Risk based supervision and interest rate guarantee for new pension scheme

Abstract

The Pension System in India was Defined Benefit type for Government Servants since its inception in formal form, during 20th century. As the DB type pension system increased the Fiscal burden to unsustainable levels, the New Pension Scheme, which is Defined Contribution type, is introduced by the Indian Government. With the introduction of this new system, government is relieved of the additional financial burden of pensions payments, as it is not financed through the Tax collection but through equal contributions from employee and employer. The pension annuity payments depend upon the amount in the Pension account (Individual Account) of the employee at the time of retirement, which is accumulated through monthly deductions from the salary income and profits earned through the investments of Individual Account savings. The IA savings of employee is partly invested in high risk equity market to get the advantage of faster progressing Indian economy. This dissertation discusses about the risk inherited in the whole process of new DC pension system and about different countries, which are moving to the risk based supervision approach to mitigate the risk. The IOPS and OECD have given detailed guidelines for risk based supervision system, which are discussed in detail in Chapter-IV. The risk based supervision approach followed by different Latin American, European and Asian countries and the challenges faced by these countries during implementation of risk-based system, is discussed in Chapter-V. A questionnaire is prepared based on the Pension Fund Risk Management Checklist prepared as per the IOPS guidelines, for analysing the prevalence of risk-based supervision in Indian NPS. Unlike other countries where DC pension system is in operation, Indian NPS is not giving any Guarantee on the accumulations in IA. The type of rate of return guarantee provided by Pension funds in different countries is discussed in Chapter-VI. Chapter-VII discusses briefly about managing these pension guarantees. Any guarantee for pension benefit is having certain cost associated with it. Chapter-VIII discusses about the various aspects of guarantee costs, like valuation of guarantee cost, financing mode of guarantee cost, choice of guarantor, pricing structure etc. Finally Chapter-IX, analyses the NPS system for prevalence of risk-based supervision on the basis of the Checklist and reply of the questionnaire by PFRDA. If was found that there is no Risk Management Committee working directly under PFRDA, but the responsibility of forming the risk management committee and risk policy is shifted to the Pension Fund Managers. The policy recommendations for certain modifications in the risk management system in suggested, by forming a risk management committee working directly under PFRDA. The concept of Stress test and risk scoring as used by BaFin Germany is suggested for implementation in NPS supervision. Some other policy implication issues are also discussed. The recommendation for introduction of certain rate of return guarantee system in NPS is suggested based on the conclusion drawn from the discussion in earlier chapters.