Ministry Of Labour Gets Its Priorities Wrong

. . . and that is reflected in its proposal to establish  a workers’ bank

Press reports suggest that the Ministry of Labour has formed a committee to explore the proposal of the EPFO (Employees’ Provident Fund Organization) to set up a worker’s bank. The EPFO is a statutory body, but effectively its functioning and governance effectiveness are dependent on the quality of leadership provided by the Ministry of Labour.

Such a proposal was made in 2011 and found to be not feasible by a committee which examined it. Reviving the proposal to set up a workers’ bank now reflects misplaced priorities of the EPFO, and by extension, of the current leadership of the Ministry of Labour.

Modernize the Governance Structure

The EPFO was set up in 1952 to provide retirement income security to private sector workers in establishments employing 20 or more workers. In spite of such a long period of existence, it has not been effective in evolving into a professionally managed, service-oriented, learning organization which is able to incorporate new organizational, service delivery and technological developments in its functioning and governance.

Its governance structures, comprises of a 45-member Board of Trustees, (15 members each from government, labour unions, and employers), each of whom is approved by the Minister of Labour. There are no term limits for the trustees, severely constraining infusion of new ideas, which as growth theory literature strongly suggests are the main driver of organizational performance. As there is little room for domain expertise or for new ideas in such a governance structure, it is unsurprising that the EPFO as an organization has neither been effective nor responsive.

It should be noted that the India’s Company law requires a minimum of three and maximum of 15 Board of Directors. The public sector statutory boards, such as EPFO, must set an example by following what is prescribed for companies as a good governance practice.

Among the major priorities of the EPFO, and particularly that of the Ministry of Labour, should be to focus on modernizing governance structure of the EPFO, and other statutory boards under the ministry. The composition of the Board should reflect domain expertise and skill sets needed to manage for long term viability a provident and pension fund, with high weightage to fiduciary responsibility.

The EPFO and Ministry of Labour should be held accountable according to the progress made by the EPFO in a benchmarked manner, for it to be regarded as an effective social security organization internationally; and by its service-orientation towards members.

Proposal inconsistent with economic logic

One of the arguments made by the EPFO in favor of establishing a bank is that if EPFO  performs the functions that it outsources to the banks, it can save on charges and commissions!. This statement is hugely puzzling as it is inconsistent with economic or financial logic. Why would an organization with no experience or competence in banking perform banking functions with lower economic costs than a specialized institution? Such statements strengthen the case for drastically reducing the size of the Board of Trustees, and introducing domain expertise in the Board.

Trespassing into areas, such as workers bank, in which it has no competence, and in which the organization merits no confidence by the stakeholder, including the taxpayers, represents misplaced priority. Taxpayers are concerned because the ultimate contingent liability of EPFO’s inability to meet its promises is on the government i.e. the taxpayers themselves.

Improving Performance Indicators

The following discussion suggests why the priority of the EPFO and the Ministry of Labor should be on improving its performance indicators by reviewing its administrative, human resources, and technological policies.

Low Coverage of the Labor Force and of Businesses

First, even after 63 years of operations, it is able to reportedly (but not verifiably by independent sources) collect regular monthly contributions from around 43 million workers, only 8.3 percent of India’s labor force of 520 million. The EPFO claims (again not verified) to have 110 million accounts (not individual members), suggesting that only two-fifths of the accounts are active. The EPFO is able to cover only 0.8 million of nearly 60 million businesses in India.

This is a reflection of poor management, inadequate technological base, and inappropriate skill-sets of its staff. Such a high proportion of inactive accounts also contribute to high administrative costs. EPFO’s administrative costs of 440 basis points makes it among the most expensive provident fund investing almost entirely in government securities. The design of administrative costs levied on the employers as percent of covered payroll does not provide incentives to EPFO to improve efficiency or lower compliance costs.

A recent step in significantly reducing this percentage (from 1.1 percent of covered wages to 0.85 percent for the EPF scheme) is welcome, but does not alter the above argument. Just as in tax policy and administration, non-adversarial environment needs to be created by the EPFO.

The EPFO has reportedly used some of the unclaimed balances (it calls them suspense accounts) to pay dividends, an undesirable governance practice.

Its continuation of EDLI (Employees Deposit Linked Insurance Scheme), introduced in 1976, but whose purpose is no longer relevant with widespread availability of life insurance products, represents an example of a static non-learning organization. Its statutory nature raises cost of employing labour, without commensurate benefits.

An organization with a membership of about one in eight workers should not be regarded as representative of the interests of the Indian workers in general. Indeed, the interests of the EPFO members are often at variance with the interest of the Indian workers as a whole. Thus, the Indian workers would benefit from expansion of manufacturing and service jobs, and high growth. But as has been noted by the analysts, mandatory contributions to the EPFO, ESIC (Employees’ State Insurance Corporation) which administers health care services, and others, account for about 45 percent of wages of those covered employees with a monthly salary of INR 5500, but only about 5 percent for an employee with a monthly salary of INR 55,000/, provided statutory wage ceiling norms are followed.

Substantial Scope to Improve Stakeholder Communication

There is substantial scope for improving the quality, relevance, and timeliness of its communication with stakeholders.

Thus, the last Annual Report on the EPFO website as of April 27, 2015 is for 2012-13. The contents of the 2012-13  EPFO report do not compare well with reports of the PFRDA or with reports of similar organizations internationally.

The EPFO report does not provide data on active and non-active members such as balances of active and non-active members, grouped by accumulated balances, and by gender. These accumulated balances are unlikely to be enough for retirement. That the EPFO does not even feel the need to publish such basic data illustrates its lack of stakeholder service orientation.

These omissions suggest poor data management capabilities; lack of urgency in communication with the stakeholders; and low priority given to fiduciary responsibility.

Instead, EPFO’s Annual Reports stress compliance and its sovereign powers of punishment under the Act. An analysis of performance, benchmarked to international standards, and its progress towards service orientation, and initiatives to reduce compliance costs which could help improve voluntary compliance by establishments, and enhance confidence of the stakeholders in the organization are not emphasized.

These qualities will increasingly need to be acquired and then sustained as greater choice between EPFO and the National Pension System (NPS) is effectively exercised as being envisaged by the government.

NPS as compared to EPFO:

The main disadvantage of the NPS over the EPF Employees’ Provident Fund) scheme of the EPFO is that withdrawals at retirement from EPFO are exempt from income tax, but for NPS, these are currently subject to tax. This uneven tax treatment between two similar retirement products is expected to be addressed by the policymakers. Only around 35 million individuals in India pay individual income tax (6.7 percent of the labour force), so this tax treatment is a relevant issue for them.

On the other hand, the returns provided by the NPS have consistently exceeded returns provided to members of EPFO, even when comparable portfolio is used. Thus, according to the 2014 annual report of the PFRDA (pension Fund Regulatory and Development Agency), for the three years ending January 31, 2015, Scheme G of the NPS investing in government securities provided annual return to members of between 10.69 percent and 11.27 percent depending on the fund manager. In sharp contrast, the returns to EPFO members were 8.75 percent in 2012-13, and in 2013-14, a difference of percentage points between 1.94 and 2.52 percent.

Total EPFO investments as at March 31, 2013 were INR 6322 billion, equivalent to 6.3 percent of 2012-13 GDP. This suggests potential loss of INR 123 Billion and INR 159 billion for EACH of these TWO YEARS.

That an organization entrusted with balances equivalent to 6.3 percent of GDP does not have an in-house investment management department, and who because of its lack of competence in modern investment management policies and practices, each year forgoes potential returns (even when greater safety and returns from portfolio diversification are ignored) should have priorities other than establishing a workers’ bank should be self-evident.

The Prime minister in his recent trip to Canada met its pension funds to invest in India. Canada’s largest pension fund manager, the Canada Pension Plan investment Board (CPPIB) has plans to invest USD 332 million in India’s infrastructure projects through a tie up with India’s Larson and Toubro. It is ironic that while India woos pension funds of other countries to invest in India, India’s largest provident and pension fund is not capable of modern investment management and practices. This competence gap must be addressed by the EPFO before even considering unrelated areas such as a workers’ bank.

The Actuarial Deficiencies of the EPS (Employees’ Pension Scheme)

The EPFO is an unusual organization in combining a DC (Defined Contribution) method under which contributions are defined, but not the benefits obtained, as evidenced in the EPF scheme; and DB (Defined Benefit) method under which benefits are defined, but its funding through contributions, investment income, and government subsidies is not defined, as  evidenced in the EPS (Employees’ Pension Scheme). The DB method requires assets and liabilities of the scheme to be in balance over a long period of about 75 years.

The last actuarial report available on the EPFO website (www.epfindia.com) for the EPS scheme is however for period ending March 31, 2008. Even that report was submitted in September 2012.The report (para 12.2) notes that:

“it is not known how far the data set valued is representative of the total membership of the Scheme. Therefore neither the estimation based on the results of actual data set nor the valuation results on the derived grouped data of members… could be taken as the actuarial liability in respect of members in service.”

The report projected the actuarial deficit as at March 31, 2008 of INR 542 billion. Since then the press reports suggest that the actuarial deficit had increased to INR 620 billion in 2009.

The 2009 deficit is equivalent to about half of the total investments in EPS in 2009. The actuarial report and others have argued for restructuring the EPS scheme to bring about actuarial balance over time. The EPFO members are on the whole in the top-half of the income group, but if taxes are used to finance the EPS deficit, these will be paid by all groups, including lower income group. This is one of the subtle ways in which interest of trade unions on the EPFO does not coincide with the interests of Indian workers as a whole.

In conclusion, the above analysis strongly suggests that the proposal by the EPFO and its encouragement by the Ministry of Labour represent misplaced priorities. It is time that the focus should be on transforming EPFO into professionally managed, service-oriented, learning organization which is able to incorporate new organizational, service delivery and technological developments in its functioning and governance.