority. With the authority to be headquarters in New Delhi, once again Mumbai has missed its justifiable claim to have the headquarters of the pension regulator located in India's business capital.

That the Government does not have an integrated policy in this matter is seen from the way it handled the issue of the insurance regulator's headquarters, initially located in New Delhi. Due, however, to the political clout of the Andhra Pradesh Government, the headquarters of the insurance regulator has been shifted to Hyderabad.

Even at the time the report was released, the Oasis chairman had said he favoured the location of the pension regulator's headquarters in Mumbai.

The Maharashtra Chief Minister, Mr Sushil Kumar Shinde, making his presentation before the Twelfth Finance Commission, asked for some Rs 6,000 crore to provide Mumbai with suitable, world-class infrastructure to make it a financial hub. He reiterated his government's Goal of making Mumbai another Singapore. Or, in keeping with current fashion, Shanghai. McKinsey & Co. recently published a plan for a host of infrastructure projects at a total estimated outlay of some Rs 2,00,000 crore in 15years.Overlooking Mumbai's claims is not in line with the ultimate aim of this plan.

Even a couple of months ago, the Finance Minister, Mr Jaswant Singh, talked of making India a regional centre for financial activities. He said recently in Mumbai that "India has all the capabilities and skills we should use them to make India a regional hub which can provide all kinds of financial services to the entire region."

Making an entire country a hub implies designating certain cities and putting them on fast-track growth. The continued neglect of Mumbai, even on matters which should have come to it automatically, such as the current one, shows that "making Mumbai an international financial centre" is only limited to issuing statements by politicians and experts.

Even now the decision can be changed; it is up to the leadership in Maharashtra to have this matter (location of pension regulator) reopened so that Mumbai's rightful claim is conceded.

The contributory pension system deals with the life-time savings of millions of workers and unorganised labour. There is, therefore, need for a cautious beginning, and the Government and the regulator must consider very carefully various aspects before starting off.