Column PFs bittersweet month

Written by Manish Sabharwal | Updated: Aug 10 2008, 03:49am hrs
Its been a bittersweet month for the Employee Provident Fund Organisation (EPFO). On one hand it held a spectacularly successful competitive bidding for fund management that gives them good names at an unbeatable price of 0.01% of assets. On the other hand the amendment to include employers with more than ten employees (the previous limit was twenty) under PF coverage represents a tragic triumph of hope over experience and has the potential to fatally undermine EPFOs already questionable financial sustainability.

Lets talk about the fund management issue first. Upset with its earlier fund manager, the EFPO put up the management of its fund for competitive auction. Given tight investment guidelines (mostly sovereign but some corporate debt), fund managers quoted various fees but the final four will be paid 1/100th of 1% of incremental assets. This is a bargain and has huge implications for the proposed national pension scheme (NPS). There is much unfinished agenda (individual account asset allocation flexibility, linking and capping the employee interest credit to earnings, etc) but the auction and free choice of fund managers (unlike earlier unstated restrictions on private managers) represent policy innovation and change at its best for which the EPFO and its leadership must receive credit.

But if the decision to end the earlier fund manager monopoly will revolutionise fund management, why not apply this magic of competition to the overall cost of administration All employers that pay their contributions into the EPFO are required to pay separate administrative fees for 1.16% of salary. This amounts to 4.64% of contributions i.e. 464 basis points. Is the cost of administration really 464 times cost of fund management Employers that manage their own trusts are required to pay 0.18% of salary as inspection charges. This amounts to 0.72% of contributions i.e. 72 basis points. Does mere inspection really cost 72 times fund management As the fund manager auction has shown, the important question is not public or private but competition versus monopoly. Why not allow the record keeping agency for NPS i.e. NSDL to bid for EPFO administration Better still, why not give employers a choice to pay their PF contribution to the individual anchored NPS A benefits plan like EPFO that is anchored to employers (rather than employees) has not kept up with the morphing of the mai baap relationship to the current taxicab transaction. Organising record keeping for benefits like EPFO, ESI, EPS, EDLI, etc by employees (backpack benefits) rather than employer greatly increases portability.

The fund manager triumph notwithstanding, EPFOs future may be doomed by the decision to increase coverage to organisations with more than 10 employees. Samuel Johnson once described second marriage as the triumph of hope over experience. While second marriages have limited downside, this toxic decision flies in the face of experience since EPFO covers less than half of its current mandate and will: a) amplify unorganised employment, and b) explode the contingent pension liability of the government.

This decision represents the death knell for attempts to increase organised employment. EPFO participation requires employees to save 24% of their salary while the IIMS Dataworks annual survey of the Invest India foundation points out that 25% of those employed in 10-19 employee firms save only 9%. Forced savings of this magnitude at lower salary levels are impossible and force informalisation. This decision represents a fundamental misunderstanding by policy makers of the Cost-to-Company (CTC) world; benefits come out of salary and are not over and above it. I guess this arises from the way government bureaucrats are paid where benefits are not monetised. Im not even factoring in questions about EPFOs ability to handle higher volumes without sinking already questionable service. Nobody should be surprised if unorganised employment accelerates.

Not many Provident Fund members realise that 8.33% of their salary is diverted to a defined benefit plan called the Employee Pension Scheme. The last actuarial valuation four years ago calculated the scheme deficit at Rs 22,000 crore. This liability was increasing rapidly with nothing done; it will now exponentially increase with the new members. I bet this hole will be larger than the erstwhile UTI unless benefits are reduced.

History shows that defined benefit plans are dangerous things to fool around with. In the 1950s, GM made pension promises it could not keep and trade unions knew this; union leader Walter Reuther urged auto makers to go down to Washington and fight with us for government pensions. In 1961, GM got away with a wage increase of 2.5% in exchange for a 12% rise in pensions. GM recently acknowledged that in the 15 years to 2007 it spent $103 billion on its legacy pensions and healthcare (versus only $13 billion in shareholder dividends). Financial markets are betting on GM declaring bankruptcy if only to dump pension liabilities onto the government operated Pension Benefit Guarantee Corporation.

EPFO, like GM, has been living beyond its means for the last few years because of regulatory capture by the left. The decision to expand coverage is delusional, akin to trying to treat obesity by mandating small sizes, and may be the beginning of the end of EPFO as we know it.

The author is chairman, Teamlease Services