Singapore, Hong Kong and Inadequate Pension Plans

Photo by Derrick Chang

Singapore’s latest adjustments to its Central Provident Fund (CPF) scheme, announced on August 9, the island republic’s National Day, make for dire reading on two accounts.

First, having been forced to save so much for so long, so many Singaporeans are as yet ill-prepared for rapidly approaching retirement. Second, other rapidly aging places in Asia, particularly Hong Kong, are even less equipped to face the twin challenges of aging and longer life spans. The lower income groups in both Singapore and Hong Kong societies are in the worst situation and will continue to get an especially raw deal.

The changes outlined for Singapore’s CPF were:

  • A 1 percent rise to 3.5 percent in the interest rate paid on CPF balances up to S$60,000.

  • A scheme – details to follow – to force members to take out insurance against living beyond the age when their CPF funds would be exhausted.

  • Phased increases to the Draw Down Age at which money can be withdrawn from the CPF (other than for approved investments). The draw-down age was once only 55, is now 62 and will rise to 65.

  • Various measures, including income supplements, to encourage employment to age 67 or above.

The interest supplement is tacit acknowledgement of how far the forced savers have been subsidizing the borrowers – the Singapore government and ultimately US and other consumers who are being financed by Singapore’s savings excess. The current normal interest rate on CPF balances is 2.5 percent -- barely above the rate of inflation. Indeed, for years, the interest rate has been about nil in real terms. It is noteworthy that while the giant state investment corporation Temasek boasts double-digit returns on investments, Singapore’s forced savers have been receiving a quarter of that amount.

The first consequence of this is that savings have not in practice earned anything, so balances are now far from adequate to sustain a reasonable standard of life for low-income retirees despite the fact that contributions to the CPF are 36 percent of income and were once as high as 40 percent.

Middle-income earners have been able to take advantage of their ability to place some of their CPF savings directly into stocks and mutual funds, which have earned much higher rates of return. But that has not applied to lower-income earners who must first accumulate enough in the CPF’s own fund before investing elsewhere.

The CPF has of course enabled most people to buy their own homes – albeit mostly in the

government-built and controlled Housing Development Board flats in which 88 percent of the population live. But it has left a situation where many are relatively asset-rich but will in future lack sufficient income, requiring them either to borrow against their flats, or sell them. Indeed, of those nearing the age in 2006 (55) when they were supposed to reach the Minimum Sum in their ordinary CPF accounts, nearly half had to pledge the value of their HDB flats.

Even the Minimum Sum, currently at S$99,000 is a modest amount given that the median wage in Singapore is around S$27,000 a year (before CPF deductions) and even the lowest paid 20% earn about S$14,000 in a year. Although the minimum sum earns interest of 4% a year, its provision is very basic even assuming people own their flats and have medical coverage under the CPF or otherwise. Based on the minimum amount, the CPF provides S$610 a month for 22 years so for someone retiring at 62 would last only till 85.

Officials now admit that “with rising life expectancy, a significant proportion of members will outlive their CPF monthly payouts,” so the government is to devise a scheme for insurance against living longer. It would provide for a monthly income of S$250-300 when their CPF annuity – assuming they start withdrawing at 62 – runs out.

People will have to buy such insurance either from the CPF or an annuity, payable till death, from a private sector insurance company. But even the latter yield only about S$550 a month assuming that the minimum sum is invested in them at 55 and payment begins at 62.

Most people have more than the minimum balance – but not so much more that they can look forward to a comfortable retirement. Which explains why the retirement age is being raised, eventually to 67, and even the government recognizes the inadequacy of CPF returns.

While the CPF has also given an enormous boost to home ownership, it is clear that an excessive percentage of most households’ wealth (particularly those of lower and middle incomes ones) is tied up an illiquid asset whose value may well stagnate as the population ages and the birth rate remains very low.

In many ways the government policy is realistic. Demographics have changed dramatically since the CPF was devised. The percentage of the population over 65 will double to 20 percent in 20 years and the average life expectancy from birth, now 79.6 is still rising. Those who reach 65 can already expect on average another 20 years of life and half, mostly women, will exceed that.

The need for an exceptionally high savings rate to develop the infrastructure and accommodate the once fast growing population has changed too. But it is disingenuous of government to suggest that the changes now to be made will reward the older groups with higher interest rates and work supplements. They are merely partial compensation for the past.

The government is entirely responsible for the abysmal return on forced savings. Fairness suggests that at the very least all past savers should be back-dated with accrued compound interest of a real (inflation adjusted) rate of 2.25-2.50 percent and that should become the standard for the future. That figure is line with average yields in developed countries of inflation-linked government bonds and over time is roughly in line with the historical post-inflation yield on Singapore government bonds. The government can readily afford this. Indeed it would be a very much better investment in Singapore’s future than its investments in US instruments that it failed to understand.

Meanwhile in Hong Kong the demographics are almost exactly the same and the end results will be too, but the path has been different. Everyone except civil servants (with generous inflation-linked pensions) is largely expected to fend for themselves beyond a very basic old age allowance, almost free health care and subsidized rental housing for about 35 percent of the population. A Mandatory Provident Fund (MPF) to which employer and employee contribute was introduced seven years ago but at a much lower contribution rate and it will be more than a generation before it has a significant role in retirement income. Potentially it should offer much higher returns but its high cost structure benefits select private sector providers rather than the savers themselves.

But for the next two decades the rapidly aging population will have to live with the consequences of the past, plus whatever the bureaucracy is willing to commit from abundant public taxpayer funds.

Like Singapore, Hong Kong, with the world’s longest average life expectancy of 81.6 years overall, has a serious problem with widening income distribution which can only get worse as the numbers of old people increase unless there is a major commitment to changes which help the latter. However, so far the tendency has been the reverse, with welfare spending lagging numbers of recipients and charges being threatened for health services.

While Hong Kong residents have not been subject to forced savings with a low-return government agency, they have in practice been only slightly better off. Middle and higher income groups have been able to invest and stocks, mutual and insurance funds and buy their own (albeit very expensive) properties. However lower-income groups have mostly been able to save only through bank deposits, and particularly savings bank accounts, which have struggled even to keep up with inflation (which due to monetary and exchange policies dating back 35 years has been consistently higher than in Singapore).

While lower-income groups have been subsidized by public rental housing (and to a lesser degree by the partly subsidized Home Ownership Scheme) unlike their Singapore counterparts, they do not have an asset against which they can borrow to finance their later years.

Despite the rapid aging of the population, which will inevitably require increased health and welfare spending, the government is still aiming to cut back its overall recurrent spending. Yet its focus on “self-reliance” and private sector insurance would ring rather more true were the government to distribute part of its HK$300 billion accumulated fiscal reserves (excluding those of the Exchange Fund) to the population at large based on a formula combining the number of years resident in Hong Kong prior to the establishment of the MPF and current age.

The objective would be to enable those approaching retirement age to purchase a small annuity for their remaining years and, for younger ones, a small capital sum which could be added to their MPF savings accounts.

The largest amounts would go to those approaching retirement age who had been in Hong Kong all their working lives, with amounts tapering to very small amounts for the very elderly and those whose working lives began before the year 2,000 when the MPF commenced.

Such a scheme would be a proper distribution of surpluses which belong to Hong Kong people as a community, and make it possible for the government to retreat from a large area of welfare provision to concentrate on health and care for the handicapped and for children (costs of whom go a long way to explain the abnormally low births rates in both Hong Kong and Singapore). It would enable the government to cut recurrent spending and reduce reliance on unstable revenue sources such as land sales and stamp duties.

The government may also help itself by looking into helping the development of a reverse-mortgage business. Its own Mortgage Corporation, which buys ordinary mortgages from banks, is redundant. Hong Kong has not shortage of banks eager to lend so the Mortgage Corporation’s main function is to create more highly paid jobs for civil servants. But it might have role in devising products which would help provide annuities linked to home values.

By any measure, creativity is needed to address the fiscal and economic consequences of aging societies. Singapore’s nanny state does seem to be making some effort partially to rectify some of the consequences of the way the CPF has been managed in the past. The leadership has recognized that a huge problem lies ahead – by 2025, 22 percent of the population will be over 65. But Hong Kong’s ruling plutocracy appears not to have begun to understand the nature and depth of the problem or think about imaginative, market-based approaches.