What are the disadvantages of Provident Fund Scheme ? 1. Money is inadequate for risks occurring early in working life. 2. Inflation erodes the real value of savings. 3. It generates forced saving that can be used to finance national development plans. Select the correct answer using the codes given below :
- (a)1 and 2 only
- (b)1 and 3 only
- (c)2 and 3 only
- (d)1, 2 and 3
Answer
Why
Correct — A, (a) 1 and 2 only.
The item asks for DISADVANTAGES, so each statement has to be judged twice: is it true of a provident fund, and if it is true, is it a drawback ? Statement 3 is true and is not a drawback, which is the whole design of the question.
STATEMENT 1 — 'Money is inadequate for risks occurring early in working life.' A DISADVANTAGE, and the most serious one. A provident fund is a SAVINGS institution, not an insurance one. Each member has an individual account into which the member and the employer pay a percentage of wages, and the benefit is whatever has accumulated in that account plus interest. Nothing else. So a member who dies, is disabled or falls seriously ill in the second or third year of working life leaves or receives a balance built from two or three years of contributions on a low starting wage — a sum bearing no relation to the loss suffered. The benefit is smallest exactly when the contingency is most catastrophic, because the family has the longest future to provide for.
Contrast SOCIAL INSURANCE, where contributions are POOLED and the benefit is defined by the contingency rather than by the individual's accumulation. A member of an insurance scheme who dies in the second year is covered on the same terms as one who dies in the thirtieth, because the risk is spread across the whole membership. That pooling is precisely what a provident fund does not do.
STATEMENT 2 — 'Inflation erodes the real value of savings.' ALSO A DISADVANTAGE. A provident fund accumulates a nominal balance over a working life of thirty or forty years and pays it as a lump sum. Nothing in the design protects the real purchasing power of that balance: unless the rate credited on it keeps pace with the price level over the whole period, contributions made early are worth a fraction of their value by the time they are drawn. A defined-benefit pension, by contrast, can be revised periodically, and a benefit expressed as a proportion of final wages is inflation-protected up to the moment of retirement by the wage itself.
STATEMENT 3 — 'It generates forced saving that can be used to finance national development plans.' TRUE, but an ADVANTAGE and not a disadvantage. This is the standard argument made FOR provident funds in developing economies. Compulsory contributions from a large workforce create a very large pool of long-term contractual savings; invested in government and public sector securities, that pool finances public investment. A country short of domestic savings gets a mechanism for mobilising them, and the member gets a return. The statement describes a benefit of the institution, and including it converts the answer into a wrong one.
Only statements 1 and 2 are disadvantages, so the answer is option (a). The stem reads 'of Provident Fund Scheme' with no article, as the booklet sets it.
Why the others are wrong
- (b)1 and 3 only — This keeps the correct statement 1 but admits statement 3, which is an advantage of the provident fund model rather than a drawback of it. Compulsory saving mobilised for national development is the argument on which provident funds were recommended to newly independent economies in the first place: they raise the domestic savings rate, they supply a captive market for government securities, and they do it without a general tax. Dropping statement 2 compounds the error, since the erosion of a nominal lump sum by inflation over a working life is the second of the two classic criticisms of the model.
- (c)2 and 3 only — This keeps the correct statement 2 and again admits statement 3, while dropping statement 1 — the most important disadvantage of the provident fund model and the one that motivated most of the reforms actually made to it. Because a provident fund pays only what has accumulated, it is structurally incapable of meeting a risk that materialises early, and that is not a defect of administration that better management could cure; it follows from the individual-account design itself.
- (d)1, 2 and 3 — This accepts all three and so treats the mobilisation of forced saving for national development as a drawback of the provident fund. It is not — it is the principal reason such funds were adopted across South Asia, Africa and South-East Asia in the middle of the twentieth century. The option is the natural landing place for a candidate who reads each statement only for whether it is TRUE OF a provident fund rather than for whether it is a disadvantage OF one. All three statements are true; only two of them are complaints.
Concept
The item rests on the fundamental distinction in social security between a PROVIDENT FUND and SOCIAL INSURANCE, and the whole subject organises itself around that contrast.
PROVIDENT FUND — a compulsory savings scheme. Individual accounts; defined CONTRIBUTIONS; the benefit is the accumulated balance with interest; typically paid as a lump sum; no pooling of risk between members; no redistribution. The member bears the investment risk, the inflation risk and the risk of an early contingency.
SOCIAL INSURANCE — a pooled scheme. Contributions go into a common fund; the benefit is DEFINED by reference to the contingency and to wages, not to the individual's accumulation; typically paid as a periodical benefit; risk is shared across the membership and there is redistribution from those who do not suffer the contingency to those who do.
That difference explains both of the disadvantages in this question. The inadequacy of the benefit for an early contingency follows from the absence of pooling. The erosion of value by inflation follows from a lump sum defined in nominal terms.
INDIA'S OWN RESPONSE is the best illustration of the point, because the country did not abandon the provident fund model but added insurance and pension elements on top of it. Under the Employees' Provident Funds and Miscellaneous Provisions Act, 1952, three schemes now run together: the Employees' Provident Fund Scheme, 1952, framed under section 5, which is the accumulation itself; the Employees' Deposit Linked Insurance Scheme, 1976, which pays an assurance benefit on death in service that does not depend on the size of the member's balance; and the Employees' Pension Scheme, 1995, framed under section 6A, which converts part of the employer's contribution into a monthly pension on superannuation, and into a widow's, children's or disablement pension on the relevant contingency. The insurance scheme is a direct answer to statement 1, and the pension scheme is a partial answer to statement 2, since a monthly pension can be revised where a lump sum cannot.
The general lesson is that the design of a social-security instrument determines which risks it can carry. A savings instrument can smooth income across a lifetime; only an insurance instrument can transfer risk between people.
This is the paper's clearest social-security concept question, and it goes to the heart of what the EPFO does. The organisation administers a provident fund, and a candidate who will spend a career on it should be able to say what that institution can and cannot do — which is exactly what this item asks.
The construction is one worth learning to recognise. Three statements are offered, all three are TRUE propositions about provident funds, and the stem asks for a subset defined by a qualifier: disadvantages. A candidate who checks each statement only for truth will accept all three and choose option (d). The discipline is to read the qualifier first and then apply it as a second test to every statement that survives the first. This paper uses the construction repeatedly across its statement-list questions.
There is a second reason the item is well made. Statement 3 is not merely an advantage; it is the historical reason the model was recommended to developing countries at all. So a candidate who has learned the subject through its policy history recognises the statement immediately as an argument in favour, while a candidate who has learned only the mechanics sees three unobjectionable sentences.
The labour-law and social-security strand of this paper is smaller than an EPFO candidate might expect — about ten questions — but this is one of the items where knowing the subject properly, rather than knowing a statute's numbers, is what decides the answer.
Key facts
- A provident fund is a compulsory SAVINGS scheme with individual accounts and defined contributions; the benefit is the accumulated balance with interest, usually paid as a lump sum.
- Social insurance POOLS contributions and defines the benefit by the contingency, so a new member is covered on the same terms as a long-serving one.
- The absence of pooling is why a provident fund benefit is inadequate for a contingency occurring early in working life — the account has barely accumulated.
- A nominal lump sum built over thirty or forty years carries no automatic protection against inflation, which is the second classic criticism of the model.
- Compulsory contributions generating long-term savings that can finance public investment is an ADVANTAGE of provident funds and the reason developing economies adopted them.
- Under the Employees' Provident Funds and Miscellaneous Provisions Act, 1952, three schemes run together: the Employees' Provident Fund Scheme, 1952 under section 5; the Employees' Deposit Linked Insurance Scheme, 1976; and the Employees' Pension Scheme, 1995 under section 6A.
- The Deposit Linked Insurance Scheme pays a benefit on death in service that does not depend on the member's accumulated balance — a direct answer to the first disadvantage.
Study next
Common traps
- Judging each statement only for whether it is TRUE of provident funds. All three are true; the stem asks which are disadvantages.
- Reading the mobilisation of forced saving as an indictment. It is the argument on which the model was recommended to developing economies.
- Assuming a provident fund covers early-career risk because contributions are compulsory from the first month. Compulsion affects who contributes, not how large the accumulated balance is.
- Overlooking that a lump sum carries the inflation risk entirely on the member, where a periodical benefit can be revised.
Social-security items on EPFO papers divide into two families. One tests the statute — thresholds, rates, sections, periods — and is answered from the text of the Act. The other, of which this is an example, tests the DESIGN of a social-security instrument and is answered from the provident-fund-against-insurance contrast. The second family uses three or four statements with numeric codes and hangs the item on a qualifier such as disadvantages, differences, features or objectives. Read the qualifier first, then adjudicate each statement against it, and be ready for one statement that is a true and favourable fact placed among genuine criticisms.
Related PYQs
EPFO_APFC_2016_Q23Which of the following are the typical differences between the private insurance programmes and the social insurance programmes ? 1. Adequacy versus Equity 2. Voluntary versus Mandatory Participation 3. Contractual versus Statutory Rights 4. Funding Select the correct answer using the codes given below :
- (a) 1, 2 and 3 only
- (b) 1, 2 and 4 only
- (c) 3 and 4 only
- (d) 1, 2, 3 and 4
Answer(d) 1, 2, 3 and 4
The typical differences between private insurance programmes and social insurance — the neighbouring half of the same design distinction, since this item contrasts a provident fund with insurance and that one contrasts two kinds of insurance.
EPFO_APFC_2016_Q92Which of the following are the instruments of providing social security in India ? 1. Income Tax 2. Employees' Provident Fund 3. General Sales Tax 4. LIC 5. National Pension Scheme 6. Postal Provident Fund Select the correct answer using the codes given below :
- (a) 1, 2, 3 and 4
- (b) 2, 3, 4 and 5
- (c) 2, 4, 5 and 6
- (d) 3, 4, 5 and 6
Answer(c) 2, 4, 5 and 6
Which instruments provide social security in India — the institutional list that the provident fund belongs to.
EPFO_APFC_2016_Q111Social Security may provide cash benefits to persons faced with 1. Sickness and disability 2. Unemployment 3. Crop failure 4. Loss of the marital partner Select the correct answer using the codes given below :
- (a) 1, 2 and 3 only
- (b) 1, 2 and 4 only
- (c) 3 and 4 only
- (d) 1, 2, 3 and 4
Answer(d) 1, 2, 3 and 4
The contingencies for which social security may provide cash benefits, which is the list of risks a provident fund's individual-account design struggles to carry.
Practice
- practice — not a real PYQ
Which of the following is the principal difference between a provident fund and a social insurance scheme ?
- (a)A provident fund is compulsory while social insurance is voluntary
- (b)A provident fund pools risk across members while social insurance does not
- (c)A provident fund pays what the member has accumulated while social insurance pays a benefit defined by the contingency
- (d)A provident fund is financed by the employer alone while social insurance is financed by the employee alone
Answer(c) A provident fund pays what the member has accumulated while social insurance pays a benefit defined by the contingency — that is the pooling distinction, and everything else about the two models follows from it. Both can be compulsory, and both are commonly financed by contributions from employer and employee together.
- practice — not a real PYQ
The Employees' Pension Scheme, 1995 was framed under which section of the Employees' Provident Funds and Miscellaneous Provisions Act, 1952 ?
- (a)Section 5
- (b)Section 6A
- (c)Section 7A
- (d)Section 14B
Answer(b) Section 6A — the Central Government framed the Employees' Pension Scheme, 1995 in exercise of the powers conferred by section 6A, replacing the Employees' Family Pension Scheme, 1971. Section 5 is the power under which the Employees' Provident Fund Scheme, 1952 itself was framed.