Interesting challenges of PF schemes

Business Line, May 31, 2007 R. VAIDYANATHAN A management and regulatory framework must be created to make the mandatory Provident Fund/pension schemes earn more. This will reduce the noise and debate about the interest rates. R. VAIDYANATHAN looks at the operations of the PF schemes, and to manage their burgeoning corpus suggests a Temasek Holdings-like organisation.

One key question hanging fire for organised sector employees is the Provident Fund interest rate. The Board of Trustees has not been able to arrive at a consensus. Employee Provident Fund Scheme is the most important mandatory retirement scheme applicable to large number of working people in India. The mandatory schemes cover provident fund, family pension fund and deposit linked insurance in factories and other establishments for the benefit of the employees. Apart from factories, the Employees Provident Funds and Miscellaneous Provisions Act, 1952 applies to establishments wherein 20 or more persons are employed and also for units for which the Centre has issued notification for coverage under Section 1(3) of the Act. The rate of contribution was increased to 12 per cent by an ordinance dated September 22, 1997. The wage ceiling for coverage of an employee under the Act was enhanced from Rs 5,000 to Rs 6,500 per month from. June 2001. These schemes are managed by the Employees Provident Fund Organization (EPFO), the Coal-miner's Provident Funds, the Assam Tea Plantation Provident Fund, the Jammu & Kashmir Provident Fund, and the Seamen Provident Fund. Table 1 provides a synopsis of the schemes available vide the Employees Provident Funds and Miscellaneous Provisions Act, 1952 (EPF & MP Act) under three schemes the Employees' Provident Funds Scheme (EPF); the Employees Deposit Linked Insurance Scheme (EDLI); and the Employees' Pension Scheme, all administered by the EPFO. The EPS has the characteristics of a defined benefit scheme and the EPF of a defined contribution scheme. Despite the extremely high contributions, (Table 2), workers covered by the EPF get inadequate terminal accumulations mainly because of liberal withdrawals and poor returns; some even face destitution in their old age.

For 2005-06 nearly 2.24 million EPF claims were settled and Rs 6,072 crore disbursed translates to an average terminal claim of Rs 27,000 or about four months pay at the highest coverage of Rs 6,500. During the same period, an average of nearly Rs 34,000 was withdrawn by members as "partial withdrawal or advances" (EPFO Annual Report 2005-2006, pp 3). In other words the EPF is more like an investment/savings scheme than a pension plan. Actually more than the interest rate debate the real challenges faced by the schemes pertain to Coverage Exemption Contributions Meagre balances Returns Investments mandated COVERAGE Establishments employing 20 or more persons and engaged in any of the 180 industries/classes of businesses specified. Co-operative societies employing 50 or more persons and working without the aid of power. Establishments not covered statutorily can come under the coverage of the Act voluntarily. An establishment continues to be covered under the Act, irrespective of the fall in the employment strength. Since the Act applies on its own force to the establishments, the employers are required to file the particulars in the specified format for registration and allotment of business number.

Membership Every employee, other than one excluded, must be enrolled with the Fund from the very first day of employment. Membership is necessary for all categories of employees irrespective of their being permanent, temporary, casual, whole time, part time or otherwise, and shall include the persons engaged by or through contractors. The number of industries/classes of establishments to which the EPF Act, 1952 applied as on March 31, 2006 was 180. The total number of establishments covered is 444,464 with 43 million members as on March 2006. The the total contribution to the PF is Rs 166 billion and the Family Pension Fund Rs 69 billion. Around 43 million members is still an inadequate coverage considering that the country's work force runs to more than 403 million as per 2001 Census. Less than 15 per cent of the working population has got old age income security, which includes government employees as well as those covered by the mandatory schemes. The major challenge facing the EPFO is enlarging the scope of the schemes to more sections of the working population. In the context of declining nature of joint family system, there is a crying need to provide pension products to the self-employed groups. This can be done by modifying the definition for coverage. It should cover any activity undertaken by 20 or more people in any form of organisation (excluding government). That is, as a company, partnership, proprietorship, cooperative, trust or society. It should also cover all salary/wage income up to, say, Rs 10,000 per month (now, it is Rs 6,500) and leave the rest for other modes of old age security. The cover must be comprehensive. Exemptions can be given only to government organisations. Contribution Table 2 provides the contributions to the EPF, the EPS, and EDLI by employees, employers and the government. The employer contributes 12.5 per cent in almost all industries, of which 8.33 per cent is diverted to the pension scheme. The contribution of the employee goes directly into the Provident Fund and the government provides a small portion of the Pension Fund. The total funding for the EPF scheme is 15.67 per cent and for the EPS 9.49 per cent. The employer also bears the administrative charges for the schemes while neither the government nor the employees do so. In spite of the relatively high funding on the scheme, the balance at retirement is inadequate, as already discussed, due to liberal withdrawal facilities. Interest Rate on EPF The rate of interest is fixed by the Centre in consultation with the EPF's Central Board of Trustees (CBT) during March/April. The rate of interest has dropped from 12 per cent in 2000 to 8.5 per cent in 2005-06. The rate for the coming period is yet to be decided with the EPFO board meeting postponed yet again. PF interest is one of few remaining administered rates. It is operated in an indirect way.

Nearly 80 per cent of the funds are invested in a Special Deposit Scheme (SDS) operated by the Centre. The Government decides the interest rates on SDS from year to year. The SDS is expected to be phased out in the coming periods. When China has invested $3 billion in the new issue of the large private equity fund namely Blackstone; the global markets are gearing for managing sovereign welfare funds. India should form an organisation like Temasek Holdings of Singapore to manage the foreign exchange reserves as also the burgeoning corpus in organisations such as the EPF to earn returns in keeping with the risk factors. There is adequate domestic expertise for this. The need of the hour is to create a management and regulatory framework to make the mandatory PF/pension schemes earn more. That will reduce the noise and debate about the interest rates. (The author is Professor of Finance and Control, Indian Institute of Management-Bangalore, and can be contacted at vaidya@iimb.ernet.in. The views are personal and do not reflect those of his organisation.) (This article was published in the Business Line print edition dated May 31, 2007)