Are pensions a part of Insurance?

One debate which is presently taking place in India is about the regulatory strategy for the pensions sector. We have two alternatives : to place it into the insurance regulator, or to create a new regulatory apparatus for it. Which direction should we take?

The argument for placing pensions into the IRDA is based on one type of a pension product : the defined benefit (DB) product. The DB product promises the pensioner what his benefits at retirement will be. At age 20, when the participant starts contributing into the pension system, DB products tell him where he will be in forty years time.

Now, the implementation of a DB product requires life insurance calculations all the time. The seller of a DB product needs to constantly recalculate whether the promises made can be upheld, and increase/decrease contributions as needed in order to assure this. This requires actuarial calculations. The regulator of DB products needs to think like the regulator of life insurance : it needs to constantly worry whether the assets in the hands of the pension provider are good enough to meet the promises made.

In recent years, researchers all over the world have highlighted the problems of DB products. DB products give lower benefits to participants, they involve large regulatory and macro-economic risks, they tend to often generate labour market distortions, and they generate wrong incentives in terms of the political economy. It is very likely that a DB program in India will involve an implicit guarantee from the government, a guarantee which the Central government should be most disinclined to give.

For these reasons, all over the world, designers of pension systems have moved away from DB products towards 'defined contribution' (DC) designs. In India, the Dave Committee, which was created by the Ministry for Social Justice and Empowerment, has highlighted the dangers inherent in the two important prevailing DB structures (the EPS program run by the EPFO, and the civil servants pension program), and its proposals for the future have been phrased entirely in terms of a DC program (like the EPF program run by the EPFO). DB products are also sold in India by LIC and others, but these are as yet small enough to be inconsequential.

In a modern view of the pension system, there are five tasks that the pension system has to perform :

  1. Collection of contributions from participants all over India
  2. Recordkeeping about contributions and returns obtained by each participant
  3. Fund management, including methods for giving individuals choices about how their funds are managed
  4. Benefits : after retirement, the participant would walk up to a life insurance company and buy an 'annuity' to get a monthly pension.
  5. Education and awareness about financial planning for retirement.

In this perspective, life insurance is only central to the fourth element. Hence, the Dave Committee has recommended that annuity providers should be regulated by IRDA. A suggestion that IRDA should regulate the entire pension system (consisting of collection, recordkeeping, fund management, benefits, and education) by virtue of its existing regulation of annuity providers is comparable to a suggestion that SEBI should perform this function (since SEBI regulates existing mutual funds).

The political economy dimension. Political economy should be central to our analysis of alternative regulatory structures. A pension system run by IRDA runs the risk of being overly influenced by one constituency : the insurance companies. For example, there is the risk of a policy bias in favour of DB programs since these give life insurance companies a bigger role in the pension sector. Conversely, if SEBI were to run the pension system, there is a risk of its being overly influenced by the agenda of the mutual funds. We should look for a regulatory and policy structure in pensions that gives a strong role to all five aspects : collections, recordkeeping, fund management, benefits and education. This can be achieved by creating a new regulatory body, which has been called 'Indian Pensions Authority' by the Dave Committee.

Today, we in India face a mammoth problem in building a strong pension sector. Each of these components (collection, recordkeeping, fund management, annuities, education) requires radical surgery as compared with existing structures. The role of the State here is much more than regulation : it is a developmental role in terms of establishing new infrastructure, and getting existing firms and individuals to cooperate and interact in drastically new ways. We need to bring half a billion new people into the pension system, over the next twenty years. This is a huge challenge, which requires a certain focus and obsession on the part of the implementors of this effort. The development of insurance in India is also a comparable and gigantic problem. However, there is a risk that if pensions are placed inside IRDA, the first function of IRDA - the development of Insurance - will crowd out the focus upon pensions.

International Evidence. These arguments are consistent with international evidence and experiences. Renuka Sane of The OASIS Foundation has recently surveyed the regulatory structure used in the pension system in around twenty countries, and she finds that insurance regulators seldom play an important role in the pension system. In UK, where the insurance regulator presently does play a major role in pension regulation, this has been widely criticised as being the source of many problems, and several observers have proposed radical surgery to move away from such a structure.

In summary, there is an important debate which is taking place right now, about the character of India's pension sector. In the next few weeks, policy makers will be making this important choice : Should pensions be an offshoot of IRDA, or is it important to have a new agency which sets about building and regulating the pension sector? The arguments above suggest that it would be inappropriate to place the pension sector into the list of IRDA's tasks.

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