Opinion Don’t reform the EPFO,NPS it

Between 2000 and 2003,and after an assessment of its features,the Central government and 25 states decided to migrate their new employees to the NPS. Today,over 11 lakh Central and state government employees have joined the NPS and are earning nearly 14 per cent per annum from reputed fund managers like UTI,SBI and LIC. This way,informal sector workers,who were traditionally excluded from formal pension programmes,now have identical pension rights as government employees.

The NPS,however,is not an option for workers in private-sector salaried employment. They continue to face an outdated,poorly-administered pension and provident fund programme run by the Employees’ Provident Fund Organisation (EPFO),which runs the Employees Provident Fund and the Employee Pension Scheme. These workers are forced to save a quarter of their incomes for old age. And since most of their savings capacity is consumed by the EPFO,they are often forced to dip into their retirement savings for a variety of their other,non-retirement expenses. This is not difficult,but unfortunately puts a serious dent in their pension corpus.

There are other important reasons also to rethink the role for the EPFO. First,despite many attempts,the organisation has been unable to create a centralised database of its membership. As a result,it is nearly impossible for EPFO’s customers to transfer their accounts and past savings when they change employers or move to new locations. It is relatively (though not always) easier for them to close their account with their last employer,withdraw (and consume) their accumulated retirement savings,and open a fresh EPFO account through their new employer. This naturally reduces the pension accumulations of its subscribers.

Second,each individual has a unique retirement need and risk profile. However,the savings of all EPFO customers,regardless of the differences in their age,income or retirement outlook,are channelled to an identical investment portfolio comprising mainly government bonds that deliver a return of roughly 8 per cent. Equity markets in India on the other hand have consistently delivered nearly 6 per cent higher returns than government bonds. Both NPS and overseas pension funds investing in Indian capital markets recognise the importance of equities in a pension portfolio as every 1 per cent of additional return could increase pension wealth by 20 per cent over a 30-year horizon. EPFO’s outdated investment policies and the resistance of its trustees to explore the equity option however takes away this upside for the private sector salaried workforce.

The difficulties with account portability and low returns (unless EPFO discovers a few thousand crores just lying around) has an even more serious impact on the retirement outcomes of the lower-income workforce that forms around 80 per cent of EPFO’s membership. Without high real returns and easy portability,most of these workers will not be able to escape old-age poverty. For these reasons,an average EPF member retires with roughly Rs 30,000 in her PF account. This can at best produce an annuity of Rs 200 per month.

It is strange that the roughly 50 million EPFO subscribers have not been very vocal about its poor service quality or its inability to evolve with time. This is perhaps because half of EPFO’s membership does not really exist as over 50 per cent of its accounts are dormant and contain barely a few hundred rupees. The majority (75 per cent) of EPFO’s assets belong to some 15 per cent of its customers who perhaps have little reason to complain about a government-guaranteed,tax-free return of 8.5 per cent on average.

While it has certainly played an important role in launching a large,mandatory retirement programme when no other options were available,it is perhaps time for some serious introspection at EPFO. And it also time for the remaining EPFO subscriber base to step forward and demand the same rights and benefits that are already available to civil servants and informal sector workers under NPS — portable individual accounts,choices regarding products and fund managers,high real returns and optimum retirement incomes. One way to achieve this would be to embark on a long-drawn struggle to reform EPFO. It may however be easier to side-step this battle and instead take an alternate route that could be simpler,faster and cheaper.

To start with,EPFO should be registered as a Point of Presence with the pension regulator. It should require every large employer,including exempt and excluded PF trusts,to open an NPS account for their employees. Every month,employers would be required to deduct,pool and transfer the PF savings of their employees,along with a matching contribution,to the NPS Trustee Bank. The NPS Trust would in turn transfer these savings to a regulated fund manager and scheme selected by each subscriber. These employees should have an option to open a tier-II NPS account for non-retirement savings. Using a central record-keeping agency,formal sector workers will be able to easily change jobs or locations without losing or consuming past retirement savings.

On the face of it,this may seem impractical since it will involve a change in the EPF Act. But if this can change the retirement outcomes for several crore Indians,updating the EPF to reflect the reality of 2010 may be well worth the effort. With a somewhat reduced workload on EPF compliance,the EPFO could perhaps turn its attention to (a) more effectively and urgently resolving the Rs 50,000 crore asset-liability mismatch in the EPS,(b) bringing smaller employers with 10 or more employees into the NPS on a mandatory basis,and (c) embarking on a nation-wide communication campaign,in collaboration with employers,to convey the new rights and choices under NPS to formal sector workers.

This will create a genuinely useful pension programme for formal sector workers that is not only portable between employers under EPFO but also across all categories of India’s labour market. After all,what is good for civil servants and the rest of the country cannot be suboptimal for EPFO’s subscribers.

The writer is director,Invest India Micro Pension Services