1. The demographic and socio-economic context of India
Together with other developing countries, the Indian population is experiencing a dramatic change in its demographic structure, which is the result of a decrease in the total fertility rate, and an increase in life expectancy and a growth in the percentage of older people within the Indian population. As a consequence, the share of retirees as a percentage of the working age population (the old age dependency ratio) has increased as well; the share of the elderly aged 65 years and above in India’s population is going to rise to 9 per cent in 2030, up from 4.6 per cent in 2000. The growth of this ageing population implies that many old people will not be covered by a pension system. Together with the lack of coverage of the elderly, the size of the informal sector is also alarming: 86 per cent of the workforce is represented by unorganized workers. Informal workers do not have a fix income and they thus cannot pay a periodic and fix contribution to a pension fund. This fact explains why usually informal employees are not covered by a national pension system. The third problem of India is the widespread poverty amongst the informal workers themselves, especially those employed in the agricultural sector: 85 per cent of rural workers earn much below than the statutory minimum wage of Rs.66 per day; more than 300 million people survive on less than $1 per day.
2. Pension reforms in India
India is making “reasonable” progress toward poverty reduction amongst those who are in working age but old age poverty is still a major issue. Poverty amongst the elderly is, indeed, the dominant form of poverty in India, mainly due to the breakdown of the joint family, the increase in life expectancy, greater migratory flows of labour and limited effectiveness of poverty-alleviation programs. An effective pension system is thus necessary in India: a modern, well-regulated pension sector will improve resource flows for the country (the overall saving rate) and will enable older low income people to reduce their vulnerability.
On August 2003, the Government of India introduced a new define contribution pension system, replacing the former defined benefit systems. The main characteristics of the New Pension System (NPS) are:
its defined contribution basis. Workers are supposed to contribute to the pension system with 10 per cent of their salary;
every employee has a voluntary withdrawable account without any contribution by the Government;
employees can exit the system at or after reaching the age of 60 years. A the time of their exit, they are supposed to invest 40 per cent of the pension wealth to purchase an annuity in order to provide for lifetime pension income. The remaining 60 per cent of pension wealth is paid to the employee in lump sum at the time of exit. Individuals may leave the pension system before reaching the age of 60 years. However, mandatory amount of the pension wealth to be invested in order to provide for lifetime pension income (annuitization) would be 80% of the pension wealth.
The New Pension System has created the opportunity for employees to join a voluntary defined contribution and fully funded private pension scheme, similar to a micro-pension provision. The introduction of a micro-pension provision helps to extend the pension coverage also to poor people living in rural areas and employed in the informal sector.
3. The role of micro-pension programs within the Indian New Pension System
Broadly speaking, a micro-pension provision builds up assets for the old age retirement income of poor people. It is typically designed as a defined contribution scheme. A micro-pension is basically a long term voluntary savings product accumulated over a long period, in order to yield returns at a later date. Savings are managed and invested in financial or capital markets by professional fund manager at low costs, accessible to poor customers1. At the pre-agreed withdrawal age (usually 58-60 years), the accumulated balance may be withdrawn in a lump-sum, annuity or some combination of these methods. Micro-pension schemes must be:
self-sufficient and sustainable;
universally accessible, especially for those workers in the informal sector;
affordable, efficient and available throughout the country;
equitable, pro-labour and pro-poor;
The introduction of micro-pension provision in India was made possible by the reform of the national pension system (see Section 2). On the whole, India offers a scenario with unique features where to promote micro-pension programs. As pointed out above, the Indian setting is characterized by a huge mass of poverty, a dominant informal labour market, a population in demographic transition population and breakdown of traditional support structures in families. Furthermore, India has a well developed financial sector and a stable political democracy, but also fiscal problems of the state and limited and constrained administrative capacity. All these characteristics make India a fertile ground for the promotion of micro-pension programs.
One of the most famous pension schemes in India was launched in 2005 by the Unit Trust of India Assets Management Company (UTI AMC) together with several third parties: SEWA (Self Employed Women’s Association), an Indian micro-finance institution; COMPFED, a federation made up of Indian milk producers; and an urban cooperative bank run by women. The main characteristics of the UTI AMC micro-pension scheme are:
contribution of small amounts from Rs. 50 to Rs. 200 per month;
flexible payments (monthly or yearly non mandatory contributions);
presence of a neutral third party, like a Micro-Finance Institution, a Non-Governmental Organization, Self Help Groups. In particular, the third parties play as aggregators for collecting a large number of pension funds members with common characteristics; they have also several administrative roles and reduce transaction costs of micro-pension providers by identifying members and collecting contributions.
In practice, the first step of the flow of UTI micro-pension scheme is the identification of members and villages to be targeted by the program. After a certain period of training and preparation through which the members enrolled are introduced to the micro-pension product, the targeted employees start to contribute to the micro-pension scheme by paying between Rs. 50 and Rs. 200 per month. Payments are actually flexible and they can be made yearly or monthly until age 55 (several individuals do it on a year after year basis). Contributions are also non mandatory. The collection of contributions is up to the third parties (MFI, cooperatives, self help groups or NGO) which have been trained by UTI Mutual Fund (a branch of UTI AMC) before. Third parties are not only aggregators; they also pool savings to be transferred to UTI and provide members of the pension fund with a unique account number. They identify the members of the pension funds sharing common characteristics, like working in the same sector or living in the same area or village2. Intermediaries undertake also administrative roles and act a as a “clearing house” between UTI AMC and pension fund’s members by ensuring smooth flow of contributions to the fund and transparent communication between the stakeholders. UTI Mutual Fund makes pension payments after a person has attained age 58, charging an exit load over the amounts withdrawn before the agreed retirement age. At the moment of the retirement, a maximum of 40 per cent of the corpus can be invested in equity, while the 60 per cent may be invested in debt. UTI AMC's main goal is providing retirees with an annual return of 10 to 12% after all expenses. The payment of pension premiums is represented by lump sum amounts, phased withdrawals, annuity or a combination of these methods. The pension income reaches and individual's personal account intermediated by third parties.
4. Benefits and costs of implementing micro-pensions
create awareness among the poor of the importance of saving and investing in long-term projects, providing them with a retirement income;
improve the financial literacy of the poor. More financial literacy increases the transparency of the financial markets: people are more aware of the risks, costs and benefits that the financial products and services provide. Therefore it is hard for financial products provisioners cheat and hide twisted clauses. More transparency makes also financial markets more competitive thus lowering operational costs;
generate a large amount of savings which can be channelized into investments in the local market;
reduce the burden of Government budget. A third-pillar may allow Governments to reduce pension provisions to the whole population and to redirect them towards other sectors like infrastructures or even support to the poorest share of total population.
However, a micro-pension provision has some shortcomings. Targeting people with low financial literacy, no permanent jobs and living in remote areas may make the launch of a micro-pension plan very difficult. Furthermore, convincing poor people to save and invest in a long-term project is challenging, since these people usually have low income and thus they do not have enough means for today and current expenses. Very often Governments do not provide support to micro-pension projects, since they are usually considered as too young, nascent, risky and uncertain products. Regulatory framework is thus not implemented, and this increases the level of risk a similar sector bear itself.
In sum, due to the peculiar characteristics of micro-pensions and their customers presented above, the fund management fees are usually high. Micro-finance institutions, in particular need to reduce their costs of delivery. This requires that organizations involved in the micro-pension industry have economies of scale3, which reduces cost and increases diversification. In the accumulation and pay-out phases of the micro-pension provision, the transaction costs associated with payment of benefits, communication to members and investment management could be minimized through the use of technology.
In some rural areas of India, for example, organizations implementing micro-pension programs are increasingly relying on mobile banking services. Next Experience (NXP) Semiconductors has designed a mobile phone enclosing an RFID card which work A Little World's (ALW)4 micro-banking platform ZERO. RFID is a wire-less connectivity technology that allow consumers to exchange and store all kinds of information, simply by bringing two devices close together – e.g. a mobile phone with an ATM. The mobile phone may act as a branch of the bank by storing all the customers' data in a village targeted by micro-pension programs and in the neighbouring areas within the phone memory. The mobile phone is also provided with a smartcard, which stores the identity of the customer (name, address, fingerprint templates and relevant details of the savings or loan accounts held by the issuing bank). For the banks using the ZERO platform and NXP's mobile, the mobile banking represents an important step toward the reduction of the cost and effort to set up physical branches in rural areas, while providing full services for cash deposits, cash withdrawals, money transfers, micro-insurance and cashless payments.
In sum, using mobile phones for micro-pension provisions in India provides several advantages:
the mobile network offers access twenty-four hours a day, seven days a week;
person based rather then location based programs: through SIM cards, mobile customers have a specific profile that allow for customized functionality that directly reflects the mode in which they want to transact business over mobile devices (Arunachalam, 2007). These SIM cards include also several other application services, like virtual credit cards and other payment instruments;
India is one of the fastest-growing mobile phone markets in the world. This means that mobiles have a great level of penetration in Indian market;
people targeted by micro-pension programs using mobile phones are moving up from Voice only usage to SMS based transactions;
mobile banking transactions are also protected by a private key stored on the SIM card. This is how mobile phones protect the proprietary purchase and financial information;
a part from the impact on cost reduction, mobile phones help fund managers to overcome disadvantages like remoteness and high transaction time and effort derived from the decentralization nature of a micro-pension program.
Overall, mobile phones are going to introduce significant changes in a cheap distribution of financial services.
The paper by Arunachalam (2007) helps in understanding deeply how the micro-pension sector is working in India. Most of all, the author reports interesting innovation in the distribution of micro-pension's customers retirement income. In particular, the paper discloses the impressive progresses of mobile-banking in rural areas of India. In sum, Arunachalam (2007) gives a useful portrait of the micro-pension sector in the Republic of India.
A. Annex: differences between micro-pension products and traditional pension products
There are many differences between micro-pensions and traditional pension products provided by private pension funds or public pension scheme. These differences have a significant implication for distribution of micro-pensions and its costs. First of all, micro-pension programs need to be easily accessible, since clients usually live in rural and far removed areas. This is not the case with traditional pension products, which have groups of potential clients much closer to their managers.
Secondly, since customers of micro-pensions usually work in the informal sector (characterized by high volatile and uncertain income), the probability of defaults in paying contributions or in drop-outs (which would avoid customers from fulfilling contractual obligations) is high. Again, traditional pension products rely on customers with stable income.
Another problem is represented by higher transactions cost, again much lower in case of traditional pension products rather than micro-pension products. Arunachalam (2009) provides a table summarizing all key distribution differences between pension funds provided through “traditional” channels and micro-credit channel.
1 For a deeper distinction between micro-pension programs and traditional pension programs, see the Annex.
2 UTI AMC, for example, use SEWA and COMPFED as intermediaries. The first one is the association of Self Employed Women in Ahmedabad while the second one is the federation of the milk producers in Bihar.
3 Economies of scale refers to the cost advantages that a business obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. In the case of micro-pension provision, as the number of customers of micro-pensions increases, the organization implementing the product will suffer from lower costs of launching its products.
4 A provider of payment systems.