Pension Needs Attention

By Dipak Mondal | Dec 30, 2010


You buy insurance because you don't want your family to suffer financially in the unexpected event of your death. But what happens if you survive the term of the policy? This is where pension plans fit in. These are plans that provide you with an income stream in retirement if you have saved regularly during your earning years. There are many ways that one can save towards pension or retirement: through mutual funds, provident fund savings, insurance plans that offer retirement savings, and other investments that can help you build the necessary corpus. The idea is to have an accumulation phase until you retire. In the process the contributions towards building this kitty compound and create a big retirement corpus that takes care of life in retirement.

For long pension plans from insurers have found favour among investors for the various options they offer, including life and health covers that some plans offered. Moreover, as insurers offer annuity payouts, they find natural affinity. However, pension plans from insurers, especially unit-linked pension plans, have also been under the regulator's radar on account of complaints about mis-selling by insurance agents. To counter this problem the Insurance Regulatory and Development Authority (Irda) has taken steps to check the costs of unit-linked pension plans. It has also forced insurers to launch products that guarantee 4.5 per cent return. The move has elicited mixed reactions. Most insurers have not found the proposition attractive, given the volatility of returns in the financial world.

The guaranteed returns force insurers to drastically reduce their equity exposure and increase the fixed-income exposure in the portfolios of their pension plans. This in turn will result in low returns from pension plans, making them less attractive for customers. Says GV Nageswara Rao, managing director and chief executive officer, IDBI Federal Life Insurance: “Guaranteed return is not practical. We are asking the regulator to at least let us offer both guaranteed and non-guaranteed options.” Perhaps it is for this reason that only the Life Insurance Corporation (LIC) has launched a pension plan since September 1, 2010, when the new regime kicked in.

Single-premium trap
Though insurers are going easy on launching new regular-premium plans, some have introduced single premium plans. Says Sumeet Vaid, managing director, Freedom Financial Planners: “This is a stop-gap strategy by insurers who are trying to get Irda do away with guarantees.” These plans are suitable for those who have already retired or will retire soon. They are not attractive for young investors who are in the accumulation phase. HNIs too favour these plans. According to Mohit Batra, group chief executive officer, Alchemy Capital Management, “These products are created to attract HNIs. Pay the premium once and enjoy the benefit of insurance up to the age of 70.”

In these plans since the policyholder pays premium only once they do not give customers the opportunity to create a retirement corpus through regular saving. Besides, the final corpus they end up with may be inadequate, since it is limited to that one investment made (compounded over the years).

Besides, insurance company executives complain that there are no long-term debt instruments in India. Actuaries argue that it would be difficult to match the assets and liabilities in a long-term guarantee plan. They feel that just a capital guarantee scheme would have been a better option: in that case insurance companies could have invested at least 50-60 per cent in equity under this class of plans.


Bleak future
The fate of holders of existing pension plans from insurers is undecided as they continue to be under the old regime. However, anyone looking for a new plan should do so at his own peril. The new plans approved by Irda are under a cloud, especially as the direct tax code (DTC) is yet to approve tax deductions for insurers' pension plans. Defer your purchase of a pension plan from insurance companies until clarity on this count emerges.

The pension roulette
With the direct tax code (DTC) coming into effect from April 1, 2012, there is confusion regarding tax benefits on unit-linked pension plans from insurers. As these plans do not find mention in the approved list of savings instruments eligible for income-tax deductions, it is unclear how these plans will get treated. On their part, insurers are hopeful that unit-linked pension plans will be eligible for income-tax deduction. However, with no clarification from the Finance Ministry or the Central Board of Direct Taxes so far, the issue remains unresolved.

However, the New Pension Scheme (NPS) floated by the Pension Fund and Regulatory Authority (PFRDA) will get the necessary push once DTC comes into play. Under DTC contributions to government-approved provident fund schemes, including EPF, PPF and NPS will qualify for tax deductions. This is likely to be a booster for the NPS as it falls under the exempt-exempt-exempt (EEE) category. As this is the only equity-linked product with a tax benefit, coupled with the EEE benefit, it certainly appears much more appealing now.

With a maximum 50 per cent equity exposure, the NPS is a realistic option for subscribers, especially given the low cost that it comes with. The annual maintenance cost of the scheme is Rs 350. Each transaction will cost Rs10 and the investment management fee is 0.009 per cent per annum. That low management fee does not guarantee a higher return is something that one needs to be aware of.

To add another twist to the plot, Irda has now proposed pension plans with two options in addition to the 4.5 per cent guaranteed plans. In the first option, policyholders will get a capital guarantee and a minimum 5 per cent return on the accumulated sum at maturity. In addition, the policyholder will also get a large portion of the actuarial surplus. For example, if a person invests Rs 10,000 a year for 10 years, he will get Rs 1.5 lakh at the end of the term, including Rs 50,000, the return on the accumulated fund. If this Rs 1 lakh grows to Rs 2 lakh in 10 years because of good fund performance, the insurer will have to share Rs 90,000 of the actuarial surplus with the policyholder. The actuarial surplus is the amount by which the value of a company's pension fund exceeds the amount it must pay out in benefits.

The second option will be similar to NPS, where 60 per cent allocation could go into equity and the remaining into fixed-income instruments rated at least AA. Moreover, in the last two to three years of the term, the entire fund would be moved to debt. However, this option may not be as attractive, as the fund management charges would be higher than the 0.009 per cent levied by the six NPS managers at present.

This move comes in the wake of the decline witnessed in new pension plan offerings since September 1, 2010 when the current plan that guarantees 4.5 per cent return a year in addition to the capital guarantee came into effect. This allows insurers to play safe and invest mainly in debt. In the first option, insurers will have the flexibility to invest half their funds in equities, which typically provide a higher return than government securities. However, it is yet to be seen if this variant will qualify for tax deductions under DTC.