Friday, June 5, 2009

New Pension Scheme

The recently launched New Pension Scheme (NPS), which is open to every citizen of India between the ages of 18 and 55, is very welcome, but the benefits of the scheme can be judged only from the response that it gets from the public and the returns that it gives to subscribers. The scheme has come into effect only on May 1, so it is still too early to judge the response.

Initially launched for the Central Government employees on April 1, 2008, the NPS was subsequently adopted by several State governments for their staff. Now even those outside Government service can have access to regulated pension benefits.

Major Step Forward
The objective of the Government was to provide a solution for the retirement income needs of the general public. Millions of people in this country have no savings or retirement benefits, and if this scheme takes off it will provide a much-needed cushion for people who are no longer working during their old age.

In throwing open the NPS to all citizens, the government has taken a major step forward on the social security front. The biggest beneficiaries from the extended NPS will evidently be those working in the private and unorganised sectors.

Scheme Under PFRDA
Unlike the earlier pension scheme for Government staff that guaranteed payment, post-retirement, of a pension pegged to the last drawn salary of the employee and paid for by the treasury, the NPS envisaged an annuity against the subscriber’s own contribution. Those appointed to manage the various schemes under the NPS as well as the Pension Fund Regulatory and Development Authority (PFRDA), however, have their tasks cut out.

According to PFRDA, six States have already signed agreements with the intermediaries of the NPS architecture for implementing the scheme. The other States are in the process of finalising the documentation. From all accounts, the scheme has so far given good returns. According to the unaudited results of the Pension Funds, these have generated returns ranging from 12 per cent to 16 per cent. In fact, the Life Insurance Corporation’s (LIC) pension fund, which has been the most aggressive fund manager for Central and state government employees, has done so well that PFRDA has increased its allocation to 29 per cent from five per cent. While the PFRDA was established in 2003, the PFRDA Bill 2005 is still awaiting Parliament’s approval.

Range of Capital Market
While the fund managers have been allowed to invest in a range of capital market instruments and government securities, a cap has been placed on investing in equities. Moreover, for now, such investments are allowed only in index funds which are less volatile. There is a strong case for making the NPS even more accessible by, for instance, simplifying the entry requirements. A clarification is needed on the tax treatment especially on maturity. A new permanent account number for every pension account holder is probably necessary at this stage but over time there is a case for having one uniform identification number for all purposes.

Over a fairly long period, safety of the funds invested is as important as a reasonable return. In the absence of any benchmark for pension funds in India, one can only draw comparisons with the operation of the two-decade-old mutual funds industry. Of late, the performance of mutual funds, especially in the equity segment, has been anything but inspiring.

Role of Government
The Government should, however, take care of fund management activism of the pension fund managers that it has appointed to handle the NPS in the unorganised sector. It is understood that in the bidding for NPS business, the lowest fund management fees quoted — including transaction cost — was 0.0009 per cent, which is much lower than what fund managers are charging in the case of mutual funds. What is of concern here is really the question of corporate ethics.

The Government should study whether such a business can be run in a profitable and sustainable manner at such a ridiculously low fee. In the mad rush of fund managers entering into the business, there should not be scope left for problems or scams in the future.

In the case of mutual funds the Government has put a cap, but here a floor has been set, and so everyone will have to accept that lowest fee — set at a ridiculous level. We do not know at this point if it can actually work, but the government would be well advised to be cautious and owes it to the trusting ordinary citizen who is putting in hard-earned money to secure that his or her future is not jeopardised.

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