Facing an aging population, longer lifespans, and a shift to the defined contributions model, India is overhauling its pension system. But the New Pension System (NPS) faces stiff competition from Employees' Provident Fund (EPF) and other options.

1. Pension Reforms in India
Pension reforms are yet to benefit a large section of the Indian population.
Significant changes on the policy and regulatory fronts, better marketing
and better pricing of products can give this sector a much-needed boost.
Executive Summary
Life expectancy has shot up in recent decades.
When public pension systems were first estab-
lished, people could typically look forward to only
a few years of retirement if any. Today, globally,
the probability of a newborn boy surviving until
age 65 is over 80%; the figure is over 90% for
a girl child. Aging populations are “a high-class”
problem, said U.S. President Bill Clinton in his
1999 State of the Union address. He continued:
“It’s the result of something wonderful: the fact
that we are living a lot longer.” Nevertheless,
there is no denying that aging populations pose
significant challenges for economic, social and
health policies in general and pension systems in
particular.
India is no exception to this global trend.
Demographic projections indicate that the share
of the aged will rise to 9% of the total popula-
tion by 2016 and to 13.3% by 2026. Life expec-
tancy has increased significantly in India, thanks
to economic development and better access to
medical care. This also means that a significant
percentage of the population is expected to live
beyond 75 years of age. Therefore, it is essential
that a formal mechanism of benefits to reach a
large section of the aged population is in place
and cost-effective products are available to the
population for creating a retirement corpus.
Background of Pension Reforms
India does not have a universal social security sys-
tem. A large number of India’s elderly are not cov-
ered by any pension scheme. Pension reforms and
a pension system with greater reach will not only
ensure citizens’ welfare in their golden years but
will also help the central and state governments
cut their future liabilities. With these broad objec-
tives in mind, the government of India set up an
expert committee in 1998 to devise a new pension
system for India. Project Oasis, which was chaired
by S.A. Dave, submitted its report in 2000.1
The report recommended setting up a new
pension system in India. It recommended
creating a pension system based on individual
retirement accounts (IRAs). An individual would
save and accumulate assets through his entire
working life. Upon retirement, the individual
would be able to use his pension assets to buy
annuities from annuity providers and obtain a
monthly pension. The pension amount would be
governed by what the employees’ pension fund
account could earn from market investments.
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2. cognizant 20-20 insights 2
This was a paradigm shift, from the existing
defined returns philosophy to a defined contribu-
tions philosophy.
The committee suggested creating a profession-
ally managed system with a large base of pension
account holders across all sectors of the economy
and centralized record-keeping. The proposed
system would ensure fair competition among
professional fund managers so as to provide
a wide range of choices to employers and fair
market-linked returns to the account holders.
In line with the above recommendations, the
government set up its New Pension System
(NPS), India's answer to the U.S.'s 401(k) plans.2
The NPS was launched in 2004 for central
and state government employees, who had to
subscribe mandatorily. In 2009, it was thrown
open to all Indian citizens in the 18-60 age group.
However, it has failed to take off in the voluntary
segment given the anemic subscriptions from the
private sector (see Figure 1).
Challenges in Implementation
The scheme’s lack of popularity has been
attributed to several factors, such as weak incen-
tives to intermediaries, a lack of awareness
among the general population, insufficient mar-
keting and promotion of the product and lower
returns compared to other investment options.
The scheme has delivered 5% to 12% returns in
the past three years. Compare this to a return
of 8.5% for Employees Provident Fund for the
financial year 2012-13, 8.7 % for Public Provident
Fund and 8.5% and 8.8% from National Savings
Certificate for five and 10 years, respectively.4
A closer look at the finer elements of the scheme
reveals that there are other issues that need to
be addressed to improve investor sentiment for
this product.
One of the most important issues is the tax
treatment. There is no clarity on the taxation
of funds at withdrawal. In India, returns from
annuity insurance plans are not exempt from
taxation. Another significant impediment is the
compulsory annuity feature of the scheme. Even
on maturity, the account holder can withdraw
only up to 60% of the accumulated sum. The
remaining amount has to be used to buy annui-
ties, the returns from which are not tax-exempt.
Also, the annuity can be bought only from one of
the six PFRDA-approved insurers. This restricts
the investor’s choices.
The fact that the scheme caps equity exposure at
50% is a dampener for younger investors, who
usually have a higher appetite for risk and would
prefer a larger equity allocation.
Also, the scheme faces stiff competition from
the mandatory Employees’ Provident Fund (EPF),
which remains the main retirement savings
instrument for a majority of Indian employees.
Given the mandatory retirement contribution to
EPF, employees are reluctant to put in additional
money in NPS.
Another challenge is to popularize this scheme in
the unorganized sector where financial literacy is
poor and workers rarely have surplus money to
invest. NPS has come up with a scheme, Swalam-
ban Yojana,5
which seeks to target this sector.
Under the scheme, the government contributes
1,000 rupees per year for three years for each
NPS account opened in the past three financial
years. However, this is not a sustainable model
in the long run. For this scheme to survive with-
out government funding, awareness campaigns
and marketing targeted to this segment of the
working population are essential.
Sector-wise NPS Status as of March 2, 20133
Figure 1
Sl. No. Employer/Sector Number of Subscribers
Corpus Under NPS
(in billion rupees)
1 Central Government 11,25,871 170.47
2 State Government 15,85,349 97.80
3 Private Sector 2,02,679 12.54
4 NPS-Lite 15,79,690 4.12
Total 44,93,589 284.93

3. cognizant 20-20 insights 3
Managing the Shift
In defined contributions models, the burden of
changes in life expectancy is borne by individual
retirees in the form of lower pensions. When
people retire in a defined-contribution plan,
the accumulated contributions and investment
returns is converted from a lump sum into a
regular pension payment, known as an
“annuity.” The calculation of the annuity is based
on projected life expectancy of retirees at the
time of retirement. Pension replacement rates
— the percentage of a worker’s pre-retirement
income that is paid out by a pension program
upon the worker’s retirement — will therefore be
automatically lower as people live longer.
In India’s pension system, the shift from a
defined benefits model to a defined contribu-
tions model will impact pensioners. The defined
benefits model has some advantages such as a
stable income replacement rate with market and
longevity risk borne by the employers. In
contrast, in defined contribution plans the
amount of retirement income cannot be known
in advance. The move to a defined contribu-
tion plan would require employees to carry out
complex financial calculations in both the asset
accumulation and retirement phases. Policy mak-
ers would need to design simple default solutions
that do not require complex calculations. They
would also need to assume the responsibility of
creating greater awareness among pensioners
Chile
United Kingdom
Netherlands
France
Sweden
China
Australia
India
Singapore
Japan
Korea
Switzerland
Germany
PolandCanada
Brazil
United States
Denmark
Global Grades for Pension System
Source: Melbourne Mercer Global Pension Index October 2012
Figure 2
Grade
Index
Value Countries Description
A >80 Denmark
A first class and robust retirement income system that delivers
good benefits, is sustainable and has a high level of integrity.
B+ 75–80
Netherlands &
Australia A system that has a sound structure, with many good features,
but has some areas for improvement that differentiates it from
an A-grade system.B 65–75
Sweden, Switzerland
& Canada
C+ 60–65 UK & Chilie A system that has some good features, but also has major risks
and/or shortcomings that should be addressed. Without these
improvements, its efficacy and/or long-term sustainability can be
questioned.
C 50–60
USA, Poland, Brazil,
Germany, Singapore
& France
D 35–50
China, Korea (South),
Japan & India
A system that has some desirable features, but also has major
weaknesses and/or omissions that need to be addressed. Without
these improvements, its efficacy and sustainability are in doubt.
E < 35 Nil
A poor system that may be in the early stages of development or
a nonexistent system.

4. cognizant 20-20 insights 4
who have shifted to the defined contributions
model and educate them on the intricacies of the
risks and returns from each type of plan. Treat-
ment of the corpus in line with the Employees’
Provident Fund or the Public Provident Fund (no
tax is levied at the investment, accumulation or
withdrawal stages) would certainly help increase
the popularity and acceptance of the defined
contributions system.
As life expectancy continues to increase,
annuity providers will be expected to provide
regular monthly benefits to retirees for longer
periods. This should not impact annuity providers’
commercial viability. Innovative products such
as index-linked funds and international diversifi-
cation to equities or equity-based products and
new tax treatment methods are needed so that
longer life expectancy does not become a burden
for annuity providers.
Global Comparison
The Melbourne Mercer Global Pension Index,
which measures countries’ retirement income
scheme against more than 40 indicators, places
India at an overall index value of 42.4 for 2012.
The index is based on a study of retirement
systems in 18 countries. The table below (in
Figure 3) shows the overall index value for each
country, together with the index value for each
of the three sub-indices: adequacy, sustainability
and integrity. Each index value represents a score
between zero and 100.
The index value for India indicates that some
sound features exist but there are some signifi-
cant omissions or weaknesses. The score also
indicates that the country is in the early stage of
development of a retirement income system.
According to the Melbourne Mercer Global
Pension Index report, India’s overall index value
could be increased by:
• Introducing a minimum level of support for the
poorest among the elderly.
• Introducing a minimum access age so that
it is clear that benefits are preserved for
retirement.
• Improving the regulatory requirements for the
private pension system.
• Continuing to improve the required level of
communication to members from pension
arrangements.
Overall Index for Each Country
Figure 3
Source: Melbourne Mercer Global Pension Index October 2012
Sub-index Values
Country Overall Index Value Adequacy (40%) Sustainability (35%) Integrity (25%)
Australia 75.7 73.5 73 83.2
Brazil 56.7 71.5 26.9 74.8
Canada 69.2 74.2 56.3 79.3
Chile 63.3 50.1 67.7 78.4
China 45.4 55.7 30.5 49.7
Denmark 82.9 78.1 86 86.4
France 54.7 74.3 32 55.2
Germany 55.3 65.2 35.9 66.7
India 42.4 37.4 40.7 52.8
Japan 44.4 46.1 28.9 63.3
Korea (South) 44.7 45.1 42.3 47.5
Netherlands 78.9 77 73 90.3
Poland 58.2 63.6 43.4 70.1
Singapore 54.8 42 54.2 76.2
Sweden 73.4 68 73.3 82.5
Switzerland 73.3 71.3 67.9 84.1
UK 64.8 68.1 46.2 85
USA 59 58.3 58.4 61.1
Average 61 62.2 52.1 71.5

5. cognizant 20-20 insights 5
• Increasing the pension age as life expectancy
continues to increase.
• Increasing the level of contributions in
statutory pension schemes.
The Road Ahead
The NPS scheme has several advantages
over other schemes in terms of cost and equity
exposure. Mutual funds can charge up to 2.25%
and ULIP Pension plans from life insurers can
charge up to 1.35% as fund management fees.
NPS charges just 0.25%, making it one of the
cheapest pension products in the world.6
The
difference in fees/charges affects the total
corpus significantly over longer periods of
investment. NPS also instills a sense of disciplined
savings and offers tax benefits.
Policy initiatives are also required to encourage
voluntary subscription to this scheme. These
initiatives could include establishing a compre-
hensive national pension policy, improvements in
the security and returns from NPS investments,
setting up distribution channels and increas-
ing the incentives for them and increasing the
channels’ regional coverage. Designing custom-
ized marketing strategies for different market
segments will also be effective; marketing
through SMS or street events/road shows could
be one option. Telecommunication companies’
support can be sought to build a database of
prospective customers.
Also, the virtues of this scheme need to be com-
municated to the investing public. One of its
biggest pluses is that the cost of administration
remains the cheapest in the world.7
Also, the
scheme is portable anywhere within the country
– i.e., employees can “carry” their accounts with
them when they change jobs. The scheme offers
a choice of investment mix and pension fund
managers. All transactions can be tracked online
through the central record keeping system, and
there is an efficient grievance management sys-
tem in place. The scheme offers an auto choice
(default) option for subscribers who do not have
sufficient knowledge about these instruments.
A concerted effort by the regulators, pension
fund administrators and the service provider is
needed to make this laudable social initiative a
true success.
A study of the retirement income system in G20
countries indicates that in a country of India’s
size and complexity, a defined contributions
model is the model for the future. There are a few
provisions which need to be incorporated from
other pension models to make the system more
beneficial: provision of minimum pension under
social security, provision for early and late
retirement and benefits calculation modeling in
line with price increases.
For Indian pension reforms to truly succeed and
be an example for emerging economies, it is not
just essential to move to a defined contribution
model; it needs to create a basic pension from
public finances. A formal old-age income support
especially for financially impoverished senior
citizens is needed urgently.
In its influential report “Averting the Old Age
Crisis,” the World Bank (1994) recommended a
multi-pillar system for the provision of old-age
income security comprising:
• Pillar 1: A mandatory publicly managed tax-
financed public pension.
• Pillar 2: Mandatory privately managed, fully
funded benefits.
• Pillar 3: Voluntary privately managed, fully
funded personal savings.
Subsequently, Holzmann and Hinz (2005) of the
World Bank extended this three-pillar system to
the following five-pillar approach:
• Pillar 0: A basic pension from public finances
that may be universal or means-tested.
• Pillar 1: A mandated public pension plan that
is publicly managed with contributions and, in
some cases, financial reserves.
• Pillar 2: Mandated and fully funded occupa-
tional or personal pension plans with financial
assets.
• Pillar 3: Voluntary and fully funded occupa-
tional or personal pension plans with financial
assets.
• The fifth pillar is a nonfinancial pillar that
includes the broader context of social policy
such as family support, access to healthcare
and housing, etc.
The key challenge in India is to continue the
pension reforms while addressing the needs for
Pillar 0 and create a universal security net for the
most needy.

6. cognizant 20-20 insights 6
Footnotes
1
http://pfrda.org.in/writereaddata/linkimages/oasisreport6305547711.pdf.
2
http://www.financialinfohub.com/index.php?pr=Investing-advantagesdisadvantges_of_401k_plans.
3
http://pfrda.org.in/writereaddata/linkimages/NPS%20status%20March2013651445507.pdf.
4
http://www.indiapost.gov.in/posb.aspx.
5
https://www.npscra.nsdl.co.in/news_detail.php?id=12.
6
http://articles.timesofindia.indiatimes.com/2013-02-04/personal-finance/36742174_1_nps-trust-nps-
account-national-pension-system.
7
http://www.thehindubusinessline.com/industry-and-economy/banking/scope-to-offer-annuity-ser-
vices-in-new-pension-scheme/article3734945.ece.
References
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• http://www.actuariesindia.org/.
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• www.forbes.com.
• www.iief.com.
• http://www.oecd.org/.
• www.statestreet.com.
• www.actuaries.org.
• http://www.ccsindia.org.
• http://financialservices.gov.in/PensionReforms_india_index.asp.
• http://financialservices.gov.in/pensionreforms/Pension%20Reforms%20in%20India.pdf.
• Ramdev Gowswami, “Indian Pension System: Problems and Prognosis.”
• S.A.Dave, Robert Palacios, Gautam Bhardwaj, “Rethinking Pension Provision for India.”
• The Project Oasis report (Old Age Social and Income Security Project), January 2000.
• Ajay Shah, “Issues in Pension System Reform in India.”
• “Pensions at a Glance 2011: Retirement-Income Systems in OECD and G20 Countries,” OECD 2011.
• Final Report of the ACA’s 2011 Pension Trends Survey, conducted by the Association of Consulting
Actuaries.
• Robert Holzmann, Global Pension Systems and Their Reform Worldwide Drivers, Trends, and Chal-
lenges.
• Dr. Ramesh Gupta, Pension Reforms in India: Myth, Reality and Policy Choices.

7. About Cognizant
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• Hertie School of Goverance, working paper, “Extending Coverage of the New Pension System in India
– Analysis of Market Forces and Policy Options.”
• http://www.aca.org.uk/files/2011_Pension_trends_report-3_January_2012-20111222162316.pdf.
• http://www.thehindubusinessline.com/opinion/columns/aarati-krishnan/same-old-story-on-pension-
reforms/article3539828.ece.
• http://www.financialexpress.com/news/india-needs-a-pension-culture/1056520/0.
• http://www.livemint.com/Home-Page/E7OCcGDCbC2DVmU2NlwFtO/IMF-Working-Paper--Financial-
market-implications-of-Indias.html.
About the Author
Rajdeep Bhaduri is a Manager with Cognizant’s Banking and Financial Services’ Product Solutions
and Applications Group. Rajdeep has more than 14 years of experience in leading business and
IT engagements, mainly in the private banking and capital markets domains. He can be reached at
Rajdeep.Bhaduri@cognizant.com.