Dormancy in pensions: boon or bane?
Change is the only constant, goes the cliché and nothing reflects it better, or worse (depending on where you stand) than the recent policymaking in pensions. Policymaking has been on steroids, resulting in a dull and prosaic area suddenly bursting with action. Actions in the National Pension System (NPS), improvements in the delivery mechanisms of Employees’ Provident Fund Organisation (EPFO), improvements in portability of pensions and changes in tax laws, are some areas of ‘high-octane action’ in occupational pensions.
While all this action has augured well for some, one should not always confuse activity with progress. Pronouncements have tended to be grandiose, execution flawed. Of more concern are constant flip-flops in policy. A recent example is the one that relates to crediting interest to dormant balances in EPF. The piquant issue of dormancy in pensions bears a deeper look.
Dormant accounts (also termed inoperative accounts in EPF parlance) are inactive balances of members. New contributions are not received in these accounts due to cessation of employment of the member with an employer. Rationally, the funds in any retirement account should be transferred to the employee’s account in the next employer’s programme or settled by payment to the member. When neither of this occurs for a defined period of time, the account or the balance turns dormant. At a higher level, sometimes aggregates of such accounts in a Trust fund may turn dormant too.
Dormancy in pension balances can occur for a plethora of reasons. In an Indian context, the more obvious ones are: employee apathy (account numbers, balances and entitlements are forgotten), employment attrition, poor administration of plans (remember the time you gave up attempting to transfer your provident fund balance after the application was rejected multiple times?) and poorly designed plans. The not so obvious ones are inadequate regulation and poor supervision.
Archaic pension regulation, which dates back 60 years, assumes limited portability and does not factor corporate actions such as mergers, acquisitions and inter-group transfers—a common occurrence today. This, coupled with employer-anchored administration design, ensures dormancy as employers and employees alike find portability a humongous task. Poor supervision accentuates the problem by hiding the extent of the issue. Data is scarce but media reports have stated that about 9,70,000 EPF records were dormant. This in a segment that suffers from over-regulation. One shudders at the thought of the numbers of under-regulated gratuity and superannuation plans that are dormant.
So, is dormancy in pensions an issue? I see two perils in the existence of dormant pensions. The attendant moral risks and the issue of lost entitlement.
During a recent discussion, a client argued forcefully on the positives of dormancy. He cited an example of an employee who left his firm in the 1980s and returned 30 years later to claim his provident fund. The costs of administering the funds of this Rip Van Winkle were borne by his ex-employer—for 30 years.
The same client also cited greater earnings, and correspondingly higher returns, to current members as a positive of dormant accounts. This occurs because funds of dormant members have become return-generating assets without corresponding return-requiring liability. Provident fund design and regulation permitted this for 3 years. This argument brought to the fore the moral risks associated with such accounts.
Trustees have routinely distributed income from earnings on dormant accounts to existing members, often to themselves. Such actions reek of failed trusteeship and flawed supervision—a common malady of pensions in India. When the state joins the circling vultures (remember the proposal to start a senior citizens’ programme using dormant account funds of the EPFO?), one begins to think of failed governance. Robbing a missing Paul to pay an available Peter isn’t exactly a best practice of pension governance.
The issues surrounding lost entitlements are larger. Companies often close down or undergo corporate actions without closing their benefit funds.
In an environment where record-keeping is poor, employees and employers alike find dormancy extremely difficult to tackle.
The presence of dormant accounts and the lack of disclosures also introduces elements of cross-subsidisation of returns, especially where accounting standards do not force marking the assets to market.
The solutions to the dormancy issue are myriad. As is the case with many Indian issues, no single solution holds. The tactical ones include better administration, more technology, greater member education and outreach, better database and single member number systems.
The real solutions lie beyond plumbing; they lie in policy. Multiple plans (EPF, superannuation, NPS) with similar outcomes, regulatory arbitrage, employee and employer choices, financial literacy and compliance are some of the threads that policymakers should consider while the next phase of reforms in pensions occur.
To me, dormancy is a symptom of a greater malady in pension policymaking, which obsesses over compliances and ignores outcomes to beneficiaries. Till this undergoes significant rebalancing, we have to live with dormancy in pensions and its resultant ills.
Amit Gopal is senior vice-president, India Life Capital Pvt. Ltd