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Contacts Details
CRISIL
Jiju Vidyadharan
Director Funds & Fixed Income Research
Email: jiju.vidyadharan@crisil.com

Sandhya Dhar
Sector Head TCL BCCL
Email: sandhya.dhar@timesgroup.com

Piyush Gupta
Associate Director Funds & Fixed Income Research
Email: piyush.gupta1@crisil.com

Sowmia Gopinathan
Manager, Sponsorship Sales TCL BCCL
Email: sowmia.gopinathan@timesgroup.com

Prahlad Salian
Manager Funds & Fixed Income Research
Email: prahlad.salian@crisil.com
Saloni Singh
Associate Funds & Fixed Income Research
Email: saloni.singh1@crisil.com

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ET Edge

RESEARCH

Table of Contents
State of the pension industry.............................................................................4
Scope of the pension industry - past, present and future...............................5
- EPFO a behemoth.....................................................................................5
- NPS the new plan on the block.................................................................6
- Potential for NPS..........................................................................................8
- Defined Benefit-Contribution mix a move to create a universal pension
system..........................................................................................................9
- Accumulation-annuity model Need a long-term system for assetliability
management...............................................................................................10
Reinventing the regulatory wheel.................................................................... 11
- Need to set the NPS design right............................................................... 11
- Need for pension and insurance coordination............................................ 11
Key takeaways from the report........................................................................12

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State of the pension industry

The $36 trillion1 global pension industry has grown at an average 6.0% annually over the past ten years,
led predictably by developed economies, which realise the importance of retirement planning and have
developed financial structures for it.
The industry follows the World Banks three-pillar framework, formed in the late 1990s, which segregates the
major objectives of pension plans as:
Pillar 1: Comprises universal/ standardised social security coverage, covering even the lowest strata
of society. This is the base on which other schemes are developed. Here, the governments of the
respective economies fund the schemes from their exchequer for instance, the US OASDI (Old
Age, Survivors and Disability Insurance) programme, which has nearly universal coverage.
Pillar 2: Comprises occupational pension schemes, where both recipients and employers contribute.
These are mandated pension plans for employees in an organisation; for instance, the 401K plan in
the US.
Pillar 3: This comprises personal savings and investments, such as private pension funds created
by asset management companies.

India presents a unique case. The joint family structure, which traditionally provided a social security net, is
fast giving way to nuclear families. From over 5 people per household in 2001, there were 4.3 per household
in 2011. Within the private sector, only about 8% of retirees receive pension2, while pure pension corpus is
about 2% of the GDP currently3. (Source: CRISIL report)
Global Pension Assets Study 2015, Towers Watson
Pensioner base in the Employees Provident Fund Organisation, Coal Mines Provident Fund Organisation, Assam Tea Plantations
Provident Fund and Pension Fund as per latest available data
3
Assets under Employees Pension Scheme of Employees Provident Fund Organisation data as of March 2013, National Pension
System data as of March 2014 and pension assets of Assam Tea Plantations Provident Fund and Pension Fund data as of March 2012
1
2

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Table 1 Indian pension industry vis--vis the World Banks pillar model
Pillar 1

The Swalambhan Scheme, which was started under the National Pension System (NPS) to cover the
lower strata, has met with limited success. The recently launched Atal Pension Yojana aims to renew
this model.

Pillar 2

The Employees Provident Fund Organisation (EPFO), Coal Mines Provident Fund Organisation
(CMPFO) and NPS (for Central and State government employees) fall under this category. EPFO,
with 8 crore subscribers, is the largest. Even so, a significant mass of population is not covered.

Pillar 3

This category, which includes NPS for the private sector, retirement plans by mutual funds, and insurance, too, has met with limited success.

The Indian pension industry seems to be a victim of low awareness of the importance of retirement planning
and lack of distributor focus for NPS schemes (due to low incentivisation). Further, people tend to have a
myopic view on pension; they focus on the short term and expect the government to cover their future social
security. The pension industry needs to deepen its penetration in a holistic manner.

Scope of the pension industry - past, present and future

EPFO a behemoth
The pension industry in India is led by the 60-year-old EPFO. Beneficial taxation policies, mandatory saving
under the plan for eligible citizens, and the countrys affinity to invest in safe fixed income instruments have
grown its corpus to Rs 8 lakh crore and subscriber base to 8 crore individuals.
In a high-inflation economy such as India, provident funds, or PFs, are not exactly the most appropriate
pension product. Being fixed income-oriented, PFs give marginal real returns (returns inflation)
(see Chart 1).
Chart 1 EPFO declared interest rate vs retail inflation rate
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
1990

1994

1998

Retail Inflation Rate

2002

2006

2010

2014

EPF Declared Interest Rate

Source: EPFO, RBI

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Realising the need for higher returns to build a better retirement corpus, the Ministry of Labour & Employment
(MoLE) has introduced equity and other investment schemes. In a country where the median age falls
between 25 and 30, equities can easily provide a windfall for a long-term goal such as pension.
Table 2 - Change in investment structure for provident funds
Investment product

Old investment pattern (%) New investment pattern (%)

Government securities

Up to 55

45-50

Debt securities and bank term deposits

Up to 55

35-45

Money market instruments

Up to 5

Up to 5

Equity and equity-related instruments

(includes Exchange Traded Fund, or ETF)

Nil

5-15

Asset-backed securities, units of real estate/

infrastructure investment trusts

Nil

Up to 5

MoLE has also revised the aspects of the investment policy. It has introduced concepts of cost management,
fiduciary responsibility, established investment safeguards and allowed trading to an extent rather than
holding the portfolio until maturity. Such reforms display a shift from regulated management of assets to a
prudent management system, and are progressive steps for the industry at large.

NPS the new plan on the block

The Government of India launched NPS in 2004 to enhance pension coverage in the country and bring in the
informal sector into the pension fold. Initially launched for government employees, it was opened to all Indian
citizens from May 1, 2009.
NPS marked the governments shift from the Defined Benefit (DB) model to the Defined Contribution (DC)
model of pension management with the aim of reducing the fiscal pressure on the country. For instance, if
private coverage stays chronically low at its current level of 8% even by 2030, the government will have to
formulate a pension scheme to support the old-age population, raising its fiscal burden to as high as 4.1%
of GDP. For the record, the Central government today spends 3-3.4% of GDP on education and just over
1% of GDP on medical and public health, water supply and sanitation (source: CRISIL Report). Greece, with
pension provision4 accounting for 16% of its GDP, is the freshest example of a fiscally imbalanced liability.
Currently, the bulk of household savings in the country is in bank Fixed Deposits (FDs) and physical savings
(real estate, gold, etc). (Source: RBI report 2013-14). In comparison, NPS allows investments in fixed income
instruments as well as in equity and newer investment options such as equity mutual fund, Infrastructure Debt
Funds (IDFs), Asset-Backed Securities (ABS) and Credit Default Swaps (CDS).
NPS offers a variety of asset allocation patterns for contributors, including one with a moderate exposure to
equities. Contributors can choose the pattern that best suits their risk profile. It offers two strategy options:
active and default.
4

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http://blog-imfdirect.imf.org/2015/06/14/greece-a-credible-deal-will-require-difficult-decisions-by-all-sides/

RESEARCH

Chart 2 Break-up of household savings

Components of financial savings

68%

Financial savings

32%

Currency

9%

Deposits

59%

Shares, debentures (private companies, banks,

PSUs and mutual funds)

3%

Life funds of LIC and private insurance companies

17%

Provident and pension funds

12%

Physical savings

Source: RBI

Active choice: Subscriber has the option to decide how to invest his/her NPS pension in the following three
options:
Asset Class E - investments in predominantly equity market instruments
Asset Class C - investments in fixed income instruments other than government securities (G-sec)
Asset Class G - investments in G-sec
Subscribers can choose to invest their entire pension wealth in C or G asset classes and up to a maximum
of 50% in E.
Default choice is lifecycle fund: If subscribers are unable/ unwilling to exercise any choice on asset
allocation, their funds will be invested in accordance with the auto choice option. Here, investments will be
made in a life-cycle fund. The fraction of funds invested across three asset classes will be determined by a
pre-defined portfolio based on the age of the investor.

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Chart 3 Growth of NPS assets

90,000
80,000
AUM in Rs Cr

70,000
60,000
50,000
40,000
30,000
20,000
10,000
0

2011-12

2012-13

Central Government

State Government

Unorganized Sector

NPS Swavalamban

2013-14

2014-15

Corporate Sector

Source: NPS Trust

The pace of coverage under NPS has been increasing, but the absolute figure still has a long way to go. Here
are the challenges:
N
 PS is voluntary: There is no successful social security scheme dependent on voluntary
contributions. A strong, mandatory basis is required to ensure schemes such as NPS succeed.
Taxation: A consistent, equitable taxation policy is required across pension products. Tax arbitrage
distorts markets as people invest as per post-tax calculations.
L
 ack of clarity regarding regulation: There is a need to align frameworks across insurance, asset
management, EPFO and PFRDA. The Financial Sector Legislative Reforms Commission (FSLRC)
mechanism may help to resolve the issue by introducing a standard regulatory structure and code
across regulators.
Trust: The level of trust in products is weak in emerging economies such as India. This is largely
reflective of the quality of intermediation, which is crucial for the sustainability of the pension industry.
Long-term contribution schemes are yet to garner enough trust.
L
 ack of awareness: There is a need for financial literacy. The general mindset should favour longterm investing.

Potential for NPS

It would be wrong to write off NPS based on modest growth over the past 11 years. We just need to direct
the demographic dividend of the country into apt investment avenues and leverage the optimistic phase of
growth.
The infrastructure required for distribution is in place. There are more than 60 points of presence (PoPs)
with a network of more than 36,000 branches, and more than 70 aggregators across the country5. National
Securities Depository Limited or NSDL, the Central Recordkeeping Agency (CRA) for NPS, updates NPS
subscribers on the status of their investments. The distribution channel, however, has to be adequately
incentivised to sustain the industry's growth potential.
5

88

As on March 31, 2014, Source: PFRDA

RESEARCH

The recently launched Atal Pension Yojana (APY), a universal target-linked pension plan, aims to renew the
Swavalambhan scheme, and is a good augury for the domestic pension industry.

Defined Benefit-Contribution mix - a move to create a universal

pension system
Though DB pension schemes are laudable, they are a huge long-term liability. On the other hand, DC
schemes free the provider of the liability, shifting the onus of retirement planning to the investor. They are two
extremes of pension planning, and either one would be unsustainable from a universal pension perspective.
Thus, a mix of both seems a good solution for social security.
Countries around the world are adopting various ratios of DB-DC. Australia has an 85% DC-based system,
while the Netherlands has 95%+ DB component. DB-DC schemes do need sufficient government funding
along with adequate equity and alternatives exposure.
Table 3 - Relative shares of DB and DC pension fund assets in select OECD countries, 2013
Country

Defined Benefit / Hybrid-mixed

Defined Contribution

Chile

0.0%

100.0%

Czech Republic

0.0%

100.0%

Estonia

0.0%

100.0%

France

0.0%

100.0%

Greece

0.0%

100.0%

Hungary

0.0%

100.0%

Poland

0.0%

100.0%

Slovak Republic

0.0%

100.0%

Slovenia

0.0%

100.0%

Denmark

6.6%

93.4%

Italy

6.8%

93.2%

Australia

9.8%

90.2%

Mexico

13.3%

86.7%

New Zealand

20.1%

79.9%

Iceland

24.9%

75.1%

Spain

27.7%

72.3%

United States

57.4%

42.6%

Turkey

60.7%

39.3%

Israel

70.4%

29.6%

Korea

72.5%

27.5%

Luxembourg

79.7%

20.3%

Portugal

84.8%

15.2%

Canada

97.2%

2.8%

99

Country

Defined Benefit / Hybrid-mixed

Defined Contribution

Finland

100.0%

0.0%

Germany

100.0%

0.0%

Switzerland

100.0%

0.0%

Source: OECD Global Pension Statistics

Going back to the World Banks three pillars of pension planning, though the Indian government has initiated
measures to strengthen pillars 2 and 3 viz., organisational and personal retirement plans, pillar one social
security net for the lower strata of the population is still weak or rather non-existent.
Though APY provides the vast population an avenue to save a small amount for retirement, the highest
possible vesting age pension is currently restricted to Rs 5,000 per month. If we consider the long gestation
period of 30 years, this money would be paltry and would not meet the subscribers needs. The government
needs to step up and support these plans. It is also important that the government start creating a corpus,
which can be fiscally sustainable over the long term.

Accumulation-annuity model Need a long-term system for assetliability management

Currently, the pension industry in India largely focuses on the accumulation phase of retirement planning.
While this stage is important, it is equally necessary to plan for disbursement of the corpus on retirement. Do
not ignore the annuity phase. Thanks to NPS, there is at least a new awareness about annuities and their
importance.
At present, under NPS, it is mandatory to use at least 40% of the corpus amount on maturity to purchase an
annuity. However, NPS has limited investors options by appointing only seven annuity providers. Investors
should be allowed to choose: 1) the amount for annuity, and 2) annuity providers from a pool of more than
seven. There is no fixed template for income required at retirement; the math varies from person to person.
Hence, annuity providers need to be flexible.
However, with distributor commissions very low in annuities, significant incentive is required for new players
to enter the market. A vibrant annuities market is essential for the pension industry to grow. Further, longevity
is a universal issue of annuities as insurers are unwilling to commit to a situation where it is unclear as to how
long a person would live.
Pure play annuity providers would be a boon to the pension industry. If foreign players are allowed to enter,
their expertise could help to lower costs by improving efficiency and promote innovation in annuity plans.
Asset management companies could also be given the option to design annuity plans. However, in the end,
the choice should be left to the investor. By putting in place a long-term system for managing assets and
liabilities, the accumulation-annuity model could be a success in India.

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Reinventing the regulatory wheel

Need to set the NPS design right
From a regulatory perspective, NPS has certain design limitations, which need to be addressed to ensure
universal social security. These include:
D
 istribution: Operational barriers between regulators are preventing effective use of the distribution
network. Depository participants can be directed to combine distribution, marketing and servicing
roles to tap economies of scale.
Competition: With one CRA monopolising the system, efficiency is limited. Introducing some
competition here can help.
P
 roduct and process innovation: Factors such as imposing a penalty for non-contribution, no
direct accounts and imposition of service charges make NPS inflexible for the informal sector, which
often lacks funds to make regular, sizeable contributions.

Need for pension and insurance coordination

In the NPS context, fund managers are responsible for the accumulation phase and have to be mindful of the
mortality element. For an insurer, the annuities phase is the focus and longevity element cannot be ignored.
Allowing pension fund managers to offer annuities can help them raise economies of scale and thus provide
better return to investors. Cross-pooling of expertise among insurers and fund managers could increase
efficiency. For e.g. in Australia, several pension fund managers are from insurance companies.
Further, a separate healthcare account could be explored as a part of NPSs current unbundled structure
once a universal pension system is in place.

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Key takeaways from the report

Social security provisions in India remain inadequate
For NPS to succeed, a mandatory basis should be introduced
A uniform tax code and regulatory structure for the pension industry are required
Financial literacy and awareness are key challenges
Incentive for distribution and quality of intermediation are crucial for expanding
reach
Asset allocation should be more flexible
Need for a vibrant annuities market
Government funding is necessary along with variations in DB-DC mix
Cross-pooling of expertise across mutual funds and insurance could increase
efficiency significantly

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About ET Edge
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