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Towards Retiring An Old Pensioning SystemAs life-spans go up, economic security for the elderly is becoming a key issue

 By Sitanshu Swain, Indian Express

 August 30, 2003

The debate on pension system reforms as part of developing social security is intensifying. The Centre is working on a blueprint for this. The country today is in the phase of rapid demographic transition. Consider the demographic profile: average life expectancy is projected to be around 80 years by 2020 or plus 20 years from the current level of 60 years!

In fact, the number of old people aged 60 and above is expected to move to 8.9 per cent of the population by 2016 (around 13.5 crore). Thus, the average worker will need adequate savings to support approximately 15-20 years of retired life. Can our domestic financial system meet these challenges posed by senior citizens in the future? A failure only means social chaos and more pressure on the delicate socio-economic fabric of the nation.

Significant reforms have been made in banking, capital and currency markets. This now provides an opportunity to revamp the hitherto untouched sectors like insurance and pension. With insurance reforms already underway, it is expected that the effect of these changes will percolate to the private pension market. A variety of issues exist in the pension system in India. Over one-eighth of the world’s elderly live in India, and a majority of them are not covered by any formal pension system: they rely solely on their earnings and support from their children.

A gradual erosion of traditional old-age support mechanisms and the rise in elderly population highlights the need for strengthening formal channels of retirement savings. As of now, there is skewed coverage of the existing benefit schemes. It favours the organised work force even as informal employment is on the rise. There has been a worsening of the financial situation of government pension schemes against a background of rising expenditure, an underdeveloped private annuity market and finally, the need to increase the domestic rate of savings through higher contractual savings, to strengthen the capital markets.

In the United States, the 401(k) Scheme launched 22 years ago, has $2.1 trillion in assets, 45 million participants and is growing at 15 per cent per year! In India, while retirement saving schemes like provident and pension funds predominantly cover workers in the organised sector, constituting only 10 per cent of the aggregate workforce, these schemes have not been able to add real value, as the investment options are restrictive and pre-defined. These retirement savings invariably go into government paper, and in the process substantially increases long-term liabilities. Around 90 per cent of the working population are today engaged in the unorganised sector which includes professionals such as doctors, lawyers and small businesses all over the country, which have no access to any formal pension saving system of old-age economic security.

The skewed coverage is further shrinking, as the informal workforce is growing while the size of formal workforce has remained more or less stable. Additional impetus for the pension reform comes from the fragmented nature of the existing benefit schemes. While private sector workers are aggrieved with low returns from their benefit schemes, public employees enjoy generous pension provisions that do not have long-term sustainability. One of the best ways to ensure compliance and expand coverage of pension programmes around the world is to motivate and incentivise participation in these programmes.

The task of providing pensions could be divided into the accumulation stage and the payout annuity stage. Only asset management companies, fund managers and specialists in retirement products with global expertise and experience in managing and understanding pensions, who have demonstrated strong administrative, record-keeping and investment management expertise could be allowed to participate in the pension business, says the Association of Mutual Funds of India’s (Amfi) chairman, AP Kurien.

Investment management expertise, coupled with the capability of offering a combination of administration and low-cost transaction processing would significantly benefit citizens. Other than the above detailed issues, there are a host of other very critical issues that need to be addressed, while putting in place a sound pension system in the country. Various issues relating to:

* Fund managers, fund management issues, fund management fees/penalties

* Costs and expenses relating to the system, types, of investment options to be offered to the investors, along with their portfolio compositions* Portability and flexibility that the new system will offer investors

Tax implications/ breaks/ incentives etc for the investors

The Centre is in the process of formation of the Pension Fund Regulatory and Development Authority (PFRDA) by an administrative fiat and setting up of central record-keeping authority for providing depository-like services to the pension account-holder will be announced by the end of the current calendar year. The PFRDA will primarily supervise the initiation of fund management till the stage of annuity. The pension authority will ensure transfer of accumulated funds to any life insurance companies for annuity purpose and also to the account-holder if he wants it. Though more than six players will be allowed to manage the government pension funds and the mobilised funds of the unorganised sector, the Centre will like to fix a number to the total number of funds which will be allowed.

The Centre will follow the exempt and tax (EET) system for tax treatment of pension funds, which basically means there will not be no tax at contribution and accumulation stage, but the money which will be refunded to the pension account-holder will be taxed. The centre is also actively considering to increase the current limit of Rs 10,000 for tax exemption. No withdrawal is allowed from the pension fund till the age of 60. There will be a Tier-II fund for the pension account-holder from which he can withdraw money.

The joint secretary in the Ministry of Finance, UK Sinha, was blunt enough to say that the Centre does want to make pension fund management an ‘attractive proposition’ for players. “We are determined to control the cost and PFRDA will come out with entry guidelines for the prospective player”, Mr Sinha had said adding that there may not be enough for everybody which can create unhealthy competition. Mr Sinha expects that though the pension industry will start with two funds, including funds out of a new pension scheme and unorganised sector, later more funds from the organised sector, exempted funds and state pension funds will be joining the bandwagon.

The Centre will also ensure job portability while opening up the sector as the account-holder can shift his account from one fund manager to another through the registrar and where the consent of his existing fund manager will not be required. “All fund transfer and account transfer can be done electronically without any exit load”, Mr Sinha explained. The search for the pension depositary is on and the government will choose one of the existing depositaries. Overseas investment will be permitted by pension funds and the Centre will not guarantee protecting the investment risk which will be borne by the investors.

“The intermediation cost would be an important criteria for us in selecting the fund managers to manage the pension assets”, said the additional secretary in the Ministry of Finance, P Ghosh, adding that there would be no subsidy for the schemes. According to Mr Ghosh, the market supervised by a pro-active regulator will have its own safety rules to provide solution for non-performance or default rather than look for government guarantees. Clarifying the role of the insurance companies in the proposed pension scheme management, M Ghosh explained that insurance companies have a role in managing the annuity component of pension fund business. The government will also look at foreign expertise in the sector and would not make individual contribution mandatory for the pension accumulation.

However the private sector liberalised insurance industry which already have pension schemes have found major faults with the proposed scheme. There is no need for a separate regulator for supervising the pension sector funds and existing insurance companies should be allowed to manage the proposed pension funds. The Insurance Regulation and Development Authority of India (Irda) with an extra division can manage the regulations. So do we need another Reserve Bank of India type entity to monitor non-banking finance companies”, asks SBI Life’s managing director & CEO, R Krishnamurthy.

According to Mr Krishnamurthy, as a confidence-building measure for the proposed pension reforms, fund managers or life insurers should take the investment risk and investors should be allowed to play safe. “The Irda had devised a simple, standard pension plan for all life insurance companies to offer to the public which is an excellent idea and could be implemented instantly”, he avers.

Agreeing with Mr Krishnamurthy, HDFC Standard Life’s managing director & CEO, Deepak Satewalekar, rejects outright the idea of limiting the players in the proposed pension plans. “There is no reason to keep the life insurers away from the proposed pension scheme. We do not want to set up another company for exclusively undertaking pension activities”, he observes. Fervently pleading to expand the ambit of the pension reforms plan to include existing mutual funds and has given so many representations to the Centre. “Asset management companies may prove to be worthy contenders for distributing and marketing pension products as they have readymade infrastructure to distribute such products”, explains Mr Kurien.

Along with the recommendations of the two committees — Dave Committee’s OASIS report and Irda report on Pension Reforms — the Centre has taken a long time to arrive at a proper solution to the nation’s greying problem. The least one expects it not to be a faulty one.

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