Back Pension reform — Risk-sharing, the smart way to manage funds
G. Srinivasan
| With over four crore workers covered under the EPF Scheme 1952, the Employees' Provident Fund Organisation is finding it difficult to meet its obligations as it has been called upon to disburse interest at rates higher than its investments fetch. The New Pension System put in place by the erstwhile NDA government, buttressed by the provisions of the Pension Fund Regulatory and Development Authority Bill, 2005, will hopefully ensure that the subscribers' interests are protected, says G. Sriniv asan. |
With improved life expectancy, old-age income security is a growing concern.
As it is, the PFRDA Bill, introduced in the Lok Sabha on March 21, was opposed from Day One, when the Left parties staged a walkout, subsequently, the Bill was referred to the House Panel on Finance.
With improved life expectancy, , the problem of old-age income security can no longer be brushed aside, particularly when the Employees' Provident Fund Organisation (EPFO) under the Employees' Provident Fund and Miscellaneous Provision Act, 1952, was finding it difficult to run its three schemes — the Employees' Provident Fund Scheme, 1952; the Employees' Pension Scheme, 1995; and the Employees' Deposit Linked Insurance Scheme, 1976.
That the EPFO was finding the going tough was widely acknowledged. With 4.09 crore workers covered under the EPFS, 1952 as on end-February 2005, the EPFO finds itself practically bankrupt, largely because of the policies of successive governments. The Organisation has been called upon to disburse interest at higher than market rates, though its investments do not fetch such high returns.
It is only recently that the Finance Ministry ratified the 9.5 per cent interest rate for 2002-03 and 2003-04 under pressure from coalition partners. For 2004-05, the Finance Ministry has not yet fixed the interest rate for EPFO subscribers, though the EPF balance-sheet shows that it can afford to pay its subscribers only 8.5 per cent.
To find ways to bridge the shortfall in the Fund and to ratify the interest rate for 2004-05 as also discuss the rate for 2005-06, a crucial meeting of the Central Board of Trustees of the EPF is scheduled for May 28.
Pension liabilities have grown faster than nominal gross domestic product (GDP), and some experts reckon that in the last 17 years, nominal GDP grew by a compound rate of 14.5 per cent while the Central government pension outgo has spurted at a compound rate of 17.8 per cent. The result is that, according to the National Council of Applied Economic Research (NCAER), along with State-level pensions, pensions now account for 1.64 per cent of GDP, which the Government can "ill afford" to discharge when there are competing development outlays to be met. The Labour Minister, Mr K. Chandrasekhar Rao, admitted in a written answer in the Lok Sabha that as on March 31, 2005, Rs 2,105.37 crore was outstanding from the defaulting establishments. The EPFO has launched a special drive for recovering outstanding dues by formulating special recovery squads in each of the regions and stepping up its coercive action under the law.
If only the EPFO can recover most of the arrears from defaulting companies, it can invest those amounts to pay the higher interest rate it has committed itself to. The Finance Ministry can ill afford to keep pressing the `pause' button vis-à-vis the Fiscal Responsibility Budget Management (FRBM) Act just to bail out the EPFO.
The investment pattern by the EPF was 25 per cent in Central government securities, 15 per cent in State government/government guaranteed securities, and 30 per cent in bonds of public sector undertakings/public sector financial institutions/term-deposit receipts. The remaining 30 per cent comes under the residual category drawn from any of the three aforesaid categories.
So, with the general interest rate not being higher, the yields from these investments were not sufficient to dole out the higher disbursements to subscribers.
Be that as it may, it is fortunate that, the erstwhile National Democratic Alliance (NDA) Government had put in place a new, restructured defined contribution pension system, which was made mandatory for all new Central Government recruits (excluding Armed Forces, in the first stage) with effect from January 1, 2004.
The monthly contribution of 10 per cent of the salary and dearness allowance to be paid by the employee and matched by the Central government. The New Pension System (NPS) would be available, on a voluntary basis, to all persons including self-employed professionals and others in the unorganised sector.
The Government, after extensive and exhaustive consultations and taking into account the various sections, decided to have a funded pension scheme, where members have investment choices. In fact, the Finance Minister, Mr P. Chidambaram, unveiling the 2005-06 Budget, said through the new scheme, it was proposed to offer the subscriber a menu of investment choices and to provide a strong regulatory mechanism to ensure that the subscribers' interests are protected. He also appealed to workers all over the country to join the new pension system as it is designed to fix the Government's pension liability upfront and ensure old age income security to subscribers.
With this intention, Mr Chidambaram introduced the Pension Fund Regulatory and Development Authority Bill, 2005. The Bill's statement of objects and reasons clearly spelt out that "an early legislative mandate" was deemed necessary as the NPS was already in vogue without the full architecture and a statutory regulatory mechanism.
The Finance Minister conceded that contributions are not being invested as envisaged under the NPS and are being credited, in the interim, to the public account, earning an administered rate of return equal to the rate on the General Provident Fund. Moreover, he said, more than 40,000 new Central government employees are mandatorily covered by the NPS since January 1, 2004 and it was essential to swiftly replace the interim arrangements with proper infrastructure under a regulatory framework to avoid complications.
It is particularly noteworthy that as many as seven State governments — Andhra Pradesh, Chattisgarh, Himachal Pradesh, Jharkhand, Manipur, Rajasthan and Tamil Nadu — have notified and introduced defined contribution pension schemes and intend to join the NPS.
The Bill explicitly provided for private pension funds under which the PFRDA might permit one or more persons to act as a pension fund for the purpose of receiving contributions, accumulating them and making payments to the subscribers in such manner as may be specified by the regulations.
Under the `safe option' of the NPS, employees or pension fund operators would invest 60 per cent in government securities, 30 per cent in corporate bonds and up to 10 per cent in equities. Any contributor to the new pension scheme will have three options.
It is on these two issues of allowing private pension funds to dabble in equities of the `sweat funds' of the working class that the Left parties have voiced serious reservations in supporting the Bill and even protested against the PFRDA's introduction in Parliament. In order to prevent them from remonstrating too much, the Government, as a quid pro quo, is reported to have allowed the 9.5 per cent interest rate for EPF subscribers for 2002-03 and 2003-04.
While this is inevitable in coalition governance, the reported remarks of the PFRDA Chairman, Mr D. Swarup, recently that the Authority is considering "a safer option" under the new pension scheme, by which the entire corpus would be invested only in government securities, cast doubts over the umpire's role.
There could be a default option too. In case an employee does not specify any option, his choice would automatically be construed as the safer option. On both counts, the attempt appears to please the political partners.
If that were to materialise, private pension funds would feel frustrated in managing the corpus funds as the avenues for deploying funds where it fetches the maximum yields without compromising the prudential norms would be slammed shut.
Even otherwise, transferring a portion of the risk to those who contribute to the fund, rather than offering assured returns, as has been the practice, is only a sustainable way of managing the funds.
The regulator of the brand new pension system has his work cut out for him. His first task is to wean the pension system from the politicians' influence.
The funds would be well managed by professionals with the risk-to-reward remaining the yardstick and in which none of the stakeholders, not even the subscribers, expect any phenomenal rate of returns.
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