Five months before the 1996 general elections, the Narasimha Rao government introduced a populist new pension scheme for workers that offered survivor benefits, allowed premature withdrawals and an option to pull out a chunk of their accumulated savings at the time of retirement–-without a penny going from employees’ share of provident fund contributions. Launched when the world was realising the dangers of lavish pension promises and mulling a switch over to defined contribution pension systems, the Employees’ Pension Scheme 1995 was the only scheme in the world where both benefits and contributions are fixed.
Nearly five months before the 2009 Lok Sabha elections, fearing that the ill-designed scheme’s deficit could shoot up dramatically if the recent decision to expand the coverage of the EPF Act to firms employing ten employees is implemented, the UPA government is doing away with the option to withdraw a lump sum amount from the scheme at retirement. It is also creating disincentives for workers who are considering premature withdrawals from the scheme.
The changes in the scheme’s rules, being notified by the labour ministry, will result in a saving of Rs 42,300 crore, which will be sufficient to wipe out the current deficit. The ministry had already reduced the rate of return given to workers withdrawing from the scheme before completing ten years of service, reducing the scheme’s liabilities by Rs 11,936 crore. Combined, these three measures will cut the scheme’s projected outgoes by Rs 54,236 crore.
Conservative departmental estimates put the scheme’s deficit at Rs 40,000 crore- Rs 45,000 crore by now, though officials admit it could be much higher. Though an annual actuarial valuation of the scheme (to examine assets vis-à-vis projected liabilities) is mandated in the rules, the scheme hasn’t been valued at all since the UPA came to power. The last valuation of the scheme—as on March 31, 2004—revealed an unfunded liability of Rs 22,021 crore.
“The valuations are being brought up-to-date. We have recently appointed an actuary and are providing the requisite data to furnish the valuation reports for 2005, 2006, 2007 and 2008,” a senior official told FE.
The draft Cabinet note, prepared by the labour ministry, to expand the coverage of the EPF Act to establishments with at least ten employees, from 20, is being vetted by the law ministry. The finance ministry has expressed concerns that the change could double the current deficit in the EPS 1995 and hence, stressed on the need to fix the shortfalls before implementing any changes.
So, even if the current deficit is Rs 40,000 crore, it could rise to Rs 80,000 crore as the change in coverage rules will bring in many more workers into the scheme’s fold. In 2001, when the Centre increased the salary ceiling for mandatory coverage under the EPF Act from Rs 5,000 to Rs 6,500, the scheme was hit by a Rs 10,000-crore deficit.
The proposed changes in the pension scheme rules will not impact workers’ post-retirement pension benefits but help the scheme’s viability, the labour ministry explains. “We are arresting the increase in the scheme’s deficit by doing away with the provisions for commutation of pension and ‘return of capital’. Commutation, which allows workers to convert a part of their monthly pension income into a cash lump sum to meet immediate big-ticket liabilities at the time of retirement, isn’t essential as Indian workers already get a lump sum benefit from their PF and gratuity funds,” a senior official pointed out.
Commutation of pension is a mechanism that helps workers meet some contingent lump sum obligations, such as for a child’s education or marriage or closing a mortgage, at the time of retirement. However, since Indian workers get a lump sum from their PF as well as gratuity funds, the commutation option in the pension scheme isn’t necessary. “The idea is to safeguard the pension income. The commutation reduces the actual monthly income for retirees dramatically,” a senior EPFO official explained.
“Commutation is relevant in European nations, where there are no PF or gratuity funds for workers,” an official explains.
Though the Employees’ Provident Fund is a colonial legacy, the British themselves and most advanced Commonwealth nations have abandoned the PF system decades ago.
The other change in the scheme is meant to not just fix its deficit but also curb immediate outflows. In 2006-07, of the Rs 3,532 crore claims settled by EPFO on the EPS account, over Rs 1208 crore was for claims other than monthly pension income.
“For those who want their pension payments to start before the retirement age of 58, we currently reduce their pension by 3% for each missing year of service. Though the actuaries have been recommending raising this to 5% to dissuade members from claiming early pension, we have raised it to 4%,” the official said.
In June, the labour ministry had reduced the rate of return on EPS contributions given to workers who withdraw from the scheme before completing ten years of service. “Earlier, we used to give 10-11% returns on premature withdrawals of EPS. It was actually profitable to withdraw from the scheme and rejoin with a new account, especially given the higher mobility seen in the labour market over the last decade,” a senior EPFO official explains. Now those who exit early from the scheme will get only a 6% return on their EPS savings.
The EPS 1995 is entirely funded by the employer’s share of PF contributions and a central government subsidy. The EPF contributions amount to 24% of a workers’ salary– with both employer and employee contributing an equal 12%. From the employer’s share, 8.33% of the salary is deducted towards the pension scheme. The Centre makes a contribution of 1.16% of salary towards the scheme — the exchequer’s liability on this account has risen from Rs 600 crore in 2004-05 to Rs 1340 crore in 2006-07.
The EPS 1995 had been introduced through an ordinance on November 16, 1995. It was carved out of the Family Pension Scheme 1971, which had a surplus. The 1971 scheme didn’t allow commutation of pension or premature withdrawals.