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Public Pension Fund Management in India


... 01) Rs 1,972,700 crore (US$ 420 billion) ... Schemes distributed through Post Offices. Special Deposit Scheme ... Post Office Savings (12.2%) Insurance ... – PowerPoint PPT presentation

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Title: Public Pension Fund Management in India

Public Pension Fund Management in India
Conference on Public Pension Fund
Management September 24-26, 2001
  • Framework of Old Age Income Security in India
  • Mandatory Retirement Plans in India
  • Governance Structure for the Plans
  • Funding Levels and Coverage
  • Investment Guidelines
  • Historical Returns
  • How do the returns compare
  • Public v. Private Management
  • Benchmarking of Returns
  • Role of Funds in allocation of capital
  • Corporate Governance
  • Future Direction

Framework of Old Age Income Security in India
Public Pillar Poverty Alleviation Programmes
  • India does not have Social Security Programmes of
    OECD Countries
  • Governments taxation power is used to fund
    Poverty Alleviation Programmes
  • 26 of population below poverty line (1999-2000)
  • Employment Generation, Food for Work, Food
    Subsidy, Subsidised Education and Health Care
  • Public Investments in a big way in industry and
    infrastructure during 1950-90
  • National Old Age Pension Scheme
  • Monthly Pension for the poor of above 65 years
  • 5.3 million beneficiaries
  • Several welfare programmes covering agricultural
    workers, construction workers and home workers

Mandatory Pillar Covers Formal Employment
  • Government employees are covered under provident
    fund and pension fund with a pay as you go system
  • Mandatory Provident and Pension Funds exist for
    the workers in organised sector
  • Employees Provident Fund and Miscellaneous
    Provisions Act, 1952 governs mandatory plans
  • All employees of notified industries and
    establishments with more than 20 employees
    mandatorily covered by three EPF Plans
  • Compliance responsibility with the employer
  • Special enactments for certain groups with funded
  • Armed forces, Coal Mine Workers, Tea Plantation
    Workers, Jammu Kashmir, Merchant Navy, Banking
  • High coverage of occupational plans among
    organised workers
  • Only 15.2 of total work force in Regular
    Salaried Employment
  • Self-employed is 53.6. Casual employment is

Voluntary Pillar Main Stay of Income Security
  • India has well-developed financial markets to
    provide savings opportunities
  • Established banking system with a vast reach
    65,000 branches with deposits of over Rs 9,62,000
    crore (US 205 billion 44 of GDP)
  • Post Office Savings products cover the whole
    country 133,000 post offices with outstanding
    deposits of Rs 1,55,000 crore (US 33 billion
    7 of GDP)
  • Market Capitalisation of Stock Market Rs
    9,12,000 crore (US 194 billion 42 of GDP)
  • Large market of Government Bonds Outstanding of
    Rs 8,95,000 crore (US 190 billion 41 of GDP).
    Growing Corporate Bond market.
  • Fairly stable macro-economic environment
  • Informal Arrangements are important sources of
    security for the old
  • Cultural factors emphasise caring for the old

Mandatory Retirement Plans in India
Mandatory Plans in India
  • All covered employees mandatorily become members
    of three EPF plans
  • Provident Fund Scheme (DC Plan) Accumulation
    paid out on retirement. Early withdrawals allowed
    for specified purposes.
  • Pension Scheme (DB Plan) Monthly Life Pension
    after retirement with Survivor and Disability
  • Deposit Linked Insurance Plan Additional
    payment based on accumulation amount in case of
    death while in service
  • Combination Benefit Structure of DC and DB Plans
  • High Contribution Rates
  • 12 Employee Contribution 12 Employer
    Contribution 24
  • In five specified industries, contribution is 10
    10 20
  • Some companies have additional superannuation
    schemes with up to 15 employer contribution
  • Bonus and Special Allowances not included for
    computation of contribution

Employees Provident Fund Scheme, 1952
  • Defined Contribution Plan
  • Contributions
  • 12 Employee Contribution 3.67 Employer
    Contribution 15.67
  • 10 1.67 11.67 in five industries
  • Benefit Structure
  • Accumulated Balance paid out on retirement.
    Balance Employee and Employer Contributions
    Interest credited Non-refundable Loans
  • No annuitisation
  • Non-Refundable Loans allowed for for housing,
    major illness, marriage or education of children
    and special circumstances
  • Portable between employers
  • Investment Risk is Borne by the Employee

Employees Pension Scheme, 1995
  • Defined Benefit Plan
  • Contributions
  • 8.33 Employer Contribution 1.16 Government
    Contribution (subject to limit)
  • Benefits
  • Monthly Superannuation Pension for life at 50 of
    Average of last 12 months Salary (for 33 years
    of service)
  • One-third pension can be commuted. Reduced
    pension with return of capital possible
  • Disablement Pension Full Superannuation pension
    without minimum service
  • Survivor Pension to surviving spouse and
    children (50 of pension for spouse and 25 for
    each dependent child)
  • No cost of living increases
  • Portable at EPF
  • Investment Risk borne by the Fund
  • Government has the power to increase contribution
    or reduce benefits
  • Pension increased by 4 5.5 after the last
    two biennial actuarial valuations

Deposit Linked Insurance Plan, 1971
  • Life Insurance Plan
  • Contributions
  • 0.5 Employer contribution
  • Benefits
  • Additional payment made to employee in case of
    death while in service
  • Amount equal to accumulated balance in the
    Provident Fund
  • Subject to a limit of Rs 60,000
  • Investment Risk borne by the Fund

Governance Structure
Governance Structure
  • The three mandatory plans are administered by
    Employees Provident Fund Organisation
  • Set up under the EPF Act
  • Central Provident Fund Commissioner appointed by
    the Federal Government is CEO. Usually a civil
    service bureaucrat.
  • Supported by Assistant and Regional Provident
    Fund Commissioners
  • Central Board of Trustees is the supervisory
  • Minister of Labour is the Chairman
  • Central Provident Fund Commissioner
  • Five Federal Government Representatives
  • Fifteen State Government Representatives
  • Ten Employer Representatives
  • Ten Employee Representatives
  • All trustees are appointed by Federal Government
    after consultation

Administrative Structure
  • EPFO carries out Benefit Administration and
    Record keeping
  • Set up an extensive administration network with
    offices all over the country
  • Headquartered at New Delhi. 281 offices
    throughout the country.
  • Employers pay contributions at designated banks
  • Fund Management is contracted out to a
    professional fund manager
  • State Bank of India is presently the fund manager
  • No change in fund manager for several years

Exempted Funds
  • Employers can opt out of the Government Schemes
    by setting up their own Provident Fund and
    Pension Fund
  • Need to get an exemption from the Government
    under EPF Act
  • Need to get an authorisation under Income Tax Act
    for tax exemption
  • Employers allowed to set up Exempted Funds when
  • Contributions and Benefits under the Employers
    Scheme are not inferior to that of the Government
  • Agree to follow all guidelines including
    Investment Pattern
  • Employers can set up own trust
  • Full funding required
  • Trustees are representatives of Employer and
  • Benefit Administration, Record-keeping and Funds
    Management done in-house
  • 2970 Exempted Funds with 4.5 million subscribers
    (18.8 of total subscribers)

Funding Levels and Coverage
Funded Schemes
  • Provident Funds
  • Both Employees Provident Fund and Exempted Funds
    are fully funded
  • Assets of the Funds are represented by portfolios
    of securities
  • Pension Funds
  • Employees Pension Fund is funded by contributions
    of Employer and Government
  • Actuarial deficits, if any, of EPS not known
  • Pension Funds managed by Employers in Banking
    Sector and Public Sector are fully funded with
    regular actuarial valuations
  • All Funded Schemes are required to follow
    prescribed Investment Pattern

Growth in Coverage of EPF
  • 177 industries and classes of establishments
    covered today
  • Started with 6 industries in 1952
  • All establishments with more than 20 employees
    covered within specified industries
  • 24 million subscribers covered
  • Approximately 9.7 of labour force covered
  • 53.6 is Self Employed
  • 31.2 is in Casual Employment

Total Pension Assets
  • Asset Growth Rates
  • EPF
  • 1998-99 16
  • 1997-98 14
  • Exempted Funds
  • 1998-99 7.5
  • 1997-98 8.1

On 31-3-1999
Reasons for low asset base
  • Total GDP (2000-01) Rs 1,972,700 crore (US 420
  • Gross Domestic Savings 22.3 ( of which Total
    Household Savings 19.8)
  • Financial Savings 10.5 (53)
  • Physical Savings 9.2 (47)
  • Provident and Pension Funds form 23 of total
    household financial savings
  • 2.1 of GDP every year goes into Provident and
    Pension Funds
  • Reasons for low asset base
  • No annuitisation in provident fund
  • High Premature Withdrawals Rs 2715 crore in EPF
    and Rs 1437 crore in Exempted Funds (in 1998)
  • 60.8 of New Contributions
  • New Contributions in 1998
  • EPF Rs 3643 crore. Exempted Funds Rs 3175
    crore. Total Rs 6818 crore

Investment Guidelines for Provident and Pension
Investment Guidelines Prescription
  • Funds are required to follow Investment Pattern
    prescribed by the Government
  • Both Employees Provident Fund and the Exempted
    Funds follow the same pattern
  • Investment Pattern prescription comes from two
  • Ministry of Labour under EPF Act Failure to
    comply could result in withdrawal of Exempted
    Fund status and imprisonment up to 6 months
  • Ministry of Finance under Income Tax Act
    Failure to comply could result in withdrawal of
    tax exemption for the Fund
  • Objectives not explicitly defined. Appear to be
  • Ensuring complete safety of employees funds and
    confidence in the system.
  • Channel funds to Government sector
  • Pay a reasonable return to the employee

Asset Class Prescription
  • Investment Guidelines define permitted Asset
  • Almost entirely channeled to Government or
    Government Enterprises
  • Percentage to be invested in each asset class
  • No investments allowed in
  • International Securities Strict Capital Account
    Controls exist in India. No Indian citizen or
    corporate can invest overseas.
  • Stocks India has a large stock market
  • Real Estate Only Financial Assets allowed
  • Gold Only Financial Assets allowed
  • No investments permitted in Bank or Corporate
  • Investment allowed only in marketable securities
  • No loans to individuals or Corporates
  • Only exception is Federal Governments Special

Investment Pattern since inception
Federal Govt Bonds
State Govt Bonds
Federal Govt Deposits
Bonds of Public Enterprises
Any Public Category
Private Sector Bonds
Investment Pattern in the past 10 years
  • Almost entirely channeled to Government or
    Government Enterprises
  • Divided among Federal Govt, State Govts and
    Public Enterprises
  • Share of Government Enterprises has gone up at
    the cost of direct Government flows
  • Private Sector Bonds allowed up to 10 since 1998
  • Not Mandatory Can be invested at the option of
  • EPF Trustees decided against investment in
    Private Sector
  • Many Exempted Funds also do not invest in Private

Federal Govt Bonds
State Govt Bonds
Federal Govt Special Deposits
Bonds of Public Enterprises
Any Public Category
Pvt Sector Bonds
One Investment Pattern fits all
  • No distinction between Provident Fund and Pension
    Fund in the Investment Pattern
  • Risk lies with Employee in a Provident Fund
  • Risk lies with Employer in a Pension Fund
  • Today, advocates of relaxation in Investment
    Pattern are focusing on Pension Funds
  • No choice to the Employer or the Employee
  • Only choice is for the Employer to opt out by
    setting up an Exempted Fund
  • No choice of alternate investment patterns based
    on risk preferences of Employees and Empoyers

Returns on Provident and Pension Funds
EPF Interest Rate in the past 12 years
  • EPF Interest Rate remained fixed at 12 from
    1991-92 to 1999-2000
  • Slashed to 11 in 2000-01 consequent to fall in
    market interest rates
  • Being further reduced to 9.5 in 2001-02 due to
    sharp fall in interest rates

Deposit Account Concept
  • Provident Fund works like a Deposit Account
  • Unlike a Mutual Fund, NAV of underlying portfolio
    not computed
  • Members Accounts are credited annually with an
    interest rate declared based on current income of
    the Fund
  • Members get annual Statements of Account
  • No loss of principal amount. Interest credited
    every year.
  • Fairly Stable Interest Rate. Changed in the event
    of substantial changes in market interest rates
  • No Disclosure of Portfolio or Actual Returns

No Active Management
  • Funds are required to hold all investments until
  • Sale before maturity requires approval of
    Provident Fund Commissioner
  • No Valuation of investments. No marking to
  • Accounted like long term investments.
  • No permission to Fund Managers to churn portfolio
  • Cannot generate profits based on market views
  • Cannot sell a security when issuers financials
  • But funds are protected from market risk
  • Specified Pattern applies to fresh accretion only
  • New contributions and redemption proceeds are
    required to be invested according to the pattern
  • Interest in any asset category is required to be
    reinvested in the same category
  • Changes in interest rates affect Provident Funds
    with a lag effect

Special Deposit Rate determines EPF Rate
  • Special Deposit Scheme started by the Government
    as a convenience to Provident Funds
  • Available round the year - A big help when
    Government Bond issuances are infrequent and
    secondary market liquidity is poor
  • Withdrawals permitted without any loss of
  • Interest Rate on Special Deposits determined by
    Federal Government
  • Broadly tracks government bond yields
  • Government equalises the EPF rate with
  • Government Provident Fund Rate
  • Public Provident Fund Rate
  • Small Savings Schemes distributed through Post
  • Special Deposit Scheme Rate
  • These are few of the administered interest rates
    in the country
  • Special Deposits were to mature in 1998
  • Federal Government unilaterally extended the
    maturity to 2003

Portfolio Composition of Funds
  • Portfolio Composition of Funds depends on their
  • Older funds are weighted towards Federal
    Government Special Deposits and Government Bonds
  • Newer funds are weighted towards Bonds of Public
    Financial Institutions and Public Enterprises

Typical New Fund (set up in 1998)
Typical Old Fund (set up in 1948)
Confidence in the System
  • Public Confidence maintained in PF System
  • Unquestioned confidence in the system from
  • PF considered the safest investment
  • Government thought to be behind the system
  • PF interest rate works like an administered rate
    despite full funding and separate portfolio

Real Rates of Return
Consumer Price Inflation is sharply down in the
last 3 years
Despite fall in nominal rates, Real rate of
interest has risen
How do the Returns compare
Where do public savings flow?
Distribution of Financial Savings Of Households
in 1999-2000
  • Total Financial Savings of Households
    (1999-2000) Rs 2,05,898 crore (US 43.8 bn)
  • Top 5 Investments
  • Bank Deposits (33.6)
  • Provident and Pension Funds (23.1)
  • Post Office Savings (12.2)
  • Insurance (12.1)
  • Currency (8.9)
  • Stocks, Bonds and Mutual Funds form a small part

PF Returns compared to Bank Deposits
  • Most of the time, Bank Deposit rates are lower
    than PF Interest Rate
  • Banks have higher administrative costs
  • Banks have to follow Cash Reserve, Liquidity
    Ratio stipulations

Bank Deposits over PF Rate
Returns on Underlying Assets Government Bonds
  • Since 1993, yields on Federal Government Bonds
    are market-driven
  • Bonds issued in auctions
  • Banks, PFs, LIC required to invest in Govt Bonds
    up to specified percentage
  • Banks hold Govt Bonds much in excess of
  • State Govt Bonds yield 15-20 bp over Federal Govt
  • Govt Bond yields have fallen sharply in the past
    four years

EPF Rate
PF Rate compared to Mutual Funds
  • Mutual Funds is a nascent industry in India
  • Experience for only 2-3 years
  • Equity Funds have made big losses due to market
  • Gilt Funds are the only exception with 18 return
    during last one year

Returns on Stocks
  • Average Returns over long periods
  • 14.7 over 9 years from 1992-93 to 1999-2000
  • 22.3 over 10 years from 1980-81 to 1989-90
  • Regular crises on Indian stock markets have
    affected confidence of retail investor
  • Substantial volatility has resulted in individual
    investor turning away

Returns on BSE Sensex In the last five years
Tax Benefits
  • Tax benefits for contributions
  • Employees get tax rebate on their contribution to
    Provident Fund
  • Employers contribution is tax free
  • Interest is tax free
  • Taking tax benefits into account, returns are

Can PF Returns be increased?
  • Without disturbing Deposit Account Concept
  • Private Sector Bonds can give a higher return
  • Will increase risk. PF managers need to have
    skills to evaluate risk.
  • Government Securities give higher return compared
    to Special Deposits
  • By Shifting to NAV Concept
  • Investment in Stocks will sharply increase risk
    and give higher return potential
  • International Diversification can increase yield
  • Active management of portfolio

Public v. Private Management
Exempted Funds
  • Employers can contract out of EPF and set up
    privately managed funds
  • Only 3,000 companies have opted to set up
    Exempted Funds
  • Most Exempted Funds manage funds in-house. Few
    engage a professional fund manager
  • Exempted Funds have obligation to declare at
    least the EPF Rate
  • Employer to bear the cost in case of shortfall
  • Little evidence of Private Management producing
    better returns
  • Some Exempted Funds declare more than EPF Rate
  • This is related to age of the fund
  • Higher return by taking higher risk
  • Small privately managed funds are at disadvantage
    compared to EPF
  • Professional management can increase returns
  • Guidelines drive the returns

No Minimum Rating Stipulation
  • Guidelines do not stipulate minimum rating for
  • Only for Private Sector Bonds are required to be
    rated at investment grade (BBB and above) by two
    rating agencies
  • Implicit assumption that public enterprises are
  • Many trustees have internal guidelines
    stipulating minimum rating
  • EPF and CMPF Trustees have minimum rating
  • Some Exempted Funds also have such criteria
  • Most Exempted Funds do not have capability to
    evaluate investments
  • Very few Exempted Funds engage a professional
    fund manager
  • Often consider all eligible securities as equal
  • Assume that market interest rates represent
    risk-adjusted return
  • Implicit assumption that public enterprises are
    safe is coming increasingly under challenge

Benchmarking of Returns
  • Exempted Funds are benchmarked against EPF Rate
    for interest declared
  • Performance can be evaluated by outperformance
    over EPF
  • No risk parameters available
  • Age of the fund becomes critical
  • Actual Returns are not disclosed
  • NAV not computed
  • Hence no benchmarking is possible
  • No satisfactory benchmarks even for debt funds
  • Couple of Govt Bonds benchmarks available in the
  • Not followed by the market
  • Equity Indices are well-established
  • Not relevant since PFs do not invest in equities

Role of Funds in Allocation of Capital
Government Bonds and Special Deposits support
fiscal deficit
  • Government Bonds are used for deficit financing
  • Central and State Governments run large deficits
  • Government has been running revenue deficit with
    high consumption expenditure financed by
  • In old funds, almost 90 of funds are with
  • Pay as you go system in substance
  • Does Investment Pattern encourage government
  • Banks and LIC are biggest subscribers of
    Government Bonds
  • Banks invest more than SLR requirements in
    Government Bonds

Private Sector funded through Public Financial
  • Financial Institutions are biggest issuers of
  • Make loans to private enterprises for setting up
    new projects
  • PSE Bonds has created productive infrastructure
    in the country
  • State Govt enterprises have set up projects in
    irrigation, road development, power projects

Total Privately Placed Bond issuances in
2000-01 (Rs 52,433 crore US 11.2 bn)
Corporate Governance
Corporate Governance
  • Provident and Pension Funds play no role in
    corporate governance
  • No investment in equities
  • Even mutual funds are yet to play an active role
  • Recently, stock exchanges have issued guidelines
    for disclosure towards corporate governance

The Future
Future Pension Reforms
  • OASIS Project initiated by Ministry of Social
    Justice to identify pension reforms required
  • Key recommendations
  • Establishment of a Pensions Authority
  • Introduction of Individual Retirement Accounts
  • To be managed by approved Pension Managers
    (committee recommended six)
  • A common servicing and record-keeping
  • Three funds from each company representing
    conservative, balanced and aggressive investment
  • Group of Ministers constituted by Government to
    examine suggested reforms

Possible Future Direction
  • Introduction of Retirement Funds
  • NAV based funds
  • Different investment objectives and management
  • Capital preservation funds
  • Option to Employees to shift fully or partially
    to Retirement Funds managed by approved pension
  • Employees may take time to get used to variable
  • Marketing and administration costs will increase
  • Strict Regulation and Disclosures required
  • Requires distribution and servicing
    infrastructure to be set up
  • Common infrastructure as suggested by OASIS may
    be a good option

Thank you for your attention