Sunday, December 9, 2007

Compulsory Savings in Singapore: An Alternative to the Welfare State

Investment Performance of the CPF Board

A distinction needs to be made between members' funds left in the CPF and the insurance funds35 that are managed by institutional fund managers and invested in fixed interest-bearing deposits, negotiable certificates of deposit, equities and bonds. Although the insurance funds are of relatively minor importance, in 1993 the implicit rate of return36 on the Medishield fund was 6.7 percent - considerably higher than the 2.5 percent rate of return the CPF pays on members' funds.

According to statutory requirements, CPF funds must be invested in government bonds and in advanced deposits with the Monetary Authority of Singapore (MAS), which eventually converts the monies into bonds. In 1993, S$44.6 billion (85.3 percent of the total balances) was invested in government bonds and S$7.7 billion (14.8 percent of the total) in advanced deposits with the MAS.37 Given that the government enjoys budget surpluses, and that amounts borrowed are not used to finance infrastructure, how and where are the CPF balances invested? They are invested by the government through the Singapore Government Investment Corporation and other channels, and most are believed to be invested abroad. However, no information is available on either the investment portfolio or the returns obtained. CPF members' interest is calculated as an average of the 12-month deposit and monthly savings rates of four major local banks, subject to a minimum rate of 2.5 percent.

The rationale for payment of short-term interest rates on long-term funds is not clear. As Table II shows, the real rate of return (the interest rate minus the inflation rate) has been slightly positive or negative since 1986. This contrasts sharply with the return on Medishield funds noted above. To the extent returns on CPF balances invested by the government are higher than what is paid to the members, the difference is an implicit tax on members, although this may be offset by tax subsidies. The implicit tax is likely to be regressive, as those with low balances have a greater proportion of their (forced savings) assets with the CPF.

16 Most social security systems tend to be somewhat progressive, paying a higher rate of return on payroll tax contributions, the lower a person’s income. By contrast, the Singapore system is slightly regressive in three ways. First, people get back exactly what they put in, plus any buildup. Second, although the practice of not taxing social security contributions (at least the employee’s share) is common throughout the world, this practice also favors those in higher tax brackets. Finally, the investment options discussed in the text favor higher-income earners. back

Reform Directions (Extracts) by Mukul Asher

The analysis in the previous section has strongly suggested that the current retirement
financing system of Singapore is unsustainable and is in urgent need of fundamental
reforms designed to address various dilemmas discussed earlier. The following
reforms are suggested in the current single-tier retirement financing system.

1. Reforms should result in much higher priority to fiduciary responsibility by the
CPF Board; greater transparency of the investment process and outcome; and
lower transactions costs.

2. The CPF Board should have independent and competent members regulated by
the newly constituted Provident Fund Authority (PFA).

3. Between 10 to 15 percentage points of the CPF contributions should be diverted
to the asset management company (with the rest for housing, health are, and
others) remaining with the current CPF Board.
4. Formation of a separate asset management company with statutory requirement
for fiduciary responsibilities and transparency should be considered
5. Over the medium term (2 to 4 years) current accumulated balances of $102 billion
should be transferred to the new asset management company.

6. The current CPFIS scheme should be restructured to restrict individual choice and
the funds should be also centrally managed.

7. The new asset management company can use its expertise and large pool of funds
to provide choice to members to allocate their balances among limited number of
portfolios of differing risk-return profile. A member may be given a choice to
reallocate the portfolio every three to four years. Since the behavioral finance
literature (Mitchell and Utkus 2003) suggests that many individuals do not rebalance
their portfolio towards more conservative investments as they get older,
some provision for default option incorporating this feature may be built into the

8. The new asset management company can take advantage of its large pool of funds
to reduce transactions and investment management costs; and to provide effective
diversification of the portfolio while giving due weight to transparency. This is
likely to encourage the funds management industry in Singapore on a more
sustainable and financially viable basis.$FILE/spdp009919.pdf

A comparison of the CPF’s Annual Report and the data available in its website with those
of Malaysia’s Employees’ Provident Fund (EPF), Hong Kong’s Mandatory Provident
Fund Schemes Authority, and information provided by the Chilean pension system
demonstrates the paucity of relevant and timely data provided by the CPF. This reflects
the strong tendency in Singapore to regard even basic socio-economic information as a
strategic resource to be employed by the policy makers for tactical purposes rather than
regarding such information as a public good. The purpose is to prevent rigorous research,
analysis and development of expertise, with a view to controlling public debate on social
security. The governance shortcomings of the CPF concerning investment policies and
design of various schemes will become clearer when these aspects will be discussed

It is now acknowledged by the policy makers that the design of housing and property
schemes of the CPF has led to over investment in these areas. Maintaining property
prices, especially of residential housing has become a vital political necessity, but this
substantially constraints restructuring of the CPF system (Lee 2004).

While the government issues non-marketable bonds, in actuality, as the government has
been consistently enjoying budget surpluses (Asher 2003), proceeds from the bonds are
turned over to Singapore Government Investment Corporation (SGIC) for investments.
The operations of the SGIC (and other government investment holding companies such
as Temasek Holdings) do not have to be revealed, even to the Parliament or the President
of the country, because of statutory provisions. The CPF balances ultimately however are
widely believed to have been almost wholly invested abroad.
There is thus a disconnect between the administered interest rate paid on CPF balances
and the actual investments and returns obtained. This is not consistent with transparency
requirements, and the fiduciary responsibilities of internationally benchmarked provident
or pension funds. The political risk inherent in this arrangement is also very high.
Predominant role of the government in Singapore in the savings – investment
intermediation process (result of large structural budget surpluses, substantial public
sector, and mandatory CPF savings), has raised efficiency concerns (Asher 2003).
This arrangement has not resulted in realizing the potential of the power of compound
interest for members as shown in Figure 1.

To the extent the government holding companies earn higher than what is paid to the CPF
members, implicit tax on CPF wealth occurs. IMF has estimated that the Singapore
Government Investment Corporation (SGIC) earned about 10.0 percent per annum during
the 1990s, substantially higher than the average nominal return of 3.4 percent credited by
the CPF. The implicit tax for 2000 is (10.0-3.4=6.6) times $90.3 billion, or $5.96 billion,
equivalent to 42 percent of contributions or 3.75 percent of GDP. The implicit tax is
recurrent, and it is regressive as low-income individuals hold proportionally greater
wealth in the form of CPF balances. At the minimum, the implicit tax is the difference
between what is earned on insurance funds and the returns to members on their balance
as shown in Figure 1.

Pension funds: Where's My Nest Egg?

    Far Eastern Economic Review . May 25, 2000

    By Ben Dolven/SINGAPORE

A CITIBANK SURVEY in 1998 found that more than 50 percent of Singaporeans believed that their stakes in the government's huge mandatory savings scheme would provide them with enough money to live on in their retirement. They were mistaken--badly mistaken.

The 45-year-old Central Provident Fund is Asia's most extensive, and many observers say most successful, social-security scheme. But in many cases, it's not going to be enough to provide more than a subsistence living standard for retirees. Strip out Singapore inflation, and CPF savings grew hardly at all between 1987 and 1998--0.07 percent annually to be precise--according to a recent report by Tom Snyder and Mukul Asher, economists at the National University of Singapore. The CPF's basic structure, which pays members low, short-term interest rates for most of their long-term savings, will make it very hard to boost returns.

Even government leaders warn that Singaporeans will need to look beyond the fund to finance their retirement. "The CPF is not sufficient," National Development Minister Mah Bow Tan said in November. "It should be supplemented. We should try as much as possible to make it sufficient, but it needs to be added to by other CPF-type schemes, preferably by the private sector."

The CPF has one fundamental problem: Essentially, it isn't a pension scheme at all. The logic of a pension scheme is that if you put away savings for the long-term, you get paid a higher rate of interest. Compound those high long-term returns over two or three decades and members build a nest egg. But that's not how the CPF works. It pegs returns on cash balances to short-term bank deposit rates--an average of interest rates on time deposits and 12-month fixed accounts. These are lower than interest rates on long-term deposits, reducing the benefit of compounding.

The trade-off for Singaporeans is that they can use their CPF accounts for major expenses such as housing and medical treatment. In fact, the CPF works more like a mortgage-finance scheme than a retirement plan. The vast majority of Singaporeans finance purchases of public housing flats from their accounts, and these come at prices well below private housing units. Many people later elect to upgrade--selling a flat on the secondary market and using the higher price to buy a bigger public flat or a private one.

But you can't eat bricks and mortar, and the CPF's negligible returns mean many Singaporeans will hit retirement with an apartment but little cash to draw on. A government-led committee on ageing noted last year that 24 percent of the CPF members who reached age 55 in 1998 had less than S$16,000 (US$9,250) in their CPF accounts--an amount that will run out quickly if the retirees lack family support.

While many Singaporeans recognize that they're getting poor returns on their CPF deposits, few truly think the scheme is a bad idea. Arthur Yeo, a 37-year-old engineer with around S$50,000 in his CPF account, says he knows he's getting little for his money, but figures that without the CPF he might have squandered it. "It's a forced saving," he says. "If we didn't have this I believe it would have gone somewhere, and I don't know where."

Singaporean citizens and permanent residents must contribute 20 percent of their wages to their CPF accounts. Their employers have to kick in 12 percent, down from 20 percent in 1998, when the government slashed employers' contributions to boost competitiveness. The bulk of the contributions go into a low-yielding ordinary account, with just 4 percent going into a higher-yielding special retirement account, and 6 percent - 8 percent into a medical account. At age 55, members can move the money into investment annuity accounts that pay monthly sums.

Looking ahead at a retirement crunch, the authorities realize they will need to allow depositors to do more with their money. In the past six years, they have allowed members to invest in a limited but growing range of unit trusts and shares. But the minimum cash balance needed to take advantage of this greater freedom is S$60,000. The minimum will gradually rise to S$80,000 in 2003. (Members can use housing assets to account for part of the sum.) The CPF's board won't say how many people qualify, but at the end of 1998, just 16.5 percent of members had moved any money out of the low-return part of their accounts.

That won't do, says Lim Hwee Hua, a ruling-party member of parliament who heads a financial subcommittee for the government's ageing panel. Lim, a strategic planner for Jardine Fleming, recognizes that short-term interest rates are no way to build a retirement kitty, but even so, her committee didn't recommend raising returns on basic CPF savings, or pegging them to fluctuating market rates. She figures Singaporeans wouldn't take the risk, even though CPF rates have consistently been below what people could get on other investments. "The risk aversion is so high here," she says.

With a little savvy, Singaporeans could do much better than the CPF. Ten-year US Treasury bonds currently yield an annual 6.47 percent while 10-year corporate bonds issued by DBS Bank yield 8.84 percent. Equities are riskier, but since January 1995 the S&P 500 Index has had annual returns of 38 percent; the Straits Times Index has recorded annual returns of 3percent.

Investment managers in Singapore figure an average retiree will need a nest egg of S$2.2 million to generate an income stream of S$3000 a month for the rest of his life. That presents plenty of opportunities for private financial planners. The favourite instruments now are life-insurance products that many use to top up their monthly post-retirement incomes. The big player is American International Assurance, which controls more than half the local market. But others are on the way: Citibank, for instance, plans to start offering insurance products in June, and hopes to win 20 - 25 percent of the local market within three to five years, says Eddie Khoo, a vice-president at the bank's local office.

The paltry returns offered by the CPF don't mean that the money is poorly invested. In fact, the returns members receive have nothing to do with the way their funds are ultimately invested. The bulk of CPF deposits are held in nonmarket government bonds that yield a weighted average of the interest rates at the four big local banks: 80 percent weighted to 12-month deposits and 20 percent weighted to demand deposits. They are placed with the Monetary Authority of Singapore, which lends to government statutory boards for investment in infrastructure.

At the end of 1998, CPF members' accounts had a combined balance of S$85 billion, though that figure includes amounts deducted for housing purchases. Singapore has recorded big fiscal surpluses for decades and the fact that it can use CPF balances to fund infrastructure projects frees other funds for more profitable investment elsewhere. Many of the country's reserves are invested overseas by nontransparent, publicity-shy investment vehicles like the Government of Singapore Investment Corp. There's no way to accurately say what return authorities actually get on CPF funds. The only thing that's clear is that there's no link between their returns and what members get. The Review's questions to the CPF board on the subject went unanswered.

The government's ageing committee recommended several tweaks to the system. It urged that people be required to put more money--6 percent of contributions, or even 8 percent -into the higher-yielding CPF accounts. It talked about ways to bring self-employed people into the plan and urged that people be allowed more options for investing in insurance annuity plans. Still, these remain just tweaks. Lim says other ways to make the CPF more market-oriented are being discussed, but she says it's unlikely that members would be offered a choice between fluctuating or fixed rates of return.

Still, Lim says she knows something has to change, recalling that many of her panel's sessions were packed with people who said they expected income from the CPF to take full care of them in their retirement. "It's sufficient for very basic, minimal needs," says Lim. "What we are concerned about is that it may not be enough to meet their expectations."

Published in the Far Eastern Economic Review. May 25, 2000

Solving the Global Pensions Crisis

Mukul Asher: I would like to take this opportunity to briefly discuss how Singapore is performing and to address what I think is the central issue in the worldwide debate on pension reform: how to structure a system that will produce sufficient benefits for retirees while simultaneously minimizing adverse effects on economic incentives and international competitiveness.

I think Singapore’s case is quite interesting, because Singapore is one of the few countries that never had a pay-as-you-go system. Instead, its retirement system consists of state-mandated and state-managed individual retirement accounts.

Before I go into a detailed analysis of the system, let me tell you that Singapore is not doing well at providing an adequate replacement rate. And that suggests that just because a system is supposedly centered around "individual retirement accounts," it isn’t necessarily desirable and sustainable. If the system is still regulated heavily by the state—or, indeed, managed almost wholly by the state—it could encounter many of the same problems that a pay-as-you-go system encounters. In this case, the devil really is in the details.

The retirement system in Singapore is administered by the Central Provident Fund, which is a government statutory body. In addition to retirement benefits, the CPF also administers housing and health care schemes, educational loans, various investment schemes, and a number of other programs. So the system is really not a pure retirement system. The multiple-objectives character of the CPF reduces transparency and makes it difficult for participants and policymakers to assess its full impact.

As you would expect, to cover those numerous schemes, you have to have very high contribution rates. Currently, the contribution rate is 40 percent—20 percent is paid by the employee and 20 percent by the employer.

Because the CPF administers so many different programs, there are substantial preretirement withdrawals. Indeed, such withdrawals averaged 71 percent of total contributions annually during the period from 1992 to 1996. Obviously, that reduces the amount available for retirement and substantially dilutes any net impact of high contribution rates on aggregate domestic savings. Indeed, an econometric study done in 1995 by the International Monetary Fund found that the CPF had virtually no impact on aggregate savings in Singapore.

Now let me focus a little bit on the system’s return on investment. There are three separate pools of investible funds under the CPF system. The net value of the largest is equivalent to about 55 percent of gross domestic product. At the end of 1996, 99 percent of the assets in that pool were in nonmarketable government bonds, issued specifically to the CPF Board to meet their interest obligations. The interest on these bonds is identical to what the CPF Board pays its members. This in turn is the average of short-term deposit rates of four local banks. The bonds do not have quoted market values.

For the last decade, the effective real rate of return on the bonds has been close to zero. And that is the primary reason why the Singapore system is failing, because no accumulation fund that provides such a rate of return can provide a proper replacement rate at the end.

And that isn’t the end of the story. Although the government of Singapore has been running a budget surplus since 1968, it has, of course, also been issuing the retirement bonds. And as a result, there is, in fact, a very large internal public debt. Currently, it is equivalent to about 80 percent of GDP. The money raised from issuing bonds to the CPF Board is invested by the Singapore Government Investment Corporation. Its portfolio and investment performance are not made publicly available. Thus, CPF members do not know the ultimate deployment of their funds.

So what you have in Singapore is a retirement system with little transparency in the investment function and a bad replacement rate. The system consists of retirement accounts that are individual in name only. Countries that are contemplating pension reform based on individual accounts may find it necessary to undertake the investment functions differently. The CPF system, however, is quite efficient in its housekeeping functions.