financial sector innovation to match the social security needs of ageing india

8/8/2019 Financial Sector Innovation to Match the Social Security Needs of Ageing India

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Financial Sector Innovation to Match the Social Security Needs of

Ageing India 1

By Dr. Ruby Ojha

Associate Professor,Dept. of Economics, PGSR,

SNDT Womens University,Churchgate, Mumbai 400020

1. Population Ageing

The trend, by which more people live to reach older age, while fewer children are

born is referred to as population ageing. In this phenomenon the share of older

individuals in the total population starts increasing. In most of the developed

countries, population ageing was a gradual process following steady socio-

economic growth over several decades and generations. But, it has been

particularly rapid in developing countries. In developing countries, the process is

compressed. Thus, while developed countries grew affluent before they became

old, developing countries are getting old before a substantial increase in wealth

occurs.

The world is experiencing an unprecedented demographic transformation. By

2050, the number of persons aged 60 years and over will increase from 600

million to almost two billion, and the proportion of persons aged 60 years and

over is expected to double from 10 to 21 per cent. The increase will be greatest

and most rapid in developing countries, where the older population is expected to

quadruple during the next 50 years ( Second World Assembly on Ageing, 2002) .

1 This article is a revised version of the paper which was presented in Third InternationalCongress of Asian Political and International Studies Association (APISA) on Conceptionsof Justice in Asia, organized by University of Delhi, from Nov. 23-25, 2007.

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The challenges of population ageing require innovative planning and substantive

policy reforms in countries in transition. Though at present most of the

developing countries, including India, are passing through the phase of

demographic transition where they are enjoying demographic dividend which

means having a positive impact on economic growth due to declining

dependency ratio, but it may not last long as population in these countries is

ageing at very fast pace. Therefore, in designing present policies, the longer-

term demographic developments have to be borne in mind.

Population ageing has many serious developmental linkages with a potential to

jeopardize economic and planning strategies. The challenge lies in finding

institutional mechanisms where individuals actually do save steadily through their

working careers, and earn the highest possible rates of return for their wealth, so

that the corpus created at age 60 is able to offer income security during old age.

Asian countries have the advantage of seeing what is happening in the west.

They can avoid the mistake of becoming an excessive social welfare state. We

need to develop funded health and pension schemes.

All over the world, one of the chief concerns of the elderly is that they will outlive

their savings. Seniors in India are no exception. Although old values still prevail

in India and children do support the parents in many instances. But this system is

changing very fast and nuclear families are becoming the order of the day. For

the majority, personal savings are their only source of retirement income.

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2. Indias Case

In the Indian context, this issue is of great relevance as ageing is occurring at

lower income levels. The issue has been further compounded because of

diminishing support for old people from families due to breaking up of the joint

family structures, higher rearing cost of surviving children and because old

people require greater resources and need support for a longer period due to

increased longevity. This is likely to put heavy pressure on Indias government

treasury through higher spending on old age social security, health care, pension

and other welfare programmes for them. The key issue is whether such support

should be provided by private or public funding (Rakesh Mohan, 2004).

In India, until recently, the provision for pensions and care for the old was

privately provided usually within the family. This is becoming difficult to sustain

and is changing because of following reasons:

In rural areas, people essentially worked as long as they could. There was

no retirement age and job content changed according to capacity to work

as people aged. This phenomenon is changing with migration of people to

urban areas.

With urbanization, the old people are left behind, and remittances provide

for pension equivalents, encompassing inter-generational resourcetransfers which is difficult to sustain.

Earlier, when the retired were expected to live until the age of 65 to 70, the

issue of within family care arose for 5 to 10 years. Now with rising

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longevity, the within family care could extend to 20 or even 30 years, and

perhaps throughout the son or daughters full working life (Rakesh Mohan,

2004).

India has been among those enlightened nations, which recognized the need for

social security during old age quite early. In Constitution of India, entry 24 in list

III of schedule VII deals with the welfare of labour, including conditions of work,

provident funds, liability for workmen's compensation, invalidity and old age

pension and maternity benefits. Item No. 9 of the State List and item 20, 23 and

24 of Concurrent List relates to old age pension, social security and social

insurance, and economic and social planning. Further, Article 41 of Directive

Principles of State Policy has particular relevance to Old Age Social Security.

According to this article, "the State shall, within the limits of its economic capacity

and development, make effective provision for securing the right to work, to

education and to public assistance in case of unemployment, OLD AGE,

sickness and disablement and in other cases of undeserved want".

The right of parents without any means to be supported by their children having

sufficient means has been recognized by the section125 (1) (d) of the Code of

Criminal Procedure 1973, and Section 20(3) of the Hindu Adoption and

Maintenance Act, 1956. Himachal Pradesh Assembly passed a Parents

Maintenance Bill in 1996 wherein a simple procedure was introduced for parents

being ignored by their children to be given maintenance.

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The Provident Fund Act was introduced back in 1925 for select public

enterprises. We have the Employees Provident Fund and Miscellaneous

Provisions Act (EPFMP) of 1952, which covers 177 industries today. From 1995,

the Employees Pension Scheme also covers workers covered under the EPFMP

Act, 1952. While these have been laudable steps, and are serving the working

class well, their coverage is very small. There is also the Public Provident Fund

(PPF) scheme for self-employed and those not covered by the EPFMP Act, but

its clientele is confined to large cities. It is not easily accessible either.

In India, only about 11% of the current working age population is participating in

mandatory, formal programmes designed to provide income security during old

age. That situation also is becoming difficult as in the case of central government

departments viz. defence and railways the pension bill is estimated to be about

25% above the wage bill, which represents a hidden cost. The participants in

these schemes salaried employees in the formal private sector and

government are among the highest income groups in India. These schemes do

not extend to nearly 85 % of workers in the informal sector who have little ability

or opportunity to save for old age. Moreover, unemployment insurance does not

exist (Rakesh Mohan, 2004).

India did not have a policy for senior citizens till 1999. Since we have a tradition

of joint families and caring at home for our senior citizens, this was not really a

major concern till migration started from villages in the big cities and children

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started going abroad for studies and work. There is no institution that can replace

the family but there is room to build into it the ideas of equality, justice and

freedom. In India a systematic thinking as to what should be the policy towards

the ageing began in 1999. Though we now have a national policy on older

people, and a plan of action has been prepared, there is scepticism over its

implementation. The introduction of social security programmes in developing

countries is a difficult task. In India the situation is far more complex because the

entire responsibility of taking care of the old continues to be with the traditional

institution of the family. Now, in this phase of transition, we have neither thefacilities of the west nor the care and concern for the elderly that has traditionally

been a part of our culture.

The Government realises that poverty alleviation programmes directed at the

aged alone cannot provide a complete solution to the problem. Faced with such

large numbers, it is apparent that the problem will have to be addressed through

thrift and self-help, where people prepare for old age by savings accumulating

through their decades in the labour force. Although, policy strategies are highly

reliant on private sector initiatives, the public sector has to play an important role

in overcoming sources of market failure. The role that the government can play in

his enterprise is to create an institutional infrastructure to enable and encourage

each citizen to undertake this task (Project OASIS, 1999).

For a number of years, policy-makers and retirement specialists in many

countries have been analyzing various options to generate retirement income

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from private houses. Annuity from reverse mortgage may be an ideal solution to

the problem of Indian middle-class, who are often called "asset-rich, but income-

poor" at retirement, because their wealth is tied up in their homes.

3. Reverse Mortgage Scheme

a. The concept

In terms of financial jargon reverse mortgage can be defined as "an agreement

by which a home owner borrows against the equity in his home and receives

regular payments from the lender''. Here equity is the value of the property over

and above any mortgage or other liabilities relating to it. Thus, reverse mortgage

is a contract between a homeowner and a financier, which enables the

homeowner to receive a stream of income, especially in retirement, from the

future realizable value of the home.

The genesis of reverse mortgage can be traced in developed countries where,

due to higher standards of living, better access to health care and higher life

expectancy, people above 65 years constitute a major chunk of the population.

The ever-rising cost of pensions and health care for the old led insurance

companies to introduce the reverse mortgage in the US, the UK and Australia.

The concept of reverse mortgage seeks to enable house-owning senior citizens

to meet their expenses without selling their house. Reverse mortgage is so

named because the payment stream is reversed, that is instead of the borrower

making monthly payments to the lender (as in a conventional mortgage), a lender

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what you owe them, that is Rs 35.78 lakh, the balance will be passed on to your

heirs.

Supposing the value of your property has appreciated to Rs 65 lakh during the

tenure of the loan, your heirs will receive Rs 29.21 lakh. However, if your heirs

want to keep the property, they can settle the amount that you owe to the bank

and keep the property.

The amount available is based on several factors, such as the applicant's age,

appraised value of the house, projected rate of house price appreciation and thecurrent interest rates. In addition, there are other costs involved, which can go up

to 5 per cent of the value of the house. Generally speaking, higher the age of the

retiree, higher the value of the house, more the money available. This amount is

paid every month until life. On the death of the last surviving spouse, the loan

amount (principal and interest) needs to be repaid to the lender. The

bank/financial institution can sell the house; take what is owed and pay the

excess, if any, to the legal heirs.

In the rare case when the value of the property does drop below the amount

owed on the reverse mortgage, the lender must absorb the loss. The heirs,

however, have the option to pay off the bank directly and keep the house

themselves. Considering the present trend in real estate appreciation, it would

not be unrealistic to presume that property values will double in 15 years, even in

non-metropolitan locations. If this trend continues, it is very likely that even after

repaying the mortgage amount there would be still be something left for the heirs.

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It would be a profitable proposition for the lenders too since they would be able to

get their expected return on capital invested.

c. Advantages

Nevertheless, there are a number of advantages that could act as incentives.

Chief among them are:

Reverse mortgage can supplement retirement income. Particularly when

there is a shortage of monthly income, this equity reduction may be

preferable to a reduction in the standard of living.

Also with the booming real estate market in India there is a good

possibility of the value of the house appreciating more rapidly than the

mortgage loan increasing. In such a scenario, there could be some equity

left over for heirs.

There is no upper age limit for getting the benefit of the reverse mortgage

facility. On the contrary, the older one is, the easier it would be to get the

loan.

For the lender, it is definitely more profitable to offer mortgages to older

people due to reduced life expectancy.

It is a non-recourse loan, which means the bank/financial institution can

never come after any person or estate for repayment of the loan. The

lender can only receive payment of the loan from the value of the home.

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At the macro level, implementation of reverse mortgage schemes could

reduce the burden on the Government and employers who are paying

pensions, whether in the public or in the private sector (Subasri, 2005).

With the changing social milieu in India and the collapse of the joint family

system, introduction of reverse mortgage products could be a worthwhile

experiment. Instead of being dependent on their children for monetary support,

this would be a good option for the elderly to continue with a graceful lifestyle.

Thus by investing in a house through a housing loan and repaying the loan

during his working life time, one will not only have a roof over his head

throughout his life time, but also secure a joint life pension, that keeps in step

with inflation, after retirement. Seen in this perspective, reverse mortgage would

motivate people to build or buy their homes and, thereby, save for their

retirement voluntarily. Hence reverse mortgage spurs economic activity and

provides economic security. In the absence of provisions for social security in the

country a product like reverse mortgage has numerous benefits.

d. The procedure

You have to approach a Housing Finance Company (HFC) or a bank and

express your interest in pledging your home for the reverse mortgage scheme.The HFC will asses the value of your house and, depending on your age and the

prevailing interest rate, the amount of loan payable to you will be decided upon.

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The value of the house will be determined by independent valuation through the

generally accepted property valuation methodology in the industry. The loan

amount will be fixed on the basis of current value and not on possible future

appreciation. There would be a provision for periodic valuation and consequent

adjustment of payments.

However, the most critical factor in deciding the amount is age. The older you

are, the chances of getting a higher value are more. This is because the lender

will have to typically provide the loan for a lesser number of years.

The interest rate at which the loan will be given will typically be marginally higher

than the prevailing interest rates as the lending company will receive its money

when the borrower dies. However, currently on the basis of present analysis, the

loan to value ratio is fixed at 45-60 per cent of the value of the property based on

the age.

e. What if you outlive the loan tenure?

Under the present recommendations of the NHB, you need to be 62 years of age

and the tenure of the loan are fixed at 15 years. There have been

recommendations to lower the age to 60 as people usually retire at that age. The

primary lenders shall however have the discretion to consider a shorter / longer

tenure. However, if you outlive the tenure of the loan, you will not be asked to

move out of the house. Although payments made to you will stop after 15 years,

the interest will keep accumulating till the accounts are finally settled.

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There is talk of adding insurance to reverse mortgage. So the premium for that

will be deducted from the payment made to you. The corpus accumulated at the

end of 15 years will be used to fund the years that you outlive the loan tenure.

There are also suggestions that a certain portion from the payments be parked in

bank fixed deposits to fund the years that you outlive the loan. The accounts will

be settled by the housing finance company only after your death or if you vacate

the property.

The settlement of the outstanding loan amount, along with the accumulatedinterest, will be met by the proceeds of the sale. In the event of your death, your

spouse can continue to occupy the property until his / her demise, and he / she is

usually made a co-borrower.

f. Re-reverse mortgage

Supposing you pledge your property for reverse mortgage and midway through

the tenure, you receive money either by sale of some investments or your

children provide you money to pay the amount and the interest you owe to the

bank, you can free your property. You can also pledge the same property for

reverse mortgage in future, if you are in need of cash.

g. The costs

Apart from interest on the loan, you will have to bear other costs as well. These

include closing costs of the primary lenders such as loan processing charges,

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documentation costs and commitment fees on indrawn loan amount, which is

generally estimated as 5%.

4. Issues

Since the concept of reverse mortgage is new in India, there are a number of

issues that may arise and need to be addressed by the authorities for ensuring

its successful implementation. These issues mainly pertain to tax-treatment,

accounting, legal and regulatory aspects. In many ways, reverse mortgage is an

unconventional retirement tool. Even in countries where it has been around for quite a while, acceptance has been very cautious.

In India, the housing finance market is booming and, therefore, financial

institutions do not see the need to launch innovative products. In addition, there

are other issues such as pricing which can be extremely complex as it involves a

number of uncertainties, such as future value of houses, life expectancy, andinterest rate risks.

On the borrower's side, the biggest challenge would be balancing the need for

supplementing retirement income and the desire and wish to bequeath homes to

children. Compounded with the natural reluctance of many seniors, who have

worked a lifetime to pay off a housing loan to go back into debt, irrespective of

the merits of the scheme, the psychological acceptance of this concept in itself

would be difficult.

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quarterly) basis, the total payment being equal to the value of the property and

the interest on the loaned amount. After the death of the borrower and the

borrower's spouse, the housing company sells the property to recover the

amount paid out along with interest at a rate similar to interest on housing loans.

The scheme is designed to supplement the monthly income of senior citizens.

This scheme is offered to retired people above the age of 60 years who own

property and have been living in it for at least one year.

The loan amount sanctioned is based on the:

Age of the borrower

Average value of the property

Rate of interest on the loan

The payment method chosen by the borrower

The eligibility for a reverse mortgage loan is simple. The borrower should be 60

years of age, living in self-owned property, which is free of any other

encumbrances, and is an approved construction. The amount loaned would

depend on the estimated value of the property (minus the interest cost), its

condition and life. The loan does not apply to ancestral property.

Saksham allows customers and their spouses to live in the property as long as

they are alive, without the fear of eviction even after the tenure expires. The

surplus amount is then paid to the legal heirs of the borrower. The legal heirs

also have the option to re-possess the property after the demise of both

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customers and their spouses. DHFL will first launch Saksham in Mumbai and its

adjoining areas before making it available nationally.

According to Shivkumar Mani, head, marketing, DHFL, "As per the guidelines laid

down by NHB, DHFL is the first company to launch this scheme in India. This

unique scheme is designed to help senior citizens to sustain their lifestyle and

help them maintain their monthly expenditure without being dependent on

anyone. It is a social security scheme designed to benefit the senior citizens post

retirement."

After this, several banks have announced their intentions to launch reverse

mortgage schemes. Taking the lead has been ICICI Bank, Punjab National Bank

(PNB), Bank of Baroda (BoB), State Bank of India and HDFC.

References:

1. Second World Assembly on Ageing, Madrid, Spain, April 2002.

2. Sitaraman Subasri, The Case for Reverse Mortgage, The Hindu Business

Line, March 15, 2005.

3. Project OASIS (Old Age Social and Income Security) Expert Committee

Report, Feb. 1, 1999.

4. Rakesh Mohan, Fiscal Challenges of Population Ageing: The Asian

Experience, RBI Bulletin, October 2004.

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financial sector innovation to match the social security needs of ageing india

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