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The design of India’s National Pension Scheme (NPS) focused on ‘lowest cost’ as its key selling point. Based on the well-accepted economic principle that low prices attract high demand, rapid adoption of the NPS was expected. An overview of the development of the NPS market, however, seems to indicate that its very low cap on the fee that could be charged by intermediaries has turned out to be deterrent to market growth. The latest regulations, applicable from April 2021, made changes to the fee structure that were expected to have a positive impact on customer acquisition and market expansion.

The NPS was launched in 2004 for government employees with three public sector pension fund managers: Life Insurance Corp of India (LIC), State Bank of India (SBI) and Unit Trust of India (UTI). It was opened up for Indian citizens in 2009 and private pension fund managers (PFMs) were allowed to participate. In 2011, a corporate NPS model was introduced by the Pension Fund Regulation & Development Authority (PFRDA) to enrol subscribers through their employers.

The PFRDA invited bids, and UTI Asset Management Company Ltd placed the lowest bid of 0.09 basis points as its fund-management fee (a basis point is one-hundredth of a percent). Other participants were asked to match the lowest bid. Six PFMs were chosen and awarded a mandate for three years from 2009 to 2012. A mid-sized PFM roughly needs a fund management fee of 7-8 basis points to break even in 8-10 years. A fee lower than 1 basis point gave very little leeway for aggressive investment in market development and consumer education. At the end of the mandate period, the PFRDA allowed PFMs to charge a fee at their discretion but capped it at 25 basis points. This encouraged PFMs to compete among themselves and step up marketing and distribution budgets. This enthusiasm was short lived. In 2013, amid allegations of the private sector being favoured, the ‘L1’ method of choosing PFMs was reinstated. In this round of bidding, Reliance PFM placed the lowest bid of 1 basis point. Citing abnormally low fees, DSP and Tata PFMs decided to opt out of the NPS. It was a replay of the earlier story of weak investment in market development, and market growth lagged. The April 2021 regulations have introduced a slab-based fee structure under which PFMs with smaller assets under management (AUMs) are allowed to charge a fee of up to 9 basis points. As AUMs increase and economies of scale kick in, the cap on the fee reduces. There is a floor fee of 3 basis points, below which no PFM can reduce its fees. Other forward-looking regulations have been introduced to encourage private sector participation. PFM licences are now available on tap. Government sector employees have also been allowed to invest with private PFMs. These changes are expected to invigorate efforts to promote rapid adoption of the NPS in others sectors.

The adoption of a financial product like a pension scheme is a complex process. A consumer’s social network has a strong influence on her choice. Some of the terms used for this phenomenon are ‘peer influence’, ‘bandwagon effect’, etc. Evidence of social effects has been reported by research studies on the adoption of retirement saving products, stock market participation and employee stock purchase plans. When a consumer purchases an investment product, her peers may also consider buying it. Peers take cues from individual purchase decisions and social networks transmit information about the product that results in wider knowledge diffusion. Often, normative pressures also play a role: the pressure on non-adopters increases when they observe that people whose approval they seek have adopted it.

The NPS offers multiple choices related to product type, investment mix, the PFM and transaction services provider. A knowledgeable investor can benefit from these options. But, for a lay person, numerous choices could add complexity to a purchase decision. In addition, the consumer has to deal with the uncertainties inherent in making a long-term financial commitment for benefits which will accrue to her in the faraway future. Due to these reasons, there will likely be a small number of well-informed customers who will buy the NPS after matching their needs with its benefits. A larger proportion of consumers, however, will probably buy it based on word-of-mouth and recommendations from friends and family, with only a limited understanding of the mechanics and benefits of the product. For such social effects to become prominent, the market needs to reach a critical mass of consumers. This requires intensive sales effort to reach out to prospective buyers and opinion makers.

Low fee caps have held back private pension market players from investing in distribution by recruiting sales teams and channel partners. This is one reason that the NPS market has yet to reach its ‘take-off’ stage. By March 2021, more than a decade of its launch, the scheme had less than 3 million non-government account holders, a figure that had risen only a little above that mark by last October. With a new fee structure, perhaps better subscriber growth can be expected in the coming years.

Traditional theories of financial intermediation hold the view that intermediaries exist because of information asymmetries and inefficiencies in executing transactions. And that once technology provides sufficient information and makes transactions relatively frictionless, intermediaries will no longer be needed. Intermediaries are thus a necessary evil to be tolerated till technology delivers its promise. Such a view might hold good for simple products like payments, but falls short in the case of long-term products like insurance and pension schemes. For such products, social networks and friendly financial advisors remain an important source of information, reminders as well as nudges. So, until a large proportion of consumers move to the ‘Metaverse’ and get financially savvy, the role played by intermediaries in promoting new product adoption would continue to be a crucial element of regulation design.

Vinay Kumar Singh is an economist and a consultant with research interests in financial inclusion and fintech.

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