The challenges we face as a society are many, starting with developing a system that matches the needs for poverty alleviation and income redistribution at one end with the need for a mechanism whereby people prepare for old age by accumulating savings through their decades in the labour force. A second challenge is to increase coverage of such schemes from the present level where it covers only 11 per cent of the work force. A third challenge is to get people used to the idea of market related returns when they have been used to the guaranteed 12 per cent currently in force.

And the fourth challenge is to be able to encourage individual choice such that a person has some control over his choice of vehicle to get him to his oldage.

Let me turn to a second set of challenges that deal with the way these funds need to be managed. It is perhaps pertinent at this point to look at what some consider to be one of the most successful pension schemes in recent times, the Chilean model. The basic plank of this model was a move from an insolvent pay-as-you-go regime to a system of privately managed pension funds. Members of the scheme are free to choose among some 26 competing fund managers who are obliged to provide fund management services, maintenance of individual records and some element of insurance. Funds operate under tight regulatory supervision and there is a comprehensive disclosure obligation.

During the early years (i.e. the early 80s), funds were allowed to invest only in gilts, bank deposits and investment grade bonds. In 1996, according to an estimate, about 28 per cent of assets were invested in equities. The returns on funds have been quite spectacular, close to 10 per cent in real terms for the last fifteen years. Thedevelopment of these funds has helped create a vibrant, liquid and a modern capital market and has encouraged privatisation and the much-needed development of infrastructure.

With that background, let us look at the challenges before us as we set out to reform the current system in India where real returns in the last decade have been a meagre 2.5 per cent.

First, we need to move to a a system where pension funds are managed by professional fund managers in a competitive and regulated atmosphere. Financial markets are getting more complex and require an active management by persons trained in dealing with volatility and in spotting market trends and anomalies. Second, we need to look at the current investment pattern with a view to modifying it to ensure it does what it means to do. Clearly, the 12 per cent rule that has been in force from the early 90s creates no incentives in an environment of higher returns and greater risk taking in an environment of lower returns. This must be replaced with a marketoriented return. And that brings me to the third big challenge, which is the necessary move to include equities as an asset class in pension funds. For various reasons, there has grown to be an aversion to equity amongst the general investing public in this country.

Equity is linked to volatility and hence risks. But this overlooks the fact that equities compensate you for the volatility in the short run with greater return in the long run. Consider that equities have returned more than any other asset class in the last 10, 15 and 20 year periods and have returned an average real return of 9 per cent over the last two decades.

Equity markets do create wealth over the long term more that almost any other asset class and therefore must form a part of the assets that a person saving for 25-30 years can invest in. The introduction of long term players in the equity market will lead to secular growth in our capital markets with concomitant benefits to the economy.

The fourth challenge before us in the areaof pension fund management is in the realisation of the concept of risk and the natural trade-off between risk and return. In the current regime, risk is determined by asset allocation and the need to generate the stipulated return. But what of price risk or credit risk or reinvestment risk? Portfolios are neither marked to market nor there is any provision for doubtful debts. Measuring and controlling risks is an essential part of fund management and must be reflected through directives from trustees and in the books of accounts.

The last challenge that I would like to list relates to regulation. In a recent study in the US, it was found that good governance practices turned out to have the strongest positive statistical association with organisation performance. We do need to put in place regulations to license and oversee the functioning of all organisations involved in the functioning of the system. The regulatory reforms need to reflect the importance of trusteeship and fiduciary responsibilities.Accredited AMCs must have stipulated capital adequacy norms and guidelines on marketing, accounting, administration, disclosure and service levels. AMCs should be allowed to manage funds entrusted to them by Trustees of any exempt category establishment and offer pension funds directly to the public. Tax regulations should also be modified so as to encourage investment and discourage premature withdrawals.

The truth is that when people are confronted by realities as opposed to abstract theories, they display a remarkable resourcefulness and ability to adapt. The reality today is enough of a catalyst to get us moving - The number of people over 60 is expected to double over the next 25 years and this is being accompanied by increasing longevity. The present formal provisions for old age security cover less than 11 per cent of the working population. The traditional informal methods for income security such as the joint family are unable to cope. And the contribution rates of India's workers are alreadyamongst the highest in the world though they are offset by low rates of return.

We therefore need to find institutional mechanisms where individuals save through their working life and earn highest possible returns for a given level of risk. We need to allow professional fund managers to operate in a competitive and well regulated market for pensions, allowing them access to manage both existing funds as well as new personal pension products. We need to change investment guidelines and move to a more optimal allocation of resources where equity will find a place. We need to encourage individual choices and options. We need to take pension funds to the masses to meet thechallenge.

The author is managing director, Prudential-ICICI AMC