Should you go for minimum assured returns?

The Pension Fund Regulatory and Development Authority is expected to launch its first minimum assured return scheme (MARS) under the National Pension System (NPS) early next financial year. There are very few products like this currently in India or abroad. Let us take a closer look.

NPS genesis

Before we delve into minimum assured return scheme specs, let us take a step back and understand how the framework of pension system evolved globally into three pillars. These are non-contributory basic social pension financed mostly by the government, occupational contributory pension schemes that are defined contribution (DC) or defined benefit (DB), and voluntary fully-funded personal pension plans. The NPS was envisioned as a defined contribution pension scheme. Till the introduction of NPS in January 2004, the main pension system was for government employees pay-as-you-go defined benefit plan. With NPS, occupational contributory pension schemes, with focus on defined contribution gained prominence.  Under this system, the pension payout post-retirement depends on returns generated by the corpus accumulated during the working years and hence not guaranteed.

MARS proposition

The minimum assured return scheme (MARS) in the new NPS is different for many reasons. One, it will reportedly have a floating rate which would reset annually. This virtually means the guarantee or assurance is not a fixed one. It is a floating one and valid for one year at a time. Suppose the guarantee is fixed for 5-6 per cent today, it will be valid for one year. Thereafter it will be reset either up or down. If a shock happens in between and yield variance is very high, PFRDA is likely to intervene and reset it.

Two, there would be a lock-in period of ten years for the product and the guarantee would be benchmarked to the rate of return on ten-year government security. But, here is where it gets slightly uncomfortable. Reportedly, the guarantee could be less than the ten-year government security and if the ten-year government paper gives 7.5 per cent interest rate, the guarantee could be five, keeping a difference of 2.5 per cent. This high difference, if it actually finds itself into the actual product, would reduce the allure. Long-term products such as annuity can, without much trouble, provide 5 per cent return. With NPS known for its lowest cost structure, PFRDA should narrow the difference between 10-year G-Sec and its guarantee/minimum assured return.

Three, if the market performs better and the rate of return is over the minimum assured rate, it will be given to investors. But if the market performs otherwise, the rate of return would not go less than minimum assured return and the fund manager will have to bear the difference. To enable pension funds and its sponsors to offer MARS-like products, PFRDA has already tweaked the capital requirement norms for the sponsors and stipulated higher networth and paid-up capital for those looking to set up pension funds in the country.

Four, there could be a ten-year lock-in period for subscribers. This means only those investors who remain invested for 10 years will get a guaranteed return.

Five, the upper age limit for the plan is below 50 years. This is probably keeping in mind the retirement age of 60 years.

Six, the expense ratio (fund management fee) in MARS could be higher, say, around 25 basis points, than other NPS schemes (maximum 9 bps) — the reasoning being expense is higher due to the guaranteed returns despite market risks.

Our take

MARS has assumed importance since a few State governments (Rajasthan, Chhattisgarh and Jharkhand) have opted out of the NPS and embraced the old pension system (OPS). Two more States are considering doing the same. Politics aside, the pensioner gets assured benefits under the OPS. In NPS’ existing offerings, there are no assured benefits but defined contributions. Hence, MARS tries to fill this void in the NPS to an extent.

MARS would be ideal for risk-averse investors looking for a guaranteed payout post-retirement. But, a low guarantee of say, 5 per cent, would be sub-optimal given that non-guaranteed NPS scheme Government Securities (‘G’) scheme over 5 years, 7 years and 10 years has given 8 per cent comfortably.

Prospective investors in MARS should understand that assured returns may give comfort. However, such assurances come at a high cost, which can limit the upside and lower the final pension corpus. It also remains to be seen as and when the number of MARS beneficiaries becomes large, how much the cost guarantee eats into effective rate of return.

COMMENT NOW