The objective is to provide the workers with funds when they need it, for specified purposes like medical treatment, education, house building, etc, for which ordinary workers would not be able to access loans from banks, etc. It was on the same lines as the government provident fund (GPF) for government employees.
It was not intended to be a pension fund for workers. Although a pension component was added in November 1995, it is primarily a provident fund organisation, and on an average about 60 lakh withdrawals are made from the fund for the eligible purposes, including at retirement, through the 120 offices of the organisation.
The National Pension System (NPS), now to be covered under an Act, is primarily for government employees, and replaces the defined benefits through budget provisions, with defined contributions into individual pension accounts of government employees who joined service after January 1, 2004. There are no defined benefits and only at the end of service the accumulations in the pension fund (60% of it) is to be invested in the annuity scheme of an insurance company for getting monthly pension, and the rest returned in cash. There is no provision to withdraw during service period in the scheme.
Now let us examine how the pension fund of EPFO works. The pension scheme was introduced in November 1995 by diverting 8.33% of employer contribution to provident fund, into a pool fund (pension fund) without individual accounts being kept (the contribution to provident fund for workers is 12% by employers, and 12% from employees). Even this 8.33% of contribution to pension fund is only up to a wage of R6,500 per month, or a contribution of R542 per month, which is the upper ceiling on wages for pension. If an employee leaves his job or retires before 10 years of service, his pension contribution (which is based on a formula, not very scientific or logical) is returned to him along with his provident fund dues.
In addition to having defined contribution to the pension fund as described above, the pension is also a defined benefit, which, putting in simple terms, is equal to 50% of his average 12-month wage at retirement, with 30-year service, proportionately less, if service is less than 30 years. It has no relation whatsoever to the amount of deposits made by a member during his working period. An employer can double the wages of an employee, in the last 12 months of service, say from R3,250 per month to R6,500 per month to reward such an employee, as he would now get a pension of R3,250 per month, which was his last drawn pay before the increment.
The pension fund also carries with it an element of insurance. If an employee works in a covered organisation for a day, and then expires, his family will get the minimum pension of R700 per monththe spouse and handicapped children, if any, for life, and two children at a time (of his/her total number of children), till they turn 25 years of age (after one of the two turns 25, the pension then passes on to the next eligible child, if any)even though no contributions have been made at all to the pension fund. In the absence of external support (except for a contribution of 1.15% of wages up to R6,500 per month made by government to pension fund), there is a lot of cross-subsidisation among members, which is not even transparent. This is surely not sustainable in the long run, whatever actuarial calculations are made.
Today, there are about 40 lakh pensioners and 4 crore subscribers, so the pension fund is surviving, but as soon as the number of pensioners increase, the fund will start getting depleted, and there is sure to be a crisis in a few decades, or much sooner if the interest rate decreases. Moreover, no DA or revision of pension is done as that would deplete the fund faster. The basic flaw in the pension scheme of EPFO is that it is based on defined contribution and defined benefit, which, without any external source of funding to meet the shortfall, is not sustainable. It is precisely to do away with the defined benefit system that the NPS was established for government employees.
So, what is the way forward The pension fund needs to be converted into individual accounts so that the scheme becomes viable and the pension fund accumulation of each member is transparent and visible to the members, which will invariably incentivise them to contribute more to it voluntarily, if they are assured that the accumulations in their account will be available to them for an annuity when they retire. As for the insurance element, there is already an insurance fund, with huge accumulations in EPFO, from which an appropriate lump-sum for converting to annuity could be paid to dependants of deceased employees, which will meet the social security needs of such unfortunate families. The government contribution to pension fund could then be made to the insurance fund to make the family pension more attractive.
At EPFO, we had attempted in 2010 to bring about a structural change in the system by converting the pension funds into individual accounts on the lines of NPS and make it transparent and viable, and do away with defined benefit. However, there is always a resistance to change, and we could not pursue it then beyond a point, since the first priority at that time was to computerise all operations of EPFO so that the latest account slips were available to the subscribers online.
NPS has been operating for more than 9 years and, so far, has a corpus of R35,000 crore, mostly from mandatory contributions. Surely, more people will not join the scheme for its coffers to swell just because it has now got a statutory cover. The projected returns are only notional, depending on NAV on a particular date, and have not actually been credited to the individual accounts. The actual value will be known only when the amount is withdrawn by an individual, and depending on the value of NAV on that date, the amount could even be less than the capital deposited.
The pension fund of EPFO, on the other hand, is invested in government securities and bonds, and held to maturity (no mark-to-market required) and the interest earned each year is credited to the fund, boosting the corpus. This also applies to the provident fund accounts where the interest earned is actually credited each year.
Once the pension fund is restructured in EPFO as stated above, it could also be opened up for voluntary contributions like NPS. With 120 offices spread over the country, and staff experienced in this work, they would be in a position to mobilise enormous amounts of funds.
So, while retaining their mandatory members, NPS and EPFO could try to attract voluntary contributions. This will not only lead to a healthy competition between the two organisations but will also result in covering a much larger number of workers under social security, without any additional cost to government. The competition will then be based on whether subscribers want real returns to be added to their corpus every year, as in EPFO, or they want notional returns based on NAV, the actual corpus being known only on withdrawal, as in NPS. A win-win situation for the subscribers, as they will be able to choose either or both schemes, depending on their risk appetite.
The author is former central provident fund commissioner