Managing National Provident Funds in Malaysia and SingaporeBy Mukul G. Asher Professor, Public Policy Programme National University Of Singapore E-mail: firstname.lastname@example.org Fax: (65) 778 1020 To be presented at the World Bank Conference on Public Pension Fund Management, 24 ~ 26 September 2001, Washington D.C.
Organization • Governance Structure • Importance of Investment Policies And Performance • Main Characteristics of the EPF And The CPF • Investment Policies And Performance: The Accumulation Phase • Will The EPF And The CPF Be Adequate For Retirement? • Distribution Of Accumulated Funds • Suggestions For Reform
Governance Structure • The EPF (Established in 1951) The CPF (Established In 1955), Have Statutory Authority Status. • Malaysia’s EPF Is Under The Ministry of Finance. • Singapore's CPF Is Under The Ministry of Manpower
Governance Structure Contd. • Malaysia’s EPF: • Operational (Mainly Administrative) Autonomy • The EPF Board Has Representation From The Government, Employers, Employees And Professionals. • The Investment Panel Is Separate From The Board. It Has Six Members, Executive Chairman Of The EPF, And Representatives Form The Finance Ministry And Private Sector Experts. • There are Indications That The Trade Unions and Other Groups in Malaysia are Uneasy About the functioning of the Investment Panel. They Desire Greater Transparency and Representation on the Investment Panel.
Governance Structure Contd. • Malaysia’s EPF Contd.: • Investment By The EPF Have Been Wholly Domestic. • Lack of Policy Autonomy And Research Capability • Insulation From Political Risk In Investments Primarily Through Government Guarantees of Individual Investments. However No Guarantee of Return on Overall Balances • Moderately Open Information Regime
Governance Structure Contd. • Singapore’s CPF • Operational (Mainly Administrative) Autonomy • The CPF Board Has Representation From The Government, Employers, Employees And Professionals. It Has 12 Members. • Key Challenge: How To Get Competent and Independent Representation on the Board in a Mono-centric Power Structure ?
Governance Structure Contd. • Singapore’s CPF Contd.: • Investment Function In Reality Performed Outside The CPF Board’s Jurisdiction By The Government Of Singapore Investment Corporation (GSIC), And Other Government Investment Holding Companies. • No Statutory Obligation On These Holding Companies To Reveal Investment Portfolio And Performance of CPF Balances. • International Investment Is However Believed To Predominate.
Governance Structure Contd. • Singapore’s CPF Contd.: • Lack of Policy Autonomy and Research Expertise. • Very Selective Openness Relating to Information; So Extensive Data Collected and Stored in Its Supper Computer Is Used in A Strategic Manner And Not As A Public Good. Therefore, Unsurprisingly Data Made Publicly Available Are Insufficient for Independent Analysis. • A Guarantee of 2.5% Nominal Return on the CPF’s Accumulated Balances. The CPF Act Requires That the Permission of the Finance Minister Be Obtained for Paying Interest Rate Higher Than 2.5 Percent. • No Other Provision For Insulation Against Political Risk.
Importance of Investment Policies and Performance • The National Provident Funds of Malaysia (the EPF) And Singapore (The CPF) Are Nominally DC-FF Schemes • Such Schemes Rely On The Power of Compound Interest • To Realize This Power, Need Effective Asset Diversification; Low Administration and Investment Management Costs;And Internationally Benchmarked Pension Fund Governance
Main Characteristics Of The EPF And The CPF • Contribution Rate • More Complex And Varied The Objectives, Higher The Contribution Rate Required. THE CPF • CPF has many other objectives beside Retirement. It Administers many schemes covering Housing, Medical Savings Accounts, Tertiary Education, and permits extensive pre-retirement investments in real estate and financial assets. • CPF Contribution Rate effective from January 1, 2001: 36% (20% By The Employee And 16% By The Employer); With The Wage Ceiling Of S$ 6000 Per Month. • Lower contribution Rates for Those > 55 (18.5% for those between 55–60; 11.0% for those 60-65; 8.5%for those >65).
Main Characteristics Of The EPF And The CPF Contd. • Contribution Rate Contd.: • Self-employed May Join Voluntarily (But Must Contribute to the Medisave Account). They Get Tax Relief for CPF Contributions up to the Combined Employer and Employee Contributions, Subject to Same Ceiling. • The CPF Contributions are channeled into three Accounts. • Ordinary Account: • For those below 55 years, between 72.2 percent and 61.1 percent of the contributions are channeled into this Account depending on age, with the proportion decreasing with age. • Balance in this Account can be used for housing, pre-retirement investment schemes, and others. For most members, housing is the pre-dominant expense.
Main Characteristics Of The EPF And The CPF Contd. • Contribution Rate Contd.: • Special Account: • This Account is for Retirement. For those < 55 years, between 11.1 percent and 16.7 percent of the contributions are channeled into this Account, with the proportion increasing with age. • The proportion for Retirement purposes is rather low by international standards.
Main Characteristics Of The EPF And The CPF Contd. • Contribution Rate Contd.: • Medisave Account: • For those < 55 years, between 16.7% and 22.2% of the contributions are channeled into this Account, with the proportion increasing with age. • Funds from this Account are used to pay for hospital and selected out-patient services; and for Catastrophic Health Insurance Premium which covers between 20 and 40 percent of the total hospital bill. • The Medisave amount can not be withdrawn until death, when it reverts to the nominee. • The Average Medisave balance of 55 year old in mid 2001 was S$16,000, while the required sum for those with enough balances is S$21,000. So many do not have even the minimum balances.
Main Characteristics Of The EPF And The CPF Contd. • Contribution Rate Contd.: The EPF • 23% (11% By The Employee And 12% By The Employer, With No Wage Ceiling). • From April 1 2001, There were plans to reduce Employees’ Contribution Rate to the EPF to 9% for a Period of One Year. Higher Priority to Short-Term Stabilization Over Retirement Security implicit in this has proved to be very unpopular The trade union and other public pressure has forced a change from mandatory to voluntary reduction in the contribution rate. • Self-employed are Permitted to Join the EPF voluntarily, but Few Do.
Main Characteristics Of The EPF And The CPF Contd. • Contribution Rate Contd.: The Contributions to the EPF are channeled into three Accounts. • Account I: 60 percent Main purpose is Retirement. 20 percent of the Balance in this Account over RM 55,000 may be withdrawn for investments in Unit Trusts approved by the EPF. Members not permitted to purchase stocks directly. Potential amount that can be thus invested, and potential number of individuals which can participate is limited. • Account II: 30 percent Main purpose is Housing. • Account III: 10 percent Main Purpose is Healthcare. There are however no health insurance schemes.
Main Characteristics Of The EPF And The CPF Contd. • Coverage • Contributors/Labor Force In 2000: 54.7% For The EPF, And Rising As Formal Sector Expands.For CPF (in 1999): 62.0% And Falling, But Not of Concern Due To 25% of Labor Force Consisting of Foreign Workers. • Total Labor Force in June 2000 For Singapore: 2.19 Million • For Malaysia as at end 2000: 9.2 Million
Main Characteristics Of The EPF And The CPF Contd. • Contributors/Members In 2000: 50.5% For EPF, And 43.2% For CPF. • EPF(2000): Total Members 9.97 Million (of which 0.6 Million Foreign Workers). [AACGR:1990-2000: 5.3%) Pressure to exclude foreign workers on grounds of disproportionate administrative and compliance costs • Active Members: 5.03 Million. [AACGR:1990-2000: 5.5%) • Total Employers 318, 220 (Default Rate 5.65%) [AACGR:1990-2000: 6.2%) • CPF(1999):Members 2.83 Million; [AACGR:1987-99: 3%) • CPF Contributors (1999) 1.22 Million. [AACGR:1987-99: 2.3%)
Main Characteristics Of The EPF And The CPF Contd. • Contributions And Withdrawals • Too Many Pre-Retirement Withdrawals Distract From The Retirement Objective • AACGR: EPF (1990-2000): Contributions: 15.2%; Withdrawals 18.0%. Withdrawals/Contributions EPF (1990-2000): 37.6%. • AACGR CPF (1987-99): Contributions 9.2% Withdrawals 9.5%.Withdrawals/Contributions CPF (1987-99): 71.9%.
Main Characteristics Of The EPF And The CPF Contd. • Members Balances : • EPF: RM 180.1 Billion (55.4% of GDP) End 2000 • CPF: S$ 90.3 Billion (56.8% of GDP) End 2000 • Average Balance per member for EPF: Year 2000 • RM 18,067 • Average Balance per member for CPF: Year 2000 • S$ 31,137 • Per Capita GDP: 2000 • RM 12,883 • Per Capita GNP: 2000 • S$ 42,212
Main Characteristics Of The EPF And The CPF Contd. • These Balances Are A Significant Proportion of Total Savings And Stock Market Capitalization. Given low levels of free-float and liquidity, market prices (and even management control) may be significantly impacted by the provident fund authorities.
Investment Policies And Performance:The Accumulation Phase Contd. • Investment Performance of The EPF • Average Returns Over 40 Years Satisfactory in Absolute Terms. • Challenge Is How to Sustain At Least The Current Level of Returns In The New Economic Environment, particularly as there is considerable unease concerning the perception that the EPF and other provident and pension funds are being used to help support the government-favored firms and business groups.
Table 1 Malaysia: Nominal and Real Rates of Dividend On EPF Balances 1961-2000 Period Nominal Inflation Real Rate Dividend Rate (CPI) of Rate % Dividend % % AACGR (%) (1961-2000) 7.04 3.49 3.55 AACGR (%) (1983-2000) 8.24 3.14 5.11 AACGR (%) (1987-2000) 8.16 3.47 4.70 AACGR (%) (1990-2000) For Nominal GDP: 10.56% - This is higher than the nominal dividend rate. So low replacement rate. AACGR (%) (1990-2000) For Members Balances: 14.18% Note: This return is after taxes and investment management fees.
Table 2 Nominal Return – Risk Performance of Malaysian and other Markets, Jan 1988 – Jan 2001 period • There are other ways to compare the EPF Returns. Malaysia Global Global Asia- US Japan (KLSE) Bond Equity Pac Cumulative Returns 78.1 139.1 172.8 -12.3 401.8 -25.6 Returns (% P.A.) 4.5 6.8 7.9 -1.0 13.0 -2.2 Std. Dev. (% P.A.) 35.7 6.3 14.0 22.3 13.7 25.0 KLSE: Kuala Lumpur Stock Exchange Source: Eliza Lim “Importance of Portfolio Diversification”, Asian Pension Funds Seminar, organized by the Citigroup Asset Management, Kuala Lumpur, May 9-11, 2001. Lim is Asset Consultant with Towers Perrin, Hong Kong. Note: Exchange rate risk is not taken into account in Table 2.
Table 2Comments on Table 2 • The annual return on KLSE is lower and volatility (as represented by the standard deviation) is much greater than the EPF dividends to members. (7.68 percent per year for 1987-99 period) • The EPF dividend is also higher than Global Bond, Asia-Pac, and Japan market returns. • But it is slightly lower than Global Equity; and substantially lower than US market returns.
Table 2Comments on Table 2 contd. • If returns net of taxes and investment management fees are considered, than only the US (and Europe but not UK) returns are likely to have exceeded the EPF returns during this period. But volatility in other markets is much lower. • The pension funds in Chile had annual real rate of return of 10.9 percent between 1981-2000. The return to the members was somewhat less due to administrative and investment management costs, and taxes. This is clearly higher than the EPF, and comparable to the U.S. and Europe.
Table 2Comments on Table 2 contd. Implications • Improve KLSE’s quality and depth. • Some international diversification will be needed as funds continue to accumulate. At present rates EPF’s balances may be RM 1,000 billion in next 15 years or so. Current Market Capitalization of the KLSE is only about RM 400 billion. • Needs to increase understanding of and develop expertise concerning the international markets. • Develop expertise and tools to manage the exchange rate risk when diversifying internationally.
Investment Policies And Performance:The Accumulation Phase Contd. • Investment Allocation And Returns: • The CPF • Three Pools of investment funds • Members’ Balances Invested By the CPF Board.Largest Pool (S$ 90.3 Billion As At End 2000) • On the CPF’s balance sheet, 100 percent of the S$90.3 billion is shown as invested in non-marketable government securities (or as advanced deposits to the Monetary Authority of Singapore for buying such securities. • Singapore Government’s total Internal Debt as at end March 2001 S$138.9 billion (87.4 percent of year 2000 GDP)
Investment Policies And Performance:The Accumulation Phase Contd. • The interest on government securities is same as that paid by the CPF Board to its members. It is a weighted average of one year fixed deposits (80% weight), and savings account rate (20% weight) of the four domestically owned commercial banks. • Interest is paid quarterly and is variable (subject to a minimum of 2.5 percent). • By administrative decision, balances in the Special Account (which is for Retirement only) receive 1.5 percentage points higher interest than on other balances. From October 1, 2001, the higher interest will also be paid on Medisave Balances. This further demonstrates the administrative nature of the interest rates.
Investment Policies And Performance:The Accumulation Phase Contd. • The receipts from the sale of government securities are not needed to finance government expenditure as the budget has been in surplus for more than two decades. • The money is channeled through the Consolidated Fund to investment holding companies of the Singapore Government, such as Temasek Holdings and Singapore Government Investment Corporation. • The operations of these holding companies are by law and practice secret and no public disclosure is required or made.
Investment Policies And Performance:The Accumulation Phase Contd. • The non-transparency and non-accountability of the CPF balances, along with administered rate of interest has turned the CPF from nominally DC-FF scheme to a Notional Defined Benefit (NDB) Scheme, financed on PAYG basis. • To the extent the government holding companies earn higher than what is paid to the CPF members, implicit tax on CPF wealth occurs.
Investment Policies And Performance:The Accumulation Phase Contd. • The implicit tax is recurrent, and it is regressive as low-income individuals hold proportionally greater wealth in the form of CPF balances. Moreover, as only about a third of the labor force pays personal income tax, the low-income members do not receive tax subsidy for contribution, income on pre-retirement investments, and at the time of withdrawal. • Investment of the Insurance Funds S$ 2.9 Billion as at End 1999. • The CPFIS Scheme
CPFIS Scheme • This is a pre-retirement withdrawal scheme. A Member May Open A CPF Investment Account With Approved Agent Banks, All of Whom are Locally Controlled Banks. Their Charges and Fees Are Not regulated. • Individual CPF Members May invest their Ordinary Account balance as well as Special Account Balance In approved assets. All investments must be in Singapore dollars. • Only safer Investments are permitted from the Special Account. Form the Ordinary Account up to 35% can be invested in shares and corporate bonds by the members directly. • As at end April 2001, S$2.1 billion (17% of the Potential) was invested from the Special Account; with about 90% in insurance products, both investment-linked and endowment.
CPFIS Scheme Contd. • There is no limit on investments in shares through the approved Unit Trusts. • Till September 30, 2001, 100.0% of the profits realized (less accrued interest which would have been payable by the CPF Board on ALL of the amounts withdrawn under this scheme) may be withdrawn by the individuals. • This proportion will be reduce to 50% for the period October 1, 2001 to September 30, 2002; and to zero thereafter.
CPFIS Scheme Contd. • As At December,31 2000, Total amount Withdrawn Under the CPFIS was S$ 18,741 (US$10,771 Million) (43.7% of the Potential) by 516,386 members,Or 17.8% of total members. The Average Investment Per Member Thus was S$36,293(US$20,858). • As At March 31, 2001, Total Investments Under CPFIS was S$ 20.192 Billion (US$ 11,218 Million).
CPFIS Scheme Contd. • The Allocation was: • Stocks and Loan Stocks S$9,550 Million (47.3%); • Insurance Policies S$9,063 Million (44.9%); • Unit Trusts S$1,285 Million (6.4%); • Others S$294 Million (1.5%).
CPFIS Scheme Contd. • Thus, Individuals have Invested on Their Own and Not Through Unit Trusts. • Transactions Costs of Unit Trust Investments Are High, With 5 to 7 Percent Spread Between the Offer and Bid (Buy and Sell) Prices Common. • In addition, there is an annual investment management fee of between 1 and 2 percent of total investments of members. • Some Effort to Address This Issue, but Low Average Investment and Small Size of the Unit Trusts Market Major Constraints. • Investment Performance Under This Scheme Appears To Be Unsatisfactory. But Insufficient Data for Rigorous Analysis.
Will The EPF And The CPF Be Adequate For Retirement? • EPF • Low Balances Per Member. In 2000, RM 18, 067, Only 1.4 Times The Per Capita GDP. • No estimates of the replacement rate provided by the EPF Board. But it is likely to be quite low for most members.
Will The EPF And The CPF Be Adequate For Retirement? Contd. • CPF (Figure 3 and 4) • The CPF Board Estimated In 1987 (No updates Since Then) That The Replacement Rate Will Vary Between 20 And 40 Percent For The Members, With No Inflation Protection, And Only A Very Limited Protection Against Longevity. • Fig 3 Shows That Average Balance Per CPF Member Doubled Between 1987-99, While The Average Monthly Earnings In 1999 Were 2.4 Times The Earnings in 1987. Thus, Monthly Earnings Have Risen Faster Than Average Balances Per Member. • For October-December 2000 Period, Average Cash Balance Withdrawn At Age 55 was Only $19,111.
Why Low Balances? • Singapore: • Highly Unequal Wage Structure. In 1999: 51.4% of Contributors Had Monthly Wage < S$ 2,000: Only 6.3% Had Wages > S$ 6,000. • The share of wages in Singapore’s GDP is unusually low at 42 percent; while the share of profits is 48 percent of GDP. • High Rate of Pre-retirement Withdrawals (71.9% for the 1987-99 period). • Tied to the Centrality of Real Estate Sector in the Economy. • Low Real Rate of Return, in Large Part Due to Implicit Tax on CPF Wealth. • Current Political Economy and Governing Philosophy Major impediments to the Reduction or elimination of This Tax.
Why Low Balances? Contd. • Singapore Contd.: • High Transactions Costs • Restricted Competition and No Regulation Over Prices Charged for Investment Services. For a sample of 14 funds in Singapore, the EXPENSE RATIO (I.e. total cost of running the fund divided by the fund size) varied between 2.9 percent and 5.7 percent. The ratio excludes several charges such as tax at source, front-end load, brokerage and other transaction costs, and foreign exchange gains and losses. • Individual Decentralized Arrangement With Wide Investment Choices Under the CPFIS Scheme Likely To Lead to Higher Cost Than a Centralized System, With Limited Individual Choice Would.
Why Low Balances? Contd. • Malaysia • Highly unequal Wage Structure. In 2000 60.18% of the Active Contributors to the EPF Reported Monthly Wages Below RM 1,000; 23.96% Between RM1,000-2,000; and only 3.37% Reported Wages Above RM 5,000. • Moderate Rate of Pre-retirement Withdrawals • Tied to Housing withdrawals • 1/3 of the Accumulated Balances can be Withdrawn at Age 50 • Rate of return is reasonable, but could be Higher • Restricted Competition and No Regulation Over Prices Changed for Investment Services. • Individual Investments through Unit Trusts has High Transaction Costs Due to The Undeveloped Nature of this Market.
The Supplementary Retirement Scheme (SRS) • Implemented From April 1, 2001 • Employers Are Not Allowed To Contribute. Self Employed May Participate. • Contribution and Income (Except Dividends) Can Be Accumulated Tax Free.
SRS Contd. • 50 Percent of Accumulated Balances at the Time of Statutory Withdrawal Subject to Applicable Marginal Income Tax Rate. Withdrawals can be Made Over a Period of Ten Years to Permit Flexibility in Conversion of Investments in to Cash (Withdrawals Can only be Made in Cash), and for tax Planning.
SRS Contd. • Full Taxation Plus 5 Percent Penalty for Early Withdrawal • Some Restrictions (Eg Concerning Property and Certain Types of Insurance) on Investment of SRS Funds.
SRS Contd. • Limitations: • Only One Third of the Labor Force Which Pays Income Tax Has the Potential to Benefit From the SRS • Restrictive Conditions • Foreigners Must Keep the Balances in the SRS for at Least 10 Years. • Only Half of the Accumulated Balances Exempt From Tax. • Penalty for Early Withdrawals: 100% Tax, Plus 5 Percent Penalty.
SRS Contd. • High Transaction Costs • Restricted Competition Among the SRS Providers • No Regulation Concerning Fees to Be Charged by the SRS Providers or by Investment Managers. • So, for Those With Small Balances And/or Low Marginal Tax Rates, Transactions Costs May Outweigh Tax Benefits.