India’s NPS: Good times and bad
India’s New Pensions System (NPS) was introduced to new recruits into its civil service from January 2004. But that represented only the first step of an ambitious plan to provide sustainable old age security that would reach down to the poorest segments of Indian society. Today, the NPS can show a number of great successes, but it also faces a number of challenges.
Gautam Bhardwaj, director of Invest India sees many of the issues as arising from two opposing forces. “The politicians have woken up to the fact the NPS may actually succeed, so that it can provide them a vote bank if they can be seen to have driven increases in benefits. But the bureaucrats are still worried that it will fail and so tinker with its structure.”
What that has meant is that politicians have been supporting enhanced benefits that may make them popular among voters, but undermines the economics of the NPS itself. Meanwhile, the Pension Fund Regulatory and Development Authority (PFRDA) is suggesting changes to the scheme to encourage more takers, but many of the suggestions go against the spirit of the NPS itself.
The key success of the NPS has been the creation of a defined-contribution (DC) pension scheme for civil servants that replaced an unfunded defined-benefit (DB) scheme that threatened to have grown into an unsustainable monster with an implicit pension debt reaching over 50% of GDP while accounting for only 12% of the workforce, according to Bhardwaj.
But the objective of the NPS has always been that it should be scalable beyond civil servants: “Ultimately, all citizens of India should be able to open an individual account with the NPS and carry that account with them through their labour force trajectory, across jobs, sectors, and locations. The NPS also offers the ability for the Government to encourage the poorest segments of society to save through running co-contribution schemes,” declare Renuka Sane and Ajay Shah in a recent assessment of the NPS.
The civil service scheme
While successful in many ways, this scheme still has a number of issues in its implementation that need to be addressed before the NPS vision can be achieved.
One of the key disappointments has been the haphazard integration of the government payroll process into the Central Record - a keeping agency that connects the NPS participants with the fund managers managing their investments. This is particularly bad in the case of state governments. What is required appears to be enabling linkages with human resource and payroll systems of the central and state governments to obtain subscriber contribution details and process linking between government accounting systems and the pensions administration system.
Transparency is also an issue. Sane and Shah argue there is a great need for dissemination of daily statistics about the number of members, assets under management, performance of all fund managers in all asset classes, summary statistics about performance of members, information about switching across fund managers and across asset classes by members and the returns drag introduced by fees and expenses. This data will enable better analysis of how the NPS is faring and modification of policy positions.
What many commentators also feel very frustrated by is the lack of investment choice. “The average age of the civil service participants in the NPS is 24, but 85% of their investment is being directed into government securities” explains Bhardwaj, adding there is also no choice of fund managers, with the funds being divided among Life Insurance Corp, State Bank of India and UTI Asset Management according to performance.
As the NPS is still in its early stages, there are many years before the first cohort of NPS entrants retires. But Sane and Shah point out there are problems with the current rules on drawdown. The NPS mandates that 40% of the accumulations be used to purchase an annuity and stipulates 60 to be the retirement age. However, the annuity market in India is not very vibrant and mortality tables for the entire population are not well developed. Increasing life expectancy may mean the retirement age also needs to get revised upwards over the years.
Attracting the informal sector
The biggest challenge the NPs still faces is that of attracting the very target base it was designed for - the huge numbers of workers in the informal sector with no old age provisions at all. Sane and Shah argue this has been caused by the poor incentives for intermediaries to sell the NPS, as opposed to the high fees paid by mutual funds and insurance companies for the sale of their products.
As a consequence, the PFRDA has started moving towards the agent -driven sales model that is in use with mutual funds and insurance companies. But Sane and Shah argue that going further down this path would lose the essence of the NPS, which is a low-cost commoditised fund management mechanism. Instead, more effort needs to be put on innovative sales models that would keep the design of the NPS, while encouraging individual members to open NPS account. “Financial firms have an incentive to lobby the PFRDA, while NPS participants have no voice. Financial firms are keen to get back to high charges, to revert from an unbundled architecture to a monolithic architecture, and to ideally go back from a DC system to a monolithic DB system run by insurance companies.”
Finding innovative ways of attracting low income workers is a key issue. Sane and Shah argue the unfortunate feature of recent years has been an effort by the PFRDA to launch a modified version of the NPS for voluntary adoption by low-income workers. A separate “NPS lite” pension system has been created and portability between the two systems has not been assured. But portability is a critical feature of the NPS design and compromising on it will dilute the essence of the system.
The creation of a separate system also implies that economies of scale would not be obtained in both areas. The targeting of organisations that represent groups of low-income workers can be an effective mechanism for the distribution of the NPS, but it also has led to what Bhardwaj sees as a high-handed bureaucratic approach. “The members within the group are given no individual choice as to where their investments should be placed. But these groupings do not represent a homogeneous cohort of people. They will have a wide variation in age for example. The rules have not been driven by genuine concerns over what is good for the customer”.
The NPS still represents what could eventually become the largest institutional pool of semi-institutional assets in India, but there are political concerns over the extent to which there should be foreign direct investment in pension funds.
UTI is however, owned 26%by US fund manager T. Rowe Price and as Bhardwaj argues, FDI in pension funds is really a non-issue. The Securities and Exchange Board of India (SEBI) provides strong regulatory oversight and clear investment regulations to ensure the savings of millions of Indians in mutual funds are protected, so FDI was not an issue when SEBI-regulated asset management companies were hired by the Employee Provident Fund Organisation, India’s previous attempt at a nation-wide occupational pension scheme. However, for the foreign fund managers, India is not an easy environment for them to operate in.
The NPS’ greatest strength, in offering low cost investments is tremendously beneficial for the consumer, but the converse is true for the fund managers. “Foreign fund management firms operating in India such as Fidelity have not been beating at the door to get into the NPS” says Bhardwaj, which perhaps is not a surprise. Even T. Rowe Price’s relationship with UTI is experiencing problems arising from disagreements over the mechanism for choosing the next CEO. The dilemma for foreign fund managers is how best to enter the Indian fund management industry in a manner that does not entail years of struggle in a highly competitive domestic market. One solution Nikko Asset Management has just announced is to focus on the offshore market. The Japanese fund management firm has signed an MOU with the Indian financial services group, Ambit Holdings, to find external investors for Indian equity strategies managed by their joint venture through Nikko’s distribution network in Asia.
When will the NPS be a success?
Despite its weaknesses, the NPS is an example of a low-cost, scalable, commoditised fund management system, argue Sane and Shah. The governance challenge India now faces is that of keeping the NPS on track, of keeping the NPS close to the original design and vision. The NPS needs to get up to world class in terms of service delivery and low cost. This requires clarity and commitment on the part of the PFRDA to stay in tune with the original goals of the NPS and not respond to the lobbying of financial firms. With about 1.1 million participants, the NPS is a large system by world standards, even though it is a small system by Indian standards. But to understand the future challenges it still faces to be seen as successful by Indian standards, its current size needs to set against the 300 million target. The journey has barely begun.