Designing an efficient pensioned society

Now that the brouhaha surrounding taxation of provident fund and it’s withdrawal is over—at least temporarily—it is time to re-focus on other aspects of the design of pension in the formal sector. The government wants a pensioned society. The two primary programmes that will get the organised sector there are the Employees’ Provident Fund (EPF) and the National Pension System (NPS). Both intend to provide retirement benefits though they differ in design and ethos.

The EPF is a near assured-return scheme. It is similar in design to a bank deposit since it is an interest bearing instrument. Interest credits are possible on the liability side since assets largely comprise bonds. This asset allocation makes the EPF a poor hedge against inflation. Till recently, the EPF was solely invested in bonds, but that changed this year with a decision to invest small sums (5% of the incremental flows) in equities. It delivers a lump sum on retirement. The EPF has ancillary schemes. One, a defined benefit mess (the Employees’ Pension Scheme, EPS) that few understand and most write off, and another, an insurance scheme that was insignificant in benefit entitlement, till recently. The EPF is largely employer-anchored though as part of a technology initiative of the Employees’ Provident Fund Organisation (EPFO), it is increasingly employee-anchored these days. For long, the EPF has been treated as labour regulation and not a retirement product. This stunted its evolution as a financial product.

The new kid on the block is the NPS. It was designed primarily to fill the gap in civil servants’ pension, and is styled on the US’s 401(K) programme. It is unitised, and gives members choice of investment managers and asset allocation. Benefits are delivered as lump sum and annuities. However, it has a limited track record in handling scale and complexities that surround a multi-employer, multi-location environment.

So, how does one marry the varying hues of the two programmes and bring about a social security ecosystem that delivers an adequate replacement rate at minimal costs to various stakeholders? Pension design can be complicated but here are a few big picture imperatives.

Government should stop playing favourites: It is fashionable these days to indulge in EPF bashing. Issues of the EPF are due to poor implementation of a well-designed programme. In a country low on financial literacy, an interest bearing retirement product such as the EPF has significant constituents. The government should be neutral with its stance manifesting itself in the form of parity in taxation and two-way portability. The proposed portability out of the EPF and into the NPS is designed to make it a one way street.

Single regulator and competition among other providers: The best thing to happen to the EPF was the NPS. Competition forced the pace in technology adoption and drove changes in asset allocation. The beneficiaries of these changes are employees (better services) and employers (lower costs). Imagine a design that results in a single regulator with multiple administrators, investment managers, and annuity providers. While most of the plumbing is in place, significant changes should occur in mindset. This will pose the biggest challenge given the legacies and conflicts that exist in current roles, especially of the EPFO.

Sunset defined benefit programmes and shift solely to defined contribution plans: Defined benefit plans queer the pitch in any pension ecosystem. They are expensive and often suffer design and implementation abuse. They create transmission losses in a high mobility age. But they are also difficult to exit. Sunsetting EPS and gratuity in the long run will result in shifting allocation of funds to more sustainable defined contribution plans. This may not be popular among employees, but a programme with limited solvency risks is a better than one with potential bankruptcy and funding risks.

Backpack benefits to employees and limit employer’s fiduciary role: Today’s high mobility era requires funded retirement benefits to backpack on the employees and not on employers. The era of employer-based benefits should end. Record keeping, database maintenance and such administrative actions should not be an overhead for employers. Technology and process should make this a reality. As corollary, employers should be responsible for funding and filing and little else. Compliances should be technologically monitored.

Retain and encourage tertiary programmes: Retirement programmes like superannuation and benevolent funds encourage people to save additional money. Unfortunately, these get branded as elitist and do not receive much focus. In recent times, they have borne the brunt of hostile tax regulation, and employer and employee apathy. In reality, these play a significant role in pensions, especially when increasingly employees admit that employer-linked programmes are the primary source of retirement corpus. Portability between such voluntary and mandatory programmes will help.

Incentivise employees to use these products: A society cannot be ‘pensioned’ solely through supply-side initiatives. Employees should be fiscally and otherwise incentivised to subscribe to these products. Separately, an ecosystem of advisers should be tasked with educating employees. Savings from technological deployment can be used to fund such initiatives initially and later employees can pay for such services. The ‘educate versus distribute’ conundrum is bound to rear its head but can be mitigated by employer-driven intervention.

Just 6% of the country’s workforce works in the formal sector. Penetration of pensions in this sector is high due to the obsession with compliance. The move to a pensioned formal sector will have to mean more than compliance. Recognising this will be a good place to start.

Amit Gopal senior vice-president, India Life Capital Pvt. Ltd