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Comparative Study of Accounting Standards for Reporting of Pension Plans

2010-07-01T11:11:00.002+05:30

By Gurtej Singh Sadiora

The main objective of pension plan reporting in financial statements is to make sure a true picture of pension scheme is provided in the plan sponsor’s financial statements. The accounting standard boards issue accounting standards to guide and regulate reporting of pension plans. Accounting standard statements have their own objectives but the main idea is to make financial statements more transparent, consistent, easily understandable to user of accounts and represent them in a more faithful manner.

A comparative study of accounting standards issued by Financial Accounting Standards Board (FASB) in USA, UK Accounting Standard Board (ASB), International Accounting Standards and by The Council of the Institute of Chartered Accountants of India is presented in this paper.

The Companies, filing accounts in USA, use accounting standards issued by Financial Accounting Standard Board (FASB). In December 1985, FASB issued SFAS No. 87 to regulate pension plan reporting in financial statements of employers, this is later amended by SFAS No. 132 in February 1998. SFAS 132 also amend SFAS No. 88 and SFAS No. 106. In September 2006 SFAS No.158 was introduced as “Employer’s Accounting for Defined Benefit Pension and other Post Retirement Plans” – an amendment to FAS 87, 88, 106 and 132(R). SFAS No. 158 is now requirement of companies to report pension plan in their financial statements.

In November 2000, the UK Accounting Standard Board (ASB) introduced FRS 17 to regulate retirement benefit plan’s reporting in financial statements of employers. It became mandatory for accounting period beginning on or after January 2005 and replaced Statement of Standard Accounting Practice (SSAP24). In December 2006, ASB issued an amendment to FRS 17 and in January 2007 (ASB) issued a reporting statement entitled “Retirement Benefits – Disclosures” and sets out additional disclosures that complement the disclosure requirement of FRS 17. This reporting Statement is a best practice guide and is not mandatory. We will discuss below the main objective of this reporting statement and the principles set out.

The companies governed by law of and EU member state, trading on a regulated market in any EU member state are required to prepare their consolidated accounts in compliance with international accounting standard for accounting period starting on or after 1 January 2005. For listed companies in UK, IAS 19 is a requirement but for unlisted companies the IAS19 is optional.

The benefit cost requirements in IAS19 and FRS17 are consistent in most respect; the only major difference is the recognition of actuarial gain and losses. We will discuses this later.

The Council of the Institute of Chartered Accountants of India issued Accounting Standard (AS) 15 in 1995 and revised it in 2005 to guide companies filing their accounts in India.

For a comparative study of the main three accounting standards please refer to the following summary of these accounting standards.

SFAS 158	FRS 17(amended in 2006)	AS 15(Revised 2005)
Other related Accounting Standards
· FAS 87 (Employer’s Accounting for Pensions) · FAS 88 (Employer’s Accounting for Settlements and Curtailment of Defined Benefit plan and for Termination Benefits) · FAS 132(Employer’s Disclosures about Pensions and Other Post Retirement Benefits.- an amendment to SFAS No. 87, 88, 106)	· FRS 17 issued in November 2000 · Statement of Standard Account Practice 24(SSAP24)	· Originally issued in 1995 Titled “Accounting for Retirement Benefits in the Financial statements of Employers”
Objectives
· Full Recognition of funded status of a defined benefit post-retirement plan as an asset or liability in its statement of financial position · Recognition of changes in funded status in comprehensive income	· Company pension assets and liabilities are measured at “fair value” · Operating and financing costs are recognized in the appropriate period · Proper disclosures are provided	· To prescribe the accounting and disclosures for employee benefits. · Recognize a liability when an employee has provided service in exchange for employee benefits to be paid in the future and recognize an expense when enterprise consume the economic benefit arising from service provided by an employee in exchange of employee benefits
Effective Dates
For employers with publicly traded equities, fiscal year ending after December 15, 2006. For employers without publicly traded equities, fiscal year ending after June 15, 2007.	Accounting period beginning on or after 1 January 2005	Accounting period commencing on or after December 2006
Measurement Date of Plan Assets and Benefit Obligation
Fiscal year end	Balance sheet date	Balance sheet date
Valuation Method
Projected Unit Credit Method for benefit obligations. Assets should be measured at their fair value as of the measurement date.	Projected unit method for benefit obligations. Assets should be measured at their fair value as of the balance sheet date	Projected unit method for benefit obligations. Assets should be measured at their fair value as of the balance sheet date
Principal Actuarial Assumptions
· Discount Rate: It should be determined by reference to return on a high quality fixed income investments of equivalent term and currency to the liability. · Expected return on Plan assets It shall be determined based on the expected long-term rate of return on market-related value of plan assets · Salary scale · Mortality · Rate of employee turnover · Other assumptions as per particular plan’s requirement.	· Discount Rate should be determined by reference to return on a high quality corporate bond of equivalent term and currency to the liability. A high quality corporate bond means a bond that has been rated at the level of AA or equivalent status. · Expected return on Plan assets · Salary scale · Mortality · Rate of employee turnover · Other assumptions as per particular plan’s requirement	· Discount Rate should be determined by reference to market yields at balance sheet date on government bonds of term equivalent to the term on liabilities. · Expected return on Plan assets. · Salary scale · Mortality · Rate of employee turnover · Other assumptions as per particular plan’s requirement
Amounts to be recognized in Balance Sheet
Funded Status measured as difference between fair value of assets and the benefit obligations should be recognized in Balance sheet as an Asset or Liability in appropriate section Recognize components of Accumulated Other Comprehensive Income (AOCI) in Capital section of balance sheet. The accumulated other comprehensive income includes the gain or losses, prior service cost or credit and transition assets or obligation that arise but are not recognized as components of net periodic benefit cost	The surplus/deficit in a defined benefit scheme is the excess/shortfall of the value of the assets in the scheme over/below the present value of the scheme liabilities. Actuarial gain and losses are recognized “below the line” in the Statement of recognized gain and loss (STRGL) The STRGL is an account used to reconcile balance sheet changes which do not form part of a company’s normal trading.	The amount recognized in balance sheet should be net total of (a) PBO at balance sheet date. (b) Less any past service cost not yet recognized (c) Less fair value of plan assets at balance sheet date If the amount determined as above is negative that can be considered as an asset but capped by present value of any economic benefit available in form of refund from the plan or reduction in future contributions.
Amounts to be recognized in Income Statement
The following components shall be included in Net Periodic Pension Cost (a) Service cost. (b) Interest Cost. (c) Actual return on plan assets. (d) Amortization of any prior service cost. (e) Amortization of gain or loss. (f) Amortization of any net transition asset/obligation.	The amount recognized in profit and loss account under FRS17 include items (a) The Service cost. (b) Interest cost. (c) Expected return on assets (d) Past service cost (if any). (e) Settlement and curtailment (if any).	The amount recognized in Profit & Loss should be net total of (a) Service Cost. (b) Interest cost. (c) Less Expected return on assets. (d) Actuarial gains and losses (fully recognized with no option of amortization) (e) Past service cost. (f) The effect of any curtailment and settlement.
Summary of Disclosure Requirements
· Reconciliation of Benefit Obligation. · Reconciliation of fair value of plan assets. · Funded Status. · The amount of Net Periodic Pension Cost (NPPC). · Asset allocation. · The amount included in Other Comprehensive Income. · Principal Actuarial Assumptions · Employer’s Best estimate of contribution expected for next fiscal year · If applicable, cost of providing special or contractual termination benefits recognized during the period and description. · Accumulated Benefit Obligation · Expected Benefit Payments · If any alternative method of amortization used. · The expected Net Periodic Benefit Cost for next fiscal year, showing separately the amount in accumulated other comprehensive income that is expected to be recognized as net gain loss, net prior service cost or credit and net transition assets or obligation in next fiscal year	· Reconciliation of Benefit Obligation. · Reconciliation of fair value of plan assets. · The total expense recognized in P&L. · Asset allocation. · Amounts recognized in Statement of Total Recognized Gains and Losses (STRGL) · Principal Actuarial Assumptions · Employer’s best estimate of contribution expected for next fiscal year · Narrative description of the basis used to determine expected rate of return on assets. · Current and previous four year’s history of o scheme liabilities , fair value of assets and surplus/deficit in scheme o Experience adjustments arising on scheme liability and assets in terms of either amount or percentage of scheme liability and assets respectively at balance sheet date · General Description of the type of scheme	· Reconciliation of Benefit Obligation. · Reconciliation of fair value of plan assets. · A reconciliation of PBO and assets to the assets and liability recognized in the balance sheet. · The total expense recognized in P&L. · Asset allocation. · Analysis of PBO in amounts arising from plans that are wholly unfunded and that are fully or partly funded. · Principal Actuarial Assumptions. · Employer’s best estimate of contribution expected for next fiscal year. · Narrative description of the basis used to determine expected rate of return on assets. · Current and previous four year’s history of o scheme liabilities , fair value of assets and surplus/deficit in scheme o Experience adjustments arising on scheme liability and assets in terms of either amount or percentage of scheme liability and assets respectively at balance sheet date · General Description of the type of scheme · The enterprise’s accounting policy for recognition of actuarial gain and losses. · Amount included of plan assets in enterprise’s own financial instruments.
Recognition of Actuarial Gain/Loss
Recognition of Actuarial gain or loss is based on 10% corridor approach. If cumulative unrecognized gain or loss exceeds 10% of the greater of PBO or market value of assets at the beginning of the year, amortization is required. The amount to be amortized is the excess divided by average remaining service period of active employees expected to receive benefits under the Plan. The unrecognized part of actuarial gain loss is set up in Accumulated Other Comprehensive Income and will be recognized in later years.	Actuarial Gain and losses are immediately recognized in Statement of Total Recognized Gain and Losses (STRGL). Gains and losses on settlement and curtailment are immediately recognized in profit and loss account.	AS 15 requires actuarial gain or losses should be recognized immediately in the statement of profit and loss as an income or expense.

IAS 19 Vs FRS 17

The pension cost requirement in FRS17 is consistent with IAS 19, the only major difference is recognition of actuarial gain or losses.

The FRS requires actuarial gain and losses to be recognized immediately in the statement of total recognized gains and losses.

IAS 19(revised) requires an entity to either

Recognize the specified portion of net cumulative actuarial gain or losses in the profit and loss account to the extent they exceed the greater of 10% of the fair value of plan assets and 10% of defined benefit obligation. The amount to be recognized is the excess that falls outside the 10% corridor spread forward over the remaining working lives of employee participating in the scheme; or
Recognize immediately all actuarial gain or losses in the period in which they occur outside the profit and loss account in a Statement of Recognized Income and Expense; or
Use any systematic method of faster recognition provided the same basis is applied to both gains and losses as the basis is applied consistently from period to period.

As we have discussed earlier ASB has issued a reporting statement on retirement benefit disclosures; the main objective of this reporting statement is to set out notes on best practice when providing disclosures for pension schemes. This statement sets out six principles to be considered when providing disclosure as following:

The relationship between the company and trustee.
The principal assumptions used to measure the scheme liability.
The sensitivity of the principal assumptions used to measure the scheme liabilities.
How the liabilities arising from the defined benefit plan are measured.
The future funding obligation in relation to the defined benefit scheme.
The nature and extent of the risk arising from financial instruments held by the defined benefit scheme.

These principles are aimed to assist the user of financial statement in understanding the risk and rewards and funding obligations arising from defined benefit scheme.

Finally we can conclude the followings:

All three standards are similar in:

Actuarial valuation method.
Composition of pension cost.
Amount to be recognized in balance sheet.

AS15 (revised 2005) and FRS17 are similar on disclosure requirements.
If an asset is to be recognized in the balance sheet, then this is limited to economically usable surplus in both AS15 and FRS17.
The 10% corridor approach is a common method for recognition of gain/loss in IAS19 and FAS 158

References

SFAS 87,132,106 and158 issued by FASB.
FRS 17 and Reporting Statement – Retirement benefit Disclosures, issued by ASB UK.
AS15 (revised 2005) issued by council of ICAI.
“Defined Benefit Answer Book”, Fourth Edition by G.Neff McGhie III.
ActEd Study Material: 2009, Subject SA-4.

About the Author
Mr. Gurtej Singh Sadiora is an Actuarial Analyst working with Ranadey Professional Services. He is a Graduate from Punjab University and Student Member of Institute of Actuaries, UK and Institute of Actuaries of India.

Disclaimer: Information contained in and presented through this material is intended to provide a general understanding of the topics included, based on the author's understanding of applicable accounting standards. It should not be used for any other purpose.

Understanding Training of Insurance Professional

2006-09-10T18:36:00.006+05:30

Prof G S Diwan memorial lecture-2006 entitled Understanding Training of Insurance Professional was delivered by Dr K C Mishra on September 10th 2006 at SNDT University, Juhu Campus.

You can download the PowerPoint presentation used in this lecture by clicking on Understanding Training of Insurance Professional.

Invest in Health - Action Plan for the City of Mumbai 2007

2007-04-07T20:38:00.011+05:30

by Dr RD Lele

Introduction

The slogan for the World Health Day, 7th April 2007, is "Invest in Health: Build for the Future".

The WHO has defined health as a state of complete physical, mental and social well-being and not merely the absence of disease or infirmity. India has a long tradition of Health Care. Ayurwveda (literally meaning. Science of Life) clearly stated 2500 years back that the aim of medicine is three-fold: Promotion of positive Health; Prevention of disease; and Treatment of disease when it arises. One new component as part of treatment is rehabilitation.

While talking of "Health Care" most people ignore the promotive and preventive components and concentrate only on the curative components. "Health Care" has therefore become "illness Care". The so-called Health Care Industry also is concerned with illness care, pushing the importance of promotive and preventive function to a poorly neglected secondary position.

Health maintenance and disease prevention need a partnership between the family and the family doctor who is a teacher and guide. Health is not a commodity that can be purchased. It is an asset to be assiduously maintained with care and effort, by following rules of conduct regarding diet, exercise and behavior, for which the doctor acts as a teacher and friend, philospher and guide. The word doctor is derived from docere (to teach). The current terms such as "consumer" AND "provider" of health care are repugnant to the concept of doctor patient partnership based on trust (fiducial relationship).

Urgent Need for paradigm shift in India

Since 2004 I have been emphasizing the urgent need for a paradigm shift in our approach to health care.

The introduction of pre-paid group praclice under an HMO (Health Maintenance Organization) necessitates a paradigm shift from the current fee-for-service pattern of medical practice in India. In the new paradigm health insurance is an integral component of an HMO and managed care. The paradigm shift encompasses:

Change of emphasis from disease management to health management.
Shift of focus from curative to promotive and preventive aspects of hcalthcare and create the infrastructure especially for health education of the general population. The periodic health checks and health education undertaken by the family physician (FP) are given in Table 1.
Change in the mind-set of the medical profession: self-discipline and social conscience to support the concept of HMO and '''managed care", especially for the poor segments of population in urban slums and rural areas.
Spread awareness among the general public including organized corporate sector as well as individuals, regarding the need to become members of HMOs to get managed care as well as insurance cover for catastrophic illness, and life insurance for the earning members in the family.
Micro-financing linked to microinsurancc is actively being pursued as a strategy to enable the 70 lakh poor citizen of Murnb8.i to participate in the HMO.

HMO - Pre Paid Managed Care

Health Maintenance Organization (HMO) providing prepaid managed care linked to health insurance is the new paradigm for health care in the 21 st Century. The medical community assumes leadership and accepts responsibility & accountability in the HMO concept.

The distinguishing features of HMO-managed care are:

Financing and delivery of health care through per capita pre-payment, so that the physician organization has a budget for the carc it will provide and an incentive to use the resources wisely.
Maintenance of continuous healing relationship of the family physician (FP) with the voluntarily enrolled population (l FP for 500 - 1000 families), to provide promotive. preventive and curative care to 3000 to 6000 individuals for which the FP will be handsomely remunerated - 1 lakh pm.
Physicians and multi-disciplinary specialist teams can design and execute best care processes, in a most cost-effective manner.
Hospital facilities, complex diagnostic equipment and laboratory investigations can be deployed on a regional basis where it can be used with greatest efficiency and economy, backed by insurance cover.
Electronic patient record (EPR) which provides an accurate and comprehensive picture of each patient. EPR avoids unnecessary duplication of tests, facilitales collaboration and coordination of care among specialties, and allows monitoring of compliance with the practice guidelines to ensure high quality of care.
Computerized prescription in the patient's own language gives detailed instructions about how to take the drugs and alerts for adverse reactions. It eliminates medication errors and transforms the care process.
Over-use and misuse of tests and procedures, so common currently, is strongly discouraged while early detection and prevention and early treatment and chronic disease management are strongly encouraged. There is great emphasis on patient education and information. Patients are encouraged to come in early and have their symptoms checked so that any potential illness can be treated sooner and at much less cost. Emphasis on prevention reduces the need for inpatient hospital care especially for Diabetes, Hypertension, Congestive Heart Failure & Asthma.
The medical peer group, not an insurance company, determines the clinical policies, which technologies and procedures will be employed and covered under the pre-payment and health insurance.
The medical peer group develop the drug formulary themselves. The drug selection is based on its therapeutic efficacy, safety and cost. Physicians have the freedom to over-ride the formulary to prescribe what they believe is medically necessary in a particular case. This approach is most effective in cost control. In the current fee-for service scenario of medical practice, new single source patent protected drugs are aggressively promoted by drug manufacturers with little head-to-head comparison with older, effective and often less expensive drugs. HMOs use evidence-based approach to promote drugs of choice.
HMO-managed care will not only ensure the elimination of the widely prevalent gender discrimination against females, it will actually put major emphasis on the care of the mother and the female child & adolescent girl eg nutrition, menstrual hygiene, sanitary napkins, prevention of iron deficiency. sex education & prevention of STD / HIV, emergency contraception & family life education, women's reproductive health & promotion of breast-feeding. Care of the pregnant women will ensure that no baby is born with a birth weight less than 2.5 kg.

Action Plan for Mumbai

According to income groups, I visualized four categories of membership:

Card Annual income Premium
Bronze Card 40,000 – 60,000 2,500
Silver card over 100,000 5,000
Gold card over 200.000 7,500
Platinum over 500,000 10,000

The HMO will tie up with:

Insurance Company for 5 yrs. for an annual premium of Rs. 11,001- per family (Bronze) and proportionately higher amount for the other categories.
Family Physicians and Specialists.
Labs and Diagnostic Centres.
Drug and Pharmaceutical Cos., for discounted rates (bulk purchases).
Life Insurance Co. for providing the (group) cover to the earning member.
Service Provider for 24 hrs. assistance and other eg. Blood etc.
Hospitals & nursing homes.

I am happy to note that the new president of IMA Mumbai, along with his team and many past presidents, had publicly committed full participation in implementing the Action Plan immediately. IMA Mumbai can give the lead for the rest of the country in this mission, "Invest in Health: Build for the Future".

References

Lele RD Editorial. Health Insurance as an integral Component of Health Maintenance Organization (HMO); Urgent Need for Paradigm Shift. JAPI 2004 Dec. 52. 947-950.
Dr R. D. Lele. Towards a 21st Century Health Care System : Leadership Role for API. Guest Lecture Delivered at the Diamond Jubilee API Conference 2005.

Why was IndianActuary.com started?

2009-03-17T11:15:00.007+05:30

Welcome to IndianActuary.com, India's first blog dedicated to the insurance industry and actuarial education.

In 2008 Prof. G. S. Diwan (born 1901) was inducted in the insurance hall of fame by International Insurance Society Inc, USA for his selfless service in the field of actuarial education in India. Prof. Diwan was an Actuary and taught Actuarial Science in Sydnham Colledge in Mumbai. He passed away in 1987. International Insurance Society has produced a brief video on the life of Prof. Diwan. This video can be viewed on the society's Hall of Fame website.

On this occasion, a gala dinner and an award presentation ceremony was held in Taipei, Taiwan. Prof. Diwan's son, Mr. Mukund Diwan, who is an Actuary himself and a retired Chairman of Life Insurance Corporation of India, has also made significant contributions in the betterment of actuarial education in India. He attended the award presentation ceremony. In a speech at the function, he assured the society and the audience that India will be a center of excellence for actuarial education.

This website has been launched in honor of Prof. G. S. Diwan and other great personalities who have made or are making significant contribution in the field of insurance in India. It has been conceived as an educational tool for people to improve their knowledge and awareness about:

the insurance industry,
insurance related government regulation,
various forms of insurance products,
underlying actuarial science,
insurance companies and market practices followed by them, etc.

This website is designed as a blog to facilitate an on-going and open dialogue between various participants in the insurance industry including consumers that buy insurance products.

This website has been launched with a foresight that it will become a preferred forum:

to regularly debate insurance industry issues & their resolutions,
for consumers to browse readily available information on insurance products,
for posting questions on any insurance related matter,
for students of actuarial science to interact with each other and with experienced actuaries,
for insurance industry new comers to exchange ideas with veterans, etc.

We at IndianActuary.com hope this blog will make a positive contribution in bettering actuarial education in India while, at the same time, sharing insurance industry information with common people.

This website is not intended to compete with either existing insurance related portals or with official websites of insurance companies, insurance industry bodies and associations.

We urge you to read various posts on this blog and share them with your colleagues, friends and family. If you wish to comment on any posts or wish to contribute your own article, please register. If you need help, please send us an e-mail to help [at] IndianActuary dot com. We will respond to you as early as possible.

Thank you for reading. Please visit again. We hope to see you in the near future.

New Risk Measures For Post Global Financial Crisis 2008 Era

2009-03-31T12:08:00.008+05:30

by Prof. Rajendra Shah

The Real Reasons for the Global Financial Crisis 2008

A common explanation that has been put forth about the real cause of the ongoing Global Financial Crisis that started in 2008 is the subprime mortgage lending. When significant number of those borrowers failed to meet their commitments, the lenders tried a recovery through selling of these mortgaged properties leading to a slump in the property market and subsequently assuring future recoveries to log losses and so on. The problem would have had a limited impact but for bold and beautiful tool of securitization (1). Use of securitization had multiplied the money available to lend many-fold and that was the reason why liberal subprime lending had become possible. The extensive use of securitization allowed the lenders to make hay because of untested optimism and lack of appropriate disclosure requirements.

Some believe that unprecedented upward move of several months in oil price up to US $147.50 per barrel led to use of substitutes like ethanol as fuel and that fueled rise in food prices and inflation causing subprime borrowers to fail in their commitments. Whether introduction of uncontrolled securitization provisions and a calculated strategy to allow oil prices to soar had terror-studded political motives or not, three root causes of all that we witnessed are greed, Greed and GREED.

Credit Related Models

The failure of mortgage borrowers makes us examine various models around Credit for their robustness and accuracy.

Credit Scoring Models: Credit score is a measure that can objectively assess credit risk of consumers. The objective of a credit scoring model is to maximize profits from lending operations. Credit scoring models can be built based on the experience data provided by banks about their past consumers. Credit bureau data can be helpful in testing and improving the accuracy of the credit scoring model. Credit scoring primarily determines the likelihood of default by a consumer based on the parameter values supplied by consumers in their credit application. It thus helps a bank to make its credit granting decisions based on objective and consistent methods thereby limiting default incidents.

Bayesian method can be used to improve credit scoring models (2).

Credit Migration Models: The companies that have active bonds are evaluated continuously to determine their credit worthiness. If a company’s financial position strengthens, its credit rating goes up and if it weakens, its credit rating goes down. While the credit ratings indicate a company’s financial strength, they do not talk about the chances of shifting or migrating into another rating. Credit migration modeling helps in this regard. The utility of credit migration models(3) is evident from the fact that Basel-II agreement requires banks to use credit migration models that are subjected to less uncertainty to reduce unnecessary risk. Modern credit derivative pricing models rely on the probabilities estimated by credit migration models to generate fair pricing. Therefore, developing credit migration models that are as accurate as possible is an essential task of risk management in front of us.

Credit Exposure Models: If a borrower defaults, the risk to a lender is the borrower’s credit exposure. In case of sub-prime borrowers, profile of exposure keeps changing and the banks lending short-term loans should well understand their credit profiles in order to deploy capital efficiently and with optimum safety. This requires banks to identify the probabilities of first-payment defaults and in the event of a default, the severity of obligation of the customer. The banks would also like to minimize their obligation which can be done using a credit exposure model (4).

The subprime borrower market is a uniquely homogeneous segment of the total borrower market. The loan decision factors such as the risk of default, the absence of collateral, the purposes of loan, the charge-off rates and the current market conditions are highly correlated. This is not conducive for building a scoring model. Statistical methods have their limitations due to high correlation between factors. In such a situation, the credit exposure models in addition to the first-payment default model are useful to deal with subprime borrowers.

Credit Portfolio Models: Following heavy losses in late eighties and early nineties, the banks started to develop more sophisticated credit risk management techniques that stressed on the credit risk of individual exposures and the intensities to which these risks were diversified. Credit portfolio models were developed to differentiate credit-risk along multiple dimensions and for large corporate exposures on an individual basis. The credit portfolio models (5) have empowered banks to take advantage of the increasing liquidity of the credit markets and to adopt a far more active approach to credit portfolio management than was previously possible. Active credit portfolio optimization has enormous potential to enhance profitability. There are a number of credit portfolio models that are characterized by their correlation structures and choice of risk measures. The risk measures used by the models are loss- based and/or NPV- based. The advantages maybe in terms of simplicity, data availability, speed of calculation, versatility, etc. The disadvantages are also in terms of limitations imposed by the same features. Credit portfolio models are useful in:

Solvency analysis
Credit risk concentrations and portfolio optimization
Sensitivity analysis and stress testing

What Precautionary Indicators Could Have Helped in Avoiding the Crisis

It appears that the sub-prime crisis could have been avoided had the lending institutions acted more cautiously in choosing their customers by paying adequate attention to their credit exposures. The indicators of rising average exposure within the limit on a credit card, increasing frequency of delayed payment instances, increasing average delay times could have given early indications of the problems in the offing.

Limitations of Standard Risk Measures

Most standard models are based on normal distribution. Building such models was an initial step towards more realistic models. In real life situations, we often come across investment returns where the distributions are leptokurtic and/or have heavy tails. The normal models are misfit in such cases. Therefore models such as CAPM, APT which are developed under the assumption of normal distribution lead to misleading results. The bank’s cumulative distribution of sold (not marketed) loans is asymmetric, leptokurtic and contains extreme values. Normal models cannot be applied to them. In mean-variance model, the risk of a portfolio was defined in terms of variance of return which required variances and covariances between the returns of all securities. The concept of introduction of the β based portfolio method was motivated by insufficient data to compute the variance covariance matrix. Now Boot-strapping techniques allow resolving this issue. As a result, βs are almost abandoned in portfolio management techniques.

To measure risk under very generic conditions the concept of VaR was introduced. Basically VaRα is α-percentile of the loss distribution. VaR (6) is not a suitable risk measure for the following reasons:

It does not measure losses exceeding VaR
It may provide inconsistent results at different confidence levels
Non-convexity makes it impossible for the use of VaR in optimization problems
A reduction of VaR may result in extending the tail beyond VaR
Non-sub-additivity of the measure means that portfolio diversification may lead to an increase in the risk and does not allow to add up the VaR of different risk sources
Many local extremes of VaR leads to unstable VaR ranking
VaR can destabilize an economy and induce crashes that would not otherwise occur

Some desirable properties of a good risk measure are:

Positive homogeneity: f(λx) = λ.f(x) for λ > 0 and all random variables x
Sub-additivity: f(x+y) ≤ f(x) + f(y) for all random variables x and y

For risk measure f( ) satisfying the above properties, convexity is implied. Additionally, if the following properties hold, then f( ) is called coherent risk measure.

Monotonicity : x ≤ y implies f(x) ≤ f(y) for all random variables x and y
Transitional invariance f(x+λr0) = f(x) – λ for all random variables x and real numbers λ and all risk free rates r0.

Need to Design New Risk Measures

The measures like Variance and VaR in case of non-elliptical joint distributions have two major drawbacks, viz.

They are not coherent and lead to non-convex risk measures and consequently to absurd results.
They fail to measure non-linear correlation between the random variables.

To overcome the first drawback, the following coherent risk measures are developed

Expected Regret (ER)
Conditional Value at Risk (CVaR)
Expected Shortfall (ES)

Expected Regret is defined as the expected value of the loss distribution beyond a threshold α.

CVaR is the expected value of the loss exceeding VaR.

In case of continuous random variables, the definition of expected shortfall coincides with that of CVaR.

To overcome the second drawback listed above, measures of dependence based on copulas were developed. Dependent extreme events have been the major sources of losses for banks. Therefore copulas-based measures need to be emphasized and strengthened. Parametric models based on copulas such as Marshall-Olkin method and maximum likelihood method are useful but complex. Non parametric dependence measures based on copulas still require some efforts to provide user-friendly algorithms.

Newer Risk Measures and their Increasing Significance

A variation of the VaR methodology known as economic capital (7) is used to determine the expected funding and borrowing levels for credit and default funding and provisioning levels for credit and default expectations. Economic capital in its simplest form, may be defined as sufficient surplus to cover potential losses at a given risk tolerance level over a specified time horizon. Economic capital is useful in

Determining company/product risk profile
Capital budgeting
Evaluating required capital in merger/acquisition situations
Insurance product pricing
Assessing risk tolerance and constraints
Asset Liability Management
Calculating risk adjusted return on capital
Performance measurement
Incentive compensation
Regulatory and rating agency discussions

“Playing a key role in both the second pillar of the new Basel framework and the Solvency II project, economic capital models are becoming increasingly important.” – Iman Van Lelyveld (8).

The concept of economic capital is expected to gather momentum and according to James Lam (9), economic capital may replace VaR in risk management in the time to come.

Another new measure: “ShockVaR” developed by Riskdata (10), may provide a better understanding of risk across markets, asset categories and hedge funds. Riskdata developed "ShockVaR" in around 2007 to overcome the possibility of overestimating risk during calm periods and underestimating it in highly volatile markets. ShockVaR is designed to be highly sensitive to market changes than typical VaR measures, which focus on the maximum estimated amount of loss at a given time horizon for a specific confidence level. ShockVaR is expected to increase sharply within days of a shock or anticipated shock and drop down to its initial value if the market volatility is back to previous levels. Riskdata’s ShockVaR calculations, for example, accurately pointed to the increased possibility of a dramatic drop in the Japanese equity markets in the week of October 2008 anticipating the big drop experienced on October 24.

The goal of ShockVaR is to help investors better analyze their portfolios in the current market crisis.

Some New Measure Suggestions

Credit Scoring models need to consider the following aspects to differentiate between customers:

More open accounts that are reported as “Paid as agreed”
More types of credit accounts
More open accounts than closed accounts
Low balance compared to credit limits
More active accounts but with lower balances
Fewer credit scoring assessment requests

However, care needs to be taken to ensure that customers’ credit rating does not go down if the credit card provider (increasingly possible under the current status of the global economy)

slashes credit limit based on new norms
closes unused or unprofitable accounts

The credit scoring models need to overcome vicious cycle effect, cascading effect of the use of credit scores and inaccuracy problems. Use of option pricing model and neural networks for credit scoring can be useful.

An improvisation of Economic capital using Bayesian approach may give a long handle. I see rigorous researches and authentication through sensitivity analysis and scenario testing for various kinds of coherent risk measures and tools to be the order of 2009 and thereafter.

REFERENCES

The Global Credit Crisis and Securitization in East Asia by Douglas W. Arner, Paul Lejot and LottSchou-Zibell, Publisher: Capital Markets Law Journal.2008; 3: 291-319
Bayesian Methods for Improving Credit Scoring Models by Gunter Lofler, Peter N. Posch and Christiane Schone
An Introduction to Credit Migration Modeling by Neil McBride
Potential Exposure – How To Get A Handle On Your Credit Risk – By Jim Rich and Curtis Tange
Active Credit Portfolio management by Andrew Kuritzes
Exploring the Limitations of Value at Risk: How Good Is It in Practice? By Andreas Krause Journal of Risk Finance, Winter 2003, pp 19-28
What Is “Economic Capital?” - A Quick Guide to the Differences between Economic Capital and Regulatory Capital, By Eric Banfield
Economic Capital Modelling : Concepts, Measurement and Implementation, Edited By Iman van Lelyveld
Enterprise Risk Management From Incentives to Controls, By James Lam, Published by John Wiley and Sons
Riskdata is now providing free access to daily shockVaR and long term VaR indicators for major equity indices.

Funding Regulations in U.S.A – The Pension Protection Act 2006

2009-09-12T06:56:00.011+05:30

By Teja Ranade-Gadhoke

Prompted by the recent default of large defined benefit pension plans in the U.S.A. and the looming breakdown of the Pension Benefit Guarantee Corporation (PBGC) – the guarantor of the US pension plans, in the early part of 2005, the Bush administration proposed pension funding reforms which would make the minimum funding requirements of pension plans more stringent and in turn strengthen the pension insurance system.

On July 28, 2006, these reforms were passed by a majority vote by the House of Representatives as the Pension Protection Act 2006 (hereafter referred to as PPA). It is the most comprehensive set of pension reforms since the Employee Retirement Income Security Act (ERISA) enacted in 1974. These regulations apply to the funding of single-employer and multiple-employer benefit plans and come into effect starting with the first plan year beginning after 01/01/2008. This paper is intended to give a brief description of the key provisions of the Pension Protection Act 2006 and its contrast with the old funding regulations under ERISA.

HIGHLIGHTS OF FUNDING REGULATIONS AS PER PENSION PROTECTION ACT OF 2006

Prescribed funding methods and prescribed actuarial assumptions: PPA has prescribed the major actuarial assumptions as follows:

Interest Rate: The interest rate used for discounting liabilities is based on a yield curve of investment grade corporate bonds that will be averaged over the most recent 24 months. This is used to generate segment interest rates over the following time frames:

Short Term Segment Rates: used to discount liabilities payable in the timeframe of 0-5 years from valuation date
Medium Term Segment Rates: used to discount liabilities payable in the timeframe of 5-15 years from valuation date
Long Term Segment Rates: used to discount liabilities payable in the timeframe of more than 15 years from valuation date

Mortality: Specific mortality tables prescribed by the Secretary of Treasury are mandatory; large plans can apply for an exception to use their own mortality table. These prescribed mortality tables are updated with the latest mortality improvements.
Funding Method: Unit Credit funding method

Contribution Range : The prescribed funding method and assumptions are used to value employee benefit liabilities and calculate a contribution range. The minimum amount of contribution required to be made is referred to as the Minimum Required Contribution (MRC). The maximum allowable contribution is referred to as the Maximum Deductible Contribution. The plan sponsor can make an annual contribution to the fund of an amount that is anywhere within the above mentioned range. If the sponsor makes a contribution that is less than the Minimum Required, then the plan has a funding deficiency and must pay an excise tax on the deficient amount; and if the sponsor makes a contribution that is greater than the Maximum Deductible the sponsor will have to pay an excise tax on the excess contribution. The actuary assists the sponsor in deciding the appropriate amount of contribution to put into the plan subject to current funding levels, financial flexibility of sponsor, and future plans of the plan sponsor.
Credit Balances: A credit balance, to be put very simply, is created when a sponsor in a particular year makes a contribution that is more than the Minimum Required Contribution for the year. The excess contribution amount counts as a credit balance. Credit balances developed prior to 01/01/2008 are called Carryover Balances; credit balances developed after 1/1/2008 are called Pre-funding Balances. A plan can elect to adjust its existing credit balance against its Minimum Required Contribution (subject to certain conditions of funded status).
Funded Status: The plan’s funded status is calculated as per the following funding ratios:

Funding Target Attainment Percentage (FTAP)
Funding Target Attainment Percentage = (Assets – Carryover Balance – Pre- funding Balance)/ (Funding Target)
Adjusted Funding Target Attainment Percentage (AFTAP)
Adjusted Funding Target Attainment Percentage = (Assets – Carryover Balance – Pre-funding Balance + Value of Annuities purchased for Non-Highly Compensated employees in prior two years)/ (Funding Target + Value of Annuities purchased for Non-Highly Compensated employees in prior two years)

Funded Status certification and Plan Restrictions: The AFTAP of the plan has to be certified by the plan Actuary within the prescribed deadlines. If not certified in a timely manner, the plan is deemed to be certified at an AFTAP of less than 60% with consequential plan restrictions till the time the plan Actuary duly certifies the AFTAP.
Plan Restrictions: Based on the AFTAP ratio, the plan may be subject to certain benefit payment restrictions or plan amendment restrictions. The following are the AFTAP thresholds at which restrictions are triggered:

AFTAP >= 80%
No restrictions on the benefit plan
AFTAP >= 60%, AFTAP <80%

No plan amendments increasing plan benefits permitted unless additional contributions are made to bring the AFTAP upto 80% under the amended formula.
Limitation on prohibited benefit payments

AFTAP < 60%
- Cessation of benefit accruals
- No prohibited benefit payments permitted to be paid
- No shutdown benefits or unpredictable contingent events benefits permitted to be paid

Notice to Participants: Notices are required to be sent to all plan participants informing them of any restrictions imposed on the plan based on the plan’s AFTAP certification. This creates transparency in the plan reporting and keeps participants informed at all times of the “health” of their retirement benefits.
At-Risk Plans: Severely under-funded plans will be labeled as At Risk plans. An “At Risk” plan will need to fund its liabilities using more aggressive funding schedules and assumptions. Plans with fewer than 500 participants in the preceding plan year are exempt from the at-risk funding requirements.
Annual Filing: After the plan sponsor puts in the annual contribution, the actuary files a Form 5500 Schedule SB with the Internal Revenue Services. This Schedule SB filing details the plan assets, plan liabilities, annual contribution made for the plan year and development of credit balances. This form has to be certified and signed by the plan Actuary.
Insurance Coverage: All plans (with certain exceptions for groups of professionals or state/church plans) are required to be insured by the Pension Benefit Guarantee Corporation (PBGC). The plans pay annual premiums to the PBGC and hence avail of insurance coverage from the PBGC in the event that the plan files for bankruptcy or distress termination. The annual premium amount payable is calculated per year based on the number of participants in the plan that have accrued benefits and the amount of unfunded benefits. PBGC was created by the Employee Retirement Income Security Act of 1974 to encourage the maintenance of private-sector defined benefit pension plans, provide security to participant’s pension benefits and yet keep pension insurance premiums at a minimum. PBGC collects insurance premiums from employers that sponsor insured pension plans, earns money from investments and receives funds from pension plans it takes over.

TECHNICAL TERMS & CALCULATIONS

Funding Target is defined as the present value of accrued liabilities discounted using the prescribed segment interest rates and prescribed mortality decrements.
Minimum Required Contribution is the sum of:

Target Normal Cost: Present Value of all benefits that plan participants will accrue during the plan year. If there is a funding surplus, the target normal cost gets offset by this amount.
Shortfall Amortization Charge: This is the amortization of the excess of the Funding Target over the Assets; amortization period is seven years.

Maximum Deductible Contribution is the sum of:

Funding Target
Target Normal Cost
Cushion Amount

The market value of assets or smoothed value of assets can be used in the calculations. The asset values are permitted to be smoothed over three years and smoothed actuarial asset values are restricted to between 90% to 110% of market value of assets.

PENSION PROTECTION ACT OF 2006 – IMPROVEMENT OVER THE OLD FUNDING RULES

The funding reforms of the Pension Protection Act 2006 have served well to simplify the funding rules and accelerate funding obligations of defined benefit plans. Key improvements are as follows:

Prior to PPA, the interest rates used to discount future liabilities were averaged over 4 years and the asset values used to calculate the Minimum Required contributions could be “smoothed” over 5 years within a corridor of 80% - 120% of the market value of assets; hence neither assets nor liabilities were appropriately calculated.
Prior to PPA, the shortfall of the liabilities over the assets could be amortized over a period as long as thirty years as compared to only seven years under PPA.
Prior to PPA, plan sponsors and actuaries were permitted to use any standard funding method; hence this flexibility could be creatively misused to minimize the annual minimum required contribution; this led to plans not being adequately funded.
Too much flexibility in choice of assumptions pre-PPA made it difficult to compare funded status of various plans
Prior to PPA, sponsors were able to misuse their credit balances as they could go for several years without making any contributions simply because they had made excess contributions in past years.

Unquestionably, 2008 has been a tough year for US pension plans since this is the first year the PPA 2006 funding regulations have come into effect so several plans have seen a large dip in estimated funded status simply due to the change in prescribed funding methods and assumptions. Added to this has been the economic downturn and crash of asset values of several large plans that has invested in equities and real estate. Actuaries have been faced with the tough job of confirming to all of the new funding regulations and giving timely advice to the clients to prevent them from getting into benefit restrictions. The next five years or so will be the acid test to judge whether PPA has achieved its aim of stabilizing and strengthening the funded status of US defined benefit pension plans or not.

TECHNICAL GLOSSARY

Non-Highly Compensated Employees: An employee is classified as a non-highly compensated employee if he is not a Highly Compensated Employee (HCE). An HCE is an employee who is either a 5% owner or is in the top-paid group as determined by compensation.
Cushion Amount: Cushion Amount is the sum of 50% of Funding Target for the plan year and increase in funding target attributable to future compensation increases.

ABOUT THE AUTHOR

The author Ms. Teja Ranade-Gadhoke is a Fellow of the Society of Actuaries of USA. She has worked at a premier actuarial consulting firm in U.S.A before moving to India to set up her own consulting company Ranadey Professional Services Pvt. Ltd. based out of Pune. Ranadey Professional Services provides actuarial consulting services in the field of employee benefits to clients in USA and India.

Journey Towards Holistic Development-From Milton Friedman to Mahatma Gandhi

2009-09-12T22:50:00.007+05:30

By Dr. N. A. Mujumdar

INTRODUCTION

I deem it a great privilege to deliver the Seventh Professor G. S. Diwan Memorial Lecture. My grateful thanks to Shri M. G. Diwan for inviting me to give this lecture.

Professor Diwan was a pioneer in the field of actuarial profession, and appropriately known as the father of Indian actuarial profession. He was a caring and affectionate teacher cast in the mould of traditional guru - shishya parampara. There is one dimension of his personality which has impressed me most. This aspect of his personality was highlighted by Principal G. L. Abhyankar who spoke on the occasion of presentation of Gold Medal to Professor Diwan on 7th March 1980.

"…… Professor Diwan was a true Gandhian and was regarded as a Mahatma by everyone, colleagues, students, peons and all …… He had simplicity that was not arrogant and humility that was not weak-kneed". In other words, his erudition was embellished by simplicity and compassion. I am happy that the main theme of my lecture centres around the Gandhian approach to development.

The dimensions of development economics, it seems, keep on extending, over time. It may be recalled that in the early 1950s, when India's Planning Commission sought to build equity into the growth Plan, the mainstream development economists scoffed at the idea. Their dictum was : Enlarge the size of the national cake : distribution would take care of itself. Those were the hey-days of the percolation or trickle down theory growth - a theory which has been disproved by empirical experience. Equity is intrinsically important as a development goal in its own right. But sharing of economic and political opportunities is also instrumental for economic growth and development. In other words, equity reinforces the growth process itself. This relatively new-found concern for growth with equity shows that development economics has come a long way. Was this belated recognition responsible for breeding predatory capitalism in the meanwhile? We are not sure. What we are sure is that the collapse of the American capitalist model in 2008 now warrants that we move away from predatory capitalism to what can be called broadly as community - centered capitalism1. Shedding our self-centeredness, we must begin to sensitise ourselves not only to the woes of our less endowed brethren but also larger concerns, at the macro level, of depletion of natural resources, environmental degradation and inter-generational equity. This is what Mahatma Gandhi taught us nearly hundred years ago, by providing the philosophical basis for evolving a society with a value system which resonates to these larger concerns. In a broader context, the recent Commission on Growth and Development asserts that there is no generic formula for growth. "Each country has specific characteristics and historical experiences that must be reflected in its growth strategy"2. Is development economics moving away from a narrow mechanistic view of growth which has resulted in dubbing economics as "dismal science" to holistic development? Examining the more recent development experience of India I would seek to show that the reform phase beginning from 1991 when the liberalization of the economy was initiated, to 2004 was the most retrogressive phase, battered as the economy was by the market theology obsessed reforms. The second phase subsequent to 2004 marks a gradual return to what one might call holistic development. We begin to wonder whether our contemporary policy makers have slowly begun to rediscover the Mahatma. The Journey of the Indian economy from the Milton Friedman phase 1991 to 2004 to Mahatma Gandhi phase 2004-2009 needs to be authentically documented.

COLLAPSE OF THE AMERICAN MODEL.

We are meeting at a defining moment in the history of global economic system. The collapse of the capitalist model of the American economy in 2008 was as traumatic as the collapse of the communist model of Russia in 1991. Perhaps more traumatic because the U.S. "economic crisis of historic proportions", to use the words of President Barrack Obama, culminated in world recession. We have thus arrived at a moment in world economics when the disillusionment with the centrally planned economies is matched by the loss of faith in the capitalist system led by unbridled market forces. We have discarded the centrally planned economic system and if we now disown the capitalist system, where do we go from here? The present global economic crisis is ferocious and it has changed dramatically the institutional and policy making landscape.

We may not have our own Reagonomics or Thatcherism to bury: but our contemporary policy makers are soaked in the market theology of IMF/World Bank. It would not be easy to disengage them from the trappings of market theology and induce them to refrain from mimicking the Western models. The period of economic reforms, a period of liberalization of the Indian economy, from 1991 to 2004, I would submit, was the most retrogressive phase in the history of India's economic development.

RETROGRESSIVE PHASE: 1991-2004

Admittedly, India's growth story is impressive with GDP growth recording an annual average growth of 8.5 per cent during the last five years 2003 to 2008. In the euphoria of sustained high growth we generally tend to overlook the mistakes committed by our policy-makers during this phase. A community centered analysis exposes clearly the darker side of these developments. While there is enough literature on the harm inflicted on the economy by the centrally planned economic phase - the so-called license-permit-raj, little attention has been paid to the negative impact of the pursuit of unbridled market philosophy during the 1991-2004 phase. Economic historians need to pay greater attention to this phase.

I have characterised this period broadly as the Milton Friedman phase: Milton who is the principal protagonist of the so-called Chicago School, which expounds free markets, de-regulation, liberalization and globalization. It advocates that the role of the state should be reduced to the minimum. As illustrative of this approach, look at Milton's corporate philosophy: "There is one and only social responsibility of business - to use its resources and engage in activities designed to increase its profits". Market fundamentalism embodied in the neo-liberalism based on the notion that markets are self - correcting, allocate resources efficiently and serve the public interest well-has collapsed. The "Washington Consensus" in favour of privatisation, liberalisation and independent Central Banks focusing exclusively on a single point agenda of controlling inflation, now stands stripped of its sanctimonious robe. It has now become clear that unbridled market forces are not self-correcting, regulation and direction of some sort is needed. The state has a critical role to play in the management of the economy.

During the first phase of reforms in India our policy makers were soaked in this market theology. The focus was on liberalization, market-led growth, fiscal correction, promotion of private and foreign investment, development of capital market and generally creation of an environment of consumerism. More basic issues of development were overlooked, which led to neglect of agriculture, deceleration of public investment in and in the flow of credit to agriculture, disdain for subsidies, whether food subsidy or credit subsidy, focusing on job-less growth, and disregard for the elementary principles of food security. I have extensively documented the pitfalls of these reforms elsewhere.

The "growth culture" itself seems to have gone through fundamental change during this phase, with reformer fond of repeating parrot like the phrases borrowed from IMF/World Bank vocabulary3; "There is no free lunch", perhaps meaning thereby that the poor must fend for themselves. The policy makers quoted with glee the American management guru James Goldsmith's well-known phrase, If you pay peanuts, you only get monkeys"4! It required the collapse of the American financial icons- banks, insurance giants and mortgage houses in 2008 to realize that even if you pay cashew nuts, you get worse monkeys'. Chief Executive Officers (CEOs) of private corporate sector would say: "We have money: we have a right to splurge". Cumulatively, we appear to have sponsored sections of Society, to borrow the expressive phrase of Arindam Chaudhuri, of "dehumanised materialistic consumer dust bins". The insensitiveness with which some state Governments went about acquiring arable land, wrenching the small farmers from the land from which they were eking out their livelihood, for accommodating industries in the Special Economic Zones (SEZs) was appalling. "Industrialization is what matters", the authorities seemed to argue. India, despite graduating to the league of fast growing economics in the world - even during the current world recession - continues to be the abode of the largest number of under-fed and undernourished persons in the world. Recent FAO estimates show that the number of under-nourished people in India has risen from 206.0 million in 1990-92 to 230.5 million in 2003-05, an increase of some 24 million4. But our reformers gloat over the fact that in the liberalized Indian economy today consumers can have the benefit of apples imported from Australia / New Zealand, grapes / Oranges imported from U.S.A and dog-food from France.

I would be content with citing four concrete instances to substantiate how the mindless pursuit of market theology during the phase led to deemphasize development: Food grains Management Policy, Inequitable Rate Regime, Fiscal Inequity and Import of Gold.

FOODGRAINS MANAGEMENT POLICY

In respect of food grains management policy, what is disturbing is that India exported a huge quantity of 27 million tones of rice and wheat during the three consecutive years 2001-02 to 2003-04. This was the result of two regressive measures taken earlier: first, the Government introduces in 1997, targeting in the public distribution system (PDS) in the form of Targeted or TPDS. This narrow targeting of the PDS based on absolute income poverty excluded a large part of nutrition vulnerable population from PDS. Second, due to the continuous raising of the issue price of food grains, the food grains with concessional price became increasingly inaccessible to the poor. The inevitable consequence was the mounting food grains stocks with the Food Corporation of India (FCI). At one time, the stocks reached a peak of 60 million tones. No wonder, our policy makers sought a soft option in exports for tackling the issue of the so-called "surplus foodgrains"5. This was nothing short of development atrocity. The irony was compounded further": while the policy makers' ostensible objective was to reduce subsidies for domestic consumption of food grains, the same policy makers did not have any qualms about subsidizing exports of food grains! If Mahatma Gandhi were alive perhaps, one could speculate there would have been a satyagraha against such mindless pursuit of flawed food grains management policy.

Bikhu Parekh has admirably encapsulated the poverty profile, as sketched by the Mahatma, in the following paragraph:

"Second, poverty dehumanizes human beings, wastes their potential and deprives their lives of all sense of meaning and purpose. It is one of the worst violence that human beings can commit against other human beings. It is as bad as killing, and even worse for the fact that it is silent, slow and invisible, arouses no anger and is outside the purview of anyone's direct responsibility. As long as even one person is starved, is malnourished or lacks decent housing, the social order stands indicted lacking legitimacy. Basic human needs have the first claim on Society's resources, and it has obligation to arrange its economic affairs in a manner that the needs of all members are met".

In my Introduction to a book on agriculture, I wrote in 2006;

"It was tragic enough for a predominantly agricultural economy not to be able to produce in the 1960s adequate quantities of food grains to meet the domestic consumption requirements of the population: it is perhaps a greater systemic tragedy today that even when we are able to produce adequate quantities of food grains we are unable to ensure that food grains so produced do reach the needy"6

Hunger and poverty are an affront to civilized society and subsidies are a characteristics of the civilized Society. One begins to wonder whether we are dismissing poverty or reduction of poverty as mere phrases of a dialectic process, denying thereby its moral urgency of addressing the task.

INEQUITABLE INTEREST RATE REGIME

These who pontificate on why the concessional lending rates do not help the poor, further expose their innocence of the realities of the present interest rate structure. Financial sector and banking sector reforms implemented in the 1990s have resulted in the emergence of an inequitable interest rate structure, a structure designed to pamper the private corporate sector, and which is biased against agricultural and the small borrower generally. For instance, a small farmer was made to pay an interest rate of 12 per cent at a time when highly rated corporate entity could raise money from banks at 6 per cent. This paradoxical situation was the result of mindless implementation of Basle norms and adoption without adaptation of concepts like "risks" as understood in the developed world. RBI Report on Currency and Finance 2005-06 provides valuable insights into the structure of interest rates. The bulk of bank lending has been taking place, at Sub-BPLR (Benchmark Prime Lending Rate). For instance, the share of Sub -BPLR lending increased to 82 per cent by March 2007. While higher credit rated corporations are setting credit at Sub-BPLR rates, agriculture and small industry and other small borrowers are generally charged BPLR, or in some cases, above BPLR rates. To quote the RBI Report: "to compensate for such Sub-BPLR lending, other segments are charged higher rates of interest, thus leading to cross subsidization of the economically well-off borrowers by the economically poor borrowers"8. This is indeed disturbing especially when the objective of both the inclusive growth in the real sector as envisaged in the Eleventh Plan and financial inclusion is to promote growth with equity. Although this inequitable situation was mollified to some extent by the Government providing interest rate subvention since 2008-09 to ensure that farmers get short - term crop loan up to Rs. 300,000 at 7 per cent, the basic issue remains. Interestingly enough, none of the reformers of financial sector has identified the problem. It is to the credit of Reserve Bank of India (RBI) that they brought out the problem in the open and appointed a Working Group, in April 2008 to look into it the issue.

FISCAL INEQUITY

The Indian fiscal system is distinguished by the fact that dividends received by individuals are totally exempt from income tax without any limit. Similarly, there are exemptions without limit, from long-term capital gains from the stock market. Thus persons receiving thousands of crores of rupees of dividend income are totally free from income tax, while those earning modest incomes from professions are taxed at high rates. These exemptions are sought to be justified on the ground that they foster the development of equity market. The ostensible rationale is that since corporations have already paid the tax, taxing dividend income of individuals would be tantamount to double taxation. This is a specious argument. In the idiom of public finance, corporations and individuals are distinct entities and hence they ought to be taxed separately. Dr. S. S. Tarapore, former Deputy Governor of RBI, has correctly argued that unlimited exemptions of dividend income are incongruous with distributive justice and are nothing short of fiscal atrocity.

IMPORT OF GOLD

One of the most retrogressive reforms introduced during the period is the liberalization of the import of gold. The annual average level of imports of gold works out to a staggering figure of $5 billion. Import of gold is in a way definancialization of savings: because financial savings, which could have been channeled to productive purposes, would be diverted to unproductive investment in gold. Today, in metropolitan and bigger towns there are more jewelry shops than grocery shops. Surely, the WTO did not prescribe the liberalization of gold imports. Even public sector banks are encouraged to sell gold coins. ARE we exporting food grains to finance the import of gold? This is a clear case of perversion of priorities in economic reforms, or the ugly face of reforms-a face that has nothing to do even remotely with development. Nobody, of course, would advocate a total ban on import of gold but what is required is restraint on the magnitude of imports. Government does not have to go out of the way to encourage the import of gold.

Overall, these reforms like low interest rate regime for the corporate elite, artificial props to develop the capital market and exemption without limit for the dividend income from tax-these reflect private corporate sector centered punditry. Milton Friedman syndrome?

Let me now briefly deal with the India-specific issues both in the financial sector and the real sector.

Revisiting Financial Sector Reforms

What are the implications of the collapse of the American capitalist model, particularly the financial model, for India's reforms? Looking ahead, there is a need for introspection and for a vision on how to move forward: introspection because we have been trying to mimic the American financial model in reforming India's financial sector, particularly in the post-1990s phase. Vision, because in our unabashed attempt to Americanise the Indian financial system our high profile reformers have sadly ignored the nature of the structure of the Indian economy as it has evolved, and India - specific implications for growth. The imperatives of financial inclusion have yet to reassert themselves. Unfortunately, there has been far too much of mimicking American models and copying "international best practices". It is high time that we must speak our minds freely about what is right and wrong with the reform path our policy makers have chalked out for us. Otherwise there is the danger that reforms might crumble under the weight of the egos of the establishment.

When the icons of American and European financial system-commercial banks, investment banks, mortgage houses, and insurance giants-collapsed like a pack of cards, what happened to the mythology built around the private financial institution like capital adequacy norms, Basle norms, provisioning requirements, assets-liability management, risk weighted lending rates, credit rating-all of which we have been trying to superimpose on our banking system? Why did not this paraphernalia of devices emit warning signals that the whole edifice is about to crumble? Professor Joseph Stiglitz, the Noble Laureate, in a recent interview to an Indian T. V. Channel said. "*The US financial collapsed because we did have a Dr. Reddy at the helm.” The reference here is to Dr. Y.V. Reddy, former Governor of Reserve Bank of India, and there can not be a better tribute to the management of the Indian financial system. Even those Indian financial wizards who scoffed at Dr. Reddy's go slow policy towards structured financial products have remained to pray.

It is therefore important that we revisit the financial sector reforms and subject the blueprint for reforms to critical scrutiny in the light of these recent development in the global financial scenario.

The blue-print for reforms has been provided by the Raghuram Rajan (RR) Committee which submitted its Report in 2008/09 . These high profile reformers, whether it is the Narasimham Committee which submitted its Report in 1998 or the Raghuram Rajan Report (RR) referred to above, share the following four characteristics. First, they are soaked in the market theology of the IMF/World Bank. Directed Credit and credit subsidies should be shunned. Second, they demonstrate a congenital dislike of the public sector in the financial system. Third, their whole focus seems to be on mimicking the financial models of the West, particularly the American model. Fourth, they lack a sense of India's financial history. Elsewhere I have examined the RR Report at length and shown that its recommended reforms are unrelated to the India-specific socio-economic milieu and are inconsistent with the strategy of inclusive growth embodied in the Eleventh Five Year Plan (2007-2012) 10. The Committee's basic approach to financial sector reforms is flawed. The RR Report reflects faithfully the market theology of IMF/World Bank, ignoring the India specific strength of public sector dominated financial system. For instance, "The majority of this Committee does not see a compelling reason for continuing government ownership" of financial institutions including banks. The Committee has therefore recommended to begin with , selling small public sector banks to the private sector. In the global financial conflagration when major private sector icons of banks and financial institutions perished both in the U.S. and Europe, Indian institutions stood, rock-like, unharmed. Indian public sector banks have made us proud. How incongruous such illogical advocacy of privatization sounds in the light of global financial crisis.

As Governor of Reserve Bank of India (RBI) emphasizes. "India's banking system remains healthy, well-capitalised, resilient and profitable. Credit markets have been functioning well and banks have been expanding credit notwithstanding the perceptions in some quarters of lack of adequate credit from banks to the commercial sector"11.

It is to the credit of the Indian public sector banks that they have been able to successfully blend the objectives of social banking with the market philosophy of optimizing profitability. It is time that our high profile reformers realize that banking efficiency is ownership neutral. Where is then the case for privatization? There is very little intellectual support for such proposals for privatization. In fact the view is gaining ground that banks should be treated as public utilities.

In a similar rein, echoing faithfully the Washington consensus, The RR Report recommends the Reserve Bank of India (RBI) should abdicate its development responsibilities and concentrate exclusively on control of inflation. This recommendation also has, I have demonstrated elsewhere, no intellectual support.

Clearly, the RR Report should be set aside. Perhaps it would be useful to set up a new committee headed by "Dr. Reddy like experts" to provide an alternative blue-print for future financial reforms-reforms which would be in consonance with the inclusive growth strategy in the real sector. While on this subject a reference may be made to Professor Robert J. Shiller's work which advocates the democratization of finance or making financial markets "works for the benefits of the common person12:.

Three Core Issues
In the contemporary financial scenario in India, there are three core issues: inclusive growth or broad-based, decentralized growth in the real sector, the new architecture of the financial system to facilitate such growth, and the inequitable interest rate structure. Logically, the reinvention of the next generation financial sector reforms should have emerged from a holistic analysis of these three core issues. Judged by these criteria, high profile reformers have frittered away their energies on a random assortment of recommendations: some relevant, some not so relevant, mainly aimed at mimicking the "best practices" of banking in the developed world.

In terms of priorities, developing a market for complex structured credit products, like credit derivations, important as it is, can wait : but addressing these core issues cannot brook any delay in terms of food and employment security, and in terms of reducing poverty. As I have spelt out elsewhere, inclusive growth in real sector has now become a growth and development imperative: growth, because a high GDP growth like the 8 or 9 percent targeted in the Eleventh Plan (2007-2012) can be sustained only if other sectors or segments of the economy, which have been sluggish because of a number of reasons, including policy neglect, can be activated. Development, because this is perhaps the best route by which bulk of the poor can be provided with livelihood and food security. In other words, we can no longer depend on "autonomous" forces for growth of the real sector, this growth has to be policy-induced with a view to enabling sections of the population, whom the growth process has by-passed, to fully engage themselves with the development process. The trickle down theory or percolation theory of growth is dead. While wealth may accumulate, men may decay. An interventionist and pro-active policy is therefore warranted. This should be the starting point for designing what are now called the next generation financial sector reforms. In this context, the contemporary experience of China is illuminating. China's Township and Village Enterprises (TVEs) provided increasing job opportunities outside agriculture and this phenomenal expansion of non-farm sector played a critical role in reducing poverty.

The unorganized sector holds the key to broad-based decentralized growth. The recent Report on the sector spells out that micro enterprises-with an investment of below Rs. 0.5 million - constitute 94 per cent of small enterprises in the country and provide employment to 70 million people and contribute 30 per cent of industrial production. Some 40 per cent of exports are contributed by this sector. Despite occupying this central position, these enterprises receive only 2 percent of net bank credit13. If additional credit is injected into this sector it may lead not only to higher production, but it may also promote up-gradation of technology, improvement in marketing efficiency, and so on.

The micro, small and medium enterprise (MSME) sector has been affected adversely by the recent global financial crisis. MSMEs particularly related to exports like textiles and garments, gems and jewelry, have been facing problems like slackness in demand for their products and delayed payments of dues by large undertakings.

To ensure that the special problems faced by this sector are addressed, there is merit in the proposal to set up a dedicated Development Finance Institution (DFI) with a mandate to provide refinance to banks for on-lending to micro enterprises. Such an umbrella institution should be also able, in addition to facilitating adequate flow of credit, to provide consultancy services.

This sector needs specialized treatment because of another reason: it is an amorphous sector with at least three different segments each of which has its own problems. First, there is a wide range of informal enterprises like tailoring shops, tea shops, auto repair centers and flour mills. Second, enterprises in the growth sectors like housing, auto, white goods, pharmaceuticals etc. The third segment relates to exporting MSME units that have thrived on the global consumption boom. Many of these have been adversely affected by the present global crisis, as mentioned earlier. To cater to these segments the establishment of a dedicated development finance institution seems appropriate. This may facilitate extending the reach of lending institutions to this sector and also upgrade of technologies.

The second core issue is the institutional infrastructure. Micro finance is expected to play an important role in promoting financial inclusion and inclusive growth. It is a sort of supplementary credit delivery system that is cost effective and user friendly for both banks and the poor borrowers, RBI's initiatives in promoting this channel of credit delivery have centered around two models, namely SHG-Bank Linkage program and Micro Finance Institutions (MFI) model. At the same time, the corporative credit structure is being reorganized, on the lines recommended by the Vaidyanathan Committee. Similarly, the more recent developments reveal that regional rural banks (RRBs) could become the main institutional mechanism for providing credit to the poor. As Dr Thingalaya, a professional banker who has made indepth study of RRBs, puts it: "The process of their merger at the state level, reducing the number from 196 to 96 has expanded their operational base considerably. The best among them like the Karnataka Vikas Grameen Bank or Pragathi Grameen Bank are comparable to the best grameen bank, anywhere in the world, including the much publicized banks of Bangaldesh…… out of the 1.29 Crore of borrowing accounts handled by them, 1.07 Crore (10.7 million) or 83 per cent are in the advances group of less than Rs. 25,000"14.

The blue print for the future institutional structure should clearly indicate how the pyramid comprising banks, RRBs, Co-operatives, micro finance institutions and SHGs needs to be built. Here again, there are regional variations. SHGs are more prominent in Southern states like Andhra, while cooperatives are strong in states like Maharashtra. NGOs working in the relevant area may also be linked to the pyramid.

The final point is related to interest rates. At present there is intense lobbying by the private corporate sector for further reduction in lending rates by banks. It is necessary to caution that this may prove counter-productive. If India's growth story continues to be in tact, despite the global financial mess, it is because India has emerged as a high saving economy with gross domestic savings of 34 per cent of GDP. As the recent Growth Commission puts it: "Capital inflows over the past several decades have a mixed record. Our view is that foreign saving is an imperfect substitute for domestic saving, including public saving to finance the investment a booming economy requires". In India investment as a percentage of GDP increased from 25 per cent in 2002-03 to 38 per cent in 2007-08. Of this 13 percentage points increase, as much as 10 percentage points was financed domestically through higher household, public sector and corporate savings. As a result of reducing lending rates recently, banks have already reduced deposits rates. If banks are compelled to reduce lending rates further, banks may reduce deposit rates even further. Such very low deposit rates and rates on savings accounts may eventually result in shrinking overall savings. This is particularly so because household sector is a major contributor to overall savings and household savings are sensitive to interest rates. We must guard ourselves against this danger.

To sum up, any blue print for future financial sector reforms cannot be meaningful, if it does not address these three core issues.

PYRAMID OF RURAL LENDING INSTITUTIONS

How should the financial system, particularly commercial banks, respond to the challenge of facilitating inclusive, or, broad based and decentralized growth in the real sector? The answer to this question can be given in two parts: first, the coverage of households and second, loan-portfolios of banks.

Is universal coverage or 100 per cent of coverage of households by banks, as the RBI seems to interpret it, the answer? I, for one, would demur. Banking sector resources are, and would continue to be, limited. Optimum utilization of banking sector resources demands a selective approach to credit extension. Ideally, credit should chase productive activities and universal coverage would be tentamount to de-hyphenating credit and productive activities: this would not augur well for facilitating inclusive growth. Of course, it is conceded that at present almost 40 per cent of the adult population of the country comprising mainly those with low incomes and those without collateral are unable to access mainstream financial products. Hence capturing this section should be our long-term objective. In the meanwhile, if credit is made to chase productive activities, we would promote optimal use of banking sector resources. Spreading available resources too thinly, which universal coverage necessarily implies, may defeat this objective. Further-more, opening "no frills" accounts with low charges may be reduced to mere tokenism. In fact this may add to transaction costs which may provoke banks to raise their general lending rates. The whole approach to universal coverage of households appears flawed. As we have emphasized, we must think in terms of a pyramid of rural lending institutions and Financial institutions as a cooperative enterprise by all the institutions involved. Bank's resources may be enabled to reach the rural borrowers, either directly or indirectly, through the use of multiple channels such as SHGs, MFIs, NGOs, farmers' clubs, panchayats, etc., as Business Facilitators or as Correspondents.

Secondly, we need top priorities sectors or segments of the rural economy which need credit support. Let me illustrate. Foremost among sluggish sectors is agriculture which is central to India's economic development. Future agricultural growth will have to be necessarily water-centric. Five inter-connected programmes assume significance in this context: watershed development both macro and micro, rain water harvesting and conservation, renovation of traditional water bodies, improving water efficiency in public irrigation works, notably in canals, and promotion of micro irrigation technology like drip and sprinkler irrigation systems.

There is another heterogeneous bunch of projects related to rural development: animal husbandry, horticulture, fisheries, development of waste lands and forests, soil conservation, drainage and flood control, organic farming with organic seed and compost preparation, food processing storage, ware housing and marketing.

The moot point in providing a list of illustrative segments is that the loan portfolios of banks and other rural lending institutions must begin to reflect the more diversified credit support to these emerging segments and not merely support crop production, important though the latter will continue to be. This involves the inculcation of a new banking culture, with evolving of appropriate procedures and practices, for project identification, appraisal and monitoring.

The building of the pyramid of rural lending institutions, including banks with all their multi-channels of credit delivery - should be the central theme of the new discourse on next generation financial sector reforms.

THE REAL SECTOR

Rediscovering the Mahatma

The ambitions Bharat Nirman program launched in 2005 - marks a radical departure from the Milton Friedman phase. Involving a massive investment of
Rs. 1.74 lakh crore this is a time bound program of rural infrastructure development focusing on six subjects: roads, drinking water, irrigation, housing, electricity and telephones. In a way this symbolizes the beginning of the rediscovery of Mahatma Gandhi's philosophy of rural development. This was subsequently supplemented by other flagship schemes for education and health. Sarva Shiksha Abhiyan for education, Mid-day Meal scheme providing cooked meals to school children, Integrated Child Development Services (ICDs) to promote nutritional supplement to children upto the age of 6 years. The mid day meal program covers some 15 crore children. Further more, the National Employment Guarantee Act (NREGA) 2005, is the best thing that could have happened to the poor. This guarantees 100 days of employment in a year to every rural household. In 2008-09 it is estimated that about 4.5 crore rural households benefited from the scheme. The culmination of these efforts is reflected in the National Food Security Act Program proposed by the President of India in her Address to the Parliament on June 4, 2009. This Act seeks to provide a statutory basis for a framework which assures food security for all. Every family below the poverty line in rural as well as urban areas will be entitled, by law to 25 kilograms of rice or wheat per month at Rs. 3 per kilogram. In the Budget Speech of June 6, 2009, the Finance Minister assured that the government will come up with the necessary Act and necessary provision or outlay for the program will be made. Taken together, these measures go a long way towards meeting the basic needs of the poor - a goal set by the Mahatma.

The Budget Speech sums up the new approach to development: "….. the UPA Government has gone for a paradigm shift for making the development process more inclusive. It involves creating entitlements backed by legal guarantee to provide basic amenities and opportunities for livelihood to vulnerable sections. "Aam Admi" is now the focus of all our program and schemes". Are we recapturing the rhythm of our old growth song?

FROM PREDATORY TO COMMUNITY CENTERED CAPITALISM

The issue of predatory capitalism has assumed a contemporary relevance with the recent fall from grace of the American capitalist image. The word "predatory" is defined in simple terms "as addicted to, or characterized by a tendency to exploit or destroy others for one's own gain". Revelation of corporate crookedness and accounting scandals have shaken the very foundations of the American capitalist model. The depth of degradation to which unbridled corporate greed can lead to has become all too obvious. The Enron, Worldcom and Xerox and Global Crossing exposures have unveiled the ugly side of western style capitalism under which, in the quest for short-term gain, wrong doings are overlooked. These developments cannot be dismissed, as some apologists of American capitalism seem to be doing, as isolated incidents. As Professor Lester C. Thurow puts it: "The Enron and Worldcom are not abnormalities in a basically sound, system - scandals are endemic to capitalism". The London Economist summed up the situation: "Chief executives and accountants have become a despised breed less trusted than politicians and Journalists". Again, take the current financial crisis in the U.S. which started as a sub-prime mortgage crisis. The litany of actors involved and the sharp practices followed is long. A fast growing new breed of lenders were luring many people into risky mortgages they could not afford. With incentives for aggressive loan disbursement, banks poured billions of dollars of loans into poor households often with incomplete documents. The unquestioned faith in the status of triple-A credit rating led to buying of billions of structured bonds which later turned out to be worth nothing, since the market for a number of structured products became non-existent during the period of financial meltdown15. Thus not only mortgage houses, but investment banks, accountants and credit raters were also involved in the melo-drama. Have the financial professionals also joined the breed of CEOs mentioned above by the Economist?

The CEO of one of the bigger banks which was sinking helped himself to a hefty bonus. There was public outrage that some executives of an insurance giant were helping themselves with handsome bonuses from out of the bail-out package extended by the U. S. government. The automobile giants Ford, Chrysler and General Motors went in their private jets to seek aid from the Congress! The peanuts - monkey philosophers could do well to ponder over the statement of the Financial Services Authority in the U. K. that overgenerous remuneration practices in the financial industry contributed to the market crisis, since they motivated staff to pursue "unduly risky practices". The multimillion dollar bonus culture of investment banks has been blamed for contributing to the risky behavior, which brought about the near-collapse of the world financial system.

Contrast this with the important revolutions that India witnessed since Independence: the Green Revolution of Dr. M. S. Swaminathan, the White Revolution of Dr. Verghese Kurian, Telecom Revolution of Mr. Sam Pitroda, the Satellite Revolution of Professor Yeshpal and the IT Revolution of Mr. Narayan Murthy. None of these were paid princely salaries nor were they motivated by the million rupee bonuses. In fact Professor Diwan belongs to this genre of visionaries.

Fortunately, such predatory capitalism is now dead and today's prophets of private sector philosophy disagree with Friedman. Take the case of Coca-Cola Chief who represents the not so pretty face of American capitalism, scarred as it is by the recent Enron and Enron like episodes, redefines corporate responsibility. As guest editor of Economics Times, Mr. E. Neville Isdell wrote:

"The future of a 21st century company is tied to the health of the community and our planet. Some leaders may consider sustainability work to be in a company’s enlightened self-interest. I disagree. In ways that will determine our ability to achieve consistent, global growth and profitability it is quite literal self-interest". (Editorial, March 17, 2008). Water is the main ingredient of Coca-Cola and lack of public access to clean water is a series problem in many communities where Coca-Cola factories are functioning. Hence the objective of the Coca-Cola company has been to return water used in its manufacturing processes safely to the environment. In India the company is installing more than 100 rain harvesting structures in 17 states. Contrast this with the rapacious mining in the colonial era by foreign companies; for example copper mining in Zambia or gold mining in South Africa. One hopes that such community-centeredness becomes in future, the focus of the functioning of private corporate sector, both Indian and foreign.

Mahatma Gandhi had distilled the core of Indian philosophy from our ancient scriptures and evolved his own philosophy. In addition to basic needs of the common man being the first charge on the Society's resources, he had another important ingredient: the concept of trusteeship. We should hold our wealth as trustees and not as exclusive owners, so that this wealth is available for sharing by others who need it most. Dr. Swaminathan would like to add intellectual property rights to well as the concept of wealth.

From times immemorial, Indian philosophy has maintained that the all-round development of a society is best achieved through betterment of the individual which no doubt includes economic well-being but extends well beyond it. Social conscience must be inculcated among individuals through education at all stages and also professional training. All individuals must be sensitized, at their young age itself, to abject poverty, the squalor, disease, ignorance and illiteracy that surround us. They must begin to think in terms of what is our dharma or duty towards alleviating some of the infirmities that affect our less fortunate fellow human beings. Some Asian countries, recently, have introduced in school textbooks lessons on corruption. But that is a narrow and negative concept. We must aim at building a holistic concept of the right conduct.

One of the ancient scriptures of India The Brihadarnyak Upanished enjoins us that our life must be guided by the following three "Das - Damyata, that is control yourself, Datta, that is give to others, and "Dayadhwam", that is be compassionate. Thus we must practice self-control, charity and compassion. Collectively, these three characteristics constitute development conscience16. Building up such conscience among all sections of the population would go a long way towards evolving a compassionate Society - an ideal which the Mahatma sought to achieve.

Incidentally, it is interesting to add here one point modern social analysts have been confirming, year after year, Denmark's status as a "happiness superpower"17. The secret of this achievement is low expectations of Danes who are not trapped in the hedonic treadmill. This modern research merely endorses what traditional Indian philosophy has been advocating centuries ago. It was left to Mahatma Gandhi to distil this wisdom and evolve a practical programme of a code of conduct.

RE-ORDERING OF PRIORITIES

The current chorus of the powerful lobby seems to be that freed from the Marxist's shackles, the new UPA government should rush into implementing liberalization reforms. What does this articulate lobby mean by reforms? Disinvestment, privatisation of public sector banks (PSBs); a bigger role for foreign direct investment (FDI) in retail, insurance, aviation and banking of government equity in profitably run state entities; making Mumbai an international financial centre where multinationals could freely enter; merger of the associate banks of State Bank of India (SBI) with the parent bank so that this bank could compete internationally, based on the principle "too big to fail", and so on. Are the ghosts of Milton Friedman still haunting our reformers and articulate lobbies?

In the post-collapse phase of the American capitalist model at least, we should be convinced that there is no intellectual support for privatization per se. Diluting public ownership of undertaking is, of course, quite another matter. In this context it is appropriate to quote the following paragraphs from President's Address to Parliament on June 4, 2009.

"Our fellow citizens have every right to own part of the shares of public sector companies while the government retains majority share holding and control. My Government will develop a road map for listing and people - ownership of public sector undertakings, while ensuring that government equity does not fall below 51%" People- ownership is the key word.”

Interpreted in terms of the Mahatma's broad principles, the new Government should shed the inherited ideological baggage and address the more mundane India specific issues both in the financial and real sectors. I have already outlined the financial sector priorities and let me end my lecture by briefly indicating the kind of real sector reforms needed on a priority basis. There are three issues in the broader area of food and water security: watershed development, rural employment and food grains management.

First, even today about 60 per cent of the total cultivated area is rainfed and hence future agriculture growth will have to be necessarily water-centric. Watershed development is the mother of all water management modes and today it is seen as the principle strategy for holistic development of rain-fed areas. Even though we have been making a lot of noise about the program, in terms of dimensions involved, the progress is tardy. We should therefore promote a massive program aimed at covering say 50 per cent of the total eligible area in the next two years. We could designate the two years 2009-10 and 2010-11 as Watershed Development Years.

Second, National Rural Employment Guarantee Act (NREGA) 2005 is the best thing that could have happened to the rural poor. Happily, the Budget for 2009-10 envisages the expansion of the scheme. Rural connectivity, water harvesting structures, drought proofing, minor and micro irrigation works are among the activities undertaken under the scheme. Perhaps, it would be good to mandate this scheme to concentrate on watershed development activities in the next two years in the rainfed areas.

Taken together, these would go a long way towards providing water and food security to the poor.

Third, there should be no exports of food grains, except some small quantities of high value commodities like Basmati rice. Domestic consumption should have the first claim on our production of food grains. Before the threat of bad monsoon during the current year, there was some talk of export of 2 million tones of wheat. Hence this position needs to be reiterated. Further more, the Food Corporation of India (FCI) needs to play a pro-active role in the management of food grains prices. We seem to treat FCI as glorified warehouse keeper. Instead, it should emerge as a market. For instance, with its present huge stocks of rice and wheat of around 50 million tones, it should ensure that food grains prices in the open market do not rise to high levels. It should be able to identify pockets of high price rises and by unloading appropriate quantities of food grains in those pockets, it should seek to bring down prices. Thus it should be able to contain food grain prices within a reasonable band. Finally, forward trading in food grains should be banned. Farmers decisions regarding crop planning and investment are guided by minimum support prices (MSP) rather than by forward prices18.

SUMMING UP

It is an irony of economic history that India which was a pioneer in emphasizing "growth with equity" in its approach to development, much before mainstream development economists caught up with it, should have relapsed into a phase of mindless pursuit of market theology. The period of economic reforms from 1991 to 2004 was the most retrogressive phase, a phase which I have called the Milton Friedman phase. Although India graduated to a high growth league during this phase, it had to pay a heavy price. While wealth accumulated, men decayed. The number of under-fed and under nourished people in India rose from 206 million to 230 during this period. The growth culture itself became toxic. A huge quantity of food grains was exported at a time when the number of under-fed persons increased. Policy makers of the time condemned subsidies for domestic consumption of food grains: but they have no qualms about subsiding export of food grains. The interest rate regime which emerged as a result of reforms pampered the corporate elite and discriminated against the small borrowers, generally. There was fiscal inequity again designed to pamper the dividend earning elite.

The launching of the Bharat Nirman programme in 2005 marked a radical departure from the Milton Friedman phase. Our policy - makers, it appears, began to rediscover Mahatma Gandhi. There was the Mid-day meal programme for school children, nutritional supplement to children upto the age of 6 years, and so on. The National Employment Guarantee Act,2005 was the best that could have happened to the rural poor. The culmination of this journey towards holistic development is the proposed National Food Security Act. I have called this phase the Mahatma Gandhi phase.

There is no generic formula for growth. "Each country has specific characteristics and historical experiences that must be reflected in its growth strategy". That is where the philosophy of Mahatma Gandhi for evolving a compassionate society with a value system which resonates to these Society's larger concerns acquires contemporary relevance. The collapse of the American capitalist model in 2008 now warrants that we move away from predatory capitalism to what can be broadly described as community centric capitalism. Let us not be trapped into hedonic treadmill. Our contemporary policy-makers, should realize that economic efficiency is ownership neutral. There is no intellectual support for privatization per se.

Viewed against this broader background, our agenda for reform would warrant a re-ordering of priorities. And I have sought to indicate what such re-ordering means both in the real and financial sectors.

The Journey towards holistic development takes us well beyond growth models. Evolving a compassionate society, for which the Mahatma struggled, involves betterment of individuals whose life must be guided by the three "Das - Damyata, Datta and Dayadhwam: practice self-central, charity and compassion.

About the Author:

Dr. N. A. Mujumdar is Editor of the Indian Journal of Agricultural Economics and Senior Professor and Adviser at the Society for Development Studies, New Delhi.

Dr. Mujumdar began his career as Lecturer in what was then known as the School of Economics, University of Bombay. He was Nuffield Fellow of University of Oxford, U.K. in 1959 and after return to India joined the Reserve Bank of India in which he held various positions, including Adviser-in-charge, Credit Planning Cell, and Principal Adviser.

He served, under the auspices of the International Monetary Fund (IMF), as Adviser to Central Banks of the following five countries: Zambia, Mauritius, Tanzania, Belize and Cambodia. He was Consultant to World Bank, FAO, ESCAP.

He has worked as a Member of Working Groups appointed by Reserve Bank of India and the Planning Commission. He has delivered Special Lectures at the Universities of Baroda, Karnataka, Kolhapur, Mumbai, Pune and Surat.

He has published several research papers in technical Journals and about a dozen books. His recent books include: "Financial Sector Reforms and India's Economic Development" (Two volumes 2002), Economic Reforms Sans Development (2004), and Inclusive Growth: Development Perspectives in Indian Economy (2007).

REFERENCES

1. For an indepth discussion of the theme, see the following three articles by the author: Native Discourse on Development; Philosophy of Sustained Development, and Predatory Capitalism is Dead: Long Live Community - Centered Capitalism: in Economic Developments in India, Academic Foundation, New Delhi, Volumes 119, 124 and 132 respectively.

2. The Growth Report: Strategies Growth and Inclusive Development World Bank, Washington D.C., 2008, page - 2.

3. See : Economic Reforms sans Development, N. A. Mujumdar, Academic Foundation, New Delhi, 2004.

4. The State of Food Security in the World, FAO, Rome, 2008.
5. For detailed discussion, see: Inclusive Growth - Development Perspectives in Indian Economy, N. A. Mujumdar, Academic Foundation, New Delhi, 2007.

6. Gandhian Way: Peace, Non-violence and Empowerment, Ed. Anand Sharma, Academic Foundation, New Delhi, 2007.

7. Indian Agriculture in the New Millennium, Ed: N. A. Mujumdar and Uma Kapila, Academic Foundation, New Delhi, 2007.

8. Report on Currency and Finance, 2005-06, Reserve Bank of India, Mumbai, (page 159).

9. Draft Report of the Committee on Financial Sector Reforms (CFRS), Planning Commission, 2008.

10. Next Generation Financial Sector Reforms and Inclusive Growth, included in the Volume: "Essays in Honour of Prof. S.L.N. Simha," Southern Economist, Bangalore, 2008.

11. Third Quarter Review of Monetary Policy 2008-09, RBI, January 29, 2009 page 20.

12. From Visionary to Innovator, Paolo Maurio, Finance and Development, IMF, Washington, D.C., December 2008.

13. Report on Conditions of Work and Promotion of Livelihood in the Unorganized Sector, Government of India, 2007, page - 211.

14. Annuals of a Central Bank, N. K. Thingalaya, Indian Economic Journal, April-June 2007.

15. See the excellent article on the subject by Tapan babu, Economic and Political Weekly, 8-11-2008.

16. The Development Conscience Factor, N. A. Mujumdar, included in the book mentioned in (3) above.

17. Where less means more, Eric Welner Times of India, 22nd July 2009.

18. Commodity Futures Market: Dehyphenating Financial Flows and Supply-Demand Fundamentals - N.A. Mujumdar, in the Volume Futures Market, Ed: Madhoo Pavaskar, Mumbai, 2009.

Tips for Passing Actuarial Examinations

2010-01-18T00:06:00.004+05:30

By Ms. Teja Ranade-Gadhoke

Actuarial examinations are considered very difficult to pass and the pass rates generally vary from 20% - 40% but not more. Also most exam takers are also working full-time, so managing the workload and simultaneously passing the exams can pose a real challenge. Having been through the same situation, I am putting down some study tips that I hope will be useful for readers. These are based on my own personal experiences and experiences of my colleagues and friends.

KNOW YOUR CONCEPTS

This is a well-known fact! You can never pass an actuarial examination until you are thoroughly familiar with the actuarial concepts. Only if one has understood the concepts clearly, can one apply them to a numerical problem.

Understanding concepts right from the first exam is very necessary as several examinations of later series build on concepts covered in earlier exams so it is important to have clarity of concepts right from the beginning.

KNOW HOW TO APPLY THE CONCEPTS

It is important to recognize that the actuarial examinations are not testing one’s knowledge of actuarial concepts presented in the study material; but they are testing one’s ability to apply those actuarial concepts in practical situations. They achieve this by testing students on numerical problems and case studies. To that extent, these examinations can be classified as application exams rather than theoretical exams.

So as application based exams, you have to know how to apply the concepts to numerical problems. The best way to do this is by doing lots of practice problems. Solve problems from all available past exams or from reference textbooks. Don’t glance through the problems but actually solve them - this helps improve speed of solving problems and helps clarify concepts further.

SEE THE BIG PICTURE

As students, it is very easy to remains focused only on the numerical details of the problems in the exam or on the specific formula to be learned without looking at the big picture. I used an effective method as follows: When you tackle a new concept, take a few minutes to think about what is the logic behind the concept, how does it co-exist with other concepts that you have learned about covered in the same or prior exams, have you faced this concept at work or heard any of your senior colleagues talk about it. Taking some time to dwell on this helps put things into perspective.

Many students feel that it is not very necessary to do this, learning the formula or method to solve a problem by rote is mostly sufficient – but incorporating this method into your studying helps you retain this information longer and apply it with ease in the examination.

START EARLY

It is impossible to start studying at the last minute and pass an exam unless the exam concepts have been studied in a prior exam, or course in college. Actuarial concepts can be complicated and take time to seep in. Start early and give yourself enough time so that there is no panic learning at the last minute which invariably fails to serve its purpose.

LIVE AND BREATHE FOR THE EXAM

Live and breathe for the exam atleast four months before the exam date. Make it an integral part of your life and daily routine (be it half an hour or one hour a day).

Assign a specific part of the day for studies or accept that any free time available (be it half an hour at lunch or one hour in the morning before office) will be used to study. Don’t make excuses that they environment is not right or the time is not right. The less excuses you have, the more time you will have.

This way the concepts and exam material will slowly filter into your brain and over the time period of four months, things will be clear and in perspective.

STUDY GROUPS

Start a study-group at work – discuss with your colleagues who have already taken the exam, post questions on discussion forums and blogs, take second opinions of your understanding of concepts. Don’t try and be a lone warrior!

PRE-EXAM PANIC

Keep the last two weeks before the exam only for revising concepts and doing old exam problems. Don’t try to cram any material at the last minute. Your brain will not accept it and may only muddle it up with other concepts learned.
If you don’t have time to cover all concepts in the study material, be thorough with what you have already covered; Don’t try and learn all of it in a hurry at the last minute since it will not help anyway.
Relax your brain one day before the exam – it deserves the rest if it has to function at it’s best on the exam day.

WHILE WRITING THE EXAM

Spare a few minutes at the very beginning to read through the examination. While reading, underline the important parts of the problems. This gives you a good idea of what is contained in the exam, what is your comfort level with problems and which are the ones you know best. This will help you intelligently tackle the exam by doing the problems you know best first.
Divide the total time available for the examination as follows:

Keep aside 10 minutes for final review and another 10 minutes for emergency reworking of problems
Keep in mind that the balance amount of time has to be divided among the total problems to be worked out
Learn to keep a track of time while doing the practice examinations itself. You will not be able to suddenly incorporate this method into your examination.

Always keep a track of the time. Don’t waste too much time on any one particular problem. Move on to the other problems and come back to it later as time permits.
Tackle the problems with the concepts you know best first so that you have guaranteed yourself some points right at the beginning.
Before you finalize an answer to a long numerical problem, take a few seconds to think about the reasonability of the answer. This method has helped me identify silly mistakes in my problem working several times. Start incorporating this method into your working while doing the practice problems; so by the time you reach the point of taking the actual exam, you’ve tuned yourself into judging the reasonability of answers as a natural reflex. Co-workers of mine who have used this method have almost always passed an exam consistently.
If the type of examination is one in which partial credit is given for part working of the problem, make sure you quickly write out the formulae for the problem first- even if your numerical working is wrong, atleast some points are guaranteed for the formulae that you put down.
Don’t panic! Stay cool! You are prone to making more mistakes in a state of anxiety. Invariably students that generally pass the exams are those who go into the exam with a cool, collected and positive attitude.

BE REALISTIC

Please be realistic – The exams are difficult and accept that they are. Also be thankful that they are difficult to pass and that is why a qualified actuary gets the deserved respect and recognition. Keep a positive attitude.

Know that it is a time commitment and be prepared to commit that amount of time, energy and grey cells to the cause. The sense of satisfaction, achievement and fulfillment on passing an exam as tough as the actuarial exams is immense. Nothing in life comes for free in life and neither does the pass mark in an actuarial examination.

About the author

The author Teja Ranade-Gadhoke is a Fellow of the Society of Actuaries of USA. She has worked at a premier actuarial consulting firm in U.S.A before moving to India to set up her own consulting company Ranadey Professional Services Pvt. Ltd. based out of Pune. Ranadey Professional Services provides actuarial consulting services in the field of employee benefits to clients in USA and India.