1.

INTRODUCTION

Insurance is a means of protection from financial loss. It is a form of risk management primarily used to
hedge against the risk of a contingent, uncertain loss. An entity which provides insurance is known as an
insurer, insurance company, or insurance carrier. A person or entity who buys insurance is known as an
insured or policyholder. The insurance transaction involves the insured assuming a guaranteed and known
relatively small loss in the form of payment to the insurer in exchange for the insurer's promise to
compensate the insured in the event of a covered loss. The loss may or may not be financial, but it must be
reducible to financial terms, and must involve something in which the insured has an insurable interest
established by ownership, possession, or pre-existing relationship. The insured receives a contract, called the
insurance policy, which details the conditions and circumstances under which the insured will be financially
compensated. The amount of money charged by the insurer to the insured for the coverage set forth in the
insurance policy is called the premium.

A pension is a fund into which a sum of money is added during an employee's employment years, and from
which payments are drawn to support the person's retirement from work in the form of periodic payments. A
pension may be a "defined benefit plan" where a fixed sum is paid regularly to a person, or a "defined
contribution plan" under which a fixed sum is invested and then becomes available at retirement age.[1]
Pensions should not be confused with severance pay; the former is usually paid in regular installments for
life after retirement, while the latter is typically paid as a fixed amount after involuntary termination of
employment prior to retirement. The terms "retirement plan" and "superannuation" tend to refer to a pension
granted upon retirement of the individual.[2] Retirement plans may be set up by employers, insurance
companies, the government or other institutions such as employer associations or trade unions.

Pension funds can be described as contributions made by employees towards their retirement. The worker
makes fixed payments into a fund which is set up to provide an income when he goes on retirement. The
most problematic issue, however, with pension funds is the length of time between the first contribution and
the payment of benefits. There is an inherent risk of inflation due to this time period. In simple terms, the
real value of contributions may fall over the lengthy time period. To combat these problems, there must be
prudent investment to compensate for these risks.

Public pension schemes (or social security schemes as they are known in some countries) have long been
recognized as having major economic and social implications. In addition to their obvious social welfare
objective of providing adequate retirement incomes for the aged, public pension schemes can influence
economic performance and capital accumulation through their effect on taxes and intergenerational transfers.
For many countries, the implicit liability to fund public pensions is by far the most significant unrecognized

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liability in their public accounts. Pension funds are a unique situation where individuals invest over multi-
decade horizons, in order to obtain consumption in old age. The ongoing financial sector reforms have made
significant progress in the spheres of banking, capital and currency markets and now provide an opportunity
to revamp the hitherto untouched sectors like insurance and pension.

The gradual collapse of the traditional old age support mechanisms and the rise in elderly population
highlights the need for strengthening the formal channels of retirement savings.

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 2.1 STRUCTURE OF PENSION SYSTEM

The ongoing financial sector reforms have made significant progress in the spheres of banking, capital and
currency markets and now provide an opportunity to revamp the hitherto untouched sectors like insurance
and pension. While insurance sector reform is already underway, the effect of which to a certain extent is
expected to percolate to the private pension market - a comprehensive policy for pension system
restructuring is yet to be undertaken.

A variety of problems plague the pension system in India. The gradual collapse of the traditional old age
support mechanism and the rise in elderly population highlights the need for strengthening the formal
channels of retirement savings. The imperative, more proximate reasons for pension reforms are also well
known – skewed coverage of the existing benefit schemes favoring organized workforce while informal
employment is on the rise, worsening financial situation of government pension schemes against a
background of rising system expenditure, unfair treatment of private sector workers vis– a vis public sector
employees, an underdeveloped private annuity market, and finally the need to increase the domestic rate of
savings through higher contractual saving.

Major retirement saving schemes like provident and pension funds predominantly cover workers in the
organized sector, constituting only about 10% of the aggregate workforce. The majority of workers around
90% of the working population is engaged in the unorganized sector and has no access to any formal system
of old age economic security. This skewed coverage is further shrinking as informal workforce is growing
while the size of formal workforce has remained more or less stagnant.

The diverse and often conflicting set of problems faced by the Indian pension system requires a more serious
and coherent approach. For example, on one hand, there is an urgent need to contain the escalating
expenditure on public pension programs while there is also an urgency to extend the coverage to the
unorganized sector. The government initiatives in recent years like advancement of retirement age for its
employees, partial conversion of provident funds into pension schemes for private workers and introduction
of new means-tested social assistance schemes for the poor have met with limited success, further
underlining the need for an early and lasting reform of the current system.

Inspite of its limited scope and size, the Indian pension system in its current form, can at best be described as
an extremely complicated and fractured one inducing distortion in the labor market. A large number of
occupation based retirement schemes with wide diversity in plan characteristics and benefit provisions are in
existence, and have created a wedge of disparity between public and private sector workers. While private

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sector workers are aggrieved with low returns from their benefit schemes, public employees are privileged
with generous pension provisions.

As per 1991 census, approximately 75% of India’s population lives in rural areas. The per capita income of
the populace stood at Rs.13193 (at 1997-98 price levels). The 1991 census estimated the Indian labor force
to comprise of 314 million workers. Of these, 15.2% were regular salaried employees, 53% were self-
employed and another 31% were casual /contract labor. The Central Government departments (including
P&T, Defence and Railways), States and UT Governments employed a total work force of approximately
11.13 million thus accounting for 23% of the total salaried employees in India. They are eligible for the full
range of government’s pensionary benefits including a non-contributory, indexed, defined benefit pension
scheme. Another 49% of the total salaried workers are covered by a mandatory Employees’ Provident Fund
(EPF) and Employees’ Pension Scheme (EPS).

Role of Pension Funds in the Economy

Fully funded pension systems do not provide benefits to the pensioners alone, but they may also exert strong
externalities that may benefit the overall economy. The most widely acclaimed externality that fully funded
pension schemes are held to generate is their stimulus for financial development. It is often claimed that
fully-funded pension systems help (a) raise the supply of long-term funds, (b) strengthen the efficiency of
fund allocation, and (c) stimulate the financial infrastructure of a country. Moreover, it is often asserted that
a funded pension system would also help stimulate the level of national savings.

In a country’s social security system Pensions play an imperative part. The development of the pension
funds market is necessary for ensuring the future needs of the country’s population and developing depth in
the equity and bond markets. In fact, liberalization of Insurance and Pension has been cornerstone of every
developing country’s embracing of free market economy.

Seen from the global economic scenario the pension industry is a key component of the financial
infrastructure of an economy, in the sense that it is one of the few sources of long term funds which have
null or least risk associated with maturity of assets and liabilities, and its viability and strengths have far
reaching consequences for not only its money and capital markets, but also for each and every facet of the
economy.

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 2.2 PENSION UNDER EPF & MP ACT 1952

The EPF program, established in 1952, is a contributory provident fund providing benefits upon retirement,
resignation or death, based on the accumulated contributions plus interest, from employers and employees.
Subscribers to the EPF have the option to make partial withdrawals for specified purposes such as house
construction, higher education for children, marriage, and medical expenses associated with illness.
Establishments covered by the EPF can either have the EPFO manage the provident fund, or can undertake
processes to qualify as an exempt establishment, whereby they manage the provident fund themselves. In
general, exempted establishments are large companies. (Private Provident Funds)

The Employees Provident Fund (EPF) is the first of the three schemes designed under the EPF&MP Act
1952. It is primarily a defined contribution scheme, which pays a lump sum benefit to its members.

Applicability

The EPF&MP Act, 1952 is applicable to all establishments engaged in the 182 specified industries
employing twenty or more people earning up to Rs.6500 p.m. The Act does not apply to co-operative
societies employing less than 50 persons. The rule under EPFO is that only those institutes that are hitherto
being provided pension either by the State or the Central Government are not under the aegis of the EPFO.
However this Act applies only to members earning up to Rs.6500. Those members above that wage are
exempt from the PF rules of contributions. The coverage of the EPF has been steadily increasing over the
years. The regional distribution of the EPF is not uniform and found to be skewed towards the more
prosperous states.

Employees' Pension Scheme (EPS)

The EPS, established in 1995, provides for the payment of a member’s pension upon the member’s
superannuation/retirement, disability, and widow/widower pension, and children's pension upon the
member’s death. The EPS program has replaced the erstwhile Family Pension Scheme (FPS). Employers
that are not mandated to be covered may voluntarily apply for coverage. The new scheme, known, as the
Employees’ Pension Scheme (EPS), is essentially a defined-benefit program providing earnings related
pension on superannuation, disability or death. Thus, EPF members are now eligible for two benefit streams
on superannuation – a lump sum EPF accumulation upon retirement and a monthly pension from the EPS.

The amount of the pension benefit is based on the employee's average salary during the final year of
employment and the total number of years of employment. Under the EPS, members must have completed a
minimum of ten years of service and must be at least 58 years old. However, if an employee has completed
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twenty years of service, he/she may obtain an early pension from age 50. Under this provision, the amount of
pension benefit is reduced by 3 per cent for every year falling short of 58. Exemption from the EPS is
allowed, but in this event, the employer will have to cover the government's contribution.

However, participation to the EPS program was voluntary for the existing workers as on 1995 but mandatory
for the new workers whose monthly pensionable earnings did not exceed Rs. 5000. Aggrieved workers
alleged that the pension from the EPS was substantially inferior compared to the public pension schemes and
that the return from the scheme was even lower than the provident fund arrangement. The debate
surrounding the EPS continues unabated till today, with many trade unions filing litigations against the
scheme.

This new system along with the recommendations of the Fifth Pay Commission Report has only added to the
liabilities of the government. Employee Pension Scheme is a defined benefit scheme where monthly
pensions are paid to the members after they retire In case of the death of the member the pension is paid to
the widow and children. The scheme commenced on November 1995 and replaced the Family Pension
Scheme, 1971.

Applicability

The scheme currently applies to all establishments engaged in 182 specified industries, employing at least 20
people. Once an establishment is covered, it remains covered even if the number of employees falls below
20. The scheme is mandatory only for employees earning a monthly salary up to Rs. 6,500, where salary
includes basic wage, with dearness allowances, retaining allowance and cash value of food concessions.
However employers usually extend it to all employees. The EPS coverage has been steadily increasing, with
a membership of 31149049 people as on March 2005.

Benefits

The number of beneficiaries under the EPS has been increasing at a fairly rapid pace. The total number of
pensioners as well as the number of pensioners in each category has shown a consistent increase over the
years. This indicates an ever increasing responsibility of the EPS to meet the pension requirements of an
increasing number of people.

Administration

The scheme is administered by the Employees' Provident Fund Organization and is governed by the
EPF&MP Act 1952. Since the inception of EPS, the working setup of EPFO has been modified in order to
ensure proper implementation of the new scheme and to provide prompt and trouble free service to the

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Pension Fund members and pensioners. A Pension Wing has been constituted in all the field offices of
EPFO. This wing comprises of Pension (Monitoring) Section, Pension (Audit) Section, Pension
(Disbursement and Reconciliation) Section and a Database Creation Cell to look into the different work
areas related to pensions. The offices have been equipped with application software programs to assist in
monitoring, maintenance of accounts and record keeping.

The Employees Pension Fund Account records all contributions into and disbursements made out of the fund
the scheme provides for the maintenance of a separate account for recording administrative expenses.
However only one account is maintained which, is the Pension Fund Account. An amount equal to 16% of
administrative expenses can be met out of the Employees Pension Fund. This includes costs of remittance of
pension which is to be charged exclusively from the Pension Fund. The balance of administrative expenses
is met out of administration accounts set up under the Employees Provident Fund Scheme.

Exemption

Under Section 17 of the EPF&MP Act, exemption can be granted to an establishment from the scheme
provided the members of such an establishment are or propose to be members of a pension scheme that
provides benefits at least at par with those in the EPS. The EPFO has been very strict in this matter and only
three establishments have received exemption so far. They are;

 M/s TELCO (Maharashtra).

 M/s Malaysian Airlines(Tamil Nadu).
 M/s Oil India (Assam).

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 3.1 GOVERNMENT PENSIONS

Government pensions in India are defined under the Directive Principles of State policy and are therefore not
under a Statute. The Government amended the regulations to put in place the new pension system. The old
scheme continues for the existing employees (i.e. those who joined service prior to January 1, 2004).
Pensions for government employees would include employees of the central as well as the state
governments.

Central Government Pensions

Civil Servants pension

Civil servants pensions in India underwent reform starting January 2004, with the introduction of the new
pension system, a defined contribution scheme for new entrants to the Central Government. This was
introduced in response to the growing pension bill of the Central Government and with a view to integrate
pension provisions for the formal and informal sectors in India. In the past, civil servants pensions have
known to be the most generous of occupational pensions in India.

Defense Pensions

The defense services employ one of the largest numbers of people in the Central Government and
simultaneously have the largest number of pensioners. There were 21 lakh pensioners as of March 2004. The
pension scheme for defense employees is a defined benefit scheme that pays a pension as per a particular
formula. The pensions are paid out of the Consolidated Fund of India. The defense services have one of the
highest expenditure on pensions among the various departments in the Central Government. They have been
kept out of the purview of the new pension scheme for the time being.

Normal retirement pension

This is calculated at 50% of the average emoluments drawn during the last ten months. In the case of
Personnel Below Officers Rank (PBOR), it is calculated at 50% of the maximum pay scale of the pay for the
rank and group, held for 10 months preceding retirement. Retiring pension cannot be less than Rs.1275/- per
month or more than 50% of the highest pay.

State Government Pensions

Pension rules in states typically vary from state to state. Each state has its own set of rules, barring a few like

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Himachal Pradesh and Tripura, which follow the Central Civil Service Pension Rules, 1972. The pension
scheme of most states is a defined benefit scheme paid out of the State Government revenues. The State
Governments have been increasingly unable to keep up with pension payments. For example, the pension
payments of all states put together were 17.1% of their own revenue receipts as of 2001-02. This number is
only likely to increase in the future. Keeping the increasing liability in mind, many State Governments have
initiated reform of their pension systems. Till now, sixteen Indian states have issued orders to join the new
pension system for the new entrants to the State Government services. The old schemes continue for the
existing employees.

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 3.2 INVESTMENT GUIDELINES FOR PENSION FUND MANAGEMENT

Funds are required to follow Investment Pattern prescribed by the Government according to the New
Pension System:

(i) Non-Government provident funds are allowed to invest 5% of assets in blue-chip shares and 10% in
corporate debt and equity-oriented mutual funds

(ii) Relaxation of norms for superannuation and gratuity funds to invest in the Gilt fund. Provident funds can
have a maximum exposure of 5% in gilt funds at any point in time.

(iii) Provident Funds can invest in bonds of financial institutions and companies having investment grade
from at least 2 credit rating agencies.

(iv) There would be multiple pension fund managers licensed by Pension Fund Regulatory and
Development Authority (PFRDA) and the choice would be with the individual employees to decide which
fund manager they would like to go with.

(v) Under the NPS, it is proposed that there would be four broad categories of pension scheme (scheme A,
B, C and D). While in scheme A, investments will be made in Government securities only, scheme D would
have relatively higher weighing for equity while retaining the dominance of fixed income instruments.
Schemes B & C will provide a balanced investment option with equity and fixed income instruments.

(vi) On the issue of guarantees on principals and/or returns, market based guarantees are proposed under the
NPS scheme. This means that the subscriber has to bear the cost of the guarantee. However, the scheme with
100% Government Securities would be totally risk free in terms of capital protection and assured returns if
the securities are held to maturity.

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 4.1 PENSION SYSTEM IN INDIA

India operates a fragmented and complex pension system with a wide variety of schemes. The basic structure
is the following: in the realm of public pensions, there is a limited social safety net for the elderly poor. The
old-age provision for civil servants is the most developed part of the system; they are covered by several
schemes. Workers in the organised portion of the private sector are covered by mandatory plans operated by
the Employees' Provident Fund Organisation, which runs two pension schemes. Employers can decide to opt
out of these schemes and establish Exempted Funds. There are also voluntary pension schemes in the
organised sector called superannuation funds. Voluntary private pensions are available for the self-employed
and for workers in the organised and unorganised sectors.

India will witness remarkably different and much more positive demographic developments than most of the
other Asian countries. The current fertility rate stands at 2.8 children per woman, significantly above the
natural reproduction rate of 2.1. With a median age of roughly 24 years, the current population is very
young. A shrinking population is not an issue in India, as the country's population is expected to grow from
1.16 billion today to 1.66 billion in 2050. Still, India's population will age, albeit at a moderate pace. The
old-age dependency ratio will increase from 8 today to 21 in 2050.

Assets in the Employee Provident Fund system currently amount to EUR 40.1 billion, and we expect a
yearly growth of at least 14.9% until 2050. For the New Pension System, our projection foresees a rapid
asset built-up, with an asset volume between EUR 17.6 billion and EUR 22.9 billion by 2015.

Public Pensions

Public pensions comprise a limited safety net for the needy elderly population, two pension schemes for civil
servants and the New Pension System, which replaces the civil servants' schemes for new entrants. In
addition, employees in the public and private sectors with more than five years of tenure receive a gratuity
upon retirement or if they leave the company before retirement. This gratuity is paid by the employer. It is
equivalent to 15 days of final salary for each year of service; the maximum amount is EUR 6,013 (INR
350,000). There are also two major ongoing pilot projects in the realm of pensions. One focuses on better
coverage for workers from the unorganised sector, and the other provides "micro-pensions" to unorganised
workers and the rural population.

Social security

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The National Old Age Pension scheme was introduced in 1995 and is part of the National Social Assistance
Programme. It aims to expand the social safety net for the poor. Needy persons over 65 below the poverty
line are eligible for this scheme, which provides monthly benefits of EUR 3.4 (INR 200), an increase from
EUR 1.3 (INR 75) in 2006. It is estimated that around 16 million people are entitled to benefits under this
scheme.

Central Civil Service Pension Scheme/Civil Service Provident Fund

The Central Civil Service Pension Scheme and the Civil Service Provident Fund are mandatory schemes for
civil servants that were established in 1972 and 1981, respectively. Both schemes are now only available to
existing central government employees. The pension system for civil servants delivers a high replacement
rate. However, it has been exposed to rapidly rising financial burdens for the government and seems
unsustainable in the long run. For this reason, access to the old schemes was closed for new entrants and
replaced by a different system.

4.2 NEW PENSION SYSTEM

The New Pension System, a defined contribution scheme, was introduced in 2004 and has since covered new
entrants to the central government's civil service. An exception is armed forces personnel, which is not in the
scope of the New Pension System. Public service employees who worked for the government prior to 2004
have remained in the old system. Employers and employees contribute 10% of salary each and contributions
are placed in individual accounts. The minimum retirement age in the new system is 60 years and taxation is
based on the EET principle, with mandatory annuitisation of 40% of accumulated capital. While the scheme
is designed for central government employees, 26 of the 29 state governments have indicated that they plan
to join the scheme. The New Pension System has a targeted replacement rate of 50% of final wage.

The Pension Law, which will establish the details of the new system, has not yet been passed. Hence,
implementation has only begun for central government employees, for which parliamentary approval is not
necessary. For the time being, contributions are held by the central government and awarded a rate of return
of 8%. The scheme will be mandatory for civil servants, but open to every Indian citizen, meaning that
employees from the organised and unorganised sectors as well as the self-employed will be able to
participate. Their participation will be voluntary, and employers will not be obliged to contribute. It is not
clear when the voluntary component of the New Pension System will become effective.

Once the system is running, members will be able to choose between three funds with different investment

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strategies and risk-return profiles. If they fail to make a choice, their contributions will be transferred to a
default fund, which is the safe fund. Assets in the three funds will be allocated as follows:

To provide funds to the system, asset managers will need to be licensed. The administrative framework for
the New Pension System foresees that contributors can access Points of Presence, such as post office and
bank branches, to ensure nationwide distribution.

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 4.3 FUNCTIONS OF PENSION FUNDS

Pension plans are serve as a means of financial stability and security after retirement. It is an
insurance plan providing financial coverage for your old age and is sponsored by the company fund. ... This
money is then given to the employee as the pension fund on retirement.

The Pension Fund functions in accordance with the terms of the Letter of Appointment and the Regulations
issued by Authority from time to time. PF is mandated to invest and manage the pension assets of the
subscribers covered under NPS, which is inclusive of but not confined to the following-

1. Investment of contributions as per investment guidelines prescribed by the Authority.

2. Scheme portfolio construction.

3. Maintains books and records of its operations.

4. Reporting to the Authority at periodical intervals.

5. Public disclosure.

Importance of pensions

As people develop through their lifetime they have an expectation that a time will come when they will be
able to retire. For some people the State pension is sufficient to provide a basic level of income. Others may
have an opportunity to accumulate wealth without using pension schemes - perhaps through their business
ventures or other assets. But most people will want to supplement what they have with some form of pension
scheme. Many employers also take the view that, while their employees are working, they should be
building up an entitlement to a pension when they retire.

Pension arrangements have a number of advantages:

 when people come to retire they will experience a reduction in income - a pension makes up for
some of this loss of income in retirement;
 pension schemes can provide protection in the form of lump sums and pensions to dependants in
the event of a member's death;
 in order to encourage pension schemes, the State provides tax relief on contributions made to
pension schemes and the growth in their investments.

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Pension plans are serve as a means of financial stability and security after retirement. It is an insurance
plan providing financial coverage for your old age and is sponsored by the company fund. In other words,
a certain amount of your current income is transferred and stored for your future. This money is then
given to the employee as the pension fund on retirement.

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 5. CONCLUSION

Indian pension system is passing through a crisis of confidence. The economic, demographic and labor
market trends of the current system are moving in troublesome directions. The problems that the system is
confronting now are quite well known: they are

1. The age structure of the population is changing drastically with increasing life expectancy and
declining birth rates.
2. Collapse of joint family system coupled with pressures of urbanization and migration are also leading
to deterioration in traditional means of support for the elderly.
3. Existing schemes predominantly cover the organized workers leaving the bulk of the workforce with
little access to any formal system of old age income security. The coverage is further diminishing due
to stronger growth in unorganized employment.
4. Within the organized labor force having access to some kind of formal retirement income system,
generous treatment of the public workers vis-à-vis the private workers is resulting further
fragmentation of the pension system.
5. The spiraling expenditure pattern of the non-contributory, unfunded public pension programs are
putting increasing pressure on governments Budgetary allocations. Unless this trend is arrested, these
schemes will be financially Unsustainable in near future.
6. Conservative investment norms for provident funds, ostensibly to safeguard the workers’ interest,
have resulted in inadequate rates of return from these schemes.

Lack of pension annuities and health insurance cover further complicates the old age economic security. In
recent years, growing realization about these deficiencies has prompted the government to take reformatory
steps to overcome these problems. However, most of these reforms are initiated in a piecemeal manner. The
policy makers, therefore, need to take a fresh view and develop new mechanisms to rejuvenate the pension
system. The benefit of such a pension regime is also likely to foster aggregate rate of savings and accelerate
capital market development.

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