I am happy to deliver the special address in this seminar. I am thankful to the organizers for inviting me to speak on this important subject of “Expanding Old Age and social security”, which is very contextual in today’s CII summit on “New Directions, New Hopes” especially for an economy like India lacking a comprehensive and adequate old age security for vast multitudes of population.
Achieving broad pension coverage and income protection in an affordable and fiscally sustainable fashion has remained an elusive goal worldwide. Greying populations have triggered pension reforms and the focus has shifted from mandatory systems to social pensions and defined contribution voluntary pensions. The demographics of today also indicate an increasing longevity with a more active lifestyle post retirement owing to betterment in medical facilities. With the shift to nuclear families, inter-generational support cannot be the sole source of old age security. Statistics indicate that only about 12% of the total population is covered by organized old age social security schemes in India and workforce in the unorganized sector has limited access to formal channels of old age economic support. Hence creation of a viable old age security system has become an imperative to counter the fast dwindling demographic dividend.
The euphoria over India’s much celebrated ‘demographic dividend’ and the consequent focus on youth has pushed to the background this important trend of a greying India. The share of elderly in population has increased from 5.6 per cent in 1961 to 7.4 per cent in 2001 and is projected to rise to 12.4 per cent by 2026. The absolute numbers will double from 77 million in 2001 to 143 million by 2021. With rising life expectancy and declining fertility, the demographic window of opportunity will close soon and the small cohort of children born during this time will find themselves supporting a large cohort of elderly parents. This trend is already visible with the old age dependency ratio climbing from 10.9 per cent in 1961 to 13 per cent in 2011. Besides, this demographic transition occurred in the developed world at higher income levels while the challenge for India in addressing the coverage gap is compounded by fiscal constraints and the un-affordability of an adequate level of public expenditure for pensions.
However, the onus of funding the entire old age security cannot squarely lie with the government which is already reeling under the pressure of ever contracting budgetary resources. In fact, the current global demographic shift toward population ageing, largely reflecting rising life expectancy and declining fertility has led many countries across the world to re-evaluate their pension systems. Typically, they switch wholly or partially from unfunded systems, e.g. pay-as-you-go (PAYG) or defined benefit system to funded systems like defined contribution system. It is this switch which is responsible for the build-up of Pension Assets in the economies in last couple of decades. This pool of assets is being increasingly looked upon as one of the potential drivers of economic growth.
India’ journey on pension reforms started in the late 90’s with a concern for the lack of old age social security for the unorganized sector but the first set of reforms that were rolled out were for the civil services pensions. The reforms for the unorganized sector have till date remained ‘work in progress’ and what we have today are a set of distinct schemes but not really a pension system.
Notably each of these schemes has come at different points of time, with distinct objectives and is administered by different arms of the government. There is a high probability that there has been no actuarial evaluation in the unfunded schemes either before the formulation or during their implementation, hence the medium term impact on the budget due to demographic transition is not known. A case in point is the civil services pensions where a similar strategy led to ballooning budgets and the then pay-as-you-go pensions had to be replaced by the defined contribution NPS (National Pension System). Even today the pension budgets which contain significant expenditure for the old scheme for a states like Bihar, Orissa, Uttar Pradesh and West Bengal account for more than 25 per cent or a quarter of their own revenues! The situation in the North Eastern states is worse with percentages exceeding 50 per cent in four states of which Nagaland’s expenditure on pensions exceeds 135 per cent of its own revenues. The present central and state government budget on pensions exceeds Rs 1,60,000.crores. It is worth noting that these budgets pertain to the retirees amongst the civil servants who constitute a small percentage of the population. A mono pillar pension system design for the 90 per cent unorganized sector workers, consisting only of defined benefit schemes, as is the case today, will have budgetary allocations spiralling out of control and crowd out development expenditure like infrastructure investments and welfare expenditure on health and education.
The NPS is a highly innovative and sophisticated product and is based on the world’s best practices in the pension sector involving disciplined saving, vigilant investment to build a sufficient retirement corpus and its judicious draw down in the post retirement phase. It was initially launched for government and semi-government employees on 01.01.2004 to put a cap on the Govt’s liability towards Civil Servants pension, unavoidable under the pay as you go system, marking a paradigm shift from defined-benefit to defined-contribution pension system.
As a result of implementation of NPS, all employees of the Central Government and of Central Government autonomous bodies, with the exception of the armed forces, are now covered by the NPS. Besides, 23 State Governments have also joined NPS and 3 State Governments have notified joining NPS in respect of their employees. As of now, around 30 lakh Government employees, from Central and State Governments, have already joined the NPS and the corpus of their contributions is presently Rs 32, 752 crores.
Subsequently NPS has also been made available to all citizens of India on voluntary basis w.e.f. 1st May, 2009. Any citizen of India between 18-60 years of age fulfilling minimum eligibility criteria can join the NPS. Subscribers are eligible for tax benefit and they can also choose the PFM, investment option from the given asset class. Till August 7 2013 NPS had a total of 52.57 lakh subscribers & managed above Rs 35000 crores.
The NPS is a well regulated and transparent scheme. It is portable across geographies and employments. It being technology driven, subscribers can view their accounts online. It has laid down prudent investing norms for the fund managers, and their performance and portfolios are regularly monitored by the NPS Trust under the overall supervision of the PFRDA. The scheme offers complete flexibility to investors in terms of choice of investment mix. The investor decides the percentage of the corpus that goes into equities, corporate bonds and government securities, with the only limitation being, there’s a 50% cap on the exposure to equities.
One of the most outstanding features of the NPS is the “life cycle fund”. It is meant for those who are not financially aware or inclined to manage their asset allocation themselves. It is also the default option for someone who has not indicated the desired allocation of his investments. Under the life cycle fund, the investor’s age decides the equity exposure. The 50% allocation to equities is reduced every year by 2% after the investor turns 35 till it becomes 10%.
This is in keeping with the strategy to opt for higher-risk-higher-return portfolio mix earlier in life, when there is ample time to make up for any possible black swan event. Gradually, as the investor approaches retirement age, he moves to a more stable fixed-return-low-risk portfolio.
This automatic re-jigging of the asset allocation is a unique feature of the NPS. No other pension plan or asset allocation mutual fund offers such a facility to investors. There are a few asset allocation funds based on age but they are one-size-fits-all solutions, not customised to the individual’s age.
NPS-Corporate model also provides a platform to the corporates to co-contribute for the employee’s pension. It also offers flexibility in contributions (equal/unequal) by employer and employee as decided mutually by them subject to the minimum contributions as prescribed by the PFRDA. NPS Corporate model provides flexibility to select the investment scheme either at corporate level or at subscriber level The Corporate model enables the employer to outsource the administrative, recordkeeping & fund management functionsto NPS at no additional burden. Besides, both employer and employee get a tax benefit. At present we have about 850 corporates that have onboarded NPS platform. Besides Many of the CPSUs, despite their keenness to offer NPS to their employees, are fence sitting , awaiting the harmonization of the existing DPE rules requiring minimum 15 years of service before being eligible for any pension.
A unique feature of the NPS is the tax benefit it offers under the newly added Section 80 CCD (2). Under this section, if an employer contributes 10% of the salary (basic salary plus dearness allowance) in the NPS account of the employee, this amount will get tax exemption without any upper limit. This exemption is over and above the Rs 1 lakh tax deduction under Section 80C. It’s a win-win situation for both because the employer also gets tax benefit under Section 36 I (IV) A of the Income Tax Act for his contribution. By contributing to NPS, employer can provide an additional tax benefit to the employee by simply reorganising the salary structure without incurring any additional cost to the company (CTC)
However, NPS is yet to achieve Tax equivalency with other financial products like EPS, PPF etc which have EEE ( Exempt –Exempt-Exempt) status as against the EET ( Exempt- Exempt- tax) status for NPS. However, a level playing field expected with the forthcoming Direct Tax Code (DTC) along with a mandate in favour of NPS , will provide the necessary fillip to the growth of NPS in the organised sector.
The unorganized sector, however, continues to be largely untapped. Lack of awareness and Complexity of the product has also influenced Customer outcome. As the awareness about NPS is low and investors seek financial consultancy before opting for NPS, since 2012, Pension Fund Managers (PFMs), who were earlier ring fenced to perform only fund management, have been directed to the stakeholders to distribute and market the product as well. The Pension Fund managers who are actually managing the investments and get a direct fee on the collected corpus, have a direct interest in marketing an NPS besides having know-how of the product.
Pension funds have an equally important role to play in the inclusive growth of the economy and hence industry will have to come up with innovative strategies and distribution system to tap the ‘Bottom of Pyramid’. In October 2010 GoI launched, a historic initiative to address the old age protection need of the unorganized sector workers. “SwavalambanYojana” is a novel endeavour by GoI to support individuals in the unorganized sector in achieving old age security and dignity. GoI will contribute Rs 1000 per annum to all eligible NPS Swavalamban accounts where the subscriber deposits a minimum of Rs 1000/- to maximum Rs. 12000/- per annum. The incentive is presently available till 2016-17. .As on August 7,2013 more than 20 lakh subscribers have been enrolled under the scheme with AUM of Rs. 648 crs.
When saving for a long-term goal such as retirement, the costs matter a lot. Over 35-40 years, the charges can shave off a significant amount from the corpus. The NPS charges fund management fees of 0.0102% for the government employees and there’s a ceiling of 0.25% for the private sector. This is perhaps the lowest in the world. Account opening, handling and administrative charges are also the lowest, making the cost adjusted returns of NPS quite attractive in the long run. It has been estimated that the all in cost of NPS including the fund management fees, will not exceed 0.50 % per year, making it the cheapest financial product in the country. The returns of the NPS for all citizens have outperformed the market in the last one year ending as on 31.03.2013 with return of 8.39% on equity, 14.19% on corporate debt and 13.52% on Govt Debt . The revised investment guidelines to allow investments in equity rather than through mutual fund route will further drive down hidden costs.
Retirement planning through NPS involves disciplined saving, prudential investment by PFMs to build a sufficient retirement corpus and its judicious draw down in the post retirement phase.The platform offers a plethora of options starting right from the point of contact viz POP / aggregators, flexibility of frequency and contribution amount , the choice of PFMs, investment mix during investment phase, and finally choice of ASPs and a bouquet of annuities to the subscriber to optimise one’s retirement wealth and replacement income as per one’s economic situation in life. For the financially unaware subscriber at the other end of the spectrum, default options like life cycle fund, default PFM , default Annuity service providers and default annuity have been built in the system to nudge him to save for old age with confidence in a financially sophisticated product. In that respect, NPS is probably the only Govt backed broad spectrum, wholesome, universal, technology driven seamless retirement planning product in the country today, which in due course can achieve the objective of providing Universal pension coverage to the increasingly graying millions in India at affordable price, both in the organised and the unorganised sector.
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