Monday, July 28, 2014

What has happened to our EPF money?

The Sunday Times has published a report on the EPF that gave me an unpleasant shock. The fund does not appear to have the money to repay it's members.

Before getting into the details, lets understand what the fund is and what it is supposed to do. The Employees Provident Fund (EPF) was established under Act No. 15 of 1958 and is currently the largest Social Security Scheme in the country. It is a compulsory fund, all employers regardless of the size or type of business must contribute to the EPF, even if they have only one employee.

The standard contribution is a percentage of the monthly salary of each employee; the employer contributes 12% and the employee 8%. Each month's contribution must be paid before the last date of the following month. Late payments are subject to penalties ranging from 5% to 50%.

The EPF contributions are supposed to be invested for the benefit of the employees. On retirement, the employee can withdraw whatever balance is to his credit - this should be the amounts contributed over the years plus whatever interest earned.

The critical point to note is that the EPF is fully funded by its contributors. The Government does not put in one cent. All the employee gets back is what was paid in by himself and his employer (plus whatever interest).

Therefore there cannot be any shortfall in funds - unless something is seriously wrong. Yet this is what there appears to be - a shortfall in funds. According to the report it appears that withdrawals from the fund by retirees are being paid out of the new contributions made by members.

"Employers’ contribution to the EPF in 2011 was Rs. 61.9 billion with a sum of Rs. 47.3 billion being withdrawn to pay back EPF money for retirees and this amounted to 76 per cent of the total contribution....In 2012 and 2013, 115,000 and 114,000 applicants had withdrawn Rs.48.7 billion and Rs. 50.2 billion, respectively. Employers’ contribution for EPF in 2012 was Rs.70.6 billion and in 2013 the contribution was Rs.80.9 billion."

What should happen by rights is that the withdrawals need to be paid from the investments made, the fresh contributions made by existing members must be invested to provide a return for the new contributors, not pay the retirees. This probably happens on paper but the fund is obviously facing serious problems of cash flow.

So what has happened to our money?

According the EPF's annual report for 2011, 90% of the funds are invested in Government securities, 7.9% in the stock market and the rest in corporate debentures and other debt instruments.

A couple of things raise a red flag.

First is increase in the proportion of the fund invested in the stock market which has jumped from 1.3% in 2009 to 5% in 2010 and 7.9% in 2011.

The second is the delay in publishing the annual reports for 2012 and 2013. We are seven months into 2014, yet the latest accounts available are for 2011. Late publication of accounts is often one of the first symptoms of malpractice. My big worry is has the percentage of funds invested in the stock market increased significantly since 2011?

We have learned of the fraud that has taken place with regard to the fund's stock market investments. A loss of 11.7 billion was reported in 2011 due to stock market losses - insignificant compared to the funds balance of Rs.1,300 billion but compared to the contributions and withdrawals in 2011 the loss is very significant: 18.9% of the contributions or 24.7% of withdrawals.

We know that a part of our money has been lost through fraudulent investments in the stock market. What of the rest? There have been other unauthorised investments such as Rs.2.97 billion on a power generating company,  Rs.810m in a loss-making hotel, Rs.500m in an airline (Mihin Air, perhaps?) and some others. (See this report for a few more details). The biggest issue is that we do not have proper information which prevents in-depth analysis- the easiest way to cover a crime is by hiding the evidence, hence the ongoing campaign against transparency in all spheres.

Regardless of the stock market and other dubious investments I believe the bulk (75%-80%) is still in treasury bills and bonds. These are Government debt and there should be no issue with cash flows - unless the Government is bust and unable to service its debt. This, I am afraid is the sad reality that is becoming ever more evident.

In simple terms, the Government has borrowed this money from the EPF. It now needs to start repaying and is facing difficulties. The way the Government handles this with other lenders is simple - they simply borrow some more and repay the loan. They take new loans to pay old ones and even have to take additional loans to pay the interest (I have looked at this issue in come depth here).

So why not do that with the EPF? The reason is that they are trying very hard to 'manage' the debt statistics. With external lenders there is no choice but to repay - when the money belongs to ordinary citizens then the Government will try some tricks to postpone payment. This is the driving force behind the moves to turn the EPF into a pension scheme. A lump sum payment will be repaced with a monthly payment, paid over heaven knows how many years.

The sustainability of Sri Lanka's debt is an issue, the rating agency Moody's recently warned that overall debt affordability is weak. The Government will not admit that it's debt levels are too high, but it's actions in this instance betray the reality of the situation.

After all, it is not Government money that we are asking for, it is our money that was given to the Government that we want back. Is that too much to ask for?


Ratmale left an excellent comment on this post. With regard to administration costs, it is essential that these be kept to a minimum. As per the annual report, the EPF administration cost is around 0.68% of the fund. However the Government runs two funds the EPF and the ETF. Both funds can be managed by a single entity with almost no increase in administration costs, so for optimal benefit the management of both EPF and ETF should be merged.



Ratmale,Minneriya,Sri Lanka said...

Excellent evaluation of the problem. I have also been preparing an alternative proposal subject to change, as follows:

1 The EPF Collections Investments and Disbursements to be handled by an Independent Body NOT answerable to or takes orders from anybody CB, Ministry of Finance or any other minister or President, but answerable to Parliament and their oversight committees like COPE etc.

2 Collections to be fully computerized, so can make payment in much the same way as paying a dialog bill, but the breakdown of the payment by individual to be done via internet account, which shows the employee number (NI) Employers 12% and Employees 8%, and it will be credited to each account on the date the payment is received in the system.

3 A published rate of interest credited to the account every 6 months and the rate of interest can change up or down at that time every six months.

4 Employee can check his balance on the internet at any time, and this will be an indirect incentive for the employers to pay on time as the employee will be able to check if his last deduction was paid into his account by the last date on the following month.

5 Employees/ Employers must contribute only till age 60, but withdrawals also prohibited till age 60. No withdrawal due to change in job or becoming self-employed etc. but a loan of 50% of the balance can taken after age 50 with interest at 2% above the paying rate if they are NOT contributing to the scheme.

6 Everyone who is contributing (working as an employee) till age 60 will get a death benefit of Rs500,000. After 60 this will NOT apply. Named beneficiaries will receive any balance on the account at death at any age, as long as there is a balance on the account.

7 An optional pension scheme will be permitted at 60 where the employee will be told what it is. There will be two schemes, one is an actuarial based scheme of an annuity, which ceases at death, but is a fixed monthly payment. The other will be method where it an interest and capital based repayment, where on death the balance on the account will be paid to the beneficiaries.

8 Eventually once this system is fully computerized the administrative staff would gradually reduce to 10% of current levels, and GN will have to inform EPF of all deaths along with their NI number irrespective of whether they are contributors or not as a check that amounts are NOT paid once people are dead.

9 The State will guarantee payment to those on due dates, no matter what!

Jack Point said...

Thank you for that detailed and informative comment.

I think your suggestions are excellent.

With regard to administration costs: I have put in an addendum to the main post.

Ratmale,Minneriya,Sri Lanka said...

Jack attached to this was a page on rationale for some of the proposals. You can include them if you wish at your discretion.

Rationale for the proposals:

1 Why not allow withdrawal or loans till 50? That is an age one can think about retirement in a rational basis, and make personal investment decisions with the 50% max you can borrow to build a retirement home or some other form of financial security over and above the EPF. If you cannot repay, it will be deducted from final payment.

2 Why stop EPF at 60? Employers will want to then employ experienced and knowledgeable workers after 60 as they don’t have to pay the 12% and with an aging population this will be needed. Employers will NOT wish to retire them as at present!

3 How can you afford a term death benefit of Rs500,000 before 60? That’s easy, as it is actuarially proved that fewer than 1% would avail themselves of sudden death! This can even be reinsured with a local or overseas insurance company if need be at minimal cost, but as a whole it would be cheaper not to do so.

4 If all data is on the net, unscrupulous people will have access to people’s EPF balances. There will be password security to get into the accounts. Further disbursements will undergo the normal checks to ensure that people are not swindled out of their accounts, with most people having accounts, and no cash transactions need be done.

5 How sure are you that costs can be minimized? If the suggestions are followed, it will be easy to allow the paperwork to the employer to input and computer systems to point out anomalies than using the EPF staff who are currently grossly underemployed harassing clients rather than helping them.

6 Why would you think that the optional pension schemes would likely be taken up? With EPF having such a large clientele and system, they will most likely be able to offer the better and more competitive scheme to potential pensioners. Whilst the annuity has risks, that if you die soon you will lose out, that is the nature of that game and that is why I have allowed two different schemes which are NOT interchangeable at will. One has to choose one or the other. Perhaps there could be built in a clause that says if you die in the first year then there would be some relief to beneficiary etc.

7 What happens when disbursements are greater than money coming in? That can be built into the system on maturities of treasury securities to meet payments out etc. It is easily manageable as there are assets that always come up to maturity. The management of investments will be by formula and professionals will be employed in a private public manner to do the management, even outsourced to different private organizations and their performance evaluated continuously.