Investing

EPF issue: Why protests against rate cut show cussedness of trade unions

EPFOLogo

The interest on the Employees’ Provident Fund(EPF) for the year 2015-2016 has been set at 8.7%.

The Central Board of Trustees(CBT) of the Employees’ Provident Fund Organisation(EPFO) had proposed an interest of 8.8%, when they had met in February earlier this year. The ministry of finance finally decided on an interest rate which is 10 basis points lower at 8.7%, than what the Trustees of EPFO had proposed. One basis point is one hundredth of a percentage.

This hasn’t gone down well with the trade unions and they have decided to protest. Bhartiya Mazdoor Sangh (BMS), the trade union closest to the ruling Bhartiya Janata Party, given its affiliation to the Rashtriya Swayamsevak Sangh(RSS), has decided to hold protests across the country.

As its general secretary Virjesh Upadhyay told PTI: “BMS strongly condemns the cut in EPF interest rates and will hold demonstrations at EPF offices on April 27,” Sangh general secretary said, adding, the Fund is managed by the Central Board of Trustees (CBT), an independent and autonomous body.”

Other trade unions have also come out strongly against the move. But the entire thing is quite bizarre. The question is what are they protesting about? It seems the ministry of finance’s decision of cutting down the interest rate offered by 10 basis points to 8.7%, from the 8.8% proposed by the CBT of EPFO, hasn’t gone down well with the unions.

As AK Padmanabhan, board member of the CBT of EPFO and the president of Centre for Trade Union Congress told The Indian Express: “It’s unusual that after the CBT recommendation, the finance ministry has decided to cut interest rate.”

Maybe, the move is unusual, but are the trade unions also totally jobless? Allow me to explain. How much difference does the 10 basis point cut actually make? On a corpus of Rs 1 lakh, it makes a difference of Rs 100.

Also, the interest rate paid on EPF in 2014-2015 and 2013-2014 was 8.75%. In comparison to that, the interest for 2015-2016 will be lower by Rs 50 per lakh.

Is it worth protesting on something like this? What are the trade unions actually trying to achieve by doing this? Or since they are trade unions, they need to protest against everything?

Also, don’t the trade unions know that 8.7% interest being paid on EPFO, is the highest interest rate being offered by the government across all its schemes? It is sixty basis points more than the 8.1% per year interest currently being offered on the Public Provident Fund and the National Savings Certificate(NSC).

It is ten basis points more than the 8.6% on offer on the Senior Citizens’ Savings Scheme and Sukanya Samriddhi Account Scheme. Even the senior citizens who typically get paid more otherwise, are being paid lower than the interest being paid on EPF. So what are the trade unions protesting about?

The government is trying to move the country towards a lower interest rate regime. Fixed deposit rates are down by more than 100 basis points in the last one year. In comparison, the EPF interest rate has been slashed by just 5 basis points. Further, interest earned on fixed deposits is taxable. Interest earned on EPF is not.

If all these reasons are taken into account, the planned protests of the trade unions essentially look very hollow.

Also, what is the government trying to achieve by cutting the EPF interest rate by 10 basis points? In an ideal world, the government would have wanted to cut the EPF interest rate much more, to bring it in line with the other prevailing interest rates. But given all the hungama that has recently happened whenever the government has tried to bring any change to the EPF, it basically wasn’t in the mood to take on any more risk.

Having said that a 10 basis point cut in the EPF interest rate essentially achieves nothing.

Further, it needs to be asked, why a provident fund as big as EPF is, is not professionally managed? As on March 31, 2015, the EPFO managed funds worth Rs 6.34 lakh crore in total. Provisional estimates suggest that in 2015-2016, the EPFO saw Rs 1.02 lakh crore being invested in the three schemes that it runs. Of this around Rs 71,400 crore was invested in the EPF. This means as on March 31, 2016, the EPFO managed funds worth Rs 7.36 lakh crore in total.

This is a huge amount of money. The question is why is this money not being professionally managed. The CBT of EPFO essentially comprises of the labour minister, a few IAS officers, a few businessmen and a bunch of trade union representatives. Which one of these categories of people has some the expertise to manage investments?

Further, why does a committee need to meet to decide on an interest rate for EPF? Why can’t it simply be declared on the basis of returns on the investments made? Why can’t returns on EPF investments be declared on a regular basis? Why is there so much opaqueness in the entire process?

The only possible explanation is that if things do become transparent, then the trade unions controlling the CBT of EPFO, will essentially become useless. When it comes to transparency, it’s the same story everywhere.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on April 26, 2016

Why we buy life insurance

LIC

Why do people buy life insurance? In a logical world, the answer would have been very straightforward.

People buy life insurance because they want to hedge against the probability of death. But is that really the case? The answer is no. Most life insurance that gets sold in this country is not really life insurance in the strictest sense of the term.

What gets sold as life insurance is essentially an investment plan with a dash of insurance. Hence, in most cases people who buy life insurance aren’t really adequately covered. So this brings us back to the question, why do people buy life insurance?

There are multiple answer to this question. I call a certain section of individuals buying life insurance as the “Papa Kehte Hain Types” or the PKHTs. The PKHTs buy insurance because their fathers ask them to do.

The only way their fathers have known to save is by buying life insurance policy regularly from the friendly neighbourhood agent.

Further, a major section of people graduate from being PKHTs. They dabble around on their own and figure out that if you buy insurance policies
save tax. This leads to people accumulating multiple insurance policies, without having much idea of what they are buying. Over the years, I have even known people who have had a dozen insurance policies and struggling to remember, when is the premium due on which policy.

Some others buy insurance because they need to oblige their friends, their relatives, their acquaintances, who have become insurance agents, for the lack of anything better to do. In fact, some portion of the PKHTs also fall into this category of buyers.

Still others are mis-sold insurance when they go into a bank to start a new fixed deposit or carry out some other transaction. In fact, given that I work as a freelance writer, my payments tend to be lumpy. The last time I went to my bank, a major payment had come through, and not surprisingly, the woman at the front desk, tried to sell me life insurance which, she said, would give me fantastic returns.

The moment I asked her, how can life insurance give returns, she got confused, and asked me to speak to her senior.

The point being that nobody really buys life insurance to hedge against the risk of dying. Further, given that most insurance policies are essentially investment plans, nobody really buys them as investment plans either.

The insurance companies are also happy letting people buy insurance for various reasons other than the probability of hedging against their death. Very rarely do insurance company advertisements talk about death. They do talk about investment but in a very vague sort of way, without really getting into the past performance of their investment plans.

As John Kay writes in Everlasting Light Bulbs—How Economics Illuminates the World: “Modern economies include many activities, like selling cars, where product quality and product attributes are complex and sellers know far more about what they sell than buyers about what they buy.” Insurance is one such product.

In case of insurance, the companies rarely go about filling the information gap and educating the buyer, through their advertising. When was the last time you saw an insurance company talk about the fantastic returns that its investment plans have generated? When was the last time you saw an insurance company talk about their premiums being the lowest?

In fact, as Kay writes: “Advertising is about managing that gap in information. And when you look more closely at advertising with that perspective, you see that the distinction between information and persuasion does not really stand up.”

Hence, the next time an agent tries to sell you life insurance, just ask them what has been the performance of their investment plan, over a period of five years, in comparison to other plans offered by other insurance companies.

Rest assured, the agent will not have an answer for this.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in the Bangalore Mirror on April 27, 2016

Why It’s Best to Stay Away from Buying LIC Policies

LIC

The Life Insurance Corporation(LIC) of India is India’s biggest insurance company. It is also India’s biggest investment firm.

It is so big that it keeps coming to the rescue of the government now and then, when the government cannot find enough buyers for the financial securities that it wants to sell.

Nevertheless, the question is, how good is LIC when it comes to generating returns on the investments it makes?

Before we figure that out, it is good to point out that LIC is basically an investment firm which also sells insurance. A major portion of the money that it collects as premium from Indians, against the so called insurance policies that it sells, is invested in stocks and bonds (both private as well as government).

The insurance policies that LIC sells are basically investment plans with a dash of insurance. And given that the premium that it collects and in turn invests, should be generating decent returns for the policyholders (actually investors). Of course, the tragedy is that most of these policy holders don’t even know that they are actually investors.

So how do things look? The accompanying table gives us the investment track record of LIC between 2005-2006 and 2014-2015. As is clear from the table the investment record of LIC has been dismal to say the least.

In 2014-2015, the investment firm earned a return of 7% on its investments. The average return on the 10-year government bond during the course of the year was 8.3%. The investment return of LIC was 130 basis points lower than the average return on a 10-year government bond. One basis point is one hundredth of a percentage.

YearIncome from investments (In Rs crore)Investments (In Rs Crore)Return (%)Average returns on 10 year govt bondDifference
2014-20151,35,48319,462,497.0%8.3%130 basis points
2013-20141,18,09716.846,907.0%8.4%140 basis points
2012-20131,03,88214,864,577.0%8.2%120 basis points
2011-201290,26713,495,326.7%8.5%180 basis points
2010-201177,66712,665,396.1%7.9%180 basis points
2009-201067,19810,958,416.1%7.3%120 basis points
2008-200956,5838,15,4846.9%7.6%70 basis points
2007-200847,9997,56,8916.3%7.9%160 basis points
2006-200740,5726,13,2676.6%7.8%120 basis points
2005-200635,4795,24,0176.8%7.2%40 basis points
Source: LIC annual reports and www.investing.com

[These numbers may not reflect mark-to-market on certain investments and hence the investment income may be higher, though it cannot meaningfully alter the returns.]

In fact, the difference between the average returns on a 10-year government bond during the course of a year and the investment returns of LIC vary between 40 basis points and 180 basis points. This is a huge difference.

The average return on investment for LIC over a period of ten years between 2005-2006 and 2014-2015 has been 6.7%. The average return on a ten-year bond has been 7.9%. The difference between the two returns is 120 basis points.

In fact, the average rate of inflation between 2005-2006 and 2014-2015 was 8.85%. Hence, the average return on investment of LIC was lower than the rate of inflation as well.

What does this tell us about a professional investment firm like LIC? It tells us that LIC is doing a terrible job of managing public money. Any investment firm should be able to generate average returns greater than the returns on government bonds, at least.  It should also be able to beat the inflation. In fact, that is what it is paid a fee for. But that doesn’t seem to be happening in case of LIC.

The investment returns of LIC have been consistently lower than the 10-year government bond returns. First and foremost, this tells us that the investment management capabilities of LIC are very bad, given that its investment returns have been 120 basis points lower than returns on a 10-year government bond, over a period of ten years.

Further, LIC would be simply better off by buying government bonds and then holding on to them till maturity, instead of actively trying to manage money. It would probably end up earning higher returns than it currently does.

Second, what this also tells us is that the government is interfering too much in the functioning of the firm and getting it to make investments, which it shouldn’t be making in the normal scheme of things. The government regularly gets LIC to invest in shares of public sector enterprises which other investors are not willing to pick up.

In the recent past LIC has picked up stakes in public-sector banks to help them meet their capital requirements. As a March 29, 2016, news-report in The Indian Express points out: “Since the beginning of 2016, LIC has brought into preferential allotment of as many as six banks, supporting the fund-raising requirement of these banks in turn. Share prices of PSBs on an average have declined close to 11.7% so far this year.”

The public-sector banks are sitting on a huge corporate-debt time bomb. Many corporates they have lent to over the years are currently no longer in a position to repay their loans or have simply siphoned off this money. The question is why is LIC money being invested in these banks? This is because the government wants to continue owning these banks, instead of selling them out.

Also, LIC now owns 21.22% of Corporation Bank, 14.37% of IDBI Bank and 14.99% of Dena Bank. Again, the question, why should an investment firm managing public money be taking on such concentrated risk? In fact, the Securities and Exchange Board of India(Sebi) regulations do not allow a mutual fund to own more than 10% of a company.

Why doesn’t the same rule apply to LIC as well? Like mutual funds LIC is also in the business of managing hard-earned public money.

Unnamed LIC officials in various news-reports justify this buying by saying that they are buying value. Maybe they are, but buying value does not mean betting the house on one stock. When an institution is managing as much money as LIC is, some basic investing principles need to be followed.

Third, it tells us that individuals are better off putting their money somewhere else rather buying LIC policies. What is the point in investing money in order to earn a return of 6-7% on an average? Yes, investing in LIC policies helps people save on tax, but there are better ways of saving tax like the Public Provident Fund(PPF).

Between 2009 and now the returns on PPF have never gone below 8%. In fact, currently the rate of interest on PPF is at 8.1%. As far as an insurance cover is concerned, individuals can look at buying a pure term insurance policy, which just offers insurance against the premium paid.

Fourth, the government needs LIC to finance its fiscal deficit and to keep rescuing the public sector enterprises which aren’t a viable business anymore. Fiscal deficit is the difference between what a government earns and what it spends. LIC helps the government finance its fiscal deficit by buying government bonds and at the same time it also helps the government meet its disinvestment target by buying shares of public sector enterprises which other investors are not interested in. This money helps narrow the fiscal deficit.

In the process, the returns that LIC is able to generate on its investment portfolio get compromised on.

Fifth, when was the last time you saw an article analysing the returns on various LIC policies?  Like is the case with other insurance companies, it is not possible to figure out which LIC plan has given what kind of return, over the years. Hence, it is best to stay away from investing in them.

The column originally appeared on Vivek Kaul’s Diary on April 21, 2016

The PF problem: Why the govt is after your EPF money

EPFOLogo

The Narendra Modi government has tried initiating a few changes to the way the Employees’ Provident Fund(EPF) operates. And this hasn’t really gone down well with those who have accumulated their savings through EPF.

These moves are in line with what the finance minister Arun Jaitley referred to as “measures for moving towards a pensioned society,” in his February 2016, budget speech.

One such move has been the restriction on the complete withdrawal of EPF. In a notification dated February 10, 2016, the government had specified that an individual investing in EPF can withdraw only his contribution made to the EPF and the interest accumulated thereon, in case the individual is unemployed for a period of at least two months.

Up until now, a 100% withdrawal was possible. In fact, given the way the Employees’ Provident Fund Organisation(EPFO) operated, one could withdraw 100% of the accumulated EPF even at the point of changing jobs. All an individual had to do was to declare that he or she was unemployed.

This loophole has now been plugged in with the introduction of the Universal Account Number(UAN). Earlier, the EPFO could not track the movement of an employee from one job to another, but with UAN that is possible.

In fact, with the new notification, premature withdrawal of 100% EPF corpus would become impossible. Further, the notification also increased the retirement age from 55 years to 58 years.

The change of not allowing to withdraw the full EPF, is in line with what Jaitley had talked about in his budget speech. The idea is to discourage individuals from withdrawing their accumulated EPF corpus. By doing this, the hope is that the individual will have enough money going around when he or she retires.

And at that point of time, the accumulated corpus can be used to generate a regular income after retirement i.e. a pension.

These changes haven’t gone down well with people who contribute to the EPF every month and there have been protests against it. Given this the notification specifying the changes has now been put in abeyance. As the labour minister Bandaru Dattareya told reporters today (April 19, 2016): “The notification will be kept in abeyance for three months till 31 July, 2016. We will discuss this issue with the stakeholders.”

In fact, a PTI news-report also points out that the labour ministry is contemplating allowing withdrawal of 100% of the corpus on grounds like marriage and education of children, purchase of house, serious illnesses etc.

The way the scheme is currently structured, it does not allow a 100% withdrawal for such things. The Section 68K of the Employees’ Provident Fund Scheme 1952, allows for withdrawal of up to 50% of the individual’s contribution and the interest accumulated thereon, “for his or her own marriage, the marriage of his or her daughter, son, sister or brother or for the post-matriculation education of his or her son or daughter.”

As far as medical emergencies are concerned, the amount that can be withdrawn from the EPF should not exceed, the individual’s “basic wages and dearness allowances for six months or his own share of contribution with interest in the Fund, whichever is less.”

News-reports suggest that these limits are likely to be withdrawn in the days to come. If something like that happens, it won’t be good for the society as a whole. The basic idea behind any provident or pension fund is to accumulate enough money so as to be able to live comfortably after retirement.

But if 100% withdrawals are allowed then this will not be possible. Hence, some withdrawals should be allowed, but allowing 100% withdrawals for weddings and education etc., is clearly not a great idea.

This did not matter earlier when people lived in joint families. But in the era of nuclear families and increasing life expectancy, it is important that those retiring from jobs have enough money for themselves.

Further, it needs to be pointed out that the current norms allow 100% withdrawal “on termination of service in the case of mass or individual retrenchment”. Of course, one is quitting the job to become an entrepreneur then a 100% withdrawal is not allowed. But big government schemes cannot be so flexible so as to meet the needs of everyone.

Anyone leaving the country is also allowed to withdraw 100% of the accumulated corpus. Further, those suffering from “total incapacity for work due to bodily or mental infirmity” can withdraw 100% of the corpus. So, the point being that the scheme is flexible “enough”.

Also, as a recent government clarification on the EPF pointed out: “The main category of people for whom EPF scheme was created are the members of EPFO who are within the statutory wage limit of Rs 15,000 per month.”

Hence, for those earning greater than Rs 15,000 per month and looking for the flexibility with their money, should essentially be negotiating with their employers to make a minimum contribution to the EPF and receiving their salaries under other heads.

To conclude, it is safe to say that the Modi government has essentially botched up the entire idea behind a pensioned society. Almost no effort has been made in order to explain the basic idea behind the phrase, which is actually a good one.

For a government which is pretty good at marketing itself that is rather ironical.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Bangalore Mirror on April 20, 2016

All You Wanted to Know About Restriction on EPF Withdrawal

EPFOLogo

 

This is one of the changes that I should have written about at least five-six weeks back, but somehow I did not. Nevertheless, given the long term impact of this change, it’s still not very late to discuss it.

From February 10, 2016, onwards, the government has restricted the total amount of money that any contributor to the Employees’ Provident Fund can withdraw. As the government notification points out: “The Central Board, or where so authorised by the Central Board, the Commissioner, or any officer subordinate to him, may on an application made by a member in such form as may be specified, authorise payment to him from his provident fund account not exceeding his own total contribution including interest thereon up to the date the payment has been authorised on ceasing to be an employee in any establishment to which the Act applies.”

The notification further points out: “The member making an application for withdrawal under sub- paragraph (1) shall not be employed in any factory or other establishment, to which the Act applies, for a continuous period of not less than two months immediately preceding the date on which such application is made.”

So what does it mean? It basically means that anyone who has been unemployed for two months or more can now withdraw only his own contribution into the Employees’ Provident Fund and the interest that has accumulated on it.

The employer’s contribution and the interest that has accumulated on it thereon, can only be withdrawn at retirement i.e. at the age of 58. The age of retirement has also been increased from 55 to 58.

This change does not apply to “female members resigning from the services of the establishment for the purpose of getting married or on account of pregnancy or child birth.”

Earlier the entire corpus that had been accumulated under the EPF could be withdrawn. And if the corpus had accumulated for five years or more, it was even tax-free.

This was a loophole used by many individuals to withdraw their entire accumulated EPF corpus at the point they changed their jobs. All it needed was a declaration that they were unemployed. The Employees’ Provident Find Organisation(EPFO) had no way of verifying this.

Of course, the move by the government to clamp down on total withdrawal of EPF, comes on account of individuals withdrawing their entire EPF corpus when they changed their jobs. This withdrawal led to people not building a good retirement corpus. If viewed from this angle, this is a good move.

It will help individuals build a good retirement corpus. Also, with only partial withdrawal allowed, it will encourage individuals to transfer their EPF accounts when they change jobs, instead of simply declaring that they are unemployed and withdrawing their contribution to the corpus.

Anyone who understands the power of compounding will know that this is a good move, given that as the corpus grows the compounding has a greater impact. An interest of 8% on Rs 1 lakh amounts to Rs 8,000. But the same interest on Rs 5 lakh amounts to Rs 40,000. A bigger corpus in case of EPF is only possible when employees transfer their EPF accounts when they move jobs.

Also, what happens to people who are actually unemployed and can only withdraw the employer’s contribution to the EPF and the interest accumulated on it, only after the age of 58?

In fact, as I write this, the EPFO has made a decision to give interest on inoperative EPF accounts. These are essentially accounts in which no contribution has been made by the employee or the employer for a period of 36 months. Hence, what this means is that an individual who is facing long-term unemployment and cannot withdraw a part of his EPF corpus, will continue to earn interest on the corpus that he cannot withdraw.

This was not possible earlier. This change had to be made given that if the government does not allow people to withdraw their entire EPF corpus, it should at least be paying interest on the part of the corpus that cannot be withdrawn.

But all this is just one side of the coin. What happens in case of individuals who actually lose their jobs and face long-term unemployment? In this day and age this is possible. Even though they have money in the form of the employer’s contribution to the EPF, and the interest earned on it, they cannot withdraw it.

This may force them to borrow money from money lenders. Hence, it is not fair on them. The trouble is that the EPFO up until now has had no way of verifying if the individual withdrawing the corpus is actually unemployed or is simply changing jobs. This is a weakness at the level of the EPFO.

Given the information technology infrastructure available these days, it shouldn’t be so difficult to figure out whether the individual is actually unemployed or is simply moving jobs. Let’s say the individual withdraws the entire corpus accumulated under EPF and then takes on another job, his permanent account number(PAN) continues to remain the same. So how difficult is it for the EPFO to figure out whether the person has actually changed jobs? Not very.

Other than people facing long-term unemployment, these days some individuals also like to take a break and go back to studying, in order to improve their job prospects. The money that they have accumulated under EPF can help in paying the part of the fee. People going back to studying at the age of 25-30 are really not thinking about retirement, they are thinking about improving their job prospects by studying more. And if they study more, their job prospects are likely to be better in the years to come.

The EPFO needs to be flexible on this front. A better information technology infrastructure can clearly help.

Also, I think we are reaching a stage, where people who are in a position to manage their money, need not depend on EPF. They need to negotiate with their organisations to have a minimal contribution made to their EPF and the remaining money be paid out to them as a part of their normal salaries, which they can then invest in order to save tax as well as accumulate a corpus. It will also ensure that a portion of their corpus is not stuck with the EPFO until the age of 58. Organisations which are looking to retain talent also need to be flexible on this front.

But given how HR departments in organisations work, I clearly don’t see this happening.

The column originally appeared on Vivek Kaul’s Diary on March 31, 2016.