Has Singapore solved the retirement incomes riddle?

While Australia struggles to cross the starting line in the race to develop an effective income product for retirees, Singapore is in the process of implementing a significant enhancement to the Central Provident Fund (CPF) for employees in the retirement phase. Deloitte superannuation consulting principal Ben Facer asks: “Can Australia learn from the retirement systems in countries such as Singapore, and then go one better?”

The Australian Superannuation Guarantee system, which began in 1992, is widely considered one of the most well established compulsory superannuation systems in the world.

However, long before 1992, in 1955 in fact, Singapore established its own compulsory “superannuation” system in the form of the Central Provident Fund, or CPF. 

In the island entrepot of then some three million people, Singapore introduced a scheme whereby throughout an individual’s working life, both the employer and employee must make contributions to the CPF.

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At rates of up to 16 per cent for employers and 20 per cent for employees, these compulsory contributions would fund the employee’s retirement, housing, and medical expenses.

The CPF is an entirely defined contribution fund under each of these components, and given that Singapore has neither a medicare-type system, nor an age pension, it is an incredibly important system.

Currently, in relation to retirement, the CPF pays a drawdown from each individual’s retirement account, a little like Australia’s allocated pension.

The key differences from our allocated pension are that the drawdown is fixed for 20 years (although a bonus interest system in reality extends the drawdown by a few years), and that the rate of interest has a floor which is guaranteed by the Government.

So, while Australians living off an allocated pension bear a longevity risk that their income may run out, Singaporeans are faced with the greater risk that if they live much longer than 20 years in retirement, their income will run out – guaranteed.

Plus, Singaporeans do not have an age pension to fall back on if this occurs.

CPF LIFE

Recognising the longevity risk, Singapore has introduced CPF LIFE (Lifelong Income For the Elderly), which commences in full from 2013. The key features of CPF LIFE are:

• At age 55, the individual uses some (or all) of their Retirement Account to purchase a deferred annuity (DA), with a second premium payment at age 65
• The DA commences from either 65 or 90 years of age
• Until the DA commences, the remainder of the Retirement Account monies may be drawn down (from age 65), and
• The CPF guarantees that the DA will provide an income for life.

This sounds like a typical annuity product, but here’s the catch – the DA is not a defined benefit.

And the CPF (as the provider) does not bear any investment or longevity risk. Rather, investment and longevity risk is pooled among the membership.

If experience is worse than expected, the pensioners bear the cost via a reduced income.

But there is some guarantee, in that the Government still promises a minimum level of interest credit.

Hence investment risk is reduced, but members still bear the full longevity risk of the pool, which the CPF manages very carefully through highly detailed actuarial advice.

The CPF is sufficiently confident to state that it does not expect income payments to vary significantly.

Has Singapore solved the post-retirement riddle?

CPF LIFE has some distinct advantages: income for life at a low cost, as the purchase price is not required to cover large risk reserves or profit margins.

It is invested conservatively, however (minimum coupon Singapore Government Bonds), which may reduce income levels relative to a higher yielding portfolio – although many may consider higher risk to be inappropriate in any case.

In the context of Singapore – no social security, inherently conservative population, government objectives – you might say that country certainly has had a pretty good crack at the riddle, although outcomes in terms of experience are still a long way off.

Should Australia be introducing SGC LIFE? Well, not exactly. 

The key difference between the Singapore and Australian systems is that the CPF already had compulsory retirement income in the form of the 20-year flat draw-down.

Extending this concept to a compulsory income for life was a cultural fit.

Australia has no compulsory annuitisation post-retirement, and moving to full compulsory annuitisation in the short term would be politically impossible.

Without compulsion, a member-pooled risk income product would be prone to selection issues, which would lead to pricing challenges and potentially failure.

We also operate our superannuation system on a multi-fund private sector basis.

This system has many merits, but does mean that unlike Singapore, we do not have the one large block of members necessary for effective risk sharing (although some of our largest funds are certainly getting there!).

Smaller funds may not have a sufficiently large pensioner population to manage the mortality uncertainty.

But maybe there is a way that we can blend some of the effective elements of CPF LIFE into our own post-retirement system.

For instance, we should begin to introduce a level of partial compulsion.

The United Kingdom has partial compulsion, whereby up to 25 per cent may be taken as a lump sum, whilst the remaining 75 per cent must be used to purchase a complying lifetime annuity, unless a defined benefit pension exists.

An even more effective system for Australia would be to allow a lump sum to pay down remaining debts as well as enable that well-earned trip around the world; an individual risk allocated pension for flexibility of income; plus a compulsory deferred annuity for longevity protection.

We note the need for tax reform to support the deferred annuity.

The compulsory deferred annuity may of course be structured as a traditional insurer-provided annuity. Alternatively, we could develop a pooled member-risk deferred annuity. 

Each superannuation fund could offer and administer the annuity, structuring other services around the income stream.

However, the longevity risk may be “reinsured” with a single national organisation which distributes the longevity profits and losses back to the funds and hence the members.

Conclusion

Singapore’s CPF LIFE product may not be the single solution for  Australia’s longevity risk problem – but it is a lighthouse project for us to leverage and consider its novel features.

In particular, the opportunity to pool longevity risk amongst members is very worthy of consideration. 

Whatever route we take, we must start that planning process now. Singapore developed CPF LIFE in 2008, for implementation in 2013, and we must have a joint government and industry response to ensure that tax, legal and commercial considerations work effectively together.