201203 pension system and management in indias01.qind.nl/userfiles/390/file/mahler...

Pension System

And

Management in India

WHITE PAPER PRESENTED BY MAHLER INDIA GROWTH FUND

Mahler Fund Management B.V.

P.O.Box 75801 1118 ZZ Amsterdam

The Netherlands Tel: 023-‐5563240

Email: [email protected]

P.O. Box 75801 | 1118 ZZ | Amsterdam | +31 23 5563240 | [email protected] |www.mahlerfunds.com Chamber of Commerce Amsterdam No. 53020991

1

An overview of the Pension System in India

As one of the weakest pension system in the world, Indian formal pension schemes cover only

11% of its workforce, which largely contributed from Government Pensions. The persistent high

rates of poverty and unemployment in this country deter the government to institute a

comprehensive financed state pension arrangement. Today, major retirement schemes in India

include provident fund, gratuity and pension schemes. The Employee’s Provident Fund

Organization (EPFO), which is mandatory for the organized sector and which offers a provident

fund and a pension scheme. The EPF requires equal contributions by both the employer and the

employee. The EPFs can be administered by either the firms themselves or by public agencies.

Another scheme is the Employees Pension Scheme (EPS), is a defined benefit, government

guaranteed scheme. It is covered by separate law, manages more than $50 billion worth of assets

for around 40 million employees and paid a 9.5 percent return in the fiscal year that ended in

March 2011.

Current regulation changes and developments

In general, these schemes are largely the privilege of the organized sector workers. The majority

of Indian sectors are unorganized and informal companies, which account for 89% of Indian

economic, could only access a few voluntary schemes like Public Provident Fund and pension

plans offered by the Life Insurance Corporation of India. In short, the underdeveloped private

annuity market, under performance of provident fund schemes and low coverage of the

unorganized workers had brought to light many shortcomings for Indian pension system.

In 2003 the Government of India established the Pension Fund Regulatory and Development

Authority (PFRDA) to develop and regulate the retirement management sector in India. Under this

scheme, PFRDA launched a New Pension System (NPS) in 2009 to act as a voluntary defined

contribution pension system to provide sustainable and efficient old age income with reasonable

market returns in the long term for all citizens.

The New Pension Scheme brought about a paradigm shift in the entire concept of pension as a

social security measure. Now the pension will be based on “defined contribution” meaning

thereby that the pension amount will be governed by what the employee’s “pension fund

account” can earn from investment in the market. The NPS does not ensure any assured amount


2

of pension to the employee despite his life-long contribution to his own pension fund. Both the

Pension Scheme notified by the government and the PFRDA Bill (both 2005 and 2011) mentioned

in clear terms that “There shall be no implicit or explicit assurance of benefits except market

based guaranteed mechanism to be purchased by the subscriber”. Two types of accounts are

suggested under the NPS:

- Tier I, mandatory, funded by 10% of Basic + DA from each Govt. and Employee,

no interim withdrawals allowed

- Tier II, voluntary, withdrawals allowed anytime, no tax concessions

The feature of NPS is its significant low cost. The scheme is designed to be affordable especially

for the 90% of the workforces who are not covered by a formal retirement scheme. Currently

the fund managers, managing pension contribution of government can invest up to 15% of funds

in equity, while the All Citizen’s Scheme i.e. unorganized sector funds can invest up to 50% of

assets in equity. The passing of the PFRDA bill in India would allow pension fund managers to

invest up to 50% in equities (instead of the present cap of 15% in equity and 85% in bonds or

100% in gilts) – thereby opening up lots of opportunities for international asset management

firms. In practical terms, the implementation of the NPS has been progressing slowly, especially

regarding the numbers of participants from the informal sector. To create an incentive for

informal sector workers to join NPS, the government has contributed Rs. 1000 per year to each

NPS account opened in the year 2010-11. This initiative, “Swavalamban” will be available for

persons who join NPS, with a minimum contribution of Rs.1000 and a maximum contribution of

Rs. 12000 per annum during the financial year 2010-11. The scheme will be available for another

three years.

India's $80 bn. Employees' Provident Fund Organisation has hired four new fund managers to

invest its money, while its sister scheme, the New Pension System, is reviewing the rock-bottom

fees -- just 0.0009% of assets -- that managers are allowed to charge.

The EPFO, the elder of the two pensions organisations, has been reviewing its managers in 2011

for several months. State Bank of India, which was entrusted with the entire fund temporarily

since March 2011, was allocated 35% of the money to manage on an ongoing basis ($28bn).


3

The new line-up is completed by HSBC Asset Management and Reliance Capital Asset

Management that have 20% each.

The NPS, a defined-contribution scheme set up in 2004 for state workers and opened up to the

general public in 2009, has so far struggled to draw in members. It currently only has about

50.000 out of a workforce of 480 million, and about $1.9 bn. assets under management.

Fund managers and financial groups express their reluctance to adopt the system to the public

because of the challenging fees. Managers earn just 0.0009% of assets for investing the money,

while distributors earn minimal one-off fees for each new member signed up. Currently there are

discussions to raise the management fees and also to pay distributors 0.5% of the assets that

workers invest. Until recently, managers agreed to a low fee to gain exclusivity. In the same

token, if the fees are to be increased now, the exclusivity will decrease gradually.

In short, 7 fund managers are currently managing the NPS: LIC Pension Fund, SBI, UTI Retirement

Solutions, IDFC Pension Fund Management, ICICI Prudential, Kotak Mahindra and Reliance

Capital. They cover over a million employees in India.

India may allow foreign investment of up to 26% in the pension sector, giving global players

access to a roughly $2 bn. pool of assets that is expected to grow quickly as more people join

the organised workforce. Foreign firms have been lobbying for liberalising access to the

pension and insurance sectors in a fast-growing country where most of the 1.2 bn. population

lack such investments.

Most of the 23 life insurance players in India, nearly all of which have a foreign partner holding a

26 percent stake, are eager to enter the pension fund market with at least the regular third pillar

products. Global players holding stakes in Indian operators include Aviva, AIG, and AXA. The

pension and the insurance bills are still being examined by a parliamentary panel.

The major obstacle for a smooth approval is the fear of especially Unions (CITU) that pension

investments can become a source of funding for foreign investment companies who have

earned the reputation to take risks and not always deliver returns. Still the government wants to

keep the avenue fully open for FDI investment if the new bill will be adopted.


4

Future opportunities and challenges

Looking forward, the NPS in India has thrown up an entire new dimension for Pension Asset

Management locally. It is estimated that pension assets under the NPS will be USD 175 billion by

2015. Without doubt, the Indian pension system still has the long way to go, yet it provides many

opportunities for experienced international experts in Pension fund arena to step in various forms

of collaborations. According to a study conducted by Mercer (Melbourne Mercer Global Pension

Index, October 2011), certain key improvements to the Indian system provide excellent

opportunities for foreign ventures in the pension management market in areas such as :

▪ improving the regulatory requirements for the private pension system

▪ improving the level of communication from pension arrangements to members

▪ increasing the pension age as life expectancy continues to increase, and

▪ increasing the level of contributions in statutory pension schemes.

Given the relative stages of development of the retirement industry in India, there are indeed

various points for cooperation to be found.

Privately managed EPFs ,for instance, can be outsourced to foreign pension fund managers who

have abundant experiences and expertises. Similarly, the government managed funds could seek

professional expertise from their foreign counterparts. This mutual learning can not only

accelerate the knowledge transfer to India but also allow foreign pension fund managers to

better diversify their portfolios by investing in India. In light of the small size of present Indian

pension fund market, sector-wise pension plans might be the most appropriate model for

implementation. For example, agriculture is the dominant industry in India and therefore

agricultural sector pension plans could be setup for each state. This scheme will cater to the

needs of all farmers within the zone and would be managed privately- outsourced to foreign

pension professionals with the advantages of manageability and feasibility. Even further, large

foreign pension fund managers could partner their Indian counterparts and form a joint

collaboration to manage Indian pension funds. As an alternative, marketing the pension schemes

run by Indian branches of foreign could be the simplest first step in this process.


5

The challenge of creating an inclusive, affordable and fair pension system is immense, but as the

experiences internationally shows, it is still possible. Structures, terms and conditions constantly

need to be revised and adapted to economic, cultural and demographic changes. For foreign

experts who aim at expansion in India, it means their investments will not have significant returns

in the short term; however, it might bring tremendous growth from the long term perspective.

Another difficulty would come from the unfamiliarity of the local capital market. Compared to

the EU for instance , India is a relatively young emerging country and its capital market has not

achieved maturity yet. It would increase the complexity for foreign investors and pension

expertises to apply their investment knowledge into the Indian market. But foreign investors are

already there and benefit from local expertise.

Pension fund industry has a very bright future in India. Favourable savings pattern, growing life

expectancy and government initiatives like pension reforms are making India as one of the

potential prospects for investors looking for pension businesses.

The majority of working population in India expects to have better quality of life or at least

maintain the current living standards after retirement. This is the prime reason why pension plans

today account for around 39% of insurance industry’s total business. The Life insurers’ pension

and annuity funds are forecasted to grow at a CAGR of around 39% between 2008-09 and 2012-

13. However, more potential lies under the New Pension System (NPS) proposed by the central

government.

This overview Paper has been prepared by Mahler Fund Management Research. NOTE: Mahler Fund Management BV (“Mahler Funds”) is providing this document to you for informational and educational purposes only. This information is intended to provide a

general overview of the topics discussed. Information and opinions expressed by us have been obtained from sources believed to be reliable. MAHLER FUNDS makes no

representation as to their accuracy or completeness and MAHLER FUNDS accepts no liability for losses arising from the use of the material presented. References to legislation

and other applicable laws, rules and regulations are based on information that MAHLER FUNDS obtained from publicly available sources that we believe to be reliable, but have not

independently verified. You should consult with your personal legal, accounting and tax counsel to ensure the proper interpretation and application of all legislation, laws, rules and

regulations, whether or not cited herein, as they apply to your situation. © 2011 Mahler Fund Management BV and/or its affiliates. All rights reserved.

© 2011 Mahler Fund Management BV and/or its affiliates. All rights reserved

201203 pension system and management in indias01.qind.nl/userfiles/390/file/mahler...

Documents