Thursday, July 17, 2003

india turns to private funds

Rising life expectancy and an increasingly prosperous middle class create fresh opportunities for private pension-fund managers in India

By Shailaja Neelakantan
(This article appeared in the Wall Street Journal and the Far Eastern Economic Review in July 2003).

NEW DELHI RESIDENTS Deepti and Kunal Varma, both 42 years old, are a husband-and-wife team who make documentary films and want to continue doing so for the rest of their lives. They have two children who are below the age of 10. Having been badly burnt in the stockmarket and with the interest rate on the government-run Public Provident Fund, or PPF, plummeting to 8% from 11% three years ago, the Varmas, who had recently sold a plot of land, were in a bind about where to invest. "We first thought of an insurance plan, but at our age the premiums were too high and our retirement kitty would have amounted to [very little], so we chose a pension plan that has more flexibility," says Varma.

Indians like the Varmas are fuelling the nascent private pension-fund industry here. The industry, including the state-run Employee Provident Fund, or EPF, and the PPF, is currently valued at 560 billion rupees ($12 billion) and is expected to grow to an estimated 1.8 trillion rupees in 2025. Private companies began to launch pension plans in 2002 following the opening of the insurance market in 2001 and they have already grabbed a 33% share of the overall pensions market.

Still, the potential for growth is huge. The pension market in India accounts for less than 1% of the insurance market, while in the United States, pension plans make up 49% of insurance policies sold. Almost all the 12 private-sector, life-insurance companies in India have introduced or plan to introduce pension products to cash in on what they see as a boom time.

That's not surprising in a country where only 11% of the working population has any form of guaranteed post-retirement income. A large proportion of the population--the self-employed, unorganized labour, farmers--have no provision at all. Individuals working in the private sector depend on group superannuation plans or on individual schemes run by the state-owned Life Insurance Corp. of India, or LIC.

They make mandatory contributions of 12% of their basic salary to the EPF. Government workers participate in a derived-benefit pension scheme, under which retirees receive a certain proportion of the salary they earned at retirement as a lifelong pension. But for neither private-sector nor government employees is the amount accrued ever enough to sustain the lifestyle the individual enjoyed before retirement.

Besides, these pension plans place a huge onus on the government because even when interest rates come down, the payouts, a guaranteed 9% for all employees under the EPF, remain the same. In fact, the government has recently said it is working on a defined-contribution pension plan for employees who will join after October 2003. This will place a lighter burden on the government, as returns to employees will be based on contributions and will not be fixed as they are under the defined-benefit plan. With the crash of the state-run mutual fund, Unit Trust of India, the government is now wary of offering guaranteed returns.

The state-run plans also present other practical limitations for the beneficiaries. "The state-run LIC's Jeevan Suraksha pension plan doesn't offer much flexibility," says a treasury manager at the Federation of India Chambers of Commerce and Industry. "Even if you fail to pay your premium, private pension funds can adjust your plan. They give you the flexibility to withdraw and change your plan as you age and as your risk-taking ability goes down. They also have professional, seasoned managers."

However, the state will still mandate how these private pension funds invest. Today most pension funds must invest as much as 40% in government securities, but few companies see that as a limitation. "We currently don't feel the need to invest more in equities. We think this is the right pattern of investment for a retirement plan, which needs to be conservative," says Shikha Sharma, managing director of ICICI Prudential Life Insurance.

Kapil Mehta, vice-president for business development and strategic planning, at Max New York Life Insurance agrees: "We prefer a conservative approach. If the government says 40% in government securities, we will invest 40%-plus." In the present interest-rate environment the private pension-fund players have a point. With interest rates having fallen 400 basis points in the last two years, yields on 10-year government bonds have fallen to 5.6%-5.8%. So there has been a significant capital appreciation on these bonds.

What the private pension players would like are more tax breaks. "The financial sector in this country opened up much later than in other countries and now it isn't fashionable to give tax breaks. In this initial period, the government should be encouraging people to look at pensions as investment and needs to give them more tax breaks," says Deepak Satwalekar, the managing director and chief executive of HDFC Standard Life Insurance. For now, there is only a 10,000-rupee tax-deduction limit and insurance players want that raised to 30,000 rupees.

The average premium size of a pension policy for private players is a mere 13,000 rupees. "The reason for that is most people have still to learn that pension plans are not just tax-benefit vehicles, they are investment vehicles," says Mehta. HDFC's Satwalekar also believes the 12% mandatory investment in the state-run EPF is hampering people from putting aside more money in voluntary private pension funds.

Nevertheless, with only 11% of the market covered, private pension players are looking forward to raking it in. Life expectancy in India has risen. A person who is 40 years old today is likely to live to the age of 80, according to ICICI Prudential. The number of people above 60 in 2001 is estimated at 71 million, or about 7% of the total population. By 2016, this number is expected to rise to 113 million, or nearly 9% of the population. To pension salesmen, that's good news.

While the life insurance business deals with the fear of "dying too soon," the pensions business deals with the fear of "living too long." Living longer after retirement means that provisions have to be made for higher expenses for a longer time, including for health care. Moreover, "over the next 20 years, the overall cost of living is expected to [significantly] increase," says ICICI's Sharma.

Ordinary Indians, too, are becoming more aware of these issues. "This market is large enough for any number of players," says Satwalekar. "Pension plans account for 20% of our business already and we only see it growing," he says. Since its inception in February 2002 HDFC Standard has collected 410 million rupees as premiums on the Personal Pension Plan.

ICICI Prudential, India's largest private life insurer, has captured 73% of the private-sector pensions market and 24% of the overall pension market, as of January 2003. "There was some talk of restricting the number of private pension players, but that wouldn't be good for the market. We need more players to expand," says Mehta of Max New York Life.

The Indian government hasn't yet set up a separate pensions regulator and all the private plans now fall under the supervision of the Insurance Regulatory and Development Authority, or IRDA. India does plan to have a separate regulator, after which experts expect even more stand-alone private pension fund companies to set up shop. But the private insurance companies that offer pension plans will then have to deal with two regulators, the IRDA and the pensions regulator. "This will be a huge administrative burden and we are trying to convince the government to allow insurance companies that offer pension funds to continue to report to the IRDA," says Mehta.