• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

Suresh Krishnamurthy

Subsidies have a way of entrenching themselves in the system. Pension subsidies are no different. Using investments in stocks to deliver pension can potentially reduce their impact.

THE pension plan introduced to support the aged is a welcome development for a country without any social security net. However, it needs to be ensured that the subsidies are not a major drain on budgetary resources.

They might well be if the plan attracts a large amount of funds. In this context, mixing stocks in the pension portfolio appears to be a suitable answer. Subsidies tend to get entrenched in the system, and a plan to contain their impact is necessary.

Stocks and pension: Stocks conjure up a picture of risk and speculation, and are generally considered unsuitable in India for older investors. However, LIC's Varistha Bima Yojana is different. The risk in this plan is borne by the Government and indirectly by taxpayers.

The pension plan is also long-term with a lock-in-period of 15 years. Non-inclusion of stocks in such a portfolio might inflate the subsidy bill.

If stocks are not included, the Government will have to cough up about Rs 4.50 for every Rs 100 invested in the plan. This assumes that investments in the debt market will fetch a return of 5.50 per cent and LIC will incur costs of 1 per cent for administering the scheme. However, the inclusion of stocks can reduce the subsidy component.

Constant sum: The plan can involve the investment of a constant sum in stocks each year. Of every Rs 100, the plan can involve investment of, say, Rs 80 in debt and Rs 20 in stocks. The sum invested in stocks will be maintained constantly at Rs 20 at the beginning of every year, irrespective of the total value of investments at the end of every year.

If the total value of investments at the end of every year is less than Rs 110 (that is, Rs 100 plus Rs 10 needed to pay out pension and manage the plan), the Government will pay the remainder. For example, if the sum is Rs 105, the Government will pay Rs 5. This way the plan will remain fully funded at all times — that is, the plan size will remain at least Rs 100 each year.

Assume that the plan had Rs 120 at the end of the year. Then, for the forthcoming year, a sum of Rs 100 can be invested in debt and Rs 20 can be invested in equity. This way the proportion of equity will come down over the years reducing the risk for the Government and the taxpayers.

Past performance: In the past ten years, if investments were made in a debt instrument fetching a return of 5.5 per cent and equities were invested in BSE 200 Index, the subsidy component would have declined by nearly 40 per cent.

However, this was mainly because the returns from stocks in the initial years were good. Let us reverse the sequence of returns. That is, let us assume that the returns in year 10 were generated in year 1, and so on. This would bring down the performance of the plan substantially. However, the subsidy component will still be lower by about 10 per cent. Over a period of 10-15 years, that would still work out to a sizeable sum.

Interestingly, if investments in equities are reduced to, say, Rs 10, the subsidy component increases. This clearly indicates that equities can help bring down the subsidy component.

Risks exist: Any plan involving stocks is exposed to risks. The fund manager can underperform an index such as BSE 200. Or, stocks may remain depressed for an unusually long period. However, given the exceedingly long-term nature of the plan, which can be taken as more than 15 years, the risks tend to be that much less.

However, what is intimidating is the possibility of political influence. Political influence can wreak havoc with any plan. As such, appropriate checks and balances appear necessary before stocks form part of the pension plan for senior citizens.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Varishtha Pension Bima Yojana — Reason to smile for pensioners

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line