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Money Jan 31, 2012

The EPFO is ruining your savings; time to wind it down

By R Jagannathan

Three unrelated bits of news have a simple connection: they explain how badly we manage our life's savings and investment.

The Employees Provident Fund Organisation (EPFO), the outfit which (mis) manages all our monthly provident fund deductions, is asking the finance ministry to subsidise a higher interest payment for 2011-12. The EPFO's trustees want to pay 8.25 percent based on what they have earned, but the unions want 9.5 percent - what they got last year.

Fidelity Group has indicated that it may want to exit its mutual fund business since it is not growing. After seven years in this country, Fidelity has under 2 percent marketshare in the mutual fund industry. It is losing money, and it's simply not worth its while to stake its global brandname for peanuts.

Managing or mismanaging. Reuters

Last week, the Pension Fund Regulatory and Development Authority (PFRDA) allowed distributors of the National Pension Scheme (NPS) to receive a commission of 0.25 percent on initial and subsequent subscriptions to the scheme. This will energise it. It has so far found few takers since commissions were fixed at an unremunerative Rs 20 per subscriber. At this level, no one was willing to sell the NPS to potential subscribers.

Under the changed incentive structure, the distributor of the NPS also gets a flat Rs 100 for initial subscriptions, and Rs 20 for further subscriptions.

So what's the connect between the EPFO, Fidelity, and NPS?

The first (EPFO) is part of the problem, the second is the result of a weak policy regime on channelising long-term savings into stocks for better returns, and the third is a part of the solution to the problem of low returns on the EPFO. The EPFO can afford to pay only 8.25 percent in a year in which inflation has been close to double-digits. Without a dollop of equity, PF subscribers will get poor or even negative returns after inflation.

The EPFO is a fairly mismanaged organisation that is poor at maintaining accounts and overcharges beneficiaries for the returns it generates. There is a conflict over returns this year because last year the EPFO goofed up: it claimed it had a surplus and announced a return of 9.5 percent. It later discovered that it didn't have a surplus, and actually had a deficit. This is why it has proposed 8.25 percent this year.

But the EPFO's real crime is overcharging for its services (what service?). According to Business Standard, the EPFO charges 6.7 percent as its annual "administrative charges" - which comes from the 1.6 percent of your salary that employers pay it.

Now contrast 6.7 percent with the modest 0.25 percent that the NPS will charge in addition to management fees of a minuscule 0.0009 percent. NPS fund managers have been asking for 0.5 percent as fund management fees (instead of 0.0009 percent) and the finance ministry has shot it down. But it does not consider the EPFO's 6.7 percent usury as a disaster. As Business Standard points out, the EPFO's effective fee structure "would be considered a scandal in the private sector."

The reason why the Fidelitys of the world have to exit India is simple: without an official push to investment in equity through pension funds, it is not possible to get ordinary people to invest in equity funds.

The logical and only sensible thing to do would be to allow either the EPFO to invest in equity or allow subscribers to opt out and migrate to the NPS in stages. Given the quality of the EPFO's fund management, allowing it to invest in equity could be an even bigger scandal than merely charging higher fees from unwary employees.

A better solution, as The Economic Times and some others have been suggesting, is to allow EPFO subscribers to migrate to the NPS voluntarily. This can be done in stages, without rocking the boat.

Firstpost believes that the EPFO, as a somnolent and irresponsible sarkari organisation, should be wound down gradually and its corpus of over Rs 3,00,000 crore distributed among the various fund managers of the NPS.

To facilitate the shift, the government could give subscribers a one-time capital protection guarantee on the initial corpus - maybe for five years. Once the fund managers establish their track records, this guarantee can be withdrawn.

One may ask: why should the taxpayer stand guarantee for pensioners who willingly move to the NPS? The answer is: they are already doing so with the EPFO. Doing that for five more years-and no more-would thus save money in future. In any case, guarantees can be restricted to the poor - those will less than Rs 1,00,000 of outstanding savings.

Either way, the EPFO needs to cut to size. It hasn't delivered.

by R Jagannathan

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