Far Eastern Economic Review . May 25, 2000

By Ben Dolven/SINGAPORE  

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."