by Renuka Sane and Susan Thomas.
When the Old Age Social and Income Security (OASIS) committee was created in 1998, it was asked to design a pension system that: (a) increased pension coverage on the large area, population and diversity of India; (b) was low cost; (c) was accessible to unsophisticated participants; (d) provided choice of investment; (e) was backed by sound regulation; and (f) had long-run sustainability. The report of the OASIS committee recommended the creation of the National Pension System (NPS), a pension system that was innovative even by the standards of pension systems in developed economies. The design included the following features:
After a decade of existence, there is need to examine the existing NPS and compare the performance of this system to the goals with which it was created. In a recent paper, we analyse the NPS from this perspective.
While several of the key features of the existing system are consistent with the original design features, there are certain critical areas in which the NPS has deviated. There continues to be an attempt to reduce transactions costs in the system, with a central record keeping agency and a limited number of pension fund managers. However, the NPS has several flaws at the ease of accessibility as well as the choice of investments to the pension contributor:
Low transparency: One of the progressive features of the original NPS design was high transparency about cumulations for the NPS member contributors. However, this has not been implemented. Members do not always get communications regarding their pension wealth. There is as yet, no clarity on how long the process of contribution deduction to actual investment takes, and the costs incurred in the form of lost interest owing to delays in the process (if any) on the customer. The PFRDA does not make available aggregate details about assets under management, number of accounts, or cumulated returns. This lack of transparency leads to a lack of awareness and trust in the system, and reduces the quality of policy analysis.
Lack of investment choice: Government employees are not allowed a choice of investment strategy, or pension fund manager. The default investment option of government employees is badly structured - it does not cater to the best interests of participants. International diversification is not permitted.
Inconsistency in tax treatment: Schemes such as the GPF and the CPF continue to be taxed on a EEE basis, while the NPS is taxed on a EET basis. Employee contributions to the NPS above Rs.100,000 are taxed. These tax inconsistencies need to be rationalised.
Confusion: A key element of the original NPS was that it was one single pension system serving the entire country. For a variety of tactical reasons, before the PFRDA Act was passed by Parliament, a series of variants of NPS were created. These create complexity, hamper portability, and increase cost. It is time to go back to one single NPS.
Beyond the scope of the original NPS design, there are other policy issues that need to be addressed in order to achieve the end objective with which the NPS was commissioned: the goal of providing old age income security with coverage across the breadth and length of India.
One such issue deals with the question of the annuity the NPS contributor member can expect to access as a pensioner. The price of an annuity will influence the monthly pension available to a pensioner. If annuity prices are very high, it will have a detrimental impact on the pension payout. As of yet, there has been no active effort on the part of the PFRDA to enable the pensioner to obtain the lowest cost annuity product. Similarly, there has been no effort to design a common draw-down policy that works in the interest of both government employees and lower-income, informal sector workers, both of whom contribute to the NPS.
Another area of broad policy concern has centered around the sales of NPS so far. This has been perceived as very low, and has led to suggestions to incentivise sales intermediaries to push the sales of NPS, by improving their commissions. However, experience from the mutual fund and insurance industries in India shows that a combination of high-powered sales incentives without any liability for mis-selling does not lead to an increase in retail participation. Instead, it can lead to defrauding of customers. This suggests that it would be imprudent for the PFRDA to incentivise the sale of the NPS in an environment that is characterised by a lack of strong consumer protection. The PFRDA needs to first re-orient its strategy towards an explicit goal of consumer protection, with a clear enumeration of the rights of consumers and obligations of sellers. A relevant benchmark that provides explicitly for protections against misleading conduct by sales agents is the Indian Financial Code.
One of the key bottlenecks for the NPS since it was implemented in 2003, was the lack of a sound regulatory framework that was implemented by an empowered and independent regulator. While the PFRDA has been in place at the same time that the NPS was implemented, it has awaited the passage of the PFRDA Bill for a regulatory mandate and empowerment. This Bill has since been passed in 2013, enabling the formal institutionalisation of the PFRDA as the regulator of the NPS.
The PFRDA can now take on the task of both the relatively short term agenda of closing the gap between the current implementation and what was visualised in the original design. This includes building trust in the system by improving the transparency and visibility of fund accumulations for contributor members and the overall system; enabling a richer choice of investments available to individual members; and resolving inconsistencies in tax treatment.
Another area which the PFRDA can take forward is to initiate the policy thinking and research analysis for the medium and long-term objectives of sound policy and regulation for annuities, and to design the regulatory framework to improve the NPS customer rights.
With these actions, India can get back on the track to achieve a pension system with universal coverage that was visualised in the OASIS reforms of 1998.
When the Old Age Social and Income Security (OASIS) committee was created in 1998, it was asked to design a pension system that: (a) increased pension coverage on the large area, population and diversity of India; (b) was low cost; (c) was accessible to unsophisticated participants; (d) provided choice of investment; (e) was backed by sound regulation; and (f) had long-run sustainability. The report of the OASIS committee recommended the creation of the National Pension System (NPS), a pension system that was innovative even by the standards of pension systems in developed economies. The design included the following features:
- Individual accounts with defined contributions.
- Central record keeping agency which will provide a single account balance statement for each individual, and will move net funds to the fund managers.
- Investments managed by multiple pension fund managers, each offering standardised asset products. Auction based selection of fund managers where the selection is based on the sum of fees and expenses.
- Collection of contributions done through a network of banks, post offices and other "points of presence" across the country.
- Withdrawals permitted only after age 60, with a minimum mandatory annuitisation of 40 percent of the terminal pension funds.
- EET tax treatment, where benefits and withdrawals are taxed as ordinary income.
After a decade of existence, there is need to examine the existing NPS and compare the performance of this system to the goals with which it was created. In a recent paper, we analyse the NPS from this perspective.
Problems with the implementation of the NPS
While several of the key features of the existing system are consistent with the original design features, there are certain critical areas in which the NPS has deviated. There continues to be an attempt to reduce transactions costs in the system, with a central record keeping agency and a limited number of pension fund managers. However, the NPS has several flaws at the ease of accessibility as well as the choice of investments to the pension contributor:
Low transparency: One of the progressive features of the original NPS design was high transparency about cumulations for the NPS member contributors. However, this has not been implemented. Members do not always get communications regarding their pension wealth. There is as yet, no clarity on how long the process of contribution deduction to actual investment takes, and the costs incurred in the form of lost interest owing to delays in the process (if any) on the customer. The PFRDA does not make available aggregate details about assets under management, number of accounts, or cumulated returns. This lack of transparency leads to a lack of awareness and trust in the system, and reduces the quality of policy analysis.
Lack of investment choice: Government employees are not allowed a choice of investment strategy, or pension fund manager. The default investment option of government employees is badly structured - it does not cater to the best interests of participants. International diversification is not permitted.
Inconsistency in tax treatment: Schemes such as the GPF and the CPF continue to be taxed on a EEE basis, while the NPS is taxed on a EET basis. Employee contributions to the NPS above Rs.100,000 are taxed. These tax inconsistencies need to be rationalised.
Confusion: A key element of the original NPS was that it was one single pension system serving the entire country. For a variety of tactical reasons, before the PFRDA Act was passed by Parliament, a series of variants of NPS were created. These create complexity, hamper portability, and increase cost. It is time to go back to one single NPS.
Broader policy problems
Beyond the scope of the original NPS design, there are other policy issues that need to be addressed in order to achieve the end objective with which the NPS was commissioned: the goal of providing old age income security with coverage across the breadth and length of India.
One such issue deals with the question of the annuity the NPS contributor member can expect to access as a pensioner. The price of an annuity will influence the monthly pension available to a pensioner. If annuity prices are very high, it will have a detrimental impact on the pension payout. As of yet, there has been no active effort on the part of the PFRDA to enable the pensioner to obtain the lowest cost annuity product. Similarly, there has been no effort to design a common draw-down policy that works in the interest of both government employees and lower-income, informal sector workers, both of whom contribute to the NPS.
Another area of broad policy concern has centered around the sales of NPS so far. This has been perceived as very low, and has led to suggestions to incentivise sales intermediaries to push the sales of NPS, by improving their commissions. However, experience from the mutual fund and insurance industries in India shows that a combination of high-powered sales incentives without any liability for mis-selling does not lead to an increase in retail participation. Instead, it can lead to defrauding of customers. This suggests that it would be imprudent for the PFRDA to incentivise the sale of the NPS in an environment that is characterised by a lack of strong consumer protection. The PFRDA needs to first re-orient its strategy towards an explicit goal of consumer protection, with a clear enumeration of the rights of consumers and obligations of sellers. A relevant benchmark that provides explicitly for protections against misleading conduct by sales agents is the Indian Financial Code.
The light at the end of the tunnel
One of the key bottlenecks for the NPS since it was implemented in 2003, was the lack of a sound regulatory framework that was implemented by an empowered and independent regulator. While the PFRDA has been in place at the same time that the NPS was implemented, it has awaited the passage of the PFRDA Bill for a regulatory mandate and empowerment. This Bill has since been passed in 2013, enabling the formal institutionalisation of the PFRDA as the regulator of the NPS.
The PFRDA can now take on the task of both the relatively short term agenda of closing the gap between the current implementation and what was visualised in the original design. This includes building trust in the system by improving the transparency and visibility of fund accumulations for contributor members and the overall system; enabling a richer choice of investments available to individual members; and resolving inconsistencies in tax treatment.
Another area which the PFRDA can take forward is to initiate the policy thinking and research analysis for the medium and long-term objectives of sound policy and regulation for annuities, and to design the regulatory framework to improve the NPS customer rights.
With these actions, India can get back on the track to achieve a pension system with universal coverage that was visualised in the OASIS reforms of 1998.
This article also covers some challenges to NPS
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