SEEMA GUPTA SURANJAN BANERJEE KAILASAM ARUMUGAM 15/12/2016 Key differences between state pension schemes and occupational pension schemes - Risks, opportunities and challenges. SEEMA GUPTA SURANJAN BANERJEE KAILASAM ARUMUGAM 15/12/2016 Indian Actuarial Profession Serving the Cause of Public Interest

Agenda Introduction to the Indian environment The 3 pillars for pension provision A comparison of state sponsored and other occupational arrangements Risks associated with current structures Some opportunities and challenges Questions www.actuariesindia.org

1. Introduction to the Indian environment Gradual collapse in traditional old age support mechanisms Skewed coverage of existing benefit schemes Growth of informal workforce Need to increase domestic rate of savings Traditionally, the joint family system would mean that the elders in a family would be supported by their children who in turn would be supported by their children. Emergence of more nuclear families has meant that people are having to think about making provisions for their own retirement income as their children shift their focus towards other needs – housing, higher standard of living etc. The current pensions system is heavily skewed with some public sector workers having access to a ‘safe’ final salary linked DB pension whereas informal workers may not have any provision for pension set up. Further, the informal sector workers are growing in number! www.actuariesindia.org

1. Introduction to the Indian environment (contd.) Worsening of financial position of unfunded state pensions arrangements Shift from DB to DC – e.g. NPS Little flexibility within different DC arrangements Under developed private annuity market Traditionally, the joint family system would mean that the elders in a family would be supported by their children who in turn would be supported by their children. Emergence of more nuclear families has meant that people are having to think about making provisions for their own retirement income as their children shift their focus towards other needs – housing, higher standard of living etc. The current pensions system is heavily skewed with some public sector workers having access to a ‘safe’ final salary linked DB pension whereas informal workers may not have any provision for pension set up. Further, the informal sector workers are growing in number! www.actuariesindia.org

2. The 3 pillars for pension provision Pillar I State Pensions Compulsory Non - contributory Pillar II Occupational Pensions Compulsory Contributory* Pillar III Private Pensions Voluntary Contributory * Public sector DB schemes contributory to the extent that no EPF contributions are made by the Government www.actuariesindia.org

2. The 3 pillars for pension provision Pillar I Core pension provided by the state to all citizens Aimed at the lower end of the economic strata, therefore ‘means tested Minimal pension benefit Several such social assistance and welfare programmes exist – both at state and central level Enables income transfer to poorer workers Generally not very well administered at the moment www.actuariesindia.org

2. The 3 pillars for pension provision (contd.) Pillar II The most well established pillar owing to legislation on Gratuity and Provident Fund Mandatory savings programmes at employment level Covers public and private sector employees Public sector employees were entitled to a final salary style DB pension e.g. Central Services Civil Pension New public sector employees now set up under a DC style arrangement – National Pension Scheme (NPS) Private sector employees via compulsory programmes e.g. Employees Provident Fund www.actuariesindia.org

2. The 3 pillars for pension provision (contd.) Pillar III This pillar includes all kinds of voluntary savings Important pillar for the self employed or members of the informal workforce Achieved via a contribution to pooled funds with low investment risk such as Public Provident Fund (PPF) Or via personal savings vehicles geared towards retirement savings – e.g. DC pension plans run by life insurance companies such as LIC Government has also opened up the NPS for individuals Incentives are usually provided by tax breaks (up to a certain limit) www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements Next few slides set out a comparison between a typical state sponsored Pension Schemes (Pillar I) and Occupational Pension Schemes (Pillar II) through the following points: Objective of providing the Scheme Eligibility Scheme Design Funding Risk www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements (contd.) Objectives State Sponsored Schemes Main objective - A welfare State Remove Poverty Social Security for old age Political & Economical Reasons Occupational Schemes Paternalism Compulsion/ Encouragement from State Competition Attract & Retain work force www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements (contd.) Eligibility State Sponsored Schemes May cover all citizens Or only BPL families Or some Target Population Occupational Schemes Eligibility conditions vary by Company/Industry Normally a minimum service is required www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements (contd.) Scheme design Retirement age usually 60 (prescribed by Government) Normally a fixed benefit Retirement age could vary by company and industry DB style benefit – Depends upon Salary/Service/both DC style benefit where actual benefit not determined in advance www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements (contd.) Scheme design (2) No refund of contribution Benefits only at a pre-determined age – No option to the beneficiaries Inflation protection Accumulated funds can be used as cash at retirement - DC Options available to beneficiaries – Commutation, Early Retirement, Annuity Option (DC Funds ) Inflation protection vary from scheme to scheme www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements (contd.) Funding Pay as you go (PAYG) arrangement backed by government No funds set aside / ring fenced Current tax payers contribute for current pensioners Generally through advance funding Regular funding – Tax, Accounting Standards, Clean Balance Sheet Contribution from Employers or Employees or both DC Schemes www.actuariesindia.org

3. A comparison of state sponsored and other occupational arrangements (contd.) Risks Theoretically, risk is retained by government In reality, adverse experience likely to impact future generations – higher taxes, lower benefits, longer working lives Risks are shared by Employer Employee Insurance Companies Investment Banks www.actuariesindia.org

4.Risks associated with current structures Macro-economic shocks Demographic shocks Political risks Managerial risks Investment risks Market risks Longevity risks Disability risks www.actuariesindia.org

4. Risks associated with current structures – Macroeconomic shocks Volatile inflation – CPI has fluctuated between 3.5% and 6.0% over the last 20 months www.actuariesindia.org

4. Risks associated with current structures – Demographic shocks Population covered under formal pension schemes in India Total Population 2015 2030 2050 Working Age Population 60+ Population Source: CRISIL Insight January 2015. 1282 m 1476 m 1620 m 806 m 944 m 1007 m 297 m 112 m 181 m www.actuariesindia.org

4. Risks associated with current structures – Demographic shocks Population covered under formal pension schemes in India 60+ Population 2015 2030 2050 Government Pension Cover Private Pension Cover Uncovered Population 181 m 297 m 112 m 35 m 68 m 92 m 4.8 m 63 m 122 m 72 m 50 m 83 m www.actuariesindia.org

4. Risks associated with current structures – Political risks Government may intervene to limit investment options and returns Continuous adherence to investment pattern Greater pressure on liquidity as well as returns Responsibility attached to the trustees Accounting standards Adherence to Professional Guidelines & Standards www.actuariesindia.org

4.Risks associated with current structures –Managerial risks Incompetent and Fraudulent behavior of manager Good management practices require established and documented chains of reporting and responsibility Those with responsibility should have suitable qualifications and experience www.actuariesindia.org

4. Risks associated with current structures- Investment risks 10 year nominal bond index has fallen to 6.2% (6 December) from 7.7% at the start of the year Source: Bloomberg www.actuariesindia.org

4.Risks associated with current structures- Market risks Market risk is the risk relating to changes in the value of the portfolio due to movements in the market value of the assets In a defined contribution scheme, even the returns on safe assets such as long-term Government bonds vary substantially depending upon whether the interest rates were low or high at the time of retirement. Lower interest rates lead to lower annuities during the lifetime of the pensioner. The problem is further compounded by the fact that the annuity markets are thin in most countries. www.actuariesindia.org

4. Risks associated with current structures-Longevity risks Life expectancy (at birth) in India has increased by c10 years since 1990 Source: World Bank It is estimated to increase by a further c5 years 2050 www.actuariesindia.org

5. Opportunities and challenges Opportunity: Strengthen Pillar I by providing a single means tested pension, inflation linked sponsored by the state Challenges: Will be hard to implement as large number of population not engaged in organised sector Difficult to determine true cost and financial implications due to uncertainty with financial and demographic parameters Possible outcome: Consolidate the current arrangements and set up a ring fenced self sustaining fund which does not rely on generation dependency for contributions www.actuariesindia.org

5. Opportunities and challenges (contd.) Opportunity: Carefully review the public and private DB pension liabilities and ensure better governance framework exists to manage key risks Consider private placement of some of the risks involved – e.g. longevity Challenges: Quantification of risks will be hard due to difficulties in setting parameters for estimating liabilities Complying with accounting standards for financial reporting (private sector) Political risks as the government may not have an appetite to engage (public sector) www.actuariesindia.org

5. Opportunities and challenges (contd.) Possible outcomes: Engage with actuarial advice and attempt to determine the funds needed for existing DB promise and how cashflows are likely to develop Use of sophisticated ALM techniques to demonstrate benefits of risk transfer / management Use these to assist funded arrangements to hold more return seeking assets with de-risking triggers or LDI Consider scenarios with stresses on bond yields, inflation and other parameters Engage with actuarial advice with adherence to professional guidelines and standards required by the professional body www.actuariesindia.org

5. Opportunities and challenges (contd.) Opportunity: Provide further incentives for investments geared towards retirement and allow portability between different DC funds (e.g. EPF and NPS) Increase coverage for informal sector, particularly self employed Challenge: Lack of awareness, particularly about effects of inflation Reluctance to move out of default state – often not the ideal option Possible outcomes: Provide more education to individuals via their employers and enable technology to deal with large volumes Some form of compulsory provision for self employed www.actuariesindia.org

6. Questions www.actuariesindia.org

References Goswami, Ranadev (2001), Indian Pension System: Problems and Prognosis, Indian Institute of Management, Bangalore Ernst and Young LLP and CII (2013), Pensions Business in India KPMG and FICCI (2015), Employee Pensions in India: current practices, challenges and prospects Allianz (2013), What’s happening in India: Pension and Retirement Update United Nations (2013), World Population Prospects the 2012 Revision Bhattacharya, B.K. (2003), Report of the Group to Study the Pension Liabilities of the State Governments, Reserve Bank of India Willmore, Larry (2000), Three Pillars of Pensions? A Proposal to End Mandatory Contributions, United Nations www.actuariesindia.org