Xi Kun Phua demystifies the new pension system in Singapore in particular the Central Provident Fund, the Lifelong Income Scheme For The Elderly, the non guaranteed annuity payouts and the bequest option.
In 1965, a 90-year old French widow sold her apartment to a lawyer under a contingency contract. The contract stipulated that the lawyer would pay the widow 2,500 Francs per month until her death, at which point the ownership of the apartment would be transferred to the lawyer. Unfortunately for the lawyer, that widow was Jeanne Calment, who turned out to be the world's longest living human being and survived for another 32 years.
As Jeanne remarked, "In life, one sometimes makes bad deals."
Fortunately for pension funds, most lifetime policyholders do not live to a ripe old age of 122 years. Still, the longevity risk of paying out more benefits due to longer life expectancy is a growing concern within the pensions industry. In this light, I will introduce Singapore's public-oriented approach to tackling the issue of longevity risk.
Introduction to Singapore's Pension System
Singapore runs a mandatory defined contributions public pension scheme, known as the CPF (Central Provident Fund). Members include citizens and permanent residents. The CPF is fully funded by compulsory contributions from its members and their employers during the course of employment, with no added guaranteed state benefits. Upon reaching retirement age, members can withdraw over a drawdown period of about 20 years, subject to the limit of their individual accumulated fund contribution.
As with other developed countries, Singapore is experiencing an aging population with increasing life expectancy. There is a looming risk that retirees may outlive their savings. In this context, Singapore launched CPF LIFE (Lifelong Income Scheme For The Elderly), which will provide lifelong income for current CPF members.
Singapore's Solution to Longevity Risk - CPF LIFE
CPF LIFE was first introduced in 2009. Under CPF LIFE, a proportion of a member's fund will be used to pay a single premium upon age 55 for a deferred lifetime annuity, with a bequest option upon early death. Members have the choice between receiving a higher lifetime income with lesser bequest, or lower lifetime income with higher bequest.
Implementation of CPF LIFE
From 2013, CPF LIFE will be made compulsory for all CPF members who turn 55 after 2013. The rationale behind this decision is to avoid adverse selection where only the healthier members will opt-in for the scheme. Also, by the law of large numbers and cross-subsidy, the larger annuitant portfolio brought about by CPF LIFE's mandatory nature will reduce the average cost per member.
One of the key features of CPF LIFE is that the annuity payout is not guaranteed. The payout is determined by actual investment returns and longevity trends. Less than expected investment returns or medical breakthroughs leading to mortality improvement in the population will result in decreased payouts. By adjusting the payout suitably, CPF LIFE is able to maintain the scheme's long-term financial sustainability. Investment risk is further mitigated by investing the annuity premiums in AAA-rated Singapore Government Bonds, with a minimum guaranteed 2.5% rate of return on the invested premiums.
Politically, having the government decide how an individual should handle his life savings is a sensitive issue. As such, the CPF board embarked on a public education and public relations campaign in the media, to explain the necessity of introducing CPF LIFE. Quite memorably, entire pages of vividly coloured comics were printed in the national papers to illustrate how CPF LIFE works to the laymen.
By taking the non-profit public goods approach, CPF LIFE aims to satisfy the public need for lifetime retirement income while managing longevity risk through national pooling and flexible payouts. The lessons learnt from its design and implementation will be useful for any government or private entity who wishes to tackle longevity risk in a sustainable fashion.
Xi Kun Phua recently graduated from Cass Business School with a distinction in MSc Actuarial Science.