The necessity of intermediaries to promote long-term schemes

The design of India’s National Pension System (NPS) focused on “lowest cost” as a major selling point. Based on the well-accepted economic principle that low prices attract high demand, rapid adoption of NPS was expected. However, an overview of the NPS market development appears to suggest that the extremely low cap on fees that brokers can charge has become a deterrent to market growth. The latest regulations, effective from April 2021, change the fee structure that were expected to have a positive impact on customer acquisition and market expansion.

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 to Indian nationals in 2009 and allowed Private Pension Fund Managers (PFMs) to participate. In 2011, the NPS form for companies was introduced by the Pension Fund Regulatory and Development Authority (PFRDA) to register subscribers through their employers.

PFRDA invited bids, and UTI Asset Management Company Ltd submitted the lowest bid of 0.09 basis points as a money management fee (the basis point is one-hundredth of a cent). The other participants were asked to match the lowest bid. Six PFM managers were selected and given a three-year mandate from 2009 to 2012. A medium-sized PFM needs roughly 7-8 basis points of fund management fees to break even in 8-10 years. Fees of less than one basis point gave very little room for aggressive investment in market development and consumer education. At the end of the mandate period, PFRDA allowed PFMs to charge fees at its discretion but set it at 25 basis points. This encouraged PFD managers to compete with each other and increase marketing and distribution budgets. This enthusiasm did not last long. In 2013, amid allegations of private sector preference, the “L1” method for selecting public financial management managers was reinstated. In this round of bidding, Reliance PFM submitted the lowest bid by one basis point. Citing abnormally low fees, DSP and Tata PFMs decided to opt out of NPS. It was a replay of the previous story of underinvestment in market development, and market growth was delayed. The April 2021 regulations introduced a panel-based fee structure under which public finance managers with smaller assets under management (AUMs) are allowed to charge up to 9 basis points. As AUMs increase economies of scale, the maximum fee decreases. There is a minimum fee of 3 basis points, without which no public finance department can lower their fee. Other forward-looking regulations have been introduced to encourage private sector participation. PFM licenses are now available on tap. Government sector employees were also allowed to invest with private public finance managers. These changes are expected to revitalize efforts to promote the rapid adoption of nuclear energy strategies in other sectors.

Adopting a financial product such as the retirement system is a complex process. The social network of the consumer has a strong influence on his choice. Some of the terms used for this phenomenon are ‘peer effect’, ‘trolley effect’, etc. Evidence for social influences has been reported by research studies on the adoption of retirement savings products, stock market participation and employee stock purchase plans. When a consumer buys an investment product, his peers may also consider buying it. Peers take cues from individual purchasing decisions and social networks transmit information about the product leading to a wider spread of knowledge. Normative pressures often play a role as well: the pressure on non-adopters increases when they notice that the people seeking their approval have adopted.

NPS offers multiple options related to product type, investment mix, financial transaction service provider and public financial management. An informed investor can take advantage of these options. But for the layman, many options can add complexity to a buying decision. In addition, the consumer has to deal with the uncertainties inherent in making a long-term financial commitment with the benefits that will accrue to him in the distant future. Due to these reasons, there will likely be a few informed customers who will buy an NPS after matching their needs with its benefits. However, it is likely that a larger percentage of consumers will buy it based on word of mouth and recommendations from friends and family, with only limited understanding of the mechanisms and benefits of the product. For these social influences to become prominent, the market needs to reach a critical mass of consumers. This requires extensive sales efforts to reach potential buyers and opinion makers.

Low fee caps have deterred pension market players from investing in distribution by recruiting sales teams and channel partners. This is one of the reasons why the NPS market has not yet reached the “take-off” stage. By March 2021, more than a decade after its launch, the program had fewer than 3 million non-government account holders, a number that had only risen slightly above that number by last October. With the new fee structure, better subscriber growth can probably be expected in the coming years.

Traditional theories of financial intermediation hold that intermediaries exist due to information asymmetry and inefficiency in executing transactions. Once the technology provides enough information and makes transactions relatively frictionless, there will be no need for middlemen. So middlemen are a necessary evil that must be tolerated for technology to live up to its promise. This view may be fine for simple products such as payments, but falls short in the case of long-term products such as insurance and pension systems. For such products, social networks and friendly financial advisors remain an important source of information and reminders as well as alerts. Therefore, until a significant proportion of consumers move to the Metaverse and gain financial knowledge, the role that intermediaries play in promoting the adoption of a new product will remain a critical component of organization design.

Vinay Kumar Singh is an economist and consultant with research interests in Financial Inclusion and FinTech.

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