Abstract
Singapore’s economic growth has been heavily dependent on factor accumulation during the past three decades. Attempts to gauge productivity growth in Singapore and other East Asian countries has led to the widely publicized debate on whether the East Asian “miracle” was driven by factor accumulation or productivity growth. According to the most recent study by the authorities, Singapore’s productivity growth was indeed very low until the 1980s, but has improved significantly to a level comparable to the Organization for Economic Co-operation and Development (OECD) average in the 1990s.
IV. Singapore’s Central Provident Fund: Options for a Comprehensive Reform1
A. Introduction
1. Singapore’s national saving rate far exceeds that of its neighbors and of other countries with comparable income (Table IV.1). Much has already been written about this remarkable saving performance and the role it has played in Singapore’s economic success over the past three decades.2 Notwithstanding the lack of reliable data on public and private saving and, within private saving, between the corporate and household sectors, there is little doubt that the mandatory contributions to the Central Provident Fund (CPF) have played a significant role in mobilizing savings.3
National Saving Rate in Selected Countries
(In percent of GDP)
National Saving Rate in Selected Countries
(In percent of GDP)
| 1969–79 | 1980–90 | 1991–99 | |
|---|---|---|---|
| United States | 19.6 | 18.3 | 17.2 |
| United Kingdom | 23.5 | 14.1 | 16.3 |
| France | 24.3 | 20.1 | 39.7 |
| Japan | 35.9 | 31.7 | 31.6 |
| Malaysia | 6.3 | 30.1 | 35.1 |
| Taiwan | 28.1 | 33.0 | 28.0 |
| Korea | 24.0 | 31.0 | 34.7 |
| Australia | 21.8 | 21.6 | 18.1 |
| Singapore | 23.8 | 40.7 | 50.8 |
National Saving Rate in Selected Countries
(In percent of GDP)
| 1969–79 | 1980–90 | 1991–99 | |
|---|---|---|---|
| United States | 19.6 | 18.3 | 17.2 |
| United Kingdom | 23.5 | 14.1 | 16.3 |
| France | 24.3 | 20.1 | 39.7 |
| Japan | 35.9 | 31.7 | 31.6 |
| Malaysia | 6.3 | 30.1 | 35.1 |
| Taiwan | 28.1 | 33.0 | 28.0 |
| Korea | 24.0 | 31.0 | 34.7 |
| Australia | 21.8 | 21.6 | 18.1 |
| Singapore | 23.8 | 40.7 | 50.8 |
2. Singapore’s CPF contribution rates are much larger than in countries with comparable, mandatory defined-contribution pension schemes (Table IV.2). The CPF contribution rate, initially set at 10 percent of wages, was gradually raised to a peak of 50 percent in 1984. The targeted long-term contribution rate of 40 percent was reached in 1994 but in 1997, in response to the crisis, the rate was cut to 30 percent. The authorities, however, plan to raise it back to 40 percent in five years.4 Countries with higher contribution rates than Singapore, such as France and Germany, have schemes that cover the entire range of social security programs rather than just pension contributions, and have higher pension replacement ratios (Table IV.2).
Contribution and Gross Replacement Rates
(In percent)
1999 figures.
1995 figures. Replacement rates at the age of 55.
Contribution and Gross Replacement Rates
(In percent)
| Contribution Rates 1/ | Gross Replacement Rates 2/ | ||
|---|---|---|---|
| Countries with mandatory defined | |||
| Contributions schemes Australia | 9 | 41 | |
| Malaysia | 24 | -- | |
| Switzerland | 15 | 49 | |
| Mexico | 16 | -- | |
| Chile | 13 | -- | |
| Sweden | 23 | 74 | |
| Other countries | |||
| United States | 18 | 56 | |
| United Kingdom | 22 | 50 | |
| Finland | 27 | 60 | |
| Germany | 41 | 55 | |
| Japan | 28 | 52 | |
| France | 49 | 65 | |
1999 figures.
1995 figures. Replacement rates at the age of 55.
Contribution and Gross Replacement Rates
(In percent)
| Contribution Rates 1/ | Gross Replacement Rates 2/ | ||
|---|---|---|---|
| Countries with mandatory defined | |||
| Contributions schemes Australia | 9 | 41 | |
| Malaysia | 24 | -- | |
| Switzerland | 15 | 49 | |
| Mexico | 16 | -- | |
| Chile | 13 | -- | |
| Sweden | 23 | 74 | |
| Other countries | |||
| United States | 18 | 56 | |
| United Kingdom | 22 | 50 | |
| Finland | 27 | 60 | |
| Germany | 41 | 55 | |
| Japan | 28 | 52 | |
| France | 49 | 65 | |
1999 figures.
1995 figures. Replacement rates at the age of 55.
3. The CPF has recently been criticized for failing to provide adequately for post retirement financial security (see Beckerling, 1996, Wong and Donghyun 1997, and Asher 1999. Survey data (reported in Section B) shows that the most important source of income for the aged is provided by their children. While this practice has been encouraged by the Singapore authorities in several forms, future prospects for this form of social safety net are weakened by the aging of the population.5 According to the World Bank demographic projections, the old age dependency ratio (the ratio of the number of individuals aged 65 and above to the working age population) is expected to rise from 10 percent in 1999 to approximately 40 percent by 2050.
4. The objective of this note is to address the reasons why a scheme with such high contribution rates has been found to be inadequate in providing income for old age, and outline some options for a re-design of the scheme.6 In particular, it will be argued that:
the CPF has been used to serve too many objectives, thus diverting its focus away from assuring financial security during retirement;
in view of the aging of population and the approaching demographic hump, the program needs to be rationalized so as to serve its original purpose of providing for old age needs. Such a rationalization would also involve shifting the typical portfolio composition of Singaporean households away from housing and towards financial assets. This would also serve to promote the development of capital markets.
Central Provident Fund
The Central Provident Fund was established in 1955 as a mandatory, fully funded, defined contribution, individual account system designed to provide a degree of financial security for workers in their old age.
Accounts
Each CPF member has four accounts: (1) Ordinary Account—savings in this account are available for pre-retirement withdrawals for home purchase, education, approved financial investments, and for topping-up parent’s retirement accounts; (2) Medisave Account—savings in this account can be used for meeting hospitalization and to pay premiums for approved medical insurance schemes such as MediShield (designed to help meet the cost of catastrophic illnesses); (3) Special Account—savings in this account are reserved for old age and contingency purposes and can only be withdrawn at age 55; and (4) Retirement Account—at age 55, a member can withdraw the remaining balance in the Ordinary Account and the balances in the Special Account as a tax exempt lump sum after setting aside a minimum sum in this account. This minimum sum in the retirement account is currently S$60,000 (out of which S$40,000 can be in pledged property and S$20,000 in cash). From the retirement age, currently 62 years, each member may receive a monthly income from this sum (plus interest). Alternatively, it can be used to buy an approved annuity product or be deposited into an approved bank.
Contribution Rates
Both the employer and the employee contribute to the CPF. Contribution rates rose from 10 percent at the inception of the scheme in 1955 to apeak of 50 percent in 1984/85. During the past 15 years, contribution rates have been lowered and raised 7 times. At present, the contribution rates are 20 percent of the wages for employees aged 55 and below and 12 percent for employers subject to a wage limit of S$6000 per month (beyond which no contribution is payable). Progressively lower rates apply to those aged between 55 and 60, those aged between 60 and 65, and those aged above 65. About ⅔ of the labor force is covered by the scheme.
Investments of CPF Balances and Returns to CPF members
CPF balances must by law be invested in government bonds. The proceeds from the sale of government securities to the CPF are invested on behalf of the government by the Government Investment Corporation (GIC). The portfolio investments of the GIC are not revealed to the public but most of its funds are invested abroad. The interest rate paid to CPF members is set on the basis of the 12-month fixed deposit rate and month-end savings rates of the four major local banks. The guaranteed statutory minimum interest rate is 2½ percent on ordinary account balances and 4 percent on special account balances. The average interest earned on CPF accounts since 1980 has been in the range of 4–5 percent. Employees contributions and the interest earned on their CPF balance are all tax-exempt. The authorities estimate the average replacement rate to be between 20 percent and 40 percent of last drawn income.
5. The rest of the paper is organized as follows. Section B will analyze the main weaknesses of CPF as a pension fund; Section C discusses some potential remedies to these weaknesses, and Section D contains some concluding remarks.
B. Evolution of CPF and Key Problems
6. There are three separate pieces of evidence supporting the view that CPF is inadequate to provide financial support for retirement. First, the average final cash withdrawal from the CPF is quite low (it was around S$19,000 during the period October-November 1998, which is approximately 60 percent of the current annual average wage). The median CPF balance for active contributors (including the amount withdrawn) is also quite low (it was between S$50,000 and S$60,000 at the end of 1997). These amounts would not be sufficient to provide even the minimum subsistence level of income during the individuals’ retirement years.
7. Second, a 1995 survey of senior citizens (generally defined as those older than 55) by the Ministry of Health and the Ministry of Community Development of Singapore showed that around 60 percent of the elderly in the sample does not have any CPF savings and 56 percent of those with an account indicated that CPF would be inadequate for old age support. Moreover, the survey found that over three quarters of senior citizens receive income from children, and 64 percent of them revealed that their children constitute the most important source of support.
8. Finally, simulations performed by Wong and Donghyun (1997) show that the replacement ratios provided by the CPF vary within a range of 25–35 percent. Similar simulations carried by the actuarial firm Watson Wyatt and reported in Beckerling, (1996) show replacement ratios ranging from 15 percent (for a high income, married contributor with a dependent spouse) to 48 percent (for a low income, single contributor). These ratios are well below the 66 percent of the final wage, generally considered as the benchmark for a comfortable level of income on retirement, and are considerably lower than the equivalent figure for other industrialized countries (see Table IV.2).
9. These studies typically point to two reasons to explain why the CPF fails to provide sufficient funds for retirement:
Low return on CPF balances.
Heavy pre-retirement withdrawals, especially for housing.
10. On the issue of low returns, Asher 1999 shows that over the period 1983—98 the real annual return on CPF funds (defined as the difference between the nominal rate less inflation as measured by the GDP deflator) has been on average 1.7 percent. This is well below the real average return on pension funds in other industrialized countries (Table IV.3).
Real Annual Pension Fund Returns, 1984–93
(In percent)
Singapore’s figure is for the period 1983–98.
Real Annual Pension Fund Returns, 1984–93
(In percent)
| United States | United Kingdom | Japan | Germany | Netherlands | Singapore 1/ |
| 10.6 | 11.8 | 6.6 | 7.4 | 8.0 | 1.7 |
Singapore’s figure is for the period 1983–98.
Real Annual Pension Fund Returns, 1984–93
(In percent)
| United States | United Kingdom | Japan | Germany | Netherlands | Singapore 1/ |
| 10.6 | 11.8 | 6.6 | 7.4 | 8.0 | 1.7 |
Singapore’s figure is for the period 1983–98.
11. However, this comparison has to be qualified on several grounds. First, the return on CPF funds is risk-free. Nominally, CPF funds are invested directly or indirectly (through the Monetary Authority of Singapore) in government bonds, and the return is fixed as an average of the deposit and saving rates of the four major local banks (subject to a minimum nominal rate of 2.5 percent for the Ordinary and Medisave Accounts and 4 percent for the Special and Retirement Accounts). Proceeds from the government bond sales are invested abroad by the Government Investment Corporation, which manages them professionally and earns a much higher return than the one paid on CPF contributions.7 The assertion that the difference between the returns on GIC investments and those paid on CPF balances amounts to an implicit tax for CPF members must be weighted against (i) the absence of taxation on CPF savings (neither the contributions, the interest or the withdrawals are taxed), and (ii) the possibility of using CPF funds to repay housing mortgages at a fixed, low rate (0.1 percent above the return on CPF).8 On balance, therefore, low returns may not be the only factor contributing to the low replacement rates under the CPF scheme.
12. A key reason for the low replacement rates provided by the CPF may be found in the evolution of the CPF scheme over time. When it started in 1955, CPF was a mandatory, fully-funded old age social insurance scheme where only those workers earnings less than S$500 a month contributed 5 percent of their wages, with employers contributing another 5 percent. It was conceived as a form of saving scheme designed to provide low-income workers with financial means during retirement. Over the years, however, CPF has expanded it role, reflecting a variety of social and political objectives (Box IV.2 presents the main steps of this evolution). A key change occurred in 1968, when it was decided that members could use CPF funds to purchase public houses, provided by the Housing Development Board (HDB). In 1981 the home ownership scheme was expanded, as CPF funds were made available to buy private residential houses.
13. The impact of these measures on home ownership has been remarkable. In 1995, 81 percent of the total population lived in owner occupied public flats, and 62 percent of CPF members owned houses purchased with CPF funds. In 1998, public housing and residential property schemes accounted for 58 percent of total withdrawals, against the 9.4 percent of the withdrawals for reaching 55 years of age.
14. The predominant role played by housing withdrawals implies that Singaporeans tend to be “asset rich but cash poor.” In the present circumstances, to assure sufficient funds in old age CPF members would need to be able to either (i) disinvest at retirement, by selling and downgrading their housing, or (ii) access a reverse mortgage. However, so far there has been no sign of the adoption of these practices on a large scale, as the elderly still count on family support as their main source of income. As noted above, population aging will make it increasingly difficult to rely on children support as well as housing disinvestment. In particular, in the absence of either strong immigration flows or very high productivity growth, the prospect of problems in the housing market arising from excess supply cannot be ruled out. This perspective makes the investment in housing very risky, and would argue for a much greater degree of diversification in the use of CPF savings.
15. As early as 1986 the authorities recognized the need to provide incentives to CPF members to diversify their investments. In 1986 they permitted small withdrawals for investments in approved stocks. In 1993 and 1997, the size of permitted withdrawals for this purpose was increased and the range of assets widened. However, these incentives have not had the same effect as in the housing scheme. In part this is because CPF members must satisfy the minimum sum requirement before they are allowed to withdraw funds for investments in financial assets. Withdrawals for housing are the only ones not subject to the restriction that CPF members must maintain minimum balances in their retirement accounts. Moreover, housing is the only asset eligible to make up the non-cash component of the minimum sum.9 Together with the subsidized mortgage rates offered by the HDB, these rules impart a strong bias in favour of housing.
Evolution of CPF Withdrawal Rules
| 1955 | Retirement withdrawal: CPF savings can be withdrawn at the age of 55, or if the member becomes permanently disabled or leaves Singapore permanently. |
| 1968 | Public housing scheme; Members can use up to 100 percent of the Ordinary Account savings to buy public flats from the Housing and Development Board. If taking up a loan they can use future CPF contributions to pay installments. |
| 1978 | Singapore Bus Services (SBS) limited share scheme: Members are allowed to use CPF savings to buy SBS shares. |
| 1981 | Residential property scheme: Private residential properties are included in the housing withdrawal scheme. |
| 1982 | Home protection insurance scheme: Withdrawals permitted to buy mortgage insurance which helps the insured members and their families pay off their outstanding housing loans in the event of the insured members’ permanent incapacity or premature death before age 60. |
| 1984 | Medisave account: Introduced to ensure savings that can be used for meeting hospital expenses. |
| 1986 | Approved investment scheme: CPF members are allowed to withdraw 20 percent (40 from 1987) of their CPF savings above the Minimum Sum for investment in gold, approved stocks, and bonds and approved unit trusts. |
| 1987 | Minimum sum: At the age of 55 a member can withdraw his saving from the Ordinary and Special Accounts as a tax exempt lump-sum after setting aside a Minimum Sum in the Retirement Account. This amount, initially S$30,000, has increased steadily since 1987, currently is 60,000 (⅔ of which can be pledged in property) and is going to be S$80,000 by the year 2003 (with 50 percent as a limit on the pledged property). From the retirement age, currently 62 years (increasing to 67 by 2003), each member may receive a monthly income from this sum (plus interest). Alternatively, he may use it to buy an approved life annuity or may deposit it in an approved bank. |
| 1989 | Family protection schemes: CPF members may use their Ordinary Account savings to pay the premium toward a life-insurance scheme (should the member die or become permanently incapacitated, his family will receive up to a certain amount, currently $36,000) |
| 1989 | Education scheme: Members can use up to 40 percent of their CPF balance (Ordinary and Special Account savings plus the amount of CPF that has been withdrawn for housing, investment and education) in excess of the Minimum Sum to pay tuition fees for full-time degree and diploma courses at approved tertiary institutions in Singapore. Since 1989 the withdrawal limit has risen, and is currently 80 percent. |
| 1990 | Medishield: Medical insurance scheme designed to help meet the cost of large medical bills and whose premium is deducted from the Medisave Account. |
| 1993 | Basic and enhanced investment scheme: These schemes replace the Approved Investment Scheme. Under the Basic scheme a CPF member can withdraw up to 80 percent of his CPF balance in excess of the Minimum Sum for investment in gold, approved securities and approved unit trusts. Under the Enhanced Scheme he could withdraw up to 80 percent of CPF savings in excess of S$50,000 for investment in a broader range of financial assets. |
| 1997 | CPF investment scheme: Replaces the Basic and Enhanced Approved Investment Scheme. This scheme allows members to invest up to 100 percent of their CPF balance in excess of the Minimum Sum (or the remaining balance of the Ordinary Account after setting aside the required cash component of the Minimum Sum, whichever is the lowest) into fixed deposits, insurance policies, Singapore Government or Statutory Boards bonds, approved unit trusts and fund management accounts (which are governed by investment guidelines set by the CPF Board). Moreover, the scheme allows–investment of up to 50 percent of the CPF balance in excess of the Minimum Sum into shares, corporate bonds and loan stocks listed on the mainboard of the SES or SESDAQ and traded in Singapore dollars, and up to 10 percent in gold. |
| 1955 | Retirement withdrawal: CPF savings can be withdrawn at the age of 55, or if the member becomes permanently disabled or leaves Singapore permanently. |
| 1968 | Public housing scheme; Members can use up to 100 percent of the Ordinary Account savings to buy public flats from the Housing and Development Board. If taking up a loan they can use future CPF contributions to pay installments. |
| 1978 | Singapore Bus Services (SBS) limited share scheme: Members are allowed to use CPF savings to buy SBS shares. |
| 1981 | Residential property scheme: Private residential properties are included in the housing withdrawal scheme. |
| 1982 | Home protection insurance scheme: Withdrawals permitted to buy mortgage insurance which helps the insured members and their families pay off their outstanding housing loans in the event of the insured members’ permanent incapacity or premature death before age 60. |
| 1984 | Medisave account: Introduced to ensure savings that can be used for meeting hospital expenses. |
| 1986 | Approved investment scheme: CPF members are allowed to withdraw 20 percent (40 from 1987) of their CPF savings above the Minimum Sum for investment in gold, approved stocks, and bonds and approved unit trusts. |
| 1987 | Minimum sum: At the age of 55 a member can withdraw his saving from the Ordinary and Special Accounts as a tax exempt lump-sum after setting aside a Minimum Sum in the Retirement Account. This amount, initially S$30,000, has increased steadily since 1987, currently is 60,000 (⅔ of which can be pledged in property) and is going to be S$80,000 by the year 2003 (with 50 percent as a limit on the pledged property). From the retirement age, currently 62 years (increasing to 67 by 2003), each member may receive a monthly income from this sum (plus interest). Alternatively, he may use it to buy an approved life annuity or may deposit it in an approved bank. |
| 1989 | Family protection schemes: CPF members may use their Ordinary Account savings to pay the premium toward a life-insurance scheme (should the member die or become permanently incapacitated, his family will receive up to a certain amount, currently $36,000) |
| 1989 | Education scheme: Members can use up to 40 percent of their CPF balance (Ordinary and Special Account savings plus the amount of CPF that has been withdrawn for housing, investment and education) in excess of the Minimum Sum to pay tuition fees for full-time degree and diploma courses at approved tertiary institutions in Singapore. Since 1989 the withdrawal limit has risen, and is currently 80 percent. |
| 1990 | Medishield: Medical insurance scheme designed to help meet the cost of large medical bills and whose premium is deducted from the Medisave Account. |
| 1993 | Basic and enhanced investment scheme: These schemes replace the Approved Investment Scheme. Under the Basic scheme a CPF member can withdraw up to 80 percent of his CPF balance in excess of the Minimum Sum for investment in gold, approved securities and approved unit trusts. Under the Enhanced Scheme he could withdraw up to 80 percent of CPF savings in excess of S$50,000 for investment in a broader range of financial assets. |
| 1997 | CPF investment scheme: Replaces the Basic and Enhanced Approved Investment Scheme. This scheme allows members to invest up to 100 percent of their CPF balance in excess of the Minimum Sum (or the remaining balance of the Ordinary Account after setting aside the required cash component of the Minimum Sum, whichever is the lowest) into fixed deposits, insurance policies, Singapore Government or Statutory Boards bonds, approved unit trusts and fund management accounts (which are governed by investment guidelines set by the CPF Board). Moreover, the scheme allows–investment of up to 50 percent of the CPF balance in excess of the Minimum Sum into shares, corporate bonds and loan stocks listed on the mainboard of the SES or SESDAQ and traded in Singapore dollars, and up to 10 percent in gold. |
16. In a nutshell, CPF has been transformed from a simple pension fund to a multi-purpose scheme, which has been used both as a channel of resource allocation and as a macroeconomic stabilization device.10 In particular, contribution rates have tended to be used pro-cyclically—decreased in order to improve competitiveness during recessions and increased to mop up liquidity during booms. Further, in most instances when the contribution rate was reduced, the cut involved mainly the contribution to the Special Account, which is associated with savings for the old age. For example, in response to the recessions in 1985–86 and 1997–98, the contribution rate to this account was temporarily reduced to zero.
17. The remainder of this paper focuses on the following point: with the objective of universal home ownership basically fulfilled and with the demographic changes approaching, the problem of insufficient funds for retirement calls for a re-design of the scheme, marked by a smaller emphasis on housing and an increased emphasis on its original role as a core pension fund.
C. Government Reforms
18. As previewed above the Singapore authorities have been aware of the problem associated with financial security in the old age. Over the past years, several measures have been taken to improve the adequacy of CPF in providing for post-retirement support. Among the most significant ones are the following:
CPF members have been allowed greater scope to invest CPF funds in the financial market for the purchase of approved stocks and approved unit trusts, and the rules governing investments by the unit trusts have been substantially liberalized and the disclosure requirements greatly enhanced (see Asher 1999);
the Minimum Sum to be kept in the Retirement Account will be increased every year in order to reach S$80,000 by 2003 (from its original amount of S$40,000 in 1995);
the proportion of the Minimum Sum that can be pledged in housing will be reduced to 50 percent in 2003 (it was 90 percent in 1995).
19. As a response to the tight labor market, the minimum retirement age was raised from 55 to 60 in 1993 and will reach 67 by 2003. However, the withdrawal age has remained at 55, and after that age the contribution rates are drastically lower (see Box IV.2).11
20. The budget for the year 2000/01 contains several measures involving income for retirement. In particular, (i) tax exemptions will be extended to annuities bought with CPF savings beyond the minimum sum; (ii) tax relief for support provided to aged parents and for the topping-up of their CPF funds will be increased; and (iii) additional saving within the Supplementary Retirement Scheme will be deductible at the time of contribution (with taxes being payable only when the savings are withdrawn). However, the efficacy of tax incentives in solving the problem of inadequate retirement funds for those in the lower income brackets is weakened by the fact that only 35 percent of the population pays income tax.
21. The authorities established in 1998 an Inter-ministerial Committee to study the potential problems arising from the demographic transition in Singapore. The key recommendations relating to the CPF are; (i) to increase the contributions paid to the Special Account (from 4 to 8 percent); (ii) to increase the cash component of the Minimum Sum beyond the 50 percent planned for 2003; and (iii) to peg the interest rate on savings in the Special Accounts to the rate of return of long term investments. The report states that these measures “should generate an annuity corresponding to the prescribed subsistence level…Beyond this basic level every individual should ascertain his or her desired standard of living and make independent provision.”12
22. With respect to the last recommendation on additional saving outside the CPF, there is some question about whether Singaporeans are in a position to contribute 40 percent of their labor incomes to the CPF and simultaneously take more responsibility for additional savings. Estimates of private non-CPF saving in Singapore vary widely. Low (1997) concludes that private non-CPF savings in Singapore is quite high (around 56 percent of the gross national saving in 1995). However, only the central government current surplus rather than the public sector operating surplus is counted as public saving. Moreover, no distinction is made between corporate and household saving. Using the 1993 Household Expenditure Survey, Wong and Donghyun (1997) state that voluntary saving comprised only 5 percent of total household savings in 1993.13 Husain (1995) finds that there is a nearly complete offset in voluntary (non-CPF) saving by households, resulting from increases in CPF savings. This suggests that unless CPF contribution rates are lowered the scope for additional household saving is likely to be limited.
D. Options for a Comprehensive Reform
23. The measures taken so far by Singapore authorities to address the inadequacy of the CPF are steps in the right direction, as they try both to stimulate a higher return on these funds (by giving members more freedom to invest in the financial market) and to impose more stringent restrictions on pre-retirement withdrawals. However, questions remain as to whether these measures are capable of significantly improving the replacement rates provided by the CPF or whether there is a need for a more substantial modification, possibly a re-engineering of the scheme.
24. In order to answer these questions a simple simulation is performed that permits the estimation of the replacement rate that a representative CPF contributor may expect on retirement, allowing for typical withdrawals on housing, education, health care and investments. Box IV.3 shows the assumptions used to generate the replacement rates implicit in the current CPF scheme.
25. Table IV.4 shows the results of the simulation in the baseline scenario, together with some sensitivity analysis on the relative importance of higher returns and lower withdrawals for housing. The key finding is that the low replacement ratios characterizing the CPF are mainly due to the withdrawal of funds before retirement, in particular for the house–ownership scheme. With no withdrawal for housing, the replacement ratio would more than double (case 3), while even doubling the rate of return the current average housing withdrawal would keep the ratio at a relatively low level (case 2).14
Replacement Rates of CPF
(In percent)
R= real rate or return on CPF contributions. R = 2 percent; house price = S$1,00,000.
R = 4 percent; house price = S$100,000.
R = 2 percent; house price = 0.
R = 2 percent; house price = S$70,000.
R = 2 percent; house price = S$130,000.
R = 4 percent; house price = S$130,000.
Replacement Rates of CPF
(In percent)
| Retirement Ape | |||
|---|---|---|---|
| 55 | 60 | 65 | |
| Baseline 1/ | 28.2 | 31.5 | 36.8 |
| High Return 2/ | 34.4 | 40.9 | 51.1 |
| No housing withdrawals 3/ | 59.5 | 68.5 | 82.5 |
| Low housing withdrawals 4/ | 33.1 | 37.2 | 43.7 |
| High housing withdrawals 5/ | 18.8 | 20.4 | 23.1 |
| High return and high housing withdrawals 6/ | 19.5 | 22.0 | 25.9 |
R= real rate or return on CPF contributions. R = 2 percent; house price = S$1,00,000.
R = 4 percent; house price = S$100,000.
R = 2 percent; house price = 0.
R = 2 percent; house price = S$70,000.
R = 2 percent; house price = S$130,000.
R = 4 percent; house price = S$130,000.
Replacement Rates of CPF
(In percent)
| Retirement Ape | |||
|---|---|---|---|
| 55 | 60 | 65 | |
| Baseline 1/ | 28.2 | 31.5 | 36.8 |
| High Return 2/ | 34.4 | 40.9 | 51.1 |
| No housing withdrawals 3/ | 59.5 | 68.5 | 82.5 |
| Low housing withdrawals 4/ | 33.1 | 37.2 | 43.7 |
| High housing withdrawals 5/ | 18.8 | 20.4 | 23.1 |
| High return and high housing withdrawals 6/ | 19.5 | 22.0 | 25.9 |
R= real rate or return on CPF contributions. R = 2 percent; house price = S$1,00,000.
R = 4 percent; house price = S$100,000.
R = 2 percent; house price = 0.
R = 2 percent; house price = S$70,000.
R = 2 percent; house price = S$130,000.
R = 4 percent; house price = S$130,000.
26. Table IV.5 presents an alternative scenario with a more narrowly focused CPF scheme. If withdrawal is allowed only at the age of 65, a larger replacement rate can be achieved through the combination of either smaller, age-independent contribution rates and a higher real return (case 4); or of larger contribution rates and a lower return (case 2). Both larger contribution rates and a higher real return on savings would allow a much higher replacement ratio (60 percent) to be reached at the age of 60 (case 5).
Replacement Rates of a “Restricted" CPF
(In percent)
Replacement Rates of a “Restricted" CPF
(In percent)
| Retirement Age | |||
|---|---|---|---|
| 55 | 60 | 65 | |
| R = 2 percent; contribution = 15 percent | 25.3 | 32.1 | 42.9 |
| R = 2 percent; contribution = 20 percent | 33.7 | 42.8 | 57.3 |
| R = 3 percent; contribution = 15 percent | 29.6 | 38.3 | 52.3 |
| R = 4 percent; contribution = 15 percent | 34.9 | 46.2 | 64.5 |
| R = 4 percent; contribution = 20 percent | 46.6 | 61.6 | 86.1 |
Replacement Rates of a “Restricted" CPF
(In percent)
| Retirement Age | |||
|---|---|---|---|
| 55 | 60 | 65 | |
| R = 2 percent; contribution = 15 percent | 25.3 | 32.1 | 42.9 |
| R = 2 percent; contribution = 20 percent | 33.7 | 42.8 | 57.3 |
| R = 3 percent; contribution = 15 percent | 29.6 | 38.3 | 52.3 |
| R = 4 percent; contribution = 15 percent | 34.9 | 46.2 | 64.5 |
| R = 4 percent; contribution = 20 percent | 46.6 | 61.6 | 86.1 |
CPF Replacement Rates: Main Assumptions Underlying the Baseline Scenario
Wage profile
The representative Singaporean enters the labor market at the age of 20 and contributes without interruption to the CPF until he retires. The wage profile is obtained by assuming an initial wage of S$10,000 (according to the General Household Survey, 1995, the average income from work for those aged 15–19 was around S$9,000) and annual real wage growth of 4 percent (in the period 1985–98 the average monthly earnings deflated by the CPI grew at an average of 4.2 percent).
Contributions
The individual contributes to the CPF according the targeted long-term (pre crisis) structure of contribution rates as showed by the table.
Return on savings
The real rate of return on CPF is assumed to be 2 percent.
CPF Contribution Rates
(In percent)
CPF Contribution Rates
(In percent)
| Age | Ordinary | Special | Medisave | Total |
|---|---|---|---|---|
| Account | Account | |||
| -34 | 30 | 4 | 6 | 40 |
| 35–44 | 29 | 4 | 7 | 40 |
| 45–54 | 28 | 4 | 8 | 40 |
| 55–59 | 12 | 8 | 20 | |
| 60–64 | 7 | 8 | 15 | |
| 65+ | 2 | 8 | 10 | |
CPF Contribution Rates
(In percent)
| Age | Ordinary | Special | Medisave | Total |
|---|---|---|---|---|
| Account | Account | |||
| -34 | 30 | 4 | 6 | 40 |
| 35–44 | 29 | 4 | 7 | 40 |
| 45–54 | 28 | 4 | 8 | 40 |
| 55–59 | 12 | 8 | 20 | |
| 60–64 | 7 | 8 | 15 | |
| 65+ | 2 | 8 | 10 | |
Withdrawal for housing
At the age of 30, the representative Singaporean buys a flat with a 20 percent cash down-payment financed by his CPF funds. For the following 25 years he uses his CPF funds to repay the loan contracted with the HDB at a mortgage rate equal to the CPF rate plus 0.1 percent. As most of the Singaporeans live in flats built by the HDB the housing cost is the average direct purchase price from HDB for a two bedroom flat (S$70,000), a three bedroom flat (S$100,000) and a four bedroom flat (S$ 130,000).
Other withdrawals
As for the other types of withdrawal, they are assumed to occur at the average rates (across the whole population and for the last three years). These are equal to 2 percent of total contributions for Medisave, and to 23 percent of total contributions for both education and asset investments. While Medisave withdrawals start at the age of 20, the other types of withdrawal start only when CPF funds are in excess of the Minimum Sum (equal to S$60,000).
Return on annuities
CPF funds withdrawn at retirement are converted into annuities at a real rate of return of 4 percent.
27. These results suggest that a more narrowly focused CPF scheme, explicitly and solely targeted to old age support, could achieve larger replacement rates. The main characteristics of such a scheme would be:
a much smaller contribution rate, that remains constant from the beginning of contribution to the final withdrawal
the aligning of the age of final withdrawal with the retirement age
the absence of pre-retirement withdrawals
a larger return on savings (to be achieved through a greater freedom in investment choices)
28. The low contributions associated with this version of the CPF would provide scope for individuals to use their discretionary saving for the purchase (or rental) of a house and for covering education and medical care needs.
29. As for the return on CPF funds, contributors should be able to choose the combination of return and risk that they prefer. However, the experience of the CPF Investment Scheme has revealed that individuals accessing capital markets tend to face very high transaction costs (administrative and management fees, bid-ask spreads etc.). To prevent these costs from reducing the incentives to seek higher returns on CPF savings, the CPF board could act as an intermediary which pools the funds from the different accounts and transacts with the market (that is, with unit trusts and fund managers) on a wholesale basis, thereby bargaining down transaction costs and monitoring the performance of the managers.15
30. Further, the success of any individual account scheme in providing for old age financial security depends on the existence of a well-developed private market for real (inflation indexed) annuities. As in other industrialized countries such a market is still lagging in Singapore, and measures should be taken to encourage its development. Among them (and in the light of the planned development of a bond market in Singapore) is the issuance of government indexed bonds (promising a fixed real return) which would make it possible for the insurers to offer real annuities without bearing inflation risk (see Brown, Mitchell and Poterba, 1999).
E. Summary and Concluding Remarks
31. Singapore’s Central Provident Fund began as a mandatory, individual-account scheme initially designed to provide financial means for retirement and was gradually transformed into a multi purpose program used (a) to channel resources toward government determined social and economic targets and (b) for macroeconomic stabilization.
32. While the CPF has been very successful in mobilizing savings, problems have risen with regard to its original role of pension fund, and thus far the most important source of income for the aged is the financial support provided by their children. Low fertility rates and rising longevity will make it increasingly difficult to overcome the inadequacy of CPF pensions through intergenerational redistribution.
33. The two main weaknesses of the CPF as a pension fund can be identified as low returns and heavy pre-retirement housing withdrawals. The authorities are trying to address the problem by giving CPF members more freedom to invest in financial markets and by reducing the bias in the scheme toward investment in housing. At the same time, Singaporeans are encouraged to save more if they want to achieve higher standards of living in retirement.
34. An alternative proposal is presented here based on (a) a re-design of the CPF to narrow its focus to being a core pension fund which pays a market-related rate of return and (b) the development of other markets-mechanisms to increase discretionary saving outside the CPF and invest it in financial instruments, that would provide greater protection against longevity risk. According to this proposal CPF members would contribute to a “no-withdrawal” account for their whole working life at a constant contribution rate that is lower than at present, while choosing among different risk-return profiles for the investment of their CPF savings.
35. Simple simulations show that such a core CPF pension fund would help achieve replacement rates in line with those of other industrialized countries. Further, the lower contribution rate would provide scope for individuals to use their discretionary saving to satisfy pre-retirement needs (housing, medical care, education) and/or to build up funds for a supplementary pension.
Asher, Mukul, 1999, “The pension system in Singapore,” SP Discussion Paper, The World Bank, No. 9919.
Beckerling, Louis, 1996, “Too small a nest egg?,” Singapore Business, March.
Besanger, Serge, Ross Guest and Ian McDonald, 2000, “Demographic change in Asia: the impact on Optimal National Saving, Investment and the Current Account,” IMF Working Paper, forthcoming.
Brown, Jeffrey, Olivia Mitchell and James Poterba, 1999, “The role of real annuities and indexed bonds in an individual account retirement program,” NBER Working Paper No.7005.
Carling, Robert and Geoffrey Oestricher, 1995, “Singapore’s Central Provident Fund,” IMF Paper on Policy Analysis and Assessment 95/11 (Washington: International Monetary Fund).
Diamond, Peter, 1993, “Privatization of social security: Lessons from Chile,” NBER Working Papers No. 4510.
Huff, William, 1995, “What is the Singapore model of economic development?,” Cambridge Journal of Economics, No.19.
Hussain, Aasim, 1995, Determinants of private saving in Singapore, IMF Occasional Paper No. 119 (Washington: International Monetary Fund).
Low, Linda and T.C. Aw, 1997, “Housing a Healthy, Educated and Wealthy Nation through the CPF,” Times Academic Press, Singapore.
Ostry, Jonathan, 1997, “Current Account Imbalances in Asean Countries: Are they a problem?,” IMF Working Paper 97/51 (Washington: International Monetary Fund).
Wong, Daniel and Park Donghyun, 1997, “The adequacy of CPF for old age support,” in East Asian Economic Issues, ed. by Jon Kendall, Park Donghyun and Randolph Tan, World Scientific Pub.Co and Nanyang Technological University, Singapore.
Prepared by Roberto Cardarelli (x38059) who is available to answer questions.
Indeed, in this context, questions that have received particular attention include whether household saving is entirely voluntary or there is a significant component of “forced saving” (Husain 1995), and whether Singapore has been oversaving with respect to some optimal benchmark (Ostry, 1997 and Besanger, Guest and McDonald, 2000). The evidence is mixed: Husain finds that changes in the ratio of CPF savings to private disposable income have no statistically significant impact on total private saving and takes this as evidence against the existence of “forced saving.” Ostry uses a consumption smoothing approach to the current account and finds no evidence of oversaving in Singapore. In contrast, Besanger Guest and McDonald, (2000) find that Singapore “oversaved" to a significant degree in the period 1996–97.
Data on the consolidated current surplus of the public sector, including the government and the major statutory boards, were published only until 1985 (see Huff, 1995). These data show that in the period from 1974 to 1985, public sector saving grew from 23 percent to around 66 percent of the gross national savings and that, by the latter date, CPF savings constituted 75 percent of private savings.
This long-term contribution rate “was rationalized as the one being sufficient to cover various CPF schemes for housing and medical needs as well as to generate a retirement annuity equivalent to between 20 and 40 percent of the individual’s last take home pay” (Low and Aw, 1997).
Key measures include the fiscal incentive to top-up parents’ CPF accounts and the Maintenance of Parents Act, a law introduced in 1995 that makes it a criminal offense for a son not to take care of his aged parents.
Box IV.1 summarizes the main characteristics of CPF as of 1999. For a comprehensive description of the CPF, see Carling and Oestricher (1995), and Low and Aw (1997).
The rate of return earned by the GIC is not revealed publicly. However, it is estimated that over the past 10 years the GIC could have made nearly 10 percent on its portfolio, broadly equally divided between stocks, bonds and cash.
Another issue is the absence of administrative costs that are usually associated with pension schemes based on individual accounts. The case of Chile is probably the most famous one, as the administrative costs of that type of individual accounts have been estimated in the order of 3 percent of average taxable earnings in 1991 (see Diamond, 1993).
A CPF member can use up to 100 percent of his Ordinary Account saving to purchase a residential property either public or private. As there is no guarantee that his Special Account covers the Minimum Sum (in its cash component), he can well find himself without this amount at retirement (in which case he can still withdraw at least half of what is left in his Ordinary and Special Accounts). The other schemes prevent this from happening, as they only allow the use of CPF balances in excess of the Minimum Sum, or of the remaining balance of the Ordinary Account (after setting aside the required cash component of the Minimum Sum), whichever is the lowest.
This has been recognized by various commentators. For example, Asher (1999) states that: “the various investments and other schemes have enabled the government to direct a significant part of the disposable income towards government determined socio-political and economic objectives.” And Low and Aw (1997) note that through CPF “consumption is strategically guided into desirable merit commodities, like housing, rather than frivolities.”
This structure of contribution rates can also be seen as a measure against the bottlenecks arising from the labor market, as lower contribution rates should encourage the employment of older workers (see Low and Aw, 1997).
The level of subsistence advocated by the report is not clearly specified. In their simulations on the replacement rates provided by the scheme, CPF officials assume that the minimum standard of living is guaranteed by S$300 per month. The average earning per month is currently around S$3,000.
Moreover, Wong and Donghyun (1997) also quote Prime Minister Goh Chock Tong saying that “many Singaporeans do not save anything beyond what was in their CPF accounts” (The Sunday Times, October 6, 1996).
The simulations focus only on the replacement rates for those who start working today and ignore old Singaporeans, who have not contributed to the CPF for their whole working life and thus are likely to face even smaller replacement rates.
The centralization of the investment function with professional fund managers selected and monitored by the Board is not a new concept in Singapore, as this is the what happens with. the Saver Scheme of the Armed force (see Asher 1999).