Pension Plans in India

Description
It compares conventional pensions plans to ULIP pension plans.

Pension Plans in India
Insurance Project

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Table of Contents
Introduction ............................................................................................................................................ 4 Customer Preferences: ........................................................................................................................... 5 Pension Fund Regulatory and Development Authority (PFRDA) ............................................................ 7 New Pension Scheme............................................................................................................................ 10 The Indian Scenario............................................................................................................................... 18 The American Scenario ......................................................................................................................... 21 UK Pension system ................................................................................................................................ 27 Emerging trends in Pension fund market ............................................................................................. 33

2

3

Introduction
Pension plans (also referred to as retirement plans) are offered by insurance companies to help individuals build a retirement corpus. On maturity this corpus is invested for generating a regular income stream, which is referred to as pension or annuity. Pension plans are distinct from life insurance plans, which are taken to cover risk in case of an unfortunate event. Currently, there are a total of 52 pension plans available across the various insurance companies in India. Bajaj Allianz and Tata AIG have the most number of pension plans issued: 6 and 5

respectively.

Number Insurance Company available

of

Pension

plans

Bajaj Allianz Life Insurance Company Tata AIG Life Insurance Company HDFC Standard Life Insurance co ICICI Prudential Life Insurance Shriram Life Insurance Co Birla Sun Life Insurance Life Insurance Corporation India SBI Life Insurance Co Reliance Life Insurance Company ING Vysya Life Insurance Kotak Mahindra Old Mutual Life Insurance Aviva Life Insurance Company India Ltd Max New York Life Insurance co Sahara India Life Insurance co

6 5 5 5 2 2 4 4 4 3 3 2 2 2

There are two main types of pension plans offered in India; Endowment and ULIP pension plans. While Endowment pension plans are currently more popular in India, the Increasing exposure to ULIP products is expanding the number of ULIP Pension plans being issued in the country.

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Customer Preferences:
Conventional plans Vs ULIP pension plans: Conventional pension plans invest a major portion of the premium monies in bonds and government securities. That is also why the returns are on the lower side for such policies. On the other hand, customers find that ULIP pension plans play a more important role in the retirement planning exercise. This is because ULIP’s have a mandate to also invest a portion of the premium in the stock market apart from bonds and G-Secs. Studies have shown from a long-term perspective, equities are equipped to give a higher return compared other fixed income instruments like bonds and Government securities. Hence, this is one of the reasons for the larger number of ULIP linked Pension policies being issued, as compared to the traditional pension plans. Since ULIP plans deduct a certain percentage as fund management charges and expenses, this will affect the investors’ returns over the long run. Therefore, this is an important factor the customer has to consider when deciding which plan to take up. Research has shown that if the individual has already invested a significant amount of his money in stocks and equity funds, then he might be better off investing in a conventional pension plan from a diversification perspective. Pricing of plans: Looking at the conventional pension plans, HDFC personal pension plan has the lowest minimum Annual premium prepayment as compared to any of the other plans, at RS 2400 per annum. ICICI prudential has a minimum annual premium payment of Rs 6000. However, although ICICI charges a higher premium for its policies, its pension plans seem to be more favourable to investors as compared to HDFC, as it offers various additional benefits and riders such as critical illness, Surgical assistance, and accident benefit riders. On the overview, these plans attract more investors, as the customer is able t o see the additional benefits of such plans, even though a slightly higher amount of premium needs to be paid. The minimum age of entering into a pension plan is 15; except for ICICI pension plan which is 18. The more popular pension plans are; HDFC, LIC and Bajaj Allianz. LIC has been the only Indian no1 insurance company, and has won 4 awards this year. Hence, the customer loyalty and trust to LIC still remains string, even due to the increasing number of competitors and new entrants into the market.

5

Since the pension industry in India is still emerging, there are very few users of pension plans in the country. Factors through which a customer decides what plan to purchase are; the lock-in period, eligibility, minimum premium payments, surrender value etc. As mentioned, ICICI and HDFC (refer to excel sheet), are two of the companies which provide the best traditional pension policies in terms of the surrender values, maturity payouts, and premium payments. However, ICICI is better in terms of additional benefits/ riders as well as because it offers full life cover availability.

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Pension Fund Regulatory and Development Authority (PFRDA)
HISTORYension Fund Regulatory and Development Authority (PFRDA), Establishment of the interim PFRDA (vide ordinance No.8/2004) in 2004 was the first step towards the evolution of pension products in India. A Govt. of India statutory body (in similar lines of IRDA) PFRDA had been constituted to regulate Pensions (Products, Investments, Producers and Consumers) in the country. It was a welcome move and aims to further push India’s savings. Although Pension or Annuity is a matured concept in the western world and generally fall into Life Insurance practice, in India this is indeed a new concept. Essentially, Pension Plan means, as name suggest, a promise to give you pension when you retire. It’s basically the reflection of your savings over period of time. If you are parking big money while you are working on your Pension portfolio, you will get bigger share when you retire. This savings will get accumulated in a bigger pool and that will get invested by professional investors who have a better probability of giving returns when one retires although not on a guarantee. The introduction of the PFRDA Bill (Bill No.36 of 2005) in the 2005 budget session of the Parliament constituted another major milestone in the history of PFRDA. The Standing Committee on Finance of the Parliament has cleared this Bill which will make pension funds in India bigger than ever. CURRENT SITUATION:Establishing a pension’s regulator in India was expected and when introduced was overwhelming. The regulatory body brought in a lot of changes that had a deep impact on the pension industry both directly and indirectly. A few of the changes were as follow:? ? ? Greater professionalism in the pensions industry Lowering of transactions costs in performing tasks noted earlier Greater efficiency in intermediating long term pensions savings to enhance economic growth which is a pre-requisite for economic security for both the young and the old. ? Potential for pensions industry (and complementary reforms) to increased India’s competitive edge

7

?

Diversify export basket for services, all strongly suggest a need for a pension’s regulator. It is noteworthy that high-income industrial countries do not leave pensions sector to be solely regulated to the forces of self-regulation or the markets, but have strong state regulators (regulation in this case is a public good which market will significantly under provide), supplemented by transparent rules requiring disclosure and transparency for even the state-run social insurance schemes.

The Pension Fund Regulatory and Development Authority Bill passed in 2005 takes away the obligation to pay pensions from the government and shift’s the responsibility of saving for old-age to the individual. It also establishes an authority to develop and regulate the new pension system (NPS) which seeks to provide old age income security for all individuals, including those in the unorganised sector. Highlights of the Bill
?

NPS will be implemented through a combination of retailers, pension funds and record keeper(s).

?

Every subscriber will have an individual pension account, which will be portable across job changes. The subscriber will choose the fund managers and schemes to manage his pension wealth. He also has the option of switching schemes and funds.

?

The NPS has already been operationalised for new central government employees through a notification. This is a 'defined contribution' scheme unlike the 'defined benefit' scheme for existing central government employees

KEY ISSUE AND ANALYSIS
?

The Bill provides a structure to the private and unorganised sectors to plan for old age income security. It is not compulsory for these sectors to take part in this system. Those not participating may still have to fall back on public resources in old age.

?

In the system for new government employees, the investment risk is entirely borne by the employee. However, he is no longer exposed to the risk of default by the government.

?

There will be no explicit or implicit guarantee on the pension wealth unless through purchase of market based guarantees. This is unlike the case of bank deposits where deposits up to Rs 1 Lakh are guaranteed.

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?

Any unfavourable event affecting market prices at the time of retirement could lower both pension wealth and the annuity rate. Subscribers may have to stay on in the system beyond their retirement date in order to ride over such a shock.

The interim PFRDA also helps in ensuring that procedures of collections of pension contributions, record-keeping, member information dissemination etc are efficient with low transactions costs. It plays an integral part in the functioning of the Central Record keeping Agency (CRA); and criteria for selecting pension fund managers. Future Prospects India faces a huge challenge in improving pension coverage (only about a fifth of the labour force is covered), particularly among workers who are not employed in the formal private or government sector. Of the total earning workforce of 450 million, 85%, or about 380 million work in sectors other than the formal private sector and the Government – and are usually classified as belonging to the unorganized sector. However, the primary occupations of workers in this category are wide-ranging- including selfemployed farmers and wage labour (accounting for over 60% of the unorganized sector), selfemployed business owners (13.8%), salaried and/or contractual employees in the informal sector (5.4%), self-employed professionals (under 1%) and others (8.9%). There is great diversity in terms of size and regularity of income, savings potential and overall awareness of the need for and ability to save for retirement. This poses serious challenges in achieving pension penetration: schemes have to be structured to enable workers in varying occupations with different income security levels to save for their retirement. The NPS permits any individual to voluntarily join scheme. The PFRDA would therefore need to devise appropriate regulations and schemes to encourage voluntary participation from both the organized and the unorganized sectors. But this will require social marketing, and considerable education and development effort. Confidence in the professionalism and competence of the PFRDA will be the key. The PFRDA shall regulate the NPS and other pension schemes under its purview. It will register and regulate all intermediaries including CRAs, PFMs and PoPs. It shall be responsible for protecting the interests of subscribers and establishing a mechanism for readressal of their grievances. It will approve the schemes and norms (including investment guidelines) for management of the investments by PFMs. It shall standardise dissemination of information about performance of pension funds and performance benchmarks. It is essential that PFRDA continues to remain the sole regulatory body for the civil service pensions. 9

New Pension Scheme
Introduction

India's total population is expected to rise by 49 per cent by 2016, the number of senior citizens aged 60 and above is expected to soar by 107 per cent to 113 million. Majority of the people in that age will need retirement security. A vast majority of this population is not covered by any formal old age income scheme and are dependent on their earnings and transfer from their children or other family members. These informal systems of old age income support are imperfect and are becoming increasingly strained.

In the organised sector (excluding the Government servants) a pension policy Involves financing by the employer as well as employee. However, it ignored the vast majority of the workforce in the unorganized sector to formal channels of old age economic support.

Most defined benefit schemes are either wholly unfunded or under-funded schemes and does not guarantee pensions at the end of the specified time period. There has been a significant improvement in healthcare facilities leading to increase in life expectancy, evolution of nuclear family systems and rising expectations due to increase in per capita income, education etc. which further compounded the problem.

Why New Pension System?

NPS was an urgent necessity mainly on account of burgeoning fiscal stress of pension payments on the Central and State revenues and the need to provide a viable alternative to the large population to save for old age income security. The new pension system, based on defined contribution and funded liability was a significant step in the direction of addressing this problem. Spread of NPS was seen by many as the direction in which the pension reforms need to move to find a viable and sustainable solution to the problem of old-age income security. Therefore, NPS was seen as a national policy initiative attempting to tackle the problems arising from increased longevity, insufficient retirement savings and absence of formal social security, particularly for the unorganised and informal segment of labour force. 10

New Pension System

The New Pension System (NPS) had its origin from the two reports OASIS (Old age social and Income Security) and HLEG (High Level Expert Group). It was made operational through a notification dated 22nd December, 2003. It has been made mandatory for new recruits in the Central Government (except Armed Forces) from 1st January 2004. NPS was also available to all individuals in the unorganized sector on a voluntary basis with effect from May 1, 2009.

Key Differences of NPS ? ? ? ? ? ?

NPS is a technology driven low cost, highly transparent pension system. A very lean team of Regulator PFRDA in charges the system in order to keep the regulator cost at low. Entire system of NPS is technology driven and all the entities of NPS interconnected. Selection of Fund Managers, CRA, POPs were done under highly transparent manner through competitive bidding. Regulation of Asset Allocation aimed at reducing the risk content in the funds by keeping the equity exposure up to 50%. Mandatory Annutization to ensure that retirement savings provide regular flow of post retirement income. Pay out is very flexible having in built provision of Mandatory annuity, Lump sum Withdrawal, Phase Withdrawal (for All Citizens Scheme)

NPS marks a shift from the defined benefit to a defined contribution regime. It is a low cost technology driven system based on the principles of defining upfront the liability of Government, giving choice to subscribers, facilitating portability of labour force and ensuring transparency and fair-play in the industry. There are multiple Fund Managers and multiple investment options under the NPS scheme.

Features of NPS System

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PRAN: Under the new pension system, Central Record Keeping Agency (CRA) maintains subscriber accounts and issues a unique Permanent Retirement Account Number (PRAN) to each subscriber.

Portability: Under NPS, employee’s pension account is portable, when subscriber switches jobs or schemes or fund managers. Investors have the flexibility to choose between fund managers.

Multiple Funds: NPS envisages multiple pension fund schemes with different weightage’s of securities and Asset Class.

Low Cost: NPS is the least cost pension system in India and probably in the world. The charges are determined through competitive bidding in a very transparent manner. The following are the charges: 1) Management Fees: 0.0009% p.a. for NPS for Govt employees as well as All Citizens. 2) 3) Custodian Bank Charges: Charges: (For 0.0075% collection at p.a. Non-RBI on asset Rs value 15/in per custody. transaction.

centres):

3) CRA charges: The CRA charges Rs 50 for opening and Rs 350 annually for maintaining PRAN.

Two

tier

Defined

Contribution

Pension

System

Tier I: Mandatory non-withdraw able Pension Account mandatory for the central Government employees who have joined services on or after 1st January 2004. The Employees contribute 10% of salary & DA and matching 10% contributed by the Government to Tier-I Pension account of the employee. Tier-I of the NPS constituting the non-withdraw able Pension account became operational for all citizens from 1st May, 2009.

Tier–II: Voluntary with-draw able Savings Account. No contribution will be made by the Government under the Tier-II account for the employees who have joined NPS.

Functioning of NPS

The functioning of NPS is divided into two parts:

Government Employees

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Operations

The NPS for Government employees came into operation in 2007-08 with the appointment of three Sponsors (LIC, SBI Mutual Fund and UTI Mutual Fund) to manage the funds of New Pension System , & Central Recordkeeping Agency (CRA) and the sponsor entities in turn has formed separate companies for managing the funds of NPS. ? ? ? LIC Pension Fund was sponsored by LIC of India , SBI Pension Fund was sponsored by SBI and UTI Retirement Solutions (P) Ltd has been sponsored by UTI Mutual Fund.

Entry

The monthly contribution under this scheme is 10 percent of the salary and DA to be paid by the employee and matched by the Central Government. However, there will be no contribution from the Government in respect of individuals who are not Government employees. The annuity should provide for pension for the lifetime of the employee and his dependent parents and his spouse at the time of retirement.

Exit

Under the NPS, an employee will be entitled to exit only at the time of retirement at the age of 60, however at least 40 per cent Pension wealth would be used for purchasing annuity from a life insurance company approved by the IRDA.

Investment of the funds

There are two schemes with investment being broadly in Debt and Equity. However during the year 2008-2009 only Scheme I was operational

Scheme 1

Government Equity

Securities

and (Direct):

Bonds

-

85% 5%

Equity-Linked Mutual Fund schemes: 10% And/or, Private Sector Debt. 13

Scheme 2

Government Securities and Bonds - 100%

All citizens other than Government employees

Operations

The subscriber to the NPS scheme should be an Indian resident and between the age of 18 to 55 years on the date of application. There are 22 point of presence appointed by PFRDA who are authorised to open the NPS account.

Entry

The annuity provides for pension for the lifetime of the employee and his dependent parents and his spouse at the time of retirement. Individual receive a lump-sum of the remaining pension wealth, which subscriber is free to utilize in any manner. Individuals have the flexibility to leave the pension system prior to age 60. However, in this case, the mandatory annuitisation would be 80% of the pension wealth. Minimum contribution per instalment is Rs 500 and minimum contribution per year is Rs 6000. There should be a minimum of 4 contributions made each year.

Exit

The normal retirement age is fixed at 60 years. At 60, the subscriber will be required to use at least 40 per cent of accumulated savings to buy a life annuity from an insurance company. A phased withdrawal is also allowed but the lump sum benefit has to be availed of before subscriber turns 70 years.

For those looking to exit before turning 60, there is an option to withdraw 20 per cent of the accumulated savings but to buy an annuity with the remaining 80 per cent. If the subscriber dies before he or she turns 60, the nominee can receive the entire pension corpus. 14

Investment of the funds

Under the investment guidelines finalized for the NPS, pension fund managers manage three separate schemes, each investing in a different asset class. The three asset classes are equity, government securities and credit risk-bearing fixed income instruments. If the subscriber does not exercise any choice with regards to asset allocation, the contribution will be invested in accordance with the Auto choice option. Investment will be determined by a predefined portfolio. There are 3 classes of asset in which the fund invests: 1. E Class: Investment would primarily in Equity market instruments. It would invest in Index funds that replicate the portfolio of either BSE Sensitive index or NSE Nifty 50 index. 2. G Class: Investment would be in Government securities like GOI bonds and State Govt. bonds 3. C Class: Investment would be in fixed income securities other than Government Securities The lowest age of entry is 18 years in the auto choice option and will entail investment of 50 % of pension wealth in “E” Class, 30% in “C” Class and 20% in “G” Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in “E” and “C” asset class will decrease annually and the weight in “G” class will increase annually till it reaches 10% in “ E”, 10% in “C” and 80 % in “ G” class at age 55.

Age( in years) Up to 35 36 37 38 39 40 41 42 43

Asset Class E 50% 48% 46% 44% 42% 40% 38% 36% 34%

Asset Class C 30% 29% 28% 27% 26% 25% 24% 23% 22%

Asset Class G 20% 23% 26% 29% 32% 35% 38% 41% 44% 15

44 45 46 47 48 49 50 51 52 53 54 55

32% 30% 28% 26% 24% 22% 20% 18% 16% 14% 12% 10%

21% 20% 19% 18% 17% 16% 15% 14% 13% 12% 11% 10%

47% 50% 53% 56% 59% 62% 65% 68% 71% 74% 77% 80%

However, the amount of funds invested in that asset can differ from the Specified weight by no more or less than 5% for purposes of portfolio balancing. Tax benefits The contributions and returns from the NPS is tax free however money withdrawn from the scheme is liable for tax purpose. The yield on the NPS scheme is higher than other scheme as the NPS is not liable for any security transaction tax (STT) and dividend distribution tax (DDT). Various Intermediaries Involved:

1. Central Record Keeping Agency (CRA): Under the new pension system, Central Record Keeping Agency (CRA) is required to maintain subscriber accounts and issue a unique Permanent Retirement Account Number (PRAN) to each subscriber. CRA undertakes Record Keeping, Administration and Customers service. National Securities Depository Ltd (NSDL) has been appointed as the CRA for the NPS. 2. Pension Funds Managers (PFMs): To manage Investment of Retirement Savings of NPS. PFRDA appointed three pension fund managers, namely LIC Pension Fund Ltd., SBI Pension Fund (Pvt.) Ltd. and UTI Retirement Solutions Ltd. for managing pension funds of Central and State Government, and Six fund managers for managing the funds of unorganized sector. 3. Trustee Bank: NPS Trust appointed Bank of India as the Trustee Bank. Bank of India branches are authorized to collect NPS Trust contributions from contributors 16

4. NPS Custodian: Custodian Agency is responsible for holdings of the NPS Trust. NPS Trust has appointed Stock Holding Corporation of India Ltd as the custodian for the new pension system. 5. Annuity Service Providers (ASP): ASP offers Annuity schemes to the Subscribers. It receives Funds from CRA & Pay Regular Monthly Annuity at the time of exit at retirement or earlier. The member who wants to purchase an annuity can purchase from one of the Life Insurance Companies regulated by IRDA. 6. Points of Presence (PoPs): PoP performs the functions relating to registration of subscribers, undertaking Know Your Customer (KYC) verification, receiving contributions and instructions from subscribers and transmission of the same to designated NPS intermediaries. Conclusion

All the scattered segments of pension market should be unified under one single regulator i.e. the PFRDA which is focusing its attention only on pension funds. This will bring more clarity on regulation, save regulatory Costs, put in place a uniform cost structure for funds management, introduce uniform risk management practices in the pension industry , speed up pension-fund research, and bring near equality in investment returns. These will ultimately benefit the millions of deserving people who need retirement income through pension savings in a non-discriminating pension-fund market. The financial crisis also brought to the fore, funding crisis in the Defined Benefit Pension System. It has been reported in an OECD study that average funding levels down by 10% which created a funding gap of about $ 2 trillion. Unfunded Defined Benefit Pension is already a strain on fiscal system in India. Such a financial crisis and market volatility in asset prices may create an unsustainable crisis in the DB system. Therefore, Defined Contribution Pension like our NPS needs to be extended further. After all, the Indian model of pension reforms implemented by introducing well-structured NPS has been able to protect the assets of investors with good returns. NPS helps to overcome the problems of delays and defaults in the pensions by providing prudential investment rules and ensuring that Pension Fund Managers diversify their portfolios. Regulations are aimed to promote competition by requiring standardized reporting and disclosure

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The Indian Scenario
Pension and annuity funds managed by life insurers are forecasted to grow at a CAGR of approx. 35% between 2008-09 and 2012-13. Pension products contribution to the Indian life insurance industry will continue to rise in coming years as majority of the working population in India expects to have better quality of life or at least maintain the current living standards post-retirement. Moreover, most of the private companies in India do not provide pensions and employees typically depend on their provident fund for finance after retirement. In fact, provident fund financing in most of the cases remains insufficient to maintain the current living standards.

These pension plans are primarily targeted at the population in the age group of 35-45 years who has already completed saving for its protection needs and is looking for retirement plans. Young couples have also been found seeking retirement plans, but their number is relatively small and mainly noticed in metropolitan cities. However, the trend is gradually expanding to tier II and tier III cities. Pension plans account for close to 40% of the life insurance industry in terms of premium. Life Insurance Corporation (LIC) dominates the pension market while private life insurers are yet to take off. Private life insurers contributed just 7.5% to total pension insurance premium in 2007-08 but it is expected to rise to about 15% by 2012-13. Majority of working population in India expects to have better quality of life or atleast maintain the current living standards after retirement. This is the prime reason – why pension plans today account for around 39% of insurance industry’s total business. Life insurers’ pension and annuity fund is forecasted to grow at a CAGR of around 39% between 2008-09 and 2012-13. However, more potential lies under New Pension System (NPS) proposed by the central government. The New Pension System (NPS) introduced by the Government of India is South Asia's first DC pension scheme with individual retirement accounts, product choices, professional fund management by competing private fund managers and portability through centralised recordkeeping and administration. Participation in this scheme is mandatory for all new employees of the Central Government (excluding armed forces). This scheme will be offered to other employers and workers including State Governments and informal sector workers after a few months. The Department of Economic Affairs (DEA) under the Ministry of Finance has been charged with the responsibility of setting up the 18

Pension Fund Regulatory and Development Authority (PFRDA) and implementing the legislative, policy, regulatory and institutional framework for the NPS. In India Pensions under the EPF&MP Act 1952 include the Employees Provident Fund, Employees Pension Scheme and Employees Deposit Linked Insurance Scheme. Insurance firms in India typically sell two types of pension plans-Unit linked pension plans & Annuities. Unit linked pension plans are fund management products sold by the insurance firms. These schemes typically provide the investor with a choice of funds for investment in accordance with the policyholders' risk appetite. An individual needs to pay the premium to be eligible to avail the benefits of a Unit linked pension plan. The premium is the amount that is paid regularly, throughout the term of the policy or a single premium in the initial period of the policy. In case of payment of a regular premium, the minimum amount is Rs.10,000 p.a. and in single premium it is Rs.25,000. The premiums are invested in the units of an investment fund. This is done according to an individual's will and is based on the prevailing unit prices. There are different kinds of Investment funds like, liquid funds, secure managed funds, defensive managed funds and balanced funds. The illustration of these funds is briefly represented in the table below: Funds Area to be invested in Level of risk

Liquid Fund

Bank deposits and short term money market instruments

Very low level

Secure Managed

Government Securities and bonds issued by Low level of risk, though unit companies price may vary

Defensive Managed

High quality Indian equities

Moderate level of risk.

Balanced Managed

High quality Indian equity and government securities and bonds

High Level of risk

19

The investment in the aforementioned areas is portable, that is, an individual can switch his existing investments from one to another unit linked pension plan. The benefits available to the members are pension benefits and cash lump sum benefit. The maximum limit for any cash lump sum is one third of the unitised fund value standing to the credit of a member. The rest of the amount is used to provide an annuity. These benefits are paid in cheque. In case of the death of the member, the beneficiary receives unitised fund value plus cash lump sum of Rs.1000. The premiums offered under the plans are subject to tax benefit under Section 80ccc of the Income Tax Act, 1961. At the time of vesting, the lump sum (1/3rd of accumulation) is tax free, whereas the annuity is treated as income and taxed accordingly. For every premium that is paid, a percentage from that is invested in buying units. This is called Investment Content rate. There is also the charge for fund management which is included in the unit price each day. Changes can be made to these charges only after getting approval from the Insurance Regulatory and Development Authority. However, the maximum limit on the fund management charge is 2% per annum. Annuities The annuity market in India is very small. Most insurance companies in India sell deferred annuities. The only company to sell an immediate annuity is the Life Insurance Corporation of India (LIC), the biggest public sector insurance company in India. Typically, the following options are available to the customers of annuity products: Life annuity Joint life annuity Annuity for certain (5/10/15) years Annuity with return of capital on death. At the time of vesting, only 1/3 of the accumulated balance can be withdrawn as a lumpsum, whereas 2/3rd of the balance has to be necessarily annuitised. All the insurance companies offer a free market option. As per this option, at the time of vesting, the customer can buy an immediate annuity from any service provider and is not bound to the insurance company from where he bought the deferred policy.

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The American Scenario
Americans’ retirement savings market have grown substantially during the past two decades, reaching a record estimated value of US$ 17.6 Trillion in 2007, accounting for approx 40% of all household financial assets in the US. And the performance of the retirement solutions market is expected to accelerate further in coming years as Americans look more serious about their income sources in old-age life span due to their increasing life expectancies. A retirement plan is a financial arrangement designed to replace employment income upon retirement. These plans may be set up by employers, insurance companies, trade unions, the government, or other institutions. Congress has expressed a desire to encourage responsible retirement planning by granting favorable tax treatment to a wide variety of plans. Retirement plans in the U.S. are defined in tax terms by the IRS code and are regulated by the Department of Labor's ERISA provisions. In the United States, public sector pensions are offered by federal, state and local levels of government. They are available to most, but not all, public sector employees. These employer contributions to these plans typically vest after some period of time. Some local governments do not offer defined-benefit pensions at all, but may offer a defined contribution retirement plan. In many states, these plans are known as Public Employee Retirement Systems (PERS). These plans may be defined-contribution or defined-benefit, although the former has become more popular. Some aspects of the market are:-Defined Contribution (DC) and IRA (Individual Retirement Accounts) accounts for the majority of retirement assets in the US and are predicted to see significant growth in future. - Consideration for individual and group annuities is anticipated to grow at a CAGR of about 11% and 5% respectively for the period 2008 to 2012.

- Defined Benefits (DB) and government plans assets are predicted to grow at a CAGR of about 7.75% and 9% respectively during the forecast period.

- Improving life expectancies and mortality rates are the main driving factors of the retirement solutions markets in the US.

- US retirement solutions market offers huge scope for IT solution providers to improve their existing level of 21 operating efficiency.

- Underestimating life expectancy, overlooking rising health care costs and retirees assumption that they can work are some of the main roadblocks for the market. Types of Pension Plans

There are two categories of pension plan: defined contribution plan and defined benefit plan. The defined contribution plan and the defined benefit plan are both covered by the employee retirement income security act. According to the Internal Revenue Code Section 414, a defined contribution plan is an employersponsored plan with an individual account for each participant. The accrued benefit from such a plan is solely attributable to contributions made into an individual account and investment gains on those funds, less any losses and expense charges. The contributions are invested (e.g., in the stock market), and the returns on the investment are credited to or deducted from the individual's account. Upon retirement, the participant's account is used to provide retirement benefits, often through the purchase of an annuity. Defined contribution plans have become more widespread over recent years and are now the dominant form of plan in the private sector. The defined contribution plan assures fixed contribution amounts to the pension fund, such as 3% of employees’ annual salary. Defined Benefit Plan Commonly referred to as a pension in the US, a defined benefit plan pays benefits from a trust fund using a specific formula set forth by the plan sponsor. In other words, the plan defines a benefit that will be paid upon retirement. The statutory definition of defined benefit encompasses all pension plans that are not defined contribution and therefore do not have individual accounts. Defined benefit plans may be either funded or unfunded. In a funded plan, contributions from the employer and participants are invested into a trust fund dedicated solely to paying benefits to retirees under a given plan. The future returns on the investments and the future benefits to be paid are not known in advance, so there is no guarantee that a given level of contributions will meet future obligations. Therefore, fund assets and liabilities are regularly reviewed by an actuary in a process known as valuation. A defined benefit plan is required to maintain adequate funding if it is to remain qualified. Difference – Portability - A defined contribution plan's assets generally remain with the employee (generally, amounts contributed by the employee and earnings on them remain with the employee, but 22

employer contributions and earnings on them do not vest with the employee until a specified period has elapsed), even if he or she transfers to a new job or decides to retire early, whereas in many countries defined benefit pension benefits are typically lost if the worker fails to serve the requisite number of years with the same company. Self-directed accounts from one employer may usually be 'rolled-over' to another employer's account or converted from one type of account to another in these cases. Investment Risk- the employee bears investment risk for defined contribution plans while the employer bears that risk in defined benefit plans. This is true for practically all cases, but pension law in the United States does not require that employees bear investment risk, it only provides an ERISA Section 404(c) exemption from fiduciary liability if the employer provides the mandated investment choices and gives employees sufficient control to customize his pension investment portfolio The defined benefit plan assures predetermined retirement benefits characterized by a pre-selected formula, such as a "specified monthly benefit at retirement" (U. S. Department of Labour). Within each category of pension plan are a variety of specific plan types. Some of these specific plans are discussed below.

Cash balance plan - defined benefit plan. A cash balance plan "defines the benefit in terms that are more characteristic of a defined contribution plan" (U. S. Department of Labour). When the individual participant in a cash balance plan retires, the benefits to be received are determined based on an account balance. "Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer" (U. S. Department of Labour).

Profit sharing plan - is a defined contribution plan. A profit sharing plan is one in which contributions are discretionary and based upon company profits. This type of plan provides "a set formula for determining how the contributions are divided" (Internal Revenue Service) among each participant.

401(k) plan - a defined contribution plan. A 401(k) plan is a deferred plan in which "employees can elect to defer receiving a portion of their salary which is instead contributed on their behalf, before taxes" (U. S. Department of Labour) to the plan. Often, employers match the employee contribution up to a stated percentage of the employee's annual salary.

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Qualified retirement plans Qualified plans receive favorable tax treatment and are regulated by ERISA. The technical definition of qualified does not agree with the commonly used distinction. For example, 403(b) plans are not considered qualified plans, but are treated and taxed almost identically. The term qualified has special meaning regarding defined benefit plans. The IRS defines strict requirements a plan must meet in order to receive favorable tax treatment, including: SIMPLE IRAs A SIMPLE IRA is a type of Individual Retirement Account (IRA) that is provided by an employer. It is similar to a 401(k) but offers simpler and less costly administration rules. Like a 401(k) plan, the SIMPLE IRA is funded by a pre-tax salary reduction. However, contribution limits for SIMPLE plans are lower than for most other types of employer-provided retirement plans. SEP IRAs A Simplified Employee Pension Individual Retirement Account, or SEP IRA, is a variation of the Individual Retirement Account. SEP IRAs are adopted by business owners to provide retirement benefits for the business owners and their employees. There are no significant administration costs for self-employed person with no employees. If the self-employed person does have employees, all employees must receive the same benefits under an SEP plan. Since SEP accounts are treated as IRAs, funds can be invested the same way as any other IRA. Keogh or HR10 Plans Keogh plans are full-fledged pension plans for the self-employed. Named for U.S. Representative Eugene James Keogh of New York, they are sometimes called HR10 plans. Nonqualified plans Plans that do not meet the guidelines required to receive favorable tax treatment are considered nonqualified and are exempt from the restrictions placed on qualified plans. They are typically used to provide additional benefits to key or highly-paid employees, such as executives and officers. Examples include SERP (Supplemental Executive Retirement Plans) and 457(f) plans.

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Employee stock ownership plan (ESOP) - is a defined contribution plan. In an ESOP, "the investments are primarily in employer stock" (U. S. Department of Labour). Basically, the company contributes new shares of its own stock to a trust fund set up for that purpose. Then, "shares in the trust are allocated to individual employee accounts.

Money purchase pension plan - is a defined contribution plan. A money purchase pension plan "requires fixed annual contributions from the employer to the employee's individual account" (U. S. Department of Labour).

Another form of pension plan is the simplified employee pension plan (SEP). In this type of plan, employees set up ownership of an individual retirement account (IRA). Employees may make taxfavoured contributions to these accounts. Employers may also contribute to the employee owned IRA (U. S. Department of Labour).

History of pensions in the United States 1884: Baltimore and Ohio Railroad establishes the first pension plan by a major employer, allowing workers at age 65 who had worked for the railroad for at least 10 years to retire and receive benefits ranging from 20 to 35% of wages. The Revenue Act of 1913, passed following the passage of the 16th amendment to the constitution which permitted income taxation, recognized the tax exempt nature of pension trusts. At the time, several large pension trusts were already in existence- including the pension trust for ministers of the Anglican Church in the United States. 1940s: General Motors chairman Charles Erwin Wilson designed GM's first modern pension fund. He said that it should invest in all stocks, not just GM. 1963: Studebaker terminated its underfunded pension plan, leaving employees with no legal recourse for their pension promises. 1974: Employee Retirement Income Security Act (ERISA) – imposed reporting and disclosure obligations and minimum standards for participation, vesting, accrual and funding on U.S. plan sponsors, established fiduciary standards applicable to plan administrators and asset managers, established the Pension Benefit Guaranty Corporation to ensure benefits for participants in

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terminated defined benefit plans, updated the Internal revenue Code rules for tax qualification, and authorized Employee Stock Ownership Plans ("ESOPs") and Individual Retirement Accounts ("IRAs"). 1985: The First Cash Balance Plan - Kwasha Lipton creates it by amending the plan document of Bank of America pension plan. The linguistic move was to avoid mentioning actual individual accounts but using the words hypothetical account or notional account. 1991: A Magazine article claims that pension- and retirement funds own 40% of American common stock and represent $2.5 trillion in assets

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UK Pension system
Additional Pension Three different state schemes have existed to provide extra pension provision above the Basic State Pension. These are collectively known as Additional Pension. This has been available only to employees paying National Insurance and certain exempted groups (not including the self employed). The three schemes are/were: 1. Graduated Pension or Graduated Retirement Benefit – It ran from 6 April 1961 until 5 April 1975. Qualification was based on payment of a number of fixed National Insurance payments ('stamps'). Graduated pension typically pays a small amount (a pound or so per week) to those affected. 2. State Earnings-Related Pension Scheme (SERPS) - It ran from 6 April 1978 to 5 April 2002. As the name implies, the level of pension payable was related to the recipients earnings via their National Insurance contributions. Qualification was based on band earnings above a Lower Earnings Limit (LEL) in each year. 3. State Second Pension (S2P) - S2P was introduced on 6 April 2002. As with SERPS, the level of pension payable is related to the recipients earnings via their National Insurance contributions. Qualification is based on earnings at, or above, the LEL, but no band earning calculation is made until earnings reach a higher base (£12,500 pa in 2006/07) called the Lower Earnings Threshold (LET). Earnings below the LET (but above the LEL) are credited up to the LET. Unlike the Basic State Pension, participation in the Additional Pension schemes is voluntary. Those who do not wish to participate can contract out. This option was introduced with SERPS in 1978 and is only available to those who have made alternative pension arrangements through Personal or Occupational schemes. Further changes to be introduced in 2012 will see S2P change from an "earnings related" to a "flat rate" pension, and individuals will lose the right to contract out. Occupational pensions Occupational pension schemes are arrangements established by employers to provide pension and related benefits for their employees. 1. Defined benefit/final salary schemes- Traditionally, a large number of UK employers offered their employees access to a defined benefit or final salary occupational pension scheme. In

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such an arrangement, the employee was promised a fixed level of pension based on their final salary to which he or she would become entitled on retirement. The amounts payable are restricted by taxation rules, but are typically either a pension of one-sixtieth of their final salary for each year of membership or a pension of one-eightieth of their salary plus a tax free lump sum of three-eightieths. 2. Defined contribution/money purchase schemes - Over recent years, many employers have closed their defined benefit schemes to new members, and established defined contribution or money purchase arrangements. In this arrangement, the occupational pension pays into a fund, and the fund is used to buy a pension (typically an annuity) when the individual retires. The pension is therefore determined by the value of the fund and the health of the annuity when the individual retires, as opposed to their salary. Funding UK occupational pension schemes are typically jointly funded by the employer and the employees. These are called "contributory pension schemes" since the employee contributes - typically something in the region of 6% of salary, tax free. "Non contributory pension schemes" are where the employer funds the scheme with no contribution from the individual. Contributions are typically put into a separate trust, whose assets will be used to provide benefits in due course. Other Pensions Individual or personal pensions It is also possible for an individual to make contributions under an arrangement they themselves make with a provider (such as an insurance company). Similar tax advantages will usually be available as for occupational schemes. Contributions are typically invested during an individual's working life, and then used to purchase a pension at or following retirement. Stakeholder pensions Stakeholder pensions are a form of pension arrangement designed to be easily understandable and available. Stakeholder pension are in effect personal pension schemes set up on terms which meet standards set by the government (for example there are restrictions on the charges the provider may make). Although a stakeholder pension is a personal pension, they can (and in some circumstances must) be offered by an employer as a cost-effective way of providing pension cover for their workforce.

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Group personal pensions Group personal pensions are another pension arrangement that are personal pensions, but are linked to an employer. A group personal pension plan (GPPP) can be established by an employer as a way of providing all of its employees with access to a pension plan run by a single provider. By grouping all the employees together in this way, it is normally possible for the employer to negotiate favorable terms with the provider, thus reducing the cost of pension provision to the employees. The employer will also normally contribute to the GPPP. Perpetual or hereditary pensions Perpetual pensions were freely granted either to favourites or as a reward for political services from the time of Charles II onwards. Such pensions were very frequently attached as salaries to places which were sinecures, or, just as often, posts which were really necessary were grossly overpaid, while the duties were discharged by a deputy at a small salary. Political pensions These are type sui generis as they either reward a career in domestic politics or are awarded in the colonial context not on grounds of justice, contract or socio-economic merits, but as a political decision, in order to take a politically significant person (often deemed a potential political danger) out of the picture by paying him or her off, regardless of seniority

Civil list pensions These are pensions granted by the sovereign from the civil list upon the recommendation of the first lord of the treasury. They were to be "granted to such persons only as have just claims on the royal beneficence or who by their personal services to the Crown, or by the performance of duties to the public, or by their useful discoveries in science and attainments in literature and the arts, have merited the gracious consideration of their sovereign and the gratitude of their country." [3] As of 1911, a sum of £1200 was allotted each year from the civil list, in addition to the pensions already in force Royal Navy An officer is entitled to a pension when he is retired at the age of 45, or if he retires between the ages c 40 and 45 at his own request, otherwise he receives only half pay. The amount of his pension depends upon his rank, length of service and age. As an example, in past, the maximum retired pay 29

of an admiral was 850 per annum, for which 30 years service or its equivalent in half-pay time is necessary; he may, in addition, have held a good service pension of 300 per annum. Self- Invested Personal Pension (SIPP) A Self-Invested Personal Pension (SIPP) is the name given the type of UK government approved personal pension scheme, which allows individuals to make their own investment decisions from the full range of HM Revenue & Customs (HMRC) approved investments. SIPPs are a type of Personal Pension Plan. Another subset of this type of pension is the Stakeholder Pension Plan. SIPPs, in common with personal pension schemes, are tax "wrappers", allowing tax rebates on contributions in exchange for limits on accessibility. The HMRC rules allow for a greater range of investments to be held than Personal Pension Plans, notably equities and property. Rules for contributions, benefit withdrawal etc are the same as for other personal pension schemes. Investment choice Investors may make choices about what assets are bought, leased or sold, and decide when those assets are acquired or disposed of, subject to the agreement of the SIPP trustees (usually the SIPP provider). The range of assets permitted by HMRC includes : ? Stocks and shares listed on a recognized exchange ? Futures and options traded on recognized futures exchange ? Authorized UK unit trusts and OEICs and other UCITS funds ? Unauthorized unit trusts that don't invest in residential property ? Investment trusts subject to FSA regulation ? Unitized insurance funds from EU insurers and IPAs ? Deposits and deposit interests ? Commercial property (inc. hotel rooms) ? Ground rents ? Traded endowments policies ? Derivatives products such as a Contract for difference (CFD) ? Gold bullion, which is specifically allowed for in legislation ? Investments currently permitted by primary legislation but subsequently made subject to heavy tax penalties (and therefore typically not allowed by SIPP providers) include :

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? Any item of tangible moveable property (whose market value does not exceed £6,000) subject to further conditions on use of property other exotic assets like vintage cars, wine, stamps and art Structure Unlike conventional personal pensions where the provider as trustee has ownership and control of the assets, in a SIPP the member may have ownership of the assets (via an individual trust) as long as the scheme administrator is a co-trustee to exercise control. The pensions industry has gravitated towards three industry terms to describe generic SIPP types: Deferred: This is effectively a Personal Pension Plan in which most or all of the pension assets are generally held in insured pension funds (although some providers will offer direct access to mutual funds). Self-investment or income withdrawal activity is deferred until an indeterminate date, and this gives rise to the name. In some newer schemes of this type, there are over 1,000 fund options, so they are not as restrictive as they once were. Hybrid: A scheme in which some of the assets must always be held in conventional insured pension funds, with the rest being able to be 'self-invested'. This has been a common offering from mainstream personal pension providers, who require insured funds in order to derive their product charges. Pure or Full: Schemes offer unrestricted access to many allowable investment asset classes.

Tax treatment Contributions to SIPPs are treated identically to contributions to personal pensions. Individual contribution will receive automatic basic-rate tax-relief; higher-rate taxpayers can claim additional relief through their tax returns. Employer contributions are allowable against corporation or income tax. Income from assets within the scheme is untaxed. Growth is free from capital gains tax (CGT). Pension income provided either from an annuity or via income withdrawal is taxed as earned income at the members highest marginal rate. Investors can invest up to 100% of earned income up to the annual allowance of £235,000 for the 2008/09 tax year. Also, if the fund value exceeds £1.6 million at retirement during the 2008/09 tax year, then the amount above £1.6 million will be taxed at 55%. 31

SIPPs can borrow up to 50% of the net value of the pension fund to invest in any assets, although in practice SIPP trustees are only likely to permit this for commercial property purchase

COMMENT With regard to portfolio composition of pension funds, countries such as United Kingdom and USA follow the prudent man concept, where the pension fund manager has investment freedom and can decide prudently where to invest. Mutual fund industry experts are of the opinion that the same practice should be followed here in India - Once the fund manager is selected, choice of assets should be left to him and true, and investment quality, investment merit and returns should be the considerations for designing a pension fund portfolio. The State has been known to use the pooled up retirement savings for developmental purposes and for financing budgetary deficit. The project Oasis report by Dr.Dave suggests that if the government wants to handle pension and provident funds, it should resist the temptation of using these funds to finance fiscal deficit and should treat these funds as fiduciary funds and create wealth for the poorest of the poor. In order to promote accountability and professionalism the report also suggests that EPF and EPS managers begin marking their investments to market and declare net asset values on a daily basis. If net asset values are to be declared on a daily basis, EPF and EPS managers will turn accountable and professionalized.

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Emerging trends in Pension fund market
The pensions fund market is still in its nascent stages in India. The growth opportunity that lies ahead is immense. The average age of Indian population is about 26 years which would not be the same going ahead. Hence the pension funds should capture this unique opportunity now in order to take advantage of the demographic profile of India. With growing life expectancy and huge working population base, pension and annuity funds managed by life insurers are forecasted to grow at a CAGR of approx. 35% between 2008-09 and 2012-13. Pension products contribution to the Indian life insurance industry will continue to rise in coming years as majority of the working population in India expects to have better quality of life or at least maintain the current living standards postretirement. Along with this, the private companies in India do not provide pensions and employees depend on the provident fund for the same. Hence, there have been changes made by the government in order to ensure the success of pension fund market in India. One of the emerging trends in pension reform is to switch over from Defined Benefit (DB) to Defined Contribution (DC) system pension. A DC pension system is broadly divided into two phases namely Accumulation phase covering collection of Contribution and funds management and pay out phase covering pension payment to the pensioners. Accumulation normally has a time limit, normally to the date of the retirement, but pay out period normally till the survival of the pensioner. The payout phase would be the core to the survival and success of new pension system. The main forms of payout in the DC payment system are lump sum payments, Programme withdrawal and life annuity. As part of the changes for new pension system, PFRDA after two rounds of bidding, selected six players as pension fund managers for tapping resources for pension. PFRDA has finally zeroed down on six players on the basis of the lowest fund management cost. The players which have been chosen are Reliance mutual fund, ICICI Prudential life insurance, IDFC MF, SBI pension fund, Kotak MF and UTI MF. One more area of innovation for the pension fund industry to succeed would need to be the annuity products. The annuity products have not worked in India at all and their growth has been very slow. The Indian market needs to provide preference oriented annuity products that could create enough regular income to the pensioners. One more area of innovation needs to be the growth in the capital market especially for long dated maturity fixed income instruments as the insurers need to invest retirement funds to generate enough inflation adjusted income. India has also introduced partially mandatory annuitization in the post accumulation period to provide regular retirement income to the pension investors.

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The new pension funds that would be offered now onwards would now concentrate at the population in the age group 35-45 years who have already completed their protection needs and are now looking out for retirement plans. Young couples can also be a target market but their number is relatively small and mainly noticed in metropolitan cities. The trend, however, is gradually expanding to tier 2 and tier 3 cities. The pension plans currently accounts for close to 40% of the life insurance industry in terms of premium. The private life insurers are yet to take off in this space and this could be an area which could expand rapidly going ahead. Private life insurers contributed just 7.5% to total pension insurance premium last year which could rise to 15% by 2012-13. It is believed that going forward there would be a mature pension business. It may be that years down the line, all pension and PF streams operating today may converge. The costs would go down dramatically due to competition and economies of scale. The rule based regulations would give way to risk- based supervision. As far as the entry of foreign players in this area is concerned, currently there is a cap of 26% on the foreign party holding in a JV. Only ICICI has an association with Prudential among the funds in India and it would continue this association going forward. The entry of foreign players would in a way be good for the pension fund industry as more competition would mean lesser costs, better efficiency and latest products. The pension fund market in India being in its very early stage would do good to learn from other countries and hence, the knowledge and products brought in by foreign players would do well to the industry.

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