EPFO's pension mirage

Dec 13 2013, 09:21 IST
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SummaryEmployee Pension Scheme is slowly defaulting on its promises and should be scrapped.

The appeal to the Congress leadership by the ministry of labour to overrule the prudent and valid objections by the ministry of finance on proposed tweaks to the Employee Pension Scheme (EPS) reinforces two things(1) any pension reform debate involves people not only coming with their own opinions but also their own facts; (2) these tweaks are short-term, politically-driven rather than greater good motivated. Wed like to make the case that EPSstarted by the Employees Provident Fund Organisation (EPFO) in 1995 despite employer objections and continued because of a Supreme Court Judgementshould be scrapped because (a) its design has birth defects that make it unviable without huge and continuous government infusion, (b) it is slowly reducing benefits despite a commitment to the Supreme Court that it would not need to, and (c) employees would be better off in reverting to individual defined contribution accounts that existed before this tinkering by EPFO.

The EPS saga has not villains but it does have victims. The noble original motivation of providing a monthly income linked to salary and working years has been negated by various design deficiencies, a one-size-fits-all structure and unrealistic assumption around investment returns, life expectancy and EPFOs administrative capabilities. Most importantly, the benefits as originally envisaged are actuarially unsustainablethe deficit in 2009 was pegged at R54,000 crore. Since introduction, a number of modifications to the scheme have broken the connection between contributions and benefits. In 2008, the factor adjustment used for early pension was increased from 3% to 4% and the option for return of capital and commutation was deleted. In the same year, the factor for benefit payment of those who moved from the early scheme to EPS was adjusted to reduce benefits by 1% to 40% and the factor for resignation payments before 10 years was reduced by 3-6%. In 2010, the cap on wages for international workers was removed, essentially creating another subsidy for the scheme since most of them do not claim benefits. Recently, EPFO proposed to increase the ceiling for contribution and benefits that, in effect, will be negative for most participants. Even without the last change, the poor value for money of EPS is demonstrated by the accompanying table that contrasts the payments between EPS Pension, LIC annuity, and the interest on the lump-sum that would have accumulated had the EPS never been started (the calculation assumes the current wage cap of Rs 6,500 for

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