How the EPFO can improve as India's largest social security provider
There is a widespread consensus, supported by evidence, that the EPFO (Employees' Provident Fund Organization) has not met its objectives. It has not adapted to the changing economy and aspirations of members.
EPFO administers the EPF (Employees' Provident fund), Employees' Pension Scheme (EPS) and EDLI (Employees Deposit Linked Insurance Scheme) , an insurance cover provided to its members. Managing these three schemes requires different skills, with EPS and EDLI needing robust actuarial skills.
Also read: The nuts and bolts of EPFO
The combined contribution rate of the three schemes varies between 18.83 and 20.83 percent.
Reports by EPFO suggest that as of 31 March 2019, the EPFO had 47 million contributing members (only around 9 percent of the labour force), of which around 22 percent were in only 1,340 exempt funds.Close
EPFO is India's largest NBFC (Non-Banking Financial Company), with total assets under management of Rs 16.6 trillion as at end-March 2019 (around 8.3 percent of GDP). Of this amount, Rs 4.6 trillion (27.7 percent) was accounted for by exempt funds whose investment pattern is regulated by the EPFO.
As at end-March 2019, the total number of pensioners under EPS was 6.5 million, less than a tenth of the population over 60 years of age. All these numbers suggest that the contribution of EPFO to India's social security goals has so far been minimal.
EPFO needs to reform itself on three broad counts: design, governance, and management information systems. These reforms could help EPFO make better contribution to India's social security goals and to meet the aspirations of its members.
The EPF, EPS and EDLI should be re-designed. Given the robust life insurance industry that the country has, EDLI is now redundant and need not be offered to future members, thereby causing minimal disruption to existing members.
The EPF scheme is still being applied to around 200 industries, a feature from the 1950s design. EPF could henceforth be offered to all employees who are eligible, with the list of industries eliminated, as India's dynamic economy spawns new economic activities.
The requirement for firms with 20 employees or more also needs to be reduced gradually as EPFO's capabilities increase. This will enable many more employees to benefit from EPFO schemes.
EPFO has over-generous withdrawal provisions before retirement, thereby drastically reducing the accumulation of members through the power of compound interest. These provisions need to be reduced, as currently the lump-sum accumulated from the EPF at retirement is quite inadequate to finance old age.
The EPS is widely believed, even by many informed government officials, to be actuarially unsustainable. This requires reducing benefits, increasing contribution rates, greater government subsidy, or turning EPS from a defined benefit to a defined contribution scheme (with grandfathering clauses to protect existing members). The sooner this exercise is undertaken, the better it would be for the viability of the EPFO as an organization.
The EPFOs investment pattern has also meant foregoing returns while increasing risk. Globally, provident and pension funds invest in a mix of debt, equity, real estate and other assets, across both domestic and global markets.
A significant portion of their earnings, from which dividends are paid, comes from trading in bonds (not keeping till maturity) and equities in a diversified portfolio.
The EPFO started investing in passive equity funds in 2015 on a gradual basis. But its lack of professionalism has led it to invest in the equity of government public enterprises - an asset class the government is trying to rationalise, including by divesting. Fortunately, the amounts involved are reportedly not very large in relation to its asset under management.
The EPFO needs to invest in broader index funds that mimic the broader stock market.
EPFO's portfolio has underperformed the National Pension System (NPS), resulting in foregone income to its members. EPFO is urged to set up an internal investment management unit that can help minimize investment management costs, and act as a benchmark to assess the performance of outsourced investments. For this, recruitment and promotion practices will need to be revamped.
Alternatively, a separate government-appointed specialist group with accountability could be formed to undertake the EPFO's investment function
EPFO's 43-member Board structure, with the Minister of Labour effectively appointing all the members - none with expertise in pension economics, finance, actuarial, and management information specialists - is unwieldy, and not conductive to outcome-oriented management. The key is to bring expertise to the EPFO Board of trustees to manage its responsibilities with competence and professionalism.
The EPFO should not continue to be a service provider as well a regulator of exempt and non-exempt funds. The two functions must be separated.
The provision of permitting EPF members and NPS members to choose between the two should be more effectively implemented as such competition would push efficiency levels in both organizations.
Management Information System (MIS) reforms
The EPFO's use of digital technology to deliver routine services has improved, but there is still scope for improvement. Settling provident fund payments, and competing pension arrangements in a shorter time after retirement are important areas.
The EPFO, however, needs a major revamp of its MIS. It must develop a dashboard, to be refined as experience is gained, which includes the following data: members and actual contributors to its three schemes both as a flow and as a stock; contributions and withdrawals for different purposes to each scheme during a period; rate of return earned by different schemes and by asset classes, stock of assets for each scheme; and balances by income range, gender, and age group.