Is EPFO ready to stand alongside NPS?

EPFO has clearly been put on notice during the last 5 years. The work on the New Pension System (NPS) had gathered steam in 2003. This was also the period (2001-2003) when EPFO went into a major rethink about doing something to justify its existence in an economy where interest rates were diving south, GOI did not want to subsidise the returns, failure to embrace technology had exposed EPFO of its inability to provide efficient and accurate record keeping and the customer was getting used to higher returns by mutual funds ( even schemes which were predominantly invested in debt). True - their long term performance was not yet tested.

Now the NPS - with private fund managers, multiple investment options, individual accounts based on unique member account and low transactions cost is expected to take off in 2008. While NPS does not cross roads with EPFO today as it is only for government employees (that too only new joinees since January 1 2004) - it might be a mistake for EPFO to believe that its 8.5% assured returns will ensure its appeal.

The formal private sector employees today do not have an option. In a few years - on the ground comparisons between NPS and EPFO would be inevitable. I have an article today in the Indian Express: Time to pension off the EPFO (pasted below)

Indian Express, Monday, July 30, 2007

As always, the Employees Provident Fund Organisation’s extended annual ritual to decide the EPF interest rate has deflected attention from the core issues. The only reason for the EPFO to exist is to provide optimum retirement benefits to its members. For this, it needs to maximise returns under the Employees Provident Fund and improve its ability to meet its commitments under the Employees Pension Scheme (EPS). While the EPFO board was passionately fighting to obtain the 8.5 per cent rate for 2006-07, mutual funds delivered a return of over 16 per cent last year (the fact that the 16% returns referred to only balanced funds with majority of assets in debt - got edited out in the print edition! - Equity oriented funds delivered over 30% returns). Though it is difficult to fault the concerns that the board harbours for its constituencies, its energies are directed at the wrong end of the stick.

As things stand, even if EPFO somehow managed to earn a 15 per cent return, would it really matter? EPFO’s data for the year 2000-01 reveals that nearly 85 per cent of accounts have a balance of less than Rs 20,000. This implies that many low-income workers are using EPFO as an umbrella savings scheme rather than a retirement plan. While bank credit is more easily available today, members are continuing to dip into EPF, implying that irrespective of whether the returns are 9.5 or 8.5 per cent, they are consigned to very low replacements. Subsidised returns will mainly benefit the higher income workers covered by EPFO — the 15 per cent who own over 80 per cent of the assets. The unions are fighting for rich workers.

So do we need EPFO? EPFO has been unable to fulfil its basic purposes. Consultants have been hired but the all too obvious recommendations — making withdrawal stricter and improving investment parameters, among others — have been politically queasy and remain unimplemented. Globally, the inability of retirement savings funds to offer assured returns have been realised, and the expectations have shifted to competitive fund management to offer the best possible returns. India has the best fund management capacity in the world. Late last year, the Coal Mines Provident Fund Organisation auctioned the fund management of its assets of Rs 20,000 crore to ICICI Securities.

The issue is not the interest rate. It is the lack of political will to reform EPFO. Other than the administrative overhaul, which has been ticking at a slow pace since 2003, no concrete action has been taken. Increasingly, the EPFO is resembling the BCCI — lots of meetings and noise, but no hard decisions. This year the EPFO trustees met seven times before they decided on 8.5 per cent returns, even though the Fund earned less. Contrast this with the EPFO in Nepal, which has slashed the rate of return from 11 per cent in 1998 to 5.25 per cent at present to make sure what it was paying was in sync with its earnings.

The labour ministry and EPFO board continue to sit on the finance ministry’s revised investment norms which could allow the EPFO to invest 10 per cent in equity-linked mutual funds and 5 per cent directly into equities. The finance ministry had relaxed the norms in January 2005. The trustees are not in favour of investing in corporate bonds. While EPFO continues to dither, the Pension Fund Regulatory and Development Authority is setting up the New Pension System for government employees based on competitive fund management and multiple investment options for members. In the case of EPFO, ordinary citizens continue to be dragged into this scheme due to its mandatory nature. Why shouldn’t an employee in the private sector have the option to switch his EPF money to the New Pension System, which offers the prospect of better investment management, therefore higher returns?

EPFO today is literally scraping the barrel to pay the returns it decides every year. On the pension front, EPFO has been unable to carry out much-needed corrections, as it waits for its trustees to arrive at a consensus. In the 1980s, most countries realised the dangers of defined benefit pension schemes, and by the mid-1990’s most had moved to the defined contribution system. But India set up the EPS as a DB in 1995. Within a decade, the estimated unfunded liability of the EPS rose from Rs 43 crore in 2001 to Rs 22,000 crore in 2004-05. With improved mortality and unpredictable interest rates, this number may increase further in the future.

The government can no longer hide behind the fig leaf that the EPFO’s board of trustees has not reached a consensus on major policy reforms.