NPS and pension schemes around the world

National Pension Scheme (NPS) and The Retirement Timebomb

tick. That’s 1.3 billion Indians having gotten older by a second. And while this might not feel important to a young country like India now, it sure will be when India greys with almost 1 in every 5 Indians being over the age of 60 by 2050. In this article, we explore pension schemes around the world, the challenges and solutions. We also see how India can shape it’s National Pension Scheme (NPS) using these learnings.

India not staying forever young

PFRDA and CRISIL released a report in 2017 titled “Financial Security for India’s Elderly“. This pension framework study corroborated a known fact – India is getting old .. and fast!

OK. Let’s start with numbers.

Here are some datapoints that the report threw up:

  • In a 2015 study, it was found that almost 90% of the Indian population is below the age of 60 years. And the working age population stands at 44%.
  • The share of the elderly in the total Indian population has risen to 8.6% in 2011 from 5.6% in 1961. The forecast is for it to increase further to 12.4% by 2026.
  • By 2050, every fifth Indian will be a sexagenarian compared to 1 in 12 now
  • Thus, by 2050, India would be in the same position as are today’s developed world in their share of elderly in population
With the Indian population ageing fast, pension programs like the NPS will become crucial in ensuring orderly fiscal management among the elderly
With the Indian population ageing fast, pension programs like the NPS will become crucial in ensuring orderly fiscal management among the elderly

A lot like India, governments around the world are fiscally worried as their citizens live longer lives in retirement. And perhaps more importantly, they struggle with low coverage provided by pension programs.

Further, a global low interest rate regime (seen since 2008) and a shift in employment characteristics compounds the problems. Many countries have shrugged innovation & resorted to inefficient measures like increasing the retirement age (Singapore), reducing benefits or imposing higher contributions etc.

In this article, we look at the more important areas that India needs to address towards its National Pension Scheme (NPS) program. I’ll also discuss some of the structurally sound initiatives from around the world that can help us. 

Expanding Coverage of NPS and Pension Programs

The retirement-readiness of Indians is quite low. Provident & pension funds form 14% of the financial savings. This is primarily contributed by the organized society.

Multiple Indian governments have targeted increasing the penetration of pension products via voluntary schemes. However these haven’t seen the desired offtake. 

Focus on Unorganized Sector

Per NSSO Labour Force Survey of 2011-12, 82.7% of India’s workforce is in the unorganized sector. This amounts to a working population of 39.14 crores.

This informal sector today runs the risk of low coverage, low contributions and low persistency. Case in point is the Atal Pension Yojana (APJ). The APJ is aimed at the lower income strata. For all the right intentions, the APJ comes up short on all the above three requirements.

The APJ scheme covers only 1% of the working population i.e. 44.7 lac subscribers by Feb 2017. Secondly, 49% of subscribers have opted for a ₹1,000 pension which is highly inadequate.

What can be done?

Monetary incentives help. The New Zealand pension program (KiwiSaver) demonstrated that with a limited period $1,000 kick-start program. This $1,000 kick-start is made available to all members who enter the pension program.

The program also offered a co-contribution from the government which pushed up subscribers. The chief benefit of this co-contribution went to the lower income groups. One of the eligibility conditions for government co-contribution was that the member investing atleast the minimum contribution.

Sounds good. Has India tried this?

The APJ has borrowed this practice to good effect. Atal Pension Yojana co-contribution has helped increase the total number of subscribers to over 30 lakhs (Jun 2016 data). Every day nearly 5000 new subscribers get added in the scheme.

The co-contribution from the Government of India is for those who have registered before 31/3/2016 with an amount of 50% of the subscribers contribution upto a maximum of ₹1000. These subscribers will be eligible for co-contribution for a period five years from 2015-16 to 2019-20. In numbers, the government of India has released co-contribution for FY 2015-16 for 16.96 lacs eligible subscribers amounting to ₹99.57 crores.

Desi-gned for India’s Unique Societal Landscape

A stronger pension program will require to manage issues specific to India. Some steps to addressed these are –

  1. Providing flexible payments & withdrawal options. This has to be in line with earning & spending patterns of people engaged in daily labour, seasonal activities & agriculture
  2. A unique designed program for females. Due to their dependency on male members of the family, a pension program for women members will do wonders. In addition to dependency, there are higher probability of fiscal burdens in future years with women member that the program can address.
  3. Bundling insurance with pension programs. The insurance part can manage death, disease and disability of pension contributors. The insurance program can extend to their dependent family members to manage underinsurance.
  4. Heed to potentially changing occupational structures. The sharing economy is on the rise with Uber (contractor) drivers, technicians at Urbanclap, food delivery boys at Zomato etc. The pension program needs to extend to more self-employed & freelancers in the workforce within a generation from now.

Auto-Enrolment of Employees

Organisations with less than 20 persons employed are not covered under EPFO. The government can adapt the experiences of pension programs in Italy, New Zealand, UK, USA & Chile. And thus can adopt auto-enrolment of these employees under the Indian pension programs.

Wont employers resist this?

While this regulation does add to the burden of employers, the government can work out ways of giving tax credits back for such contribution.

Improving the Adequacy of Returns

The Indian pension system is debt-focused as compared to global systems. Global systems use equities for long-term investments.

This is certainly worth addressing as India enjoys a demographic advantage with a large proportion of the workforce in their 20s and 30s.

An analysis of the top private pension funds based on investments shows that they continue to remain strongly invested in long-term asset classes such as equity.

An analysis of the BSE Sensex 15-year rolling returns show that the index has not given negative return in that period and has delivered returns of more than 10% in 93% of the cases.

NPS programs are for long-term investments. And the longer you stay in equities, the chances of losing the initial investment goes down. The BSE Sensex experience has been that a 15-year rolling has never seen negative returns.

A longer investment period also reduces volatility in equity-based returns. Pension funds prefer low volatility structures.

In India, the NPS for private sector employees allows investors to invest upto 75% in equities at a young age. However other schemes like the EPF (Employee Provident Fund) take very minimal exposure to equities. This is a case of missed opportunity for a larger part of the current workforce.

Option of Switching from EPS to NPS

While this is shelved now due to resistance from trade unions, the option of moving monies from a ‘fixed’ return EPS regime to a market-linked NPS module is a wise option.

The initial trepidation aside, it will help in increasing the retirement corpus of most subscribers using the equity route. Like many countries, a larger chunk of the money gets diverted to equities managed by professional fund managers. 

Higher Returns by Investing Abroad

South Korea’s National Pension Service is the world’s third largest pension fund. The pension fund has started to move more assets towards foreign opportunities. The move is on account of going where higher returns are available as compared to the overheated domestic markets. The fund expects to shift assets from a current domestic-to-foreign ratio of 70:30 to 50:50 by the end of 2024. Similarly pension funds in other developed economies see a higher return-risk ratio in emerging markets as compared to home markets.

Offering Return Guarantees

To build the popularity of NPS, the government can include some kind of guarantee in the form of absolute returns or relative rate of return. Relative rate of return is returns which are benchmark based like inflation or risk-free rate.

Inflation-linked bonds issued by some governments do just that. These are fixed income securities. And the principal value is periodically adjusted according to the rate of inflation. This provision provides support (guarantee) to buyers of these bonds. And when extended to pension programmes can lift the popularity of these and improve adequacy of returns.

Hmm … give me an example.

Chile’s pension program used inflation-linked bonds to good effect. Their pension program benefited from the use of inflation-linked fixed income instruments available in the country’s capital market. Infact, unlike other countries which offer smaller tenures, Chilean bonds run with maturities ranging from 5 to 30 years.

Note: Not all was good about the Chilean pension program which has seen mass protests. I found an excellent article on solving Chile’s pension crisis. Have a read.

Opponents of the Chile pension system say that it has left the 10 million Chileans enrolled in it with extremely low retirement benefits. Photo credit: MARTIN BERNETTI/AFP via Getty Images

Spreading NPS Awareness

Most people find it difficult to address basic financial concepts. This extends to pension systems which require individuals to make key decisions with their money. These include how much to save, which investment to choose, how long are they likely to live, when to retire etc.

Some of these questions are difficult to answer for financial consultants let alone for the pension subscriber. In effect, the subscriber is his own investment manager, actuary and insurer.

Increasing the awareness of pension programs, its benefits and advantages is paramount to having a healthy pension infrastructure in the country.

Some areas that need to be addressed include –

Sufficient Incentives for Intermediation

Intermediaries have played a massive role in raising the awareness of many financial products. Strong examples include LIC‘s agent driven model in insurance and NJ Invest India‘s sub-agent model in mutual funds.

When incentivised well and supported with awareness programs, intermediaries go the extra mile. They help raise awareness, enrol customers, ensure persistency and handhold during decumulation. Decumulation is when the investor needs to identify options related to purchase of annuities including taxation, choice of provider etc.

India has an open structure for selling pension schemes under NPS. However the program’s expansion is lacking due to low incentives to distributors.

Mainstream Awareness of NPS

Ireland, Poland, New Zealand, Sweden, Hungary & Mexico have achieved major milestones in their pension program.

Such awareness is being was built with a concerted and intense consumer awareness strategy. This included use of TV, radio and the Internet to reach 25 to 39 year olds, women, first time job seekers and the farming community. Encouragement helps them understand the adequacy aspect of retirement planning. The campaigns also went to grassroot levels and educational institutions and financial planning became a part of their curriculum.

Importance of building a well-designed NPS

In the next 30 years, India will become the most populated country in the world. And it will also be home to over 300 million sexagenarians.

Around the world, retirement systems reforms are continuing as aging population and systemic financial threats loom large. If not designed smartly, these can put national budgets into a steady tailspin.

The Indian experience with voluntary pension is relatively new with the NPS (National Pension Scheme). The country will do well to borrow best practices from the world systems. And adapt it to its unique nature of program dissemination powered by populace.

tick. tick. tick. The retirement support timebomb is ticking away.

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