1. 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

2. 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

3. 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!

4. 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!

5. 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

6. 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

7. 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

8. 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)

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

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

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

18. 4. Risks associated with current structures – Demographic shocks
Population covered under formal pension schemes in India
Total Population
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

19. 4. Risks associated with current structures – Demographic shocks
Population covered under formal pension schemes in India
60+ Population
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

20. 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

21. 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

22. 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

23. 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.

24. 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

25. 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

26. 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)

27. 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

28. 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

29. 6. Questions

30. 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 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