Que sera sera. Whatever will be, will be. This seems to be the defining theme for a lot of young and even not so young Indians who just can’t seem to start saving and investing for their retirement. Surveys show that though Indians are thinking and concerned about how they will live out their retirement years, yet don’t start investing for the event in time. Most of them just save/invest enough to get tax breaks. Since currently there is no exclusive tax break for retirement plans, the amount put aside for this purpose is relatively low.
However, the situation will change once the direct taxes code (DTC) comes comes into effect in April 2012 with an exclusive tax break for National Pension System (NPS), provident fund and superannuation schemes at Rs 1 lakh per year. Out of these schemes, NPS is the only one with a transparent allocation to equity and that should make it popular. Hopefully with the added incentive of the exclusive tax break, the amount saved towards creating a retirement corpus will become more significant.
This exclusive focus on the accumulation phase of retirement planning obscures the limited choice available today when a consumer wishes to use the retirement corpus to get pension for life. Now at least 40% of the amount received from NPS will need to be used to buy an annuity policy from a life insurance company. This aspect of retirement planning has yet to get the attention of policymakers since the number of people who are required to mandatorily buy such annuity policies is still relatively small.
The effective interest rates offered on the annuity policies are relatively low. One reason for low return is that the annuities (which are in the nature of interest paid on the sums invested in annuity schemes if we consider only those schemes that provide lifetime annuity and return of purchase price after death) are guaranteed for the lifetime of the person buying the annuity. So irrespective of the interest rates that the scheme itself is able to get, the insurance company still pays a guaranteed return to the purchaser. Longer the period for which such guarantee operates, higher is the risk of mismatch between the actual returns of the scheme and the guaranteed returns.
Obviously the insurance company needs to keep a cushion to absorb any drops in the future interest rates when it works out the annuity payable to you over your lifetime. The interest rate risk as well as the annuitant living longer than the assumed life expectancy is thus borne by the insurance company. The second risk of increased lifespan is quite significant as has been proven in many countries as medical advances and improved lifestyle increase lifespan significantly.
In fact, Steven Levitt and Stephen Dubner in their book SuperFreakonomics, say, “... People who buy annuities, it turns out, live longer than people who don’t and not because the people who buy annuities are healthier to start with. The evidence suggests that an annuity’s steady payout provides a little extra incentive to keep chugging along.” While this is written in the context of California pensioners, even in India the people who buy annuities belong to the population strata that have access to good medical and other facilities and will live longer than the general population.
In India though most retired people use various other government savings schemes that offer relatively higher interest rates, such as Post Office Monthly Income Scheme and Senior Citizens Savings Scheme, even though the interest rate is guaranteed only for a fixed period of time and not for their lifetime. These schemes also have a maximum cap for the investment amount.
Clearly, life insurance companies will need to start providing differential annuity policies to the rush of captive consumers that they are likely to get in a few years time once NPS becomes popular with the general public after DTC comes into effect. People will expect innovative annuity policies. The insurance industry, in turn, is itself handicapped in the absence of a deep long-term debt market, which prevents it from offering more innovative products. This is one more reason why the long-promised reforms for a vibrant and deep debt market needs to be pushed through now rather than later. After all, the policymakers or the insurance industry cannot afford to take que sera sera attitude on this crucial issue.
Harsh Roongta is CEO, Apnapaisa.com.