Que Sera Sera, Whatever Will be, Will be!
“This seems to be the defining theme for lot of young even not so young Indians who just can’ seem to start saving and investing for their retirement. Survey after Survey is showing that though Indians are thinking and concerned about how they will live out their retirement years yet don’ start investing for the event in time. Most of them just save/invest enough to get the tax breaks on offer. 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 DTC comes into effect in April 2012 with an exclusive tax break for National Pension Scheme (NPS) /PF/Super Annuation schemes at Rs. 1 lakh per year. Out of these schemes, NPS is the only one with a transparent allocation to equity which should make it quite 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 the retirement planning obscures the limited choice available today when a consumer wishes to use the retirement corpus to get himself a lifelong pension. Now at least 40% of the amount receivable from the NPS will need to be used to buy an annuity policy from a life insurance company. This aspect of the retirement planning has yet to get the attention of the policy makers 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. (See Table).Â One reason for the lower return is that the annuities (which are in the nature of interest paid on the sums invested in the 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 life span is quite significant as has been proven in many countries as medical advances and improved lifestyles increase life spans 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’ and not because the people who buy annuities are healthier to start with. The evidence suggests that an annuity steady payout provides a little extra incentive to keep chugging along. Whilst 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 Citizen saving scheme even though the interest rate is guaranteed only for a fixed period of time and not for their life times. These schemes also have a maximum cap for the investment amount. (See Table for comparison)
Clearly the 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 such as inflation-indexed pensions apart
of course for better returns from their 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 policy makers or the insurance industry cannot afford to take que sera sera attitude on this crucial issue.
Analysis of lifetime annuity schemes
We compared the lifetime annuity schemes of these companies for both scenarios where the purchase price is returned on the death of the purchaser and where it is not (obviously the annuity is far higher for the second option). We assumed the person to be 60 years of age and the purchase price of the particular annuity at Rs. 50 lakhs.
Here is what we found
With return of purchase price
Annual amount paid
Effective Interest rate
Without return of purchase price
Interest Rate as per (2) above
Annual amount paid without return of purchase price
Number of years ****
Rough life expectancy assumed (60 plus years at (6) above)
****Reverse calculation of period based on given purchase price
interest rate and the annuity amount
*Direct purchase from company
Post office monthly income scheme offers a return of 8% pa payable monthly. The maximum tenure in this scheme is 6 years and the maximum amount for a single holder is Rs. 4.5 lakhs and 9 lakhs in case of joint holders. Senior citizen savings scheme is available for a total tenure of 8 years with an interest rate of 9% quarterly payout for a maximum limit of Rs. 15 lakhs in the name of husband and Rs. 15 lakhs in the name of spouse in case provided both have completed 60 years of age. This means that the total investment will be to a maximum of Rs. 30 lakhs.”