There is a need for NPS and EPFO to shape up

As India progresses towards a pensioned society, addressing select governance issues concerning India’s two major pension organizations—the EPFO (Employees’ Provided Fund Organisation), established in 1952; and the National Pension System (NPS), whose various components have been established since 2004—has acquired greater urgency.

The EPFO is reported to have 50 million active members as of early 2018, equivalent to 9.6% of the labour force of 520 million. Its total membership is much larger due to inactive accounts. But EPFO’s relative lack of past investment in digital-based data management and reporting systems makes it difficult to analyse them. As of early 2018, EPFO’s reported assets under management (AUM) were Rs11 trillion (equivalent to 6.7% of GDP).

In January 2018, the NPS had a total membership, comprising mandatory membership of the central government and those state governments which have adopted it, and voluntary membership by corporate and citizens, of 11.3 million. The assets under management were Rs2.2 trillion (equivalent to 1.3% of GDP).

As EPFO further modernizes its administrative and organizational structure and its investment policies, its assets and active membership will continue to increase. For NPS, its mandatory nature and its design which enables individuals to benefit from compound interest, and its investment options, with low management and administrative costs, will

also continue to exhibit healthy growth. The combined membership of EPFO and NPS of about 61 million, assuming average family size at 4, covers 244 million, nearly a fifth of India’s population.

Governance at EPFO

To help EPFO achieve its goal of becoming a globally recognized professional social security organization, the following governance reforms merit consideration.

The EPFO’s Board structure, which has remained essentially unchanged since its inception in 1952, is not consistent with international practices.

Not only is the number of Board members at 43 too high (Malaysia’s Employees Provident Fund, EPF, with nearly 14 million members, has 17 members), there are no members drawn from those who have professional expertise in the sector.

As EPFO becomes more receptive to modernizing its investment policies, and earn better returns, it should consider setting up an in-house investment unit. The unit would enhance EPFO’s capabilities of understanding financial and capital markets, and managing investment mandates it provides to asset managers more professionally, lowering costs, and benefitting members.

EPFO’s growing asset base, changing expectations of members (particularly of those with large balances), and the constructive competition from NPS (which has usually provided higher returns than EPFO, even when risk levels are made comparable), require that the EPFO consider developing this capability.

Setting up such a unit will, however, be challenging given the skill sets of EPFO’s current staff, and the management’s mindset. EPFO’s communication efforts with all stakeholders will also need to undergo a qualitative change. Its annual report has remained essentially unchanged for decades, and does not convey information that the stakeholders or analysts need. A thorough revamp of the annual report to make it internationally compatible; and making actuarial reports of the Employees’ Pension Scheme, its pension scheme, publicly available in a timely manner, are strongly suggested.

The EPFO also needs to be more focused on setting benchmarks in service standards, and develop an appropriate dashboard to measure its progress.

Governance at NPS

There are two key organizations in the NPS. The first is the NPS regulator, Pension Fund Regulatory and Development Authority (PFRDA); and the other is the NPS Trust. While PFRDA is the overall regulator, NPS Trust oversees the entities of the NPS architecture. These currently comprise two central record-keeping agencies, one Trustee bank, one custodian (Stock Holding Corporation of India), eight pension funds, around 80 points of presence (PoPs: with around 70,000 service providers), 40 aggregators (mainly microfinance institutions and NGOs), and government nodal offices to address grievances.

The number and complexity of entities is expected to grow, greatly expanding the responsibilities of the NPS Trust, and of PFRDA.

Human resources and skills-sets: There is an urgent need for the two NPS organizations to augment and streamline their human resources and skills sets. For example, the digital NPS architecture requires staff with expertise in forensic accounting, data mining and analytical capabilities, and more specialized legal skills.

Human resources of the PFRDA and the NPS need to be as separate as possible. Simply seconding the PFRDA staff to the NPS Trust, as appears to be the case currently, will become less appropriate as the skills needed by the regulator and by the Trust are increasingly diverging. The NPS Trust staff must be fully oriented towards the Trust and its Board, but PFRDA may continue to influence broad human resource strategies of the Trust.

Funding reforms: The NPS Trust Board needs a predictable source of funding, while being fully accountable to the PFRDA. The current arrangement of providing 0.01% of AUM to NPS, and also the fund management charge of 0.01%, need to be made transparent. The funds accruing to NPS Trust could be put under a separate escrow account, from which the arrangements for drawing funds by the NPS Trust can be worked out jointly. The underlying objective of the arrangements should be to ensure that moral hazard on the part of the Trust is minimized, without affecting the need to give a secure and trusted avenue for long-term retirement saving.

This piece was first published at Live Mint on 14 March 2018.