I D B I

C A P I T A L

Public Pension Fund

Management in India
Conference on Public Pension Fund Management
September 24-26, 2001
1

Outline

I D B I
C A P I T A L

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
2

I D B I
C A P I T A L

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

I D B I
C A P I T A L

26% of population below poverty line (1999-2000)

Employment Generation, Food for Work, Food Subsidy, Subsidised
Education and Health Care Programmes
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 old
5.3 million beneficiaries

Several welfare programmes covering agricultural workers, construction

workers and home workers
4

Mandatory Pillar Covers

Formal Employment

I D B I
C A P I T A L

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 plans

Armed forces, Coal Mine Workers, Tea Plantation Workers, Jammu & Kashmir,
Merchant Navy, Banking Sector

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 31.2%.

Voluntary Pillar Main Stay of

Income Security

India has well-developed financial markets to provide savings

opportunities

I D B I
C A P I T A L

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

I D B I
C A P I T A L

Mandatory Retirement
Plans in India

Mandatory Plans in India

All covered employees mandatorily become members of three EPF plans

I D B I
C A P I T A L

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 Benefits.
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
8

Employees Provident Fund

Scheme, 1952

I D B I
C A P I T A L

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
9

Employees Pension Scheme,

1995

Defined Benefit Plan

Contributions

8.33% Employer Contribution + 1.16% Government Contribution (subject to limit)

Benefits

I D B I
C A P I T A L

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

10

Deposit Linked Insurance Plan,

1971

Life Insurance Plan

Contributions

I D B I
C A P I T A L

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

11

I D B I
C A P I T A L

Governance Structure

12

Governance Structure

I D B I
C A P I T A L

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 authority

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

13

Administrative Structure

I D B I
C A P I T A L

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

14

Exempted Funds

I D B I
C A P I T A L

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 Scheme
Agree to follow all guidelines including Investment Pattern

Employers can set up own trust

Full funding required
Trustees are representatives of Employer and Employees
Benefit Administration, Record-keeping and Funds Management done in-house

2970 Exempted Funds with 4.5 million subscribers (18.8% of total

subscribers)
15

I D B I
C A P I T A L

Funding Levels and Coverage

16

Funded Schemes

I D B I
C A P I T A L

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

17

Growth in Coverage of EPF

Year

Covered
Covered
Establish- Employees
ments
(Million)
1952-53
1,400
1.20
1959-60
7,373
2.70
1969-70
46,504
5.60
1979-80
93,094
10.46
1989-90
194,961
14.66
1999-2000
331,504
23.96

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

I D B I
C A P I T A L

Total Covered Employees

EPF Act
Coal Mine Workers
Assam Tea Plantation
Workers
Seamen's PF
J & K PF
Banking Sector
Govt Employees
Total Coverage

(Million)
23.96
0.80
0.76
0.03
0.15
1.00
26.70
11.14
37.84

Approximately 9.7% of labour force

covered
53.6% is Self Employed
31.2% is in Casual Employment

18

Total Pension Assets

Total Pension Assets

On 31-3-1999

(Rs Crore)
Provident Fund
EPF
Exempted Funds
Pension Fund
EPF
DLI Fund
EPF
Other Funds
Coal Mines
Assam Tea Plantation (est)
Banks (est)
Total Assets

I D B I
C A P I T A L

Asset Growth Rates

EPF
1998-99: 16%
1997-98: 14%

41,310
28,691
22,016

Exempted Funds
1998-99: 7.5%
1997-98: 8.1%

2,188
22,000
10,000
8,000
134,205
US$ 28.5 billion
7% of GDP
19

Reasons for low asset base

I D B I
C A P I T A L

Total GDP (2000-01) Rs 1,972,700 crore (US$ 420 billion)

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
20

I D B I
C A P I T A L

Investment Guidelines for

Provident and Pension Funds

21

Investment Guidelines
Prescription

I D B I
C A P I T A L

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 sources:
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

22

Asset Class Prescription

I D B I
C A P I T A L

Investment Guidelines define permitted Asset Classes

Almost entirely channeled to Government or Government Enterprises
Percentage to be invested in each asset class specified

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 Deposits

Investment allowed only in marketable securities
No loans to individuals or Corporates
Only exception is Federal Governments Special Deposits

23

Investment Pattern since

inception

I D B I
C A P I T A L

100%

90%
80%
70%

Federal Govt Bonds

Federal
Govt
Deposits

60%
50%
40%

State Govt Bonds

Bonds of Public
Enterprises

30%
20%

Any Public Category

10%

Private Sector Bonds

0%

Pvt Sector Bonds

State Govt Bonds

Any Public Category

Fed Govt SDS

Public Enterprises Bonds

Fed Govt Bonds

24

Investment Pattern in the past

10 years

100%
90%

Federal Govt Bonds 25%

80%
70%
60%
50%
40%
30%
20%
10%
0%

Federal Govt
Special
Deposits

State Govt Bonds

15%

Bonds of
Public
Enterprises

40%

Any Public Category 10%

Pvt Sector Bonds 10%

Almost entirely channeled to

Government or Government
Enterprises

I D B I
C A P I T A L

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 Trustees
EPF Trustees decided against
investment in Private Sector
Many Exempted Funds also do not
invest in Private Sector

25

One Investment Pattern fits all

I D B I
C A P I T A L

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

26

I D B I
C A P I T A L

Returns on Provident and

Pension Funds

27

EPF Interest Rate in the past 12

years

16%
15%

14%
13%

12%

12%

11%

11%

9.5%

10%
9%
8%
7%
6%
1991 1992 1993

1994 1995 1996

1997 1998 1999

2000 2001 2002

I D B I
C A P I T A L

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
10 year Govt Bond Yield
1997
12.9%
1998
11.9%
1999
11.9%
2000
10.4%
2001
9.2%
28

Deposit Account Concept

I D B I
C A P I T A L

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

29

No Active Management

I D B I
C A P I T A L

Funds are required to hold all investments until maturity

Sale before maturity requires approval of Provident Fund Commissioner
No Valuation of investments. No marking to market.
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 deteriorate
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

30

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

Interest Rate on Special Deposits determined by Federal Government

I D B I
C A P I T A L

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 Offices
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

31

Portfolio Composition of Funds

I D B I
C A P I T A L

Portfolio Composition of Funds depends on their age

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)

Federal Govt
Bonds
State Govt Bonds
Bonds of PSEs
Special Deposits

32

Confidence in the System

I D B I
C A P I T A L

Public Confidence maintained in PF System

Unquestioned confidence in the system from employees
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

33

Real Rates of Return

16%
14%
12%
10%
8%
6%
4%
2%
0%
-2%
-4%

I D B I
C A P I T A L

Consumer Price Inflation

is sharply down in the last
3 years
Despite fall in nominal rates,
Real rate of interest has risen

PF Rate

Real Rate

CPI

34

I D B I
C A P I T A L

How do the Returns compare

35

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

Currency
Stocks
Govt Schemes
Provident and Pension Funds

Bank Deposits
Mutual Funds
Insurance
Others

I D B I
C A P I T A L

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

36

PF Returns compared to Bank

Deposits

14%
12%
10%

I D B I
C A P I T A L

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

8%

6%
4%
2%
0%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
PF Rate
2%
1%

Bank Deposits

Bank Deposits over PF Rate

1%
0%
-1%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

-1%
-2%
-2%
-3%

37

Returns on Underlying Assets

Government Bonds
16%

15%
14%
13%
12%

I D B I
C A P I T A L

Since 1993, yields on Federal

Government Bonds are marketdriven
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 requirement

11%
10%

EPF Rate

9%
8%
7%
6%
1991

1992

1993

1994

1995

PF Rate

1996

1997

State Govt

1998

1999

2000

2001

2002

Central Govt

Central Govt Bonds over PF Rate

2.00%
1.50%

State Govt Bonds yield 15-20 bp over

Federal Govt
Govt Bond yields have fallen sharply
in the past four years

1.00%
0.50%
0.00%
-0.50%

1991

1992 1993 1994 1995 1996 1997 1998 1999 2000

2001

2002

-1.00%

38

PF Rate compared to Mutual

Funds
How are mutual funds doing?
Annual Return
Category
%
Equity-Diversified
-33.82
Equity-ELSS
-32.72
Equity-Index
-27.17
Sectoral-Basic
-6.01
Sectoral-FMCG
-22.7
Sectoral-MNC
-23.9
Sectoral-Pharma
-12.59
Sectoral-TMT
-58.27
Gilt
18
Income
5.59
Liquid
9.01
MIP
-6.66
Balanced
-16.89

Mutual Funds is a nascent industry in India

I D B I
C A P I T A L

Experience for only 2-3 years

Equity Funds have made big losses due to

market conditions
Gilt Funds are the only exception with 18%
return during last one year

39

Returns on Stocks
Returns on BSE Sensex
In the last five years

I D B I
C A P I T A L

14.7% over 9 years from 1992-93 to

1999-2000
22.3% over 10 years from 1980-81 to
1989-90

50.00%
40.00%

30.00%
20.00%
10.00%

0.00%
-10.00%

1997

1998

1999

2000

2001

Average Returns over long periods

Regular crises on Indian stock

markets have affected confidence
of retail investor
Substantial volatility has resulted in
individual investor turning away

-20.00%
-30.00%
-40.00%

40

Tax Benefits

I D B I
C A P I T A L

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 unmatched

41

Can PF Returns be increased?

I D B I
C A P I T A L

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

42

I D B I
C A P I T A L

Public v. Private Management

43

Exempted Funds

Employers can contract out of EPF and set up privately managed funds

Employer to bear the cost in case of shortfall

Little evidence of Private Management producing better returns

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

I D B I
C A P I T A L

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 marginally

Guidelines drive the returns

44

No Minimum Rating Stipulation

I D B I
C A P I T A L

Guidelines do not stipulate minimum rating for investment

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 safe

Many trustees have internal guidelines stipulating minimum rating

EPF and CMPF Trustees have minimum rating criteria
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

45

I D B I
C A P I T A L

Benchmarking of Returns

46

Benchmarking

I D B I
C A P I T A L

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 market
Not followed by the market

Equity Indices are well-established

Not relevant since PFs do not invest in equities

47

I D B I
C A P I T A L

Role of Funds in Allocation of Capital

48

Government Bonds and Special

Deposits support fiscal deficit

120000

Rs Cr

Central and State Governments run

large deficits
Government has been running
revenue deficit with high
consumption expenditure financed by
borrowing
In old funds, almost 90% of funds are
with government

8.00%
7.00%

80000

6.00%
5.00%

60000

4.00%

40000

3.00%
2.00%

20000

1.00%

0.00%
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Revenue Defict

Fiscal Deficit

% of Fiscal Deficit to GDP

Government Bonds are used for

deficit financing

9.00%

100000

I D B I
C A P I T A L

Pay as you go system in substance

Does Investment Pattern encourage
government deficit?
Banks and LIC are biggest
subscribers of Government Bonds
Banks invest more than SLR
requirements in Government Bonds

49

Private Sector funded through

Public Financial Institutions
Total Privately Placed Bond
issuances in 2000-01
(Rs 52,433 crore US$ 11.2 bn)

Private
Sector
17%
State PSEs
22%

Financial Institutions are biggest

issuers of bonds

Make loans to private enterprises for

setting up new projects

PSE Bonds has created productive

infrastructure in the country

FIs and
Banks
46%

I D B I
C A P I T A L

State Govt enterprises have set up

projects in irrigation, road
development, power projects

Central PSEs
15%

50

I D B I
C A P I T A L

Corporate Governance

51

Corporate Governance

Provident and Pension Funds play no role in corporate governance

I D B I
C A P I T A L

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

52

I D B I
C A P I T A L

The Future

53

Future Pension Reforms

OASIS Project initiated by Ministry of Social Justice to identify pension

reforms required
Key recommendations

I D B I
C A P I T A L

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 infrastructure
Three funds from each company representing conservative, balanced and
aggressive investment styles

Group of Ministers constituted by Government to examine suggested

reforms

54

Possible Future Direction

I D B I
C A P I T A L

Introduction of Retirement Funds

NAV based funds
Different investment objectives and management styles
Capital preservation funds

Option to Employees to shift fully or partially to Retirement Funds

managed by approved pension companies
Employees may take time to get used to variable returns
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

55

I D B I
C A P I T A L

Thank you for your

attention

56